Introduction to Financial Management FIN 102 Dr. Andrew L. H. Parkes “A practical and hands on course on the valuation and financial management of corporations”

Syllabus and Our Course The syllabus provides an outline of what we will do this semester: Chapters as well as Chapters 12, 13 and 14 of the textbook. The syllabus provides an outline of what we will do this semester: Chapters as well as Chapters 12, 13 and 14 of the textbook. This week we will talk about Chapter 1 and some of 2; The role of financial management and the business environment This week we will talk about Chapter 1 and some of 2; The role of financial management and the business environment The required textbook

Lectures and Practice Problems Lectures: 2 hours per week I will introduce the new material to you Lectures: 2 hours per week I will introduce the new material to you Practice Problems: 2 hours we will do assignments my slides and from the textbook Practice Problems: 2 hours we will do assignments my slides and from the textbook You will have to prepare assignments for every class; there is NO class without homework … (Hwk). You will have to prepare assignments for every class; there is NO class without homework … (Hwk). You will work on a group project during the course and select a S&P500 company that you would like to work on with your team. You will work on a group project during the course and select a S&P500 company that you would like to work on with your team. You will simulate your own investments and learn about financial markets (e.g. investopedia.com - Forbes). You will simulate your own investments and learn about financial markets (e.g. investopedia.com - Forbes). Keep up to date with Finance related issues

Grading Mid-term test - 20% Mid-term test - 20% Final Exam - 40% Final Exam - 40% Homework - 30% Homework - 30% Quizzes - 10% Quizzes - 10% Total - 100% Total - 100%

Financial Management (ch.1) What are the most admired companies in the world? (see What are the most admired companies in the world? (see  Innovative companies  High management quality companies  High employee talent companies  High product quality companies  High return on investment value companies  Financial sound companies  Social responsible (ethical) companies  Efficient use of assets companies

Career Opportunities in Finance 1. Money and capital markets 2. Investments 3. Financial management Warren Buffett – The Oracle of Omaha - #2 Forbes World’s Billionaires - $52 Billion

Responsibility of the Financial Staff Maximize stock value by: Maximize stock value by: –Forecasting and planning –Investment and financing decisions –Coordination and control –Transactions in the financial markets –Managing risk Who owns GEICO?

Role of Finance in a Typical Business Organization

Sole proprietorships & Partnerships Advantages Advantages –Ease of formation (to start-up the company) –Subject to few regulations –No corporate income taxes Disadvantages Disadvantages –Difficult to raise capital –Unlimited liability –Limited life Stores along the Street

Corporation Advantages Advantages –Unlimited life –Easy transfer of ownership –Limited liability –Ease of raising capital Disadvantages Disadvantages –Double taxation –Cost of set-up and report filing (difficult)

Setting up a Corporation… The incorporators of the corporation have to: The incorporators of the corporation have to:  Create a charter of the company –Name of the company –Types of activities of the company –Amount of capital stock –Number and names/addresses of directors  Define a set of so called bylaws for the company –How directors are elected –Will shareholders have the first right on newly issued shares (right of first refusal) –The conditions for changing the bylaws of the company

3 Main decisions of Financial Management Investment decision: what assets does the firm need to hold and in what quantities? Investment decision: what assets does the firm need to hold and in what quantities? Financing decision: how should these assets be financed? (debt or equity/ short or long?) Financing decision: how should these assets be financed? (debt or equity/ short or long?) Asset management decision: how should assets develop over time with the growth/change of the business? Asset management decision: how should assets develop over time with the growth/change of the business?

Financial Goals of the Corporation The primary financial goal is shareholder wealth maximization, which translates to maximizing stock price. The primary financial goal is shareholder wealth maximization, which translates to maximizing stock price. –Do firms have any responsibilities to society at large? –Is stock price maximization good or bad for society? –Should firms behave ethically?

Is stock price maximization the same as profit maximization? No, despite a generally high correlation amongst stock price, EPS, and cash flow. No, despite a generally high correlation amongst stock price, EPS, and cash flow. Current stock price relies upon current earnings, as well as future earnings and cash flow. Current stock price relies upon current earnings, as well as future earnings and cash flow. Some actions may cause an increase in earnings, yet cause the stock price to decrease (and vice versa). Some actions may cause an increase in earnings, yet cause the stock price to decrease (and vice versa).

Creating Value… For stakeholders of the company like: For stakeholders of the company like: –Customers (sustainable flow of products and services) –Suppliers (sustainable flow of raw material orders) –Employees (sustainable jobs with career perspectives) –Shareholders (growing share value and dividends) –Banks and Financial Institutions (sustainable pay back of loans and interest) –The Government … (more profit is more tax income) The Textbook approach…

In reality companies create value by… Increasing Free Cash flow (FCF) Increasing Free Cash flow (FCF) Reducing The Weighted Average Cost of Capital (WACC%) Reducing The Weighted Average Cost of Capital (WACC%) The Company Value = Long Term FCF/ WACC% The Company Value = Long Term FCF/ WACC% Increasing FCF or lowering WACC%

Free Cash Flow is… NOPAT (Net Operating Profit [Earnings before Interest] After Tax) NOPAT (Net Operating Profit [Earnings before Interest] After Tax) + Depreciation Depreciation – The increase in Net Working Capital (NWC) The increase in Net Working Capital (NWC) – Capital Expenditure (CAPEX) Capital Expenditure (CAPEX) NOPAT you will find in the income statement of your company Depreciation you will find in the income statement and cash flow statement of your company NWC = Accounts Receivables plus Inventories minus Accounts Payables; the change from your to year you can calculate (a decrease in NWC from one year to another is a Cash In Flow so this adds to FCF) CAPEX you will find in the cash flow statement it’s the amount spend on investments…

Simple Valuation… So if Google Inc. in the Long Term can generate a FCF of $ 3 b. And the WACC of Google Inc. is 10% then the value of Google Inc. is (follow the formula) So if Google Inc. in the Long Term can generate a FCF of $ 3 b. And the WACC of Google Inc. is 10% then the value of Google Inc. is (follow the formula) Company Value (Google Inc.) = Company Value (Google Inc.) = $ 3 b/0.10 = $ 30 billion $ 3 b/0.10 = $ 30 billion Of course this is an example and I just made up the estimated FCF and WACC. We will learn during the course how to estimate FCF and WACC to enable us to calculate the value of any company … under certain assumptions Of course this is an example and I just made up the estimated FCF and WACC. We will learn during the course how to estimate FCF and WACC to enable us to calculate the value of any company … under certain assumptions This in fact is the core capability of finance This in fact is the core capability of finance Once we can calculate the value of a company periodically, we can calculate if the company is in fact creating value for its stakeholders or destroying value Once we can calculate the value of a company periodically, we can calculate if the company is in fact creating value for its stakeholders or destroying value

Assignment 1: Value your S&P company You have picked a S&P500 company to work on during the course: You have picked a S&P500 company to work on during the course: –Try to figure out what the Long Term Free Cash Flow is of your company by reading its annual reports ( ) Limit yourself to the financial paragraph (5 years is fine). –Assume your companies’ WACC is anywhere in between 5% and 25%; 5% if your company is extremely financially solid and rather low risk, 25% if your company has a very volatile performance over the last 5 years and a bumpy road ahead and is an extremely high risk business (you may pick any WACC in between). –Step 1: Calculate the Company Value of your company under these assumptions.

Step 2 in Valuing your S&P company Now look up the Long Term debt from the latest available Balance Sheet (sure you will find it under liabilities) Now look up the Long Term debt from the latest available Balance Sheet (sure you will find it under liabilities) Subtract this figure from the Company Value you found in 1a) Subtract this figure from the Company Value you found in 1a) Now you have the companies’ equity value Now you have the companies’ equity value Divide that number by the number of common shares outstanding Divide that number by the number of common shares outstanding Now you find the equity value per share outstanding or the calculated share price of your company Now you find the equity value per share outstanding or the calculated share price of your company Compare this share price with the current share price of your company (take the latest closing price for comparison) Compare this share price with the current share price of your company (take the latest closing price for comparison) Does the market value the share of your company higher (over priced) or lower (under priced) then what you calculated? Does the market value the share of your company higher (over priced) or lower (under priced) then what you calculated? Why do you think there is a difference? Why do you think there is a difference?

Help… You can find your company’s figures at You can find your company’s figures at –Go to Filings and Forms (EDGAR) –Search for company filings –Look up the ticker symbol of your company at Yahoo Finance (symbol lookup) –Plug in the found ticker symbol at EDGAR –Try GOOG and you will find all the filings of Google Inc. –Now search for the latest 8 and 10-K (annual reports) filings or 10-Q (quarterly reports)

More help… Go to Yahoo Finance Go to Yahoo Finance Plug in the ticker of your company Plug in the ticker of your company See the left hand buttons “More on…” See the left hand buttons “More on…” For a quick scan of your company For a quick scan of your company Click Profile, Key Statistics Click Profile, Key Statistics For Historical Share Prices click… For Historical Share Prices click… Professional research on your company… Professional research on your company… Company events, news on your company… Company events, news on your company… Everything is here…Use it! Everything is here…Use it!

So summarizing … Your Homework is: Your Homework is: –1) form a team 4-5 members max. –2) pick a S&P 500 company –3) download FY 2006 annual report of the company you have chosen –4) Try to calculate Free Cash Flow –5) Assume that the Cost of Capital is 10% (WACC%) –6) Calculate The Value of the company by: Value= Free Cash Flow/Cost of Capital Who is this man? Did he create value in his companies?