*Understand the 3 Foundations of Finance
Economics, Accounting, Statistics
*The goal of Finance is to Maximize the wealth of the business’s owners (Shareholders) by maximizing the value per share of the firm’s stock price.
*Understand the 3 Important Concepts that Underlie Managerial Finance: More value is preferred to less
The sooner cash is received, the more valuable it is
Less risky assets are more valuable than riskier assets
*Understand the 3 Decisions
Invest in projects (assets) that yield a return greater than some minimum acceptable rate.
Choose a mix of finance sources (equity and debt) that maximizes the value of the firm.
If there are not enough investments that create value, return the cash to the owners.
*The Agency Problem
A “principal” hires an “agent” to represent his/her interests.
Stockholders (Principals) hire managers (agents) to run the company
Conflict of interest between principal and agent, i.e. do managers always work in the best interests of the stockholders?
Agency costs are borne by the stockholders
Direct agency costs include compensating a Board of Directors and the cost of various types of risk aversion tactics, such as insurance and management compensation.
Indirect agency costs include the opportunity cost of managers foregoing investment opportunities that could have ultimately added value to the firm. Shareholders (owners) are made up of two broad classifications:
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Institutional investors (Mutual funds, banks, pension funds) We also discuss several other topics like pain scake
*A financial market is made up of groups of “players”, called sectors, such as: Households (Individuals)
Governments (Both domestic and foreign)
*Suppliers, especially the household sector, tend to save or invest funds in relatively small increments.
Demanders, especially Businesses and Domestic Governments, require funds in large increments.
For small amounts, Direct transfers can occur.
For large amounts, Indirect transfers are necessary
*A Security is a investment instrument issued by a corporation, government, or other organization which offers evidence of debt or equity. If you want to learn more check out uwga
*Markets can be described by:
Type of securities (equity vs debt)
Maturity of securities(Money vs Capital)
Whether the securities are being sold for the first time (Primary) or being resold (Secondary)
Developed vs Emerging markets
*Types of Ratio Comparisons:
Crosssectional Analysis (aka “Peer Group Analysis” or “Benchmarking”) compares different firms at the same point in time.
The benchmark can be industry standards, closest peer competitors, or internallyderived goals.
TimeSeries Analysis evaluates the performance of the same firm over time with the focus upon any trends, both positive and negative. If you want to learn more check out Question #1 What is a system?
TIE (Times Interest Earned) = EBIT (Operating Income) / Interest
EBIT= SalesExpenses = Operating income If you want to learn more check out replacement fertility ________.
A very simple, but useful tool in financial analysis.
Each income statement item is expressed as a percentage of sales. If you want to learn more check out paige selzer
Each balance sheet item is expressed as a percentage of total assets.
This helps greatly with trend analysis.
ROE= (Net Income / Sales) x (Sales / Total Assets) x (Total Assets / Equity) =Net Income
Determined by three levers
(Net profit margin) x (Total Asset Turnover) x (Equity Multiplier)
(Profitability) (Efficiency) (OPM)
*Problems with Financial Analysis
Ratios uncover the possibility of a problem.
Firms can use different accounting methods in their statements (LIFO vs FIFO) Firms don’t always use the same fiscal years.
Accounting data can be temporarily manipulated (Window Dressing)
Inflation can cause older assets to appear more efficient and profitable than newer assets.