CHAPTER 9: Finance - robertleecannon.com€¦ · • How do financial managers evaluate capital...
Transcript of CHAPTER 9: Finance - robertleecannon.com€¦ · • How do financial managers evaluate capital...
© 2009 South-Western, a division of Cengage Learning
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Chapter 9: FINANCE
Using Funds To Maximize Value
© 2009 South-Western, a division of Cengage Learning
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LOOKING AHEAD
• How does maximizing financial value relate to social responsibility?
• How do financial managers use key ratios?
• How do financial managers use cash budgets?
• Why is working capital management important?
• How do financial managers evaluate capital budgeting proposals?
• How do financial managers determine the firm’s capital structure?
© 2009 South-Western, a division of Cengage Learning
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WHAT MOTIVATES FINANCIAL DECISIONS
• What types of assets do we need to achieve goals?
• How do we get the funds we need?
• Evaluate financial performance
• Plan financial resources
• Manage working capital
• Evaluate investment opportunities
• Determine appropriate strategy
© 2009 South-Western, a division of Cengage Learning
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EVALUATING PERFORMANCE: WHERE DO WE STAND?
• Financial ratios provide insight into financial strengths and weaknesses
• Use financial data from balance sheet and income statement
• Companies can compare their ratios with other businesses
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KEY FINANCIAL RATIOS
RATIO TYPE HOW IT IS COMPUTED
Current Liquidity: ability to pay short-term liabilities.
Current Assets
Current Liabilities
Inventory
Turnover
Asset Management: how firm is using assets to generate revenue.
Cost of Good Sold
Average Inventory
Debt-to-equity Leverage: extent to which a firm relies on debt.
Total Debt
Total Owner’s Equity
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KEY FINANCIAL RATIOS
RATIO TYPE HOW IT IS COMPUTED
Debt-to-assets
Leverage: measures the extent to which a relies on debt
Total Debt
Total Assets
Return on equity
Profitability: compares the amount of profit compared to resources invested
Net Income – Preferred Div
Avg Common Stock Equity
Return on assets
Profitability: compares the amount of profit compared to resources invested
Net Income
Average Total Assets
Earnings per share
Profitability: compares the amount of profit compared to resources invested
Net Income – Pref Dividends
Avg # of Shares Out
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FINANCIAL PLANNING: PROVIDING A ROAD MAP FOR
• What assets must be obtained?
• How much additional financing is needed?
• How much can the firm generate Internally? Externally?
• When will external financing be required?
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BASIC PLANNING TOOLS
Pro Forma Income Statement – forecasts the sales,
expenses and net income
Pro Forma Balance Sheet – forecasts the types and amounts
of assets a firm will need to carry out plans.
Cash Budget – detailed projection of
cash flows to determine when cash shortages
and surpluses will occur.
© 2009 South-Western, a division of Cengage Learning
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MANAGING WORKING CAPITAL: CURRENT EVENTS
• Net Working Capital:
– Difference between current assets and liabilities
• Working capital must be managed
– Appropriate level of current assets
– Current liabilities needed to finance activities
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MANAGING CASH
• Need cash to pay bills
• Cash does not earn returns
• Report cash equivalents as cash
– Commercial Paper
– T-Bills
– Money Market Mutual Funds
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CASH EQUIVALENTS
• Commercial Paper– Short-term unsecured promissory note (IOUs).
– Issued by major corporations with excellent credit rating
– Sold at a discount; price plus interest is paid when the paper comes due
• T-bills– Short-term IOUs issued by the U.S. government.
– T-Bills normal mature in 4, 13, or 26 weeks
– Sold at a discount; face value is paid at maturity
– Good market for T-Bills since they are backed by the government
• Money Market Mutual Funds– Pooled funds to purchase a portfolio of short-term, liquid securities
– Affordable way for small investors to get into the market
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MANAGING ACCOUNTS RECEIVABLE
• Set Credit Terms
• Establish Credit Standards
• Design Appropriate Collection Policy
Accounts Receivable - Money which is owed to a company by a customer for products and services provided on credit.
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SMALL LOANS MAKE A BIG DIFFERENCE
• Muhammad Yunus and the bank he founded won the Nobel Peace prize for his research and development of microcredit
• Grammen Bank provides small loans to poor entrepreneurs in third-world countries.
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SHORT-TERM FINANCING
• Spontaneous Financing
– Trade Credit
• Short-Term Bank Loans
– Line of Credit
– Revolving Credit
• Factoring
• Commercial Paper
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BORROWING MONEY
““
“If you want to know the value of
money, go and try to borrow some.”
- Benjamin Franklin
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CAPITAL BUDGETING: IN IT FOR THE LONG HAUL
• Replace machines and equipment
• New machines and equipment
• Build a new factory, warehouse or office
• Introduce a new product line
Capital Budgeting – a systematic evaluation of a firm’s major long-run
capital investment opportunities.
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COMPARING CASH FLOWS THAT OCCUR AT DIFFERENT
Managers must evaluate costs and benefits of investment that occur over a period of many years.
Time Value of Money – a dollar received today is worth more than a dollar received in the future.
Compounding – earning interest in the current period on interest from previous periods.
© 2009 South-Western, a division of Cengage Learning
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USING NET PRESENT VALUE TO EVALUATE CAPITAL
• Managers use the process of discounting to calculate the present value.
• Present value depends on the interest rate the invested money will earn.
• Net present value is the present value of all cash flows associated with an investment, including the initial (negative) cash flow of the investment.
Present Value – How much a given amount of cash received in a future period is worth today, given the time
value of money.
© 2009 South-Western, a division of Cengage Learning
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SOURCES OF LONG-TERM CAPITAL: LOANERS VS.
Capital Structure – the mix of equity and debt financing a firm uses for financing needs.
Debt Financing – creditors.
Equity Financing – owners.
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SOURCES OF DEBT FINANCING
• Long-term loans
• Private placements
• Issuing notes or bonds
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SOURCES OF EQUITY FINANCING
• Direct contributions by owners
– Owners directly contribute resources to unincorporated businesses
– Corporations raise equity capital by issuing stock
• Retained earnings
• Equity financing provides more flexibility than debt financing
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FINANCIAL LEVERAGE: USING DEBT TO MAGNIFY GAINS
• Heavy debt in capital structure
• Potential high returns to owners
• Increased risk
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FINANCING YOUR EDUCATION
• How are you currently financing your education?
• How leveraged are you?
• What are the sources of your equity financing?
• What are the advantages/disadvantages to your capital structure?
• What adjustments might you consider?
© 2009 South-Western, a division of Cengage Learning
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LOOKING BACK
• How does maximizing financial value relate to social responsibility?
• How do financial managers use key ratios to evaluate the firm?
• How do financial managers use cash budgets?
• Why is working capital management important?
• How do financial managers evaluate capital budgeting proposals?
• How do financial managers determine the firm’s capital structure?