Introduction to Financial Management FIN 102

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Introduction to Financial ManagementFIN 102

• Dr. Andrew L. H. Parkes
• A practical and hands on course on the valuation
  and financial management of corporations

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Syllabus and Our Course

• The syllabus provides an outline of what we will
  do this semester Chapters 1 - 4 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

The required textbook
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Lectures and Practice Problems

• Lectures 2 hours per week I will introduce the
  new material to you
• Practice Problems 2 hours we will do assignments
  (_at_)from my slides and from the textbook
• 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 SP500 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).

Keep up to date with Finance related issues
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Grading

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

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Financial Management (ch.1)
http//money.cnn.com/galleries/2007/fortune/0704/g
allery.f100_employers.fortune/2.html

• What are the most admired companies in the world?
  (see www.fortune.com)
• 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

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Career Opportunities in Finance

1. Money and capital markets
2. Investments
3. Financial management

Warren Buffett The Oracle of Omaha - 2 Forbes
Worlds Billionaires - 52 Billion
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Responsibility of the Financial Staff

• Maximize stock value by
• Forecasting and planning
• Investment and financing decisions
• Coordination and control
• Transactions in the financial markets
• Managing risk

Who owns GEICO?
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Role of Finance in a Typical Business Organization
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Sole proprietorships Partnerships

• Advantages
• Ease of formation (to start-up the company)
• Subject to few regulations
• No corporate income taxes
• Disadvantages
• Difficult to raise capital
• Unlimited liability
• Limited life

Stores along the Street
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Corporation

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

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Setting up a Corporation

• 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

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3 Main decisions of Financial Management

• 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?)
• Asset management decision how should assets
  develop over time with the growth/change of the
  business?

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Financial Goals of the Corporation

• 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?

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Is stock price maximization the same as profit
maximization?

• 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.
• Some actions may cause an increase in earnings,
  yet cause the stock price to decrease (and vice
  versa).

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Creating Value

• 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
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In reality companies create value by

• Increasing Free Cash flow (FCF)
• Reducing The Weighted Average Cost of Capital
  (WACC)
• The Company Value Long Term FCF/ WACC

Increasing FCF or lowering WACC
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Free Cash Flow is

• NOPAT (Net Operating Profit Earnings before
  Interest After Tax)
• Depreciation
• The increase in Net Working Capital (NWC)
• 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 its the amount spend on
investments
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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)
• Company Value (Google Inc.)
• 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
• 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

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Assignment 1 Value your SP company

• You have picked a SP500 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 (1999-2005) 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.

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Step 2 in Valuing your SP company

• 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)
• Now you have the companies equity value
• 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
• 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?
• Why do you think there is a difference?

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Help

• You can find your companys figures at
  www.sec.gov
• 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)

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More help

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

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So summarizing

• Your Homework is
• 1) form a team 4-5 members max.
• 2) pick a SP 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?