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Strategic Capital Group Workshop #1: Investment Fundamentals.

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1 Strategic Capital Group Workshop #1: Investment Fundamentals

2 Agenda Introduction to USIT & SCG Creating a Company Financial Statements Raising Capital Exercise and Closing

3 Meet the USIT Shirt Company Currently run out of Parker’s dad’s garage, we are providers low cost, awful quality t-shirts to any suckers who will buy them.

4 The Business + Key Terms We sell t-shirts for $20 each, and on sell 100 per year The $2,000 of sales we make each year is referred to as revenue We pay Parker’s little brother $2 per shirt to assemble and $3 per shirt for the input materials. Price x Volume = Revenue This $5 per shirt of costs are referred to as cost of goods sold, or the direct costs of the inputs and labor that goes into the product Cost per unit x Volume = Cost of Goods Sold

5 The Business + Key Terms Benedikt, the CEO, who does not actually make the products, gets paid a fixed $500 salary per year. The $500 paid to him is referred to as an operating expense Operating expenses are not the same as cost of goods sold because they reflect costs uninvolved in production

6 Now how to we represent the state of the business? The Income Statement Revenue $2,000 -COGS 500 Gross Profit$1,500 -Operating Expenses 500 Net Income$1,000 Tells us how much the business sold and what it cost to sell the products, all the way down to the leftover profit. Typically shows the state of the business for a year or a quarter of a year Important to know how profitable the business is

7 The Income Statement Key terms: Gross Profit Margin = Net Margin = Gross Profit Revenue Net Income Revenue $1,500 $2,000 $1,000 $2,000 = 75% = 50% After paying off all expenses and costs, 50% of every dollar of sales will be left over as profit. As this percentage increases, the amount of costs per dollar of sales are declining and the business is becoming more cost efficient

8 The Business + Key Terms Parker contributed $500 of cash when the business first started Benedikt loaned the business $500 dollars $200 was used to buy a t-shirt making machine.

9 The Balance Sheet AssetsLiabilitiesEquity What you own What you oweWhat’s contributed and left over =+ Cash $500 Machinery $200 Loan from Ben $500 Contributed Capital $500 $1,000 $800

10 Sanity Check #1 We’ve had an introduction to two financial statements (forms that describe a business’s condition) – Balance Sheet – tells us about the resources of the business and how they were funded – Income Statement – tells us how much we sold and how much we spent during a period

11 Expanding A sudden fad for overpaying for cheap shirts has developed, meaning demand for USIT Co.’s shirts has skyrocketed. Making t-shirts out of Parker’s dad’s garage is no longer enough, and we need to expand. In order to expand, we need to buy more buildings, more machines, and more inventory. To get more assets, we need more capital!

12 Options for Raising Capital – “Financing” Debt (liabilities)Equity Types of debt: Loans – offers of money now in order for a promise of a return of capital and interest later on Bonds – a loan that can trade ownership on public exchanges Types of Equity: Common stock – the traditional stock, or shares of a company that are traded on stock exchanges. These represent fractional ownership of a company and claims on voting rights and profits Preferred Stock – stock that has no voting right, but has guaranteed payments from a pool of profits Key Terms: Debt Equity Face Value – the amount of money returned to the lender at the end of the loan/bond Maturity – the amount of time before the loan is due back Interest/Coupon – the required payments to investors Initial Public Offering – the first time a company puts its stock for sale to any investor through a stock exchange Secondary Market – the market where investors can publicly exchange stock

13 So which do we choose? Debt Equity Advantages Your creditors (loaners) have no control over the company Easy to raise Good tax implications Advantages You have no obligation to pay anyone. Investors are not guaranteed distributions Disadvantages You are legally required to pay interest and principal or risk bankruptcy Disadvantages You are essentially selling control of your company. If you sell more than 51%, your decisions can be vetoed Potential for hostile investors

14 …and how do we do it? Step 1: Find an investment banker Step 2: Have your investment banker overwork his junior bankers to figure out what your company is worth, then find people to invest in your newly issued securities Step 3: Figure out how much money you need to raise, then sell that proportion of your company (if equity)

15 Sanity Check #2 We’ve talked about the two ways to raise capital: – Debt – loans with obligatory interest payments – Equity – stock with no obligation to pay, but gives away voting rights

16 USIT Co.’s Capital Decision Debt Equity $10M of “senior” bonds at a 5% interest rate $10M of “junior” bonds at a 10% interest rate $50M of proceeds from issuing 1M shares of stock related to a 25% stake in the company How much money in total did we receive? How much is the total equity of the company worth? What was the stock price we issued at?

17 Stock price is arbitrary! It’s important to note that the company chooses the stock price it wants to issue at. We could have issued: 10 million $5 per share 100 million $.50 per share 1 $50 million per share Either way, we still receive $50 million dollars in proceeds

18 Implications After raising publicly-traded stock, you are considered a public company. Every quarter and at year end, you file an annual report with various financial statements and notes called a 10-K or 10-Q

19 A quick update on what our new balance sheet looks like, post-financing Assets: Cash$70,000,800 Machines $ 200 Liabilities: Loans$ 500 Bonds Payable $20,000,000 Equity: Common Stock$50,000,000 Contributed Capital$ 500 $70,001,000

20 Let’s fast forward a year… The Income Statement Revenue $100,000,000 -COGS (40,000,000) Gross Profit $60,000,000 -Operating Expenses (50,000,000) Net Income $10,000,000 Earnings Per Share $10.00 Net Income (earnings) Shares of stock outstanding EPS = Literally…how much your company earns per each share Stock price at issuance: $50 per share Number of shares: 1 million

21 Valuation Finance is the process of raising capital for a business, but in order to know the appropriate amount of capital to raise and how much it will cost, we need to value a company Investors and bankers have several tools to value a company, but first…

22 Valuation Your exotic friend asks you to go buy this fruit you’ve never seen for him, but to not spend too much for him. The fruit is only sold by one vendor and costs $5 per pound, but you have no idea if that’s a good price. What do you do? You compare it to other things that are like it, namely, other fruit! You can refine your search further by comparing to other fruit that look and taste like it.

23 The same concept can apply to companies: Price = $50.00 per share Price = $5.00 per share Which is the cheaper investment? T-shirt Co T-shirt Co

24 What about if we look at EPS? EPS = $10.00 per share EPS = $3.00 per share USIT seems to pay out more per share… T-shirt Co T-shirt Co

25 P/E- The Price to Earnings Ratio Share price is not enough! P/E: how much does one dollar of this company’s earnings cost? USIT P/E = Price (the amount you pay) Earnings per share (how much the firm makes) = $50.00 $10.00 = 5x SCG P/E = Price (the amount you pay) Earnings per share (how much the firm makes) = $5.00 $2.00 = 2.5x

26 Become The Investor So now which is the cheaper investment? 5x 2.5x Remember: P/E ratios are a measurement of how much you pay per dollar of earnings

27 The answer is… there isn’t one. Widely varying interpretations of P/E – High P/E – investors value the earnings more, willing to pay more Could mean optimism – Low P/E – cheaper earnings, better deal Note: This is all relative – We are comparing to similar companies – “Cheap-er”, “costli-er”

28 Valuation Relative valuation is just one of the ways we value a company and has its advantages and disadvantages. Later during the year we will discuss different ways to value a company and will flesh out further how to use these tools.

29 Sanity Check #3 We’ve learned about the P/E multiple We’ve compared two companies and decided which to invest in

30 Exercise Which of the following companies would you buy? Why? CompanyPriceSharesAssetsRevenueProfitMarginP/EP/BP/S USIT$4.0010,000,000$11,000,000$100,000,000$33,300, % SCG$7.575,000,000$12,000,000$125,000,000$48,000, % UCF$82.531,000,000$19,800,000$228,000,000$49,500, % Nike$67.732,000,000$8,000,000$48,000,000$35,700, % Average$ $12,700,000$125,250,000$41,625, %

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