Review for Midterm Dr.Sarina

Important Roles of Corporate Financial Managers: What long-term investments should the firm undertake? (Capital budgeting or Investing decision) How should the firm finance these investments? (Capital structure or Financing decision) How the firm manage its cash flows as they arise from day-to-day operations? (Working capital management decision) How the firm distribute cash back to shareholders? (Distribution policy – cash dividend payments) The Goal of the Corporation To maximize shareholder’s wealth (as measured by share prices) = To maximize firm value Form of businesses Advantages &Disadvantages

PRINCIPLE 1: Time Value of Money. PRINCIPLE 2: Risk-Return Trade-off. PRINCIPLE 1: Time Value of Money. A dollar received today is more valuable than a dollar received in the future. We can invest the dollar received today to earn interest. Thus, in the future, you will have more than one dollar, as you will receive the interest on your investment plus your initial invested dollar. 1st Choice = Receive $1 M. today 2nd Choice = Receive $1 M. next year We only take risk when we expect to be compensated for (the extra risk) with additional return. The higher the risk, the higher will be the expected return. Realized return >=< Expected return 1st Choice = Buy T-bills 2nd Choice = Buy stocks

PRINCIPLE 3: Cash Flows Are The Source of Value. Profit vs. Cash Profit is an accounting concept used to measure business performance over an interval period. Cash flow is the amount of cash that can actually be taken out of the business over this same interval. It is possible for a firm to report profits but have no cash. For example, if all sales are on credit, the firm may report profits even though no cash is being generated. But “Cash is King” since firm can only use cash to pay for employee salary, debt, dividend. Financial decisions in a firm should consider “incremental cash flow” i.e. the difference between the cash flows the company will generate with the potential new investment and what it would make without such investment. Project A = Existing product Project B = New product CF (A&B) CF (A only) Incremental CF $3 M. $1 M. $2 M.

PRINCIPLE 4: Market Prices Reflect Information. PRINCIPLE 5: Principal & Agent Conflicts Investors respond to new information by buying and selling securities. Investors in stock markets tend to react positively to good decisions or good news made by the firm resulting in higher stock prices. Whereas stock prices tend to decrease when there is bad news about the firm. Thus, the market prices of stocks reflect information. In a corporation, the managers are the agents and the shareholders are the principal. Agency problems arise when there is conflict of interest between the shareholders and the managers. Examples: Not pursuing risky project for fear of losing jobs, stealing firm’s assets, expensive perks (employee benefits), insider trading etc. Agency problems reduce firm value.

Chapter5&6: TVM Basic & Annuity * Make sure know all formula and use them correctly. *Practice on exercises and in-class exercises frequently. *Know your tool Financial calculator Table Equation

FV = PV(1+r)^n, PV =FV/(1+r)^n EAR = (1+APR/m)^m-1 Summary of TVM Basic FV = PV(1+r)^n, PV =FV/(1+r)^n EAR = (1+APR/m)^m-1 Financial Calculator N = periods, year I/Y = interest rate, discount rate, ytm, rate of return PV = Present value, Value of securities, Price of securities. FV = Future value, Expected money, Principal, par value, Maturity value. PMT = series of Payment, Coupon payment, Interest payment, Dividend payment annually or semiannually or with equal amount for certain periods. M is the multiplier number of periods Semiannually ; m =2 Quarterly; m =4 Bi-monthly; m = 6 Monthly; m = 12 Daily; m =365 *when periods changed, Use M to multiply N, divide all i

Future Value of an Ordinary Annuity, annuity due

Annuities (Ordinary Annuity vs. Annuity Due) End of period PVA = 100(PVIFA5%,3) Present Value Beginning of period PVA Due = 100(PVIFA5%,3)(1+5%)

Present Value of a Level , a growing Perpetuity

Table 4 2013 2012 2013 Decrease 2013

Income Statement Table 1 2013 2013

Table 2 2012 and 2013 2012 2013 2012 2013

Five Groups of Financial Ratios Questions Category of Ratios Used 1. How liquid is the firm? Will it be able to pay its bills as they become due? Liquidity ratios 2. How has the firm financed the purchase of its assets? Capital structure ratios 3. How efficient has the firm’s management been in utilizing it assets to generate sales? Asset management ratios (Efficiency ratios) 4. Has the firm earned enough returns on its investments? Profitability ratios 5. Are the firm’s managers creating value for shareholders? Market value ratios

Average collection period Inventory turnover 2.5 Debt ratio 58%   Industry Averages 2012 2013 Current ratio 2 Acid-test ratio 0.8 Average collection period 37 days Inventory turnover 2.5 Debt ratio 58% Times interest earned 3.8 Operating profit margin 10% Total asset turnover 1.14 Fixed asset turnover 1% Operating return on assets 11.40% Return on equity 9.50% EPS = Net Income/ Number of common share outstanding P/E = Market Price per share / Earnings per share Market-to Book Ratio = Market Price per Share / Book Value per share Book value per share = common shareholders’ equity/ common share outstanding Dupont Method ROE = NPM x TATO x Equity Multiplier

Securities Valuation

Financial Calculator Bond: N = periods, year I/Y = interest rate, discount rate, ytm, rate of return PV = Present value, Value of securities, Price of securities. FV = Future value, Expected money, Principal, par value, Maturity value. PMT = series of Payment, Coupon payment, Interest payment, Dividend payment annually or semiannually or with equal amount for certain periods. Bond: PMT = Coupon, Interest FV = 1,000, Principal, Face value, Par value I = YTM, Yield of market PV = Vb, Price, Present value of bond N = maturity period, yea left to maturity

Equation Vb =Interest(PVIFAytm%,n)+Principal(PVIFytm%,n) Vps = Dps/Rps Vcs = D0(1+g)/(Rcs-g); g = retention ratio x ROE Retention ratio = 1-Dividend payout ratio = (1-D1/E1) D(PVIFr%,n) + (FV+D)(PVIFr%,n)

Good luck!