1. Review for Midterm
Dr.Sarina

2. 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

3. 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

4. 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.

5. 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.

6. 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

7. 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

8. Future Value of an Ordinary Annuity, annuity due

9. 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%)

10. Present Value of a Level , a growing Perpetuity

11. Table 4
2013
2012
2013
Decrease
2013

12. Income Statement
Table 1
2013
2013

13. Table 2
2012 and 2013
2012
2013
2012
2013

14. 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

15. 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

16. Securities Valuation

17. 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

18. 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)

19. Good luck!