Last week
The first chapter introduces us to Corporate finance is essential to all managers as it provides all the skills managers need to; Identify corporate strategies and individual projects that add value to the organization and come up with plans for acquiring the funds. The types of business forms are; sole proprietorship, corporation and partnerships. A sole proprietorship form of business possesses different advantages and disadvantages. A partnership maintains roughly similar pros and cons of a sole proprietorship. A corporation is a legal entity that is separate from its owners and managers. Advantages include a smooth transfer of ownership, limited liability, ease of raising capital. The disadvantages include; double taxation, and a high cost of set-up and report filing. The chapter then deals with Objective of the firm, which is to maximize wealth. The final topic is an in-depth look at Financial Securities, which are markets and institutions.
In the second chapter, we are introduced to financial statements, Cash flow and taxes. Financial statements include; the Income statement and the Balance sheet. An income statement is a financial statement that shows a company’s financial performance regarding revenues and expenses, over a particular period, mostly one year. A balance sheet, on the other hand, is a financial statement that states a company’s assets, liabilities and capital at a particular point in time. Under the cash flow, the chapter covers on the Statement of cash flows, indicates how various changes in balance sheet and income statement accounts affect cash and analyses financing, investing and operating activities. A free cash flow shows the cash that an organization is capable of generating after investment to either maintain or expand its database. Under taxes, Corporate and personal taxes are well explained and the scenarios under which they apply.
Chapter Three analyzes Financial Statements. This analysis is broken down into; Ratio Analysis, DuPont equation. The effects of improving ratios, the limitations of ratio analysis and the Qualitative factors. Ratios help in comparison of; one company over time and one company versus other companies. Ratios are used by; Stockholders to estimate future cash flows and risks, lenders to determine their creditworthiness and managers to identify areas of weaknesses and strengths. Liquidity ratios show whether a company can meet its short-term commitments using the resources it has at that particular time. Asset management ratios exemplify how well an organization utilize its assets. Debt management ratios, leverage ratios as well as profitability ratios are explained.
The DuPont equation focuses on several issues. These are; Debt Utilization, Asset utilization and the Expense Control. Consequently, Ratio analysis has various problems and limitations. These include; Distortion of ratios from seasonal factors, various operating and accounting practices can distort comparisons and also it is quite difficult to compare an industry where a firm operates different divisions. Finally, qualitative factors ask the following questions; what is a competitive situation? What products are in the pipeline? And what are the legal and regulatory issues?
Chapter 4
In this chapter we learn of two different types of compensation plan; defined benefit (DB) and defined contribution (DC) pension plans. In DB plan, the company puts funds in your pension and invests it in bonds, real estates, stocks, etc. they later use this funds to the promised payments after your retirements. In DC plan, the company invests in a mutual fund, and you decides which assets to buy, later you withdraw money after you retire. According to this chapter, managers should strive in making their firms more valuable. The primary objective of financial management is in maximizing the intrinsic value of a firms stock. Stock values depend on cash flows investors timing.
The way the timing of cash flows is also discussed and also how it affects the value of assets plus the rates of returns. The applications of time value analysis include retirement planning, loan payment schedules plus the decision to invest in new equipment. Time value of money (TVM) is the most critical concept used in finance. It is also known as discounted cash flow (DCF) analysis. Dollars that are paid or received at different points in time are different. This difference is dealt with by application of TVM. Compounding according to this chapter is defined by the act of determining the future value (FV) of cash flow or a series of cash flows. Discounting is the process of finding present value (PV) of future cash flow or a set of cash flows.
Chapter five
This chapter generally explains bond pricing and the bond risk that affects the return demanded by a firm’s bondholders. A bondholder return is a cost from a company point of view. These costs of debts affect the firms weighted average price of capital (WACC) that then changes the company’s intrinsic value. According to this chapter, a bond is a long-term contract in which the borrower agrees to make payments of interests and principle, on specific dates, to the bonds holder.
Characteristics of a bond are; par value, coupon interest rate, and maturity date, provision to call or redeem bonds, which are discussed in this chapter. Par value is the stated value of the relationship. It generally represents the amount of money the firm borrows and promises to repay on the maturity date. Coupon interest rate is the divisions of coupon payments. The coupon payment is the set level that will enable the bond to be issued at or near its par value. Relationships have a maturity date in which the par value must be repaid. Most corporate bonds have a call provision which gives the issuing corporations the right to call the warrants for redemption. This chapter explains that business is insolvent when it does not have enough cash to meet its interests and principal payments.
Chapter6. Risk, Return, and the Capital Asset Pricing Model.
Risk is a chance that something unfavorable will happen.The assets risk is analyzed according to:
1) The asset is considered in isolation. As per the standalone basis
2) As part of a portfolio, this is a collection of assets.
Taking risk as a discrete distribution, political and economic uncertainties always affect stock market risk. When the economy picks up sufficiently, the stimulus is discontinued while if it does not pick up, the stimulus continues. At the risk of oversimplification, the outcome represents distinct cases of the market. In this case, risk is measured in three ways; i) probability distributions, ii) The expected rate of return and iii) Measuring stand-Alone Risk: The standard deviation.
In normal economic times, investors use scenario approach instead of estimating discrete outcomes. The standard deviation gives a measure of dispersion which provides information about a range of possible outcomes.
The risk of an asset is defined in capital asset pricing model. It is the risk that the stocks donate to market collection.
Chapter7. Stock, Stock Valuation and Stock Market Equilibrium.
Some companies have only one type of stock while others use classified stocks to meet special needs. Some firms link stocks together with dividends to specific parts. This helps them to distinct the cash flows and allows detached valuations. For managers to make good decisions they estimate the influence which policies, campaigns and schemes have on company’s value. Free cash flow valuation model defines the value of a company’s procedures the current worth of its predictable free cash flows after cut-rate at the weighted average price of principal. Stock market equilibrium is achieved when the supply and demands are balanced hence there is no fluctuation of prices. Prices go up when there is an oversupply of goods hence high demand.
Chapter8. Financial Options and Applications in Corporate Finance.
Option is a indenture that gives the proprietor the right to purchase or trade an asset at a value within a stated period of time. A call option springs the proprietor the right to buy a share of stock at a static price. On the other hand, a put option springs the proprietor the right to trade a share of stock at a static price. Each of the two options has its termination date after which the option cannot be applied. An American option is the one which can be applied before its termination date while European option is the one which can only be applied to its termination date. Investors who write call options against stock held in their portfolio is said to be selling covered options while the ones sold without the stock to back them era called naked options. Options are also available on several stock indexes. Indexes options documents one to hedge on a rise or fall in the market.
Cost of capital of a certain project is what most companies investigate before investing in the project. Additionally, companies also require capital to create more factories, create new products and to expand and grow internationally. Admittedly, the value of a company is determined by the risk of free cash flow, timing, and size. Apparently, the intrinsic value of a company is evaluated when the free cash flow is subtracted from the weighted average cost of the capital
Flotation costs are a cost which a company incurs when it applies new securities, an example of these costs include, legal expenses, commission, and fee. Organizations which offers debts have low flotation costs and hence this makes most analysts to ignore them especially when evaluating the after-tax cost of debt. Additionally, most organizations use or intend to use preferred stock in a section of their financing mix and hence tax adjustment is not used when evaluating the cost of preferred stock.
Moreover, most organizations have a tendency of paying dividends of which it is not a must. The cost utilized in the calculation of the WACC is the preferred stock cost component. The rate at which the shareholders need to be compensated for their risk is the required rate return of the stock and hence the stock is both the required return and the capital cost of the project.
Consequently, capital budgeting is also import in evaluating cash flows. Cash flow of project can be evaluated in many methods. When doing a valuation for the whole company the discount is free cash flows for the overall weighted mean cost of the capital. However, when doing a valuation of a certain project in the organization the discount is cash flows at the risk of the project adjusted cost of capital. Managers of the organization may analyze the company and decide to replace some facilitates which will facilitate continuity of the profitable operations, reduce costs, expand existing markets or products, safeties and mergers.
Before investing in a certain project it is good to analyze and evaluate some risks which the project might face. The initial step which all people should focus on when starting a project is by identifying and evaluating the best cash flows. Assets acquisition results in a cash flow while the accountants don’t portray the purchase of assets which are fixed as a deduction from accounting earning. Apparently, the interest changes are not part of the cash flows of a project. When doing the capital budgeting analyses cash flows should be discounted according to the exact duration when they happen and hence a daily cash flow is better than the annual flows. Sunk costs are information associated with a project which was incurred initially, and which can be recovered irrespective of whether the project is acceptable or not.
In conclusion, cash flow is very important since lack of a cash can make a certain project fail. Additionally, cash flows determine a lot of activities in a project. For instance, a project with good cash flow is able to grow rapidly and expand since it is able to manufacture a lot of goods.
Cash Distributions and Capital Structure (Distributions to Shareholders: Dividends and Repurchases & Capital Structure Decisions).
Distribution to shareholders which include dividends and share repurchases is a vital subject in an organization. When setting target distribution levels, four factors affect the process. These are capital structure, investor’s preferences for dividends vs. capital gains and the company’s and the investment opportunities. Distributions are defined as Net income- (Target equity ratio * (The total capital budget).
A change in investment opportunities affects dividends in several ways. First, fewer good investments would lead to smaller capital budget leading to a higher dividend payout. For a firm to enjoy low dividend payouts, it has had good investments. The advantages of the residual model are that it reduces new cost issues and flotation costs. Disadvantages are that it leads to conflicting ideas, increases risk and results in variable dividends
Capital structures are simply described as a combination of capital. Capital structures are designed to minimize the cost of capital, reducing risks, and to enable the firm to have adequate finances. Capital structure decisions are affected by business and financial risks. Financial leverage is shown by the extent of a financial risk. The formula is given by % change in EPS/ %change in EBIT. The EBIT/EPS Analysis shows that the cost of debt is always lower than that of equity. This hence raises debt, increases the EPS hence benefitting the shareholders. The theory of optimal capital structure states that we can obtain an optimum capital structure if when we raise the debt, we can raise the value of the firm to a particular level.
Managing Global Operations (Working Capital Management & Multinational Financial Management).
Working capital is referred to as the net current assets that are available to a firm, for the day-to-day running of the firm. Working capital is derived from the current assets less current liabilities. Working capital management is an essential component of activities in an organization for it to remain in business. One of the primary objectives of the working capital management is to ensure the firm’s liquidity. The other key goal is to ensure that the firm remains profitable. The firm invests less in working capital to sustain this objective.
Multinational Financial Management
This chapter deals with Globalization and the role of Multinational Corporations, International financial management and the international financial considerations. International finance has two major functions, treasury, and control. International finance has various distinguishing features which include, foreign exchange risk, political risk, and market imperfections. In the recent past, there has been a rapid emergence of financial markets and Multinational Corporations since the 1980s. MNCs function their businesses by, licensing, franchising, joint ventures, management contracts.