financial mgmt slides

Exam I

♦ Chapters –  1 –  2 –  3

Chapter 1

What is Financial Managing?

♦ Introductory concepts – what is finance? ♦ The development of the finance discipline ♦ The purpose of the firm ♦ Concerns about shareholder wealth

maximization ♦ Emerging new approaches that begin re-

integrating societal and shareholder interests

What is Finance?

♦ The study and practice of how money is raised and used by organizations

♦ Finance derives in part from economics –  The microeconomic “theory of the firm”

♦ Finance has many stakeholders –  Product/service markets – customers,

employees, suppliers –  Financial markets – lenders, investors –  Governments and society

Money Flows of a Business

Organizing Finance by Academic Studies and Career Paths

♦ Financial managing ♦ Investments

–  Investment analysis –  Portfolio management –  Derivatives and financial engineering

♦ Markets and institutions –  Banks –  Money and capital markets

Organizing Finance by Academic Studies and Career Paths

Organizing Finance Around the Concerns of Financial Managers

♦ The financial environment –  Economic, political, legal, ethical, social, etc.

♦ Financial instruments –  Securities – stocks, bonds –  Investment bankers –  Commercial bankers

♦ Financial managing

A Timetable of Financial Thought

The Development of the Finance Discipline ♦ The continuing evolution of financial

managing –  Change is dramatic, rapid, and accelerating –  Examples from the U.S.

•  Banking industry •  Automobile industry •  Computer industry

The Development of the Finance Discipline ♦ Major forces for change

–  Increased international cooperation, communication, and competition

–  Revolutionary rates of improvement in the quality of goods and services

–  Global sustainability –  Increased diversity in organizations’ work

forces, customers, and suppliers –  Rapid changes in information technologies –  A shift from physical capital to human capital

The Development of the Finance Discipline Major forces for change (continued)

–  Changes in ethical standards and expectations –  Changes in the ways organizations are managed –  Changes in governmental policies and actions

♦ Implications of these forces for financial managing –  Life-long education –  Seeing the organization as a system –  Understanding the value in sustainable products

and production technologies

The Purpose of the Firm

♦ The need for goals ♦ The role of business in society

–  Capitalist economic system

♦ The microeconomic goal: profit maximization –  Efficient allocation of resources –  Problems

•  Accounting profits may not equal economic profits •  Profits do not consider risk

The Purpose of the Firm

♦ The traditional finance goal: maximization of shareholder wealth –  Equals share price plus dividends –  Avoids many profit definition issues –  In an efficient capital market, provides for

•  Effective allocation of new investment funds •  Evaluation of investment risks

–  Investors provide feedback to (“signal”) management about risk and return levels

The Logic of Share-Price Maximization

Concerns About Shareholder Wealth Maximization ♦ Outcomes for society

–  Income inequality –  Failure to take socially responsible actions –  Poorly directed business activities

♦ Actions within the firm –  A useful measuring stick? –  Creating the right image? –  Inspiring commitment? –  Encouraging ethics?

Emerging New Approaches

♦ Aligning goals throughout the organization –  Using process-focused goals –  Building on people’s integrity –  Focusing on cross-functional relationships

Emerging New Approaches – A Sequence of Goals ♦ On a day-to-day basis

–  Treat customers like royalty –  Treat employees fairly –  Treat suppliers and creditors with respect and courtesy –  Treat neighbors as they would wish to be treated –  Constantly strive to reduce costs, increase quality, and

add to market share in all aspects of the business

♦ On a long-term basis –  Treat shareholders to the high returns that will come

from properly implementing the day-to-day actions

A Sequence of Goals – The Johnson & Johnson Company Credo

Emerging New Approaches – The UN Global Compact ♦ Human rights:

1.  Businesses should support and respect the protection of internationally proclaimed human rights; and

2.  make sure that they are not complicit in human rights abuses.

Emerging New Approaches – The UN Global Compact ♦ Labour:

3.  Businesses should uphold the freedom of association and the effective recognition of the right to collective bargaining;

4.  the elimination of all forms of forced and compulsory labour;

5.  the effective abolition of child labour; and 6.  the elimination of discrimination in respect of

employment and occupation.

Emerging New Approaches – The UN Global Compact ♦ Environment:

7.  Businesses are asked to support a precautionary approach to environmental challenges;

8.  undertake initiatives to promote greater environmental responsibility; and

9.  encourage the development and diffusion of environmentally friendly technologies.

Emerging New Approaches – The UN Global Compact ♦ Anti-corruption:

10. Businesses should work against corruption in all its forms, including extortion and bribery.

Emerging New Approaches – Global Sustainability ♦ The simultaneous pursuit of financial/

economic success, environmental preservation, and social inclusion

Chapter 2

Data for Financial Decision Making

Data for Financial Decision Making ♦ Introductory concepts – the need for good

data ♦ Financial accounting data ♦ Financial ratios ♦ Managerial accounting data ♦ Other data

The Need for Good Data

♦ Good judgments require good data ♦ Theory precedes data

–  Economic-finance theory teaches us to look at financial data – cash flow, profitability, liquidity, leverage, resource use

–  Modern management theory teaches us to look at customer satisfaction and process performance

Financial Accounting Data

♦ Used to produce public financial statements –  Balance sheet, income statement, statement of cash flows –  Rules made by FASB, SEC

♦ The limitations of GAAP –  Two different valuation methods mixed together

•  Monetary items – cash value •  Nonmonetary items – historical cost

–  Alternative numbers for the same event –  Important information omitted

Financial Accounting Data

♦ The need to compare numbers –  Impossible to make a judgment with one number –  Types of comparisons:

•  Benchmark – comparison to a standard value •  Competitive benchmark – comparison to best example •  Time-series– comparison to previous values of the

same measure, a trend over time •  Cross-section – comparison across peer companies at

a point in time

Ratios That Measure Profitability ♦ Profitability compared to sales

Ratios That Measure Profitability ♦ Profitability compared to assets

♦ Profitability compared to equity

Ratios That Measure Effective Use of Working Capital ♦ Working capital

–  Refers to current assets and current liabilities –  Mathematically:

♦ Measures of overall liquidity

Ratios That Measure Effective Use of Working Capital ♦ Measures of the effective use of accounts

receivable

♦ Measures of the effective use of inventories

Ratios That Measure Effective Use of Working Capital ♦ Measures of the effective use of accounts

payable

♦ The cash conversion cycle

The Cash Conversion Cycle

Ratios That Measure the Use of Fixed and Total Assets ♦ A measure of the productivity of fixed

assets

♦ A measure of the productivity of total assets

Ratios That Measure the Choice and Management of Funding ♦ Measures of the financing mix

Ratios That Measure the Choice and Management of Funding ♦ Measures of the ability to service debt

Ratios That Measure the Choice and Management of Funding ♦ Measures of payments against equity

Managerial Accounting Data

♦ Used for internal planning, analysis, decision making

♦ Cash flows vs. accrual accounting –  Cash flow – real, tangible event; clearly

identifiable; has immediate value –  Accrual numbers – based on accounting

conventions, depend on human-made rules –  We use a cash flow spreadsheet to summarize

cash flows

Cash Flow Spreadsheet

Cash Flow Spreadsheet A company is trying to organize the following cash flows: Buy a machine for $25,000 in 2012. Increase cash inflows by $15,000 in 2013, 2014, and 2015. Pay additional taxes of $8,000 in 2014. Sell the machine for $10,000 in 2015. Question: Prepare a cash flow spreadsheet to summarize this information Solution:

Year 0 Year 1 Year 2 Year 3 Event 2012 2013 2014 2015 Buy machine (25,000) Additional cash inflows 15,000 15,000 15,000 Additional taxes (8,000) Sell machine 10,000 Net cash flows (25,000) 15,000 7,000 25,000

Types of Costs

♦ Total, average, marginal –  Total – sum of the costs for all units made –  Average – cost per unit –  Marginal – cost of making one more unit

♦ Incremental – the change from taking an action

♦ Sunk – spent in the past, cannot change ♦ Opportunity – a lost benefit ♦ Variable, fixed – with respect to sales

A U-Shaped Cost Curve

Managerial Accounting Data

♦ Tax rates –  Taxes are a cash flow, therefore important in

financial decision making –  The government requires a company pay only

the taxes specified by law — paying more taxes takes value from other stakeholders

–  While the tax code is complex, the textbook uses flat rates of 34% or 35% to simplify illustrations

Other Data

♦ Economic data –  GNP growth, inflation, interest rates, foreign

exchange rates, etc. –  Competitive actions, pressures within industry

♦ People data – customer and employee satisfaction

♦ Process data –  Absolute number of failures –  Relative number of failures – failures per

opportunity to fail, six sigma goal –  Cycle time – time for a process or process step

Other Data

♦ ESG data –  Environmental data – energy use and efficiency,

greenhouse gas emissions, water use, eco-friendly product innovation

–  Social data – employee health and safety, diversity, human rights, community support, product safety

–  Governance data –independence of board, transparency of public reporting, company code of conduct

Chapter 3

The Time Value of Money

♦ Introductory concepts – the money rules ♦ The fundamental relationship ♦ Multiple cash flows – uneven flows ♦ Multiple cash flows – cash flows that

form a pattern

The Money Rules

♦ Value depends on the AMOUNT –  Choose to receive MORE, pay LESS

♦ Value depends on the TIMING –  Choose to receive SOONER, pay LATER

♦ The value of a business deal involves a tradeoff between amount and timing

♦ Money flows can only be compared after being adjusted for time value

form a pattern

The Fundamental Relationship

♦ Compound interest

♦ Solved for present value

Using a Time Value Table

Using a Financial Calculator

The Four Fundamental Calculations ♦ Finding future value (FV)

–  Given PV, n, i

♦ Finding present value (PV) –  Given FV, n, i

♦ Finding a time period (n) –  Given PV, FV, i

♦ Finding an interest rate (i) –  Given PV, FV, n

form a pattern

Multiple Cash Flows – Uneven Flows ♦ To calculate the PV or FV of a “package”

of cash flows –  Calculate the PV or FV of each flow –  Add the PVs or FVs to get the total value

♦ Alternative method – use the “cash flow list” feature of your financial calculator –  Input all cash flows and an interest rate –  Obtain the total PV or FV with one calculation –  Can also calculate an interest rate

form a pattern

The Annuity

♦ Defined – a set of equal cash flows –  Equal amounts –  Equal direction of flow (all inflows or all

outflows) –  Equal spacing in time (e.g., all at monthly

intervals)

The Five Annuity Calculations

♦ Finding present value (PV) –  Given PMT, n, i

♦ Finding the amount of an annuity (PMT) –  Given n, i, and either PV or FV

♦ Finding future value (FV) –  Given PMT, n, i

♦ Finding a time period (n) –  Given PMT, i, and either PV or FV

♦ Finding an interest rate (i) –  Given PMT, n, and either PV or FV

Ordinary Annuities vs. Annuities Due ♦ Payments at the END of the period

–  Ordinary annuity –  Annuity in arrears –  END annuity

♦ Payments at the BEGINNING of the period –  Annuity due –  Annuity in advance –  BEGIN annuity

The Growing Cash Stream

♦ An infinitely long sequence of equally spaced cash flows

♦ Each flow is different from the previous one by a constant rate of growth (g)

♦ PV of a growing cash stream

The Perpetuity

♦ An annuity that continues forever ♦ (A growing cash stream with zero

growth) ♦ PV of a perpetuity

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