INTRO CAP ALLOCATION FIN MARKETS FIN INSTITUTIONS STK MKTS & RET STK MKT EFF
URNS
HOW IS CAPITAL TRANSFERRED
BETWEEN SAVERS AND BORROWERS?
• Direct transfers
• Investment banks
• Financial intermediaries
2-1
INTRO CAP ALLOCATION FIN MARKETS FIN INSTITUTIONS STK MKTS & RET STK MKT EFF
URNS
TYPES OF FINANCIAL MARKETS
• Physical assets vs. Financial assets
• Spot vs. Futures
• Money vs. Capital
• Primary vs. Secondary
• Public vs. Private
2-3
INTRO CAP ALLOCATION FIN MARKETS FIN INSTITUTIONS STK MKTS & RET STK MKT EFF
URNS
TYPES OF FINANCIAL INSTITUTIONS
• Investment banks
• Commercial banks
(http://www.marketwatch.com/investing/stock/bac/financials/balance
-sheet)
• Credit unions
• Pension funds
• Life insurance companies
• Mutual funds (www.fidelity.com)
• Exchange traded funds (http://www.etf.com/etfanalytics/etf-finder)
• Hedge funds (
http://marketplace.publicradio.org/display/web/2008/
12/15/whiteboard_a_look_inside_hedge_funds
/)
2-4
INTRO CAP ALLOCATION FIN MARKETS FIN INSTITUTIONS STK MKTS & RET STK MKT EFF
URNS
WHAT IS AN IPO?
• An initial public offering (IPO) occurs when a company
issues stock in the public market for the first time.
• “Going public” enables a company’s owners to raise
capital from a wide variety of outside investors. Once
issued, the stock trades in the secondary market.
• Public companies are subject to additional regulations
and reporting requirements.
2-5
INVESTMENT BANKING PROCESS
VONTAGE EXAMPLE
2-7
BALANCE SHEET
• The balance sheet is a snapshot of the firm’s
assets and liabilities at a given point in time
• Assets are listed in order of decreasing
liquidity
Ease of conversion to cash
Without significant loss of value
• Balance Sheet Identity
Assets = Liabilities + Stockholders’ Equity
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THE BALANCE SHEET
FIGURE 2.1
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NET WORKING CAPITAL
AND LIQUIDITY
• Net Working Capital
= Current Assets – Current Liabilities
Positive when the cash that will be received over the next 12 months exceeds
the cash that will be paid out
Usually positive in a healthy firm
• Liquidity
Ability to convert to cash quickly without
a significant loss in value
Liquid firms are less likely to experience financial distress
But liquid assets typically earn a lower return
Trade-off to find balance between liquid and illiquid assets
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U.S. CORPORATION BALANCE
SHEET TABLE 2.1
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MARKET VALUE VS. BOOK VALUE
• The balance sheet provides the book value of the
assets, liabilities, and equity.
• Market value is the price at which the assets,
liabilities, or equity can actually be bought or sold.
• Market value and book value are often very different.
Why?
• Which is more important to the decision-making
process?
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EXAMPLE 2.2
KLINGON CORPORATION
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INCOME STATEMENT
• The income statement is more like a video of the
firm’s operations for a specified period of time.
• You generally report revenues first and then deduct
any expenses for the period
• Matching principle – GAAP says to show revenue
when it accrues and match the expenses required to
generate the revenue
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U.S. CORPORATION INCOME
STATEMENT – TABLE 2.2
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WORK THE WEB EXAMPLE
• Publicly traded companies must file regular reports
with the Securities and Exchange Commission
• These reports are usually filed electronically and can
be searched at the SEC public site called EDGAR
• Click on the web surfer, pick a company, and see
what you can find!
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TAXES
• The one thing we can rely on with taxes is that
they are always changing
• Marginal vs. average tax rates
Marginal tax rate – the percentage
paid on the next dollar earned
Average tax rate – the tax bill / taxable income
Average tax rates vary widely across different
companies and industries
• Other taxes
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EXAMPLE: MARGINAL VS.
AVERAGE RATES
• Suppose your firm earns $4 million in taxable
income.
What is the firm’s tax liability?
What is the average tax rate?
What is the marginal tax rate?
• If you are considering a project that
will increase the firm’s taxable income
by $1 million, what tax rate should you
use in your analysis?
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THE CONCEPT OF CASH FLOW
• Cash flow is one of the most important pieces of
information that a financial manager can derive
from financial statements
• The statement of cash flows does not provide us
with the same information
that we are looking at here
• We will look at how cash is generated from
utilizing assets and how it is paid to those that
finance the purchase of the assets
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CASH FLOW FROM ASSETS
• Cash Flow From Assets (CFFA) = Cash Flow to
Creditors + Cash Flow
to Stockholders
• Cash Flow From Assets = Operating Cash Flow
– Net Capital Spending
– Changes in NWC
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EXAMPLE: U.S. CORPORATION –
PART I
• OCF (I/S) = EBIT + depreciation –
taxes = $547
• NCS (B/S and I/S) = ending net fixed assets –
beginning net fixed assets + depreciation =
$130
• Changes in NWC (B/S) = ending
NWC – beginning NWC = $330
• CFFA = 547 – 130 – 330 = $87
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EXAMPLE: U.S. CORPORATION –
PART II
• CF to Creditors (B/S and I/S) = interest
paid – net new borrowing = $24
• CF to Stockholders (B/S and I/S) =
dividends paid – net new equity raised =
$63
• CFFA = 24 + 63 = $87
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