CFI Certificate Course

Finance

What to buy, where to get the money to buy it, and how to manage it once you have it

Long term (infrastructure), short term (inventory, staffing, marketing, etc)

What do you need to buy?

Borrow, shareholders

How to get the money to buy it?

Scheduling, budgets, controls/processes

How to manage the assets?

The likelihood of a bad outcome

Risk

Don’t put all your eggs into one basket

How to avoid risk, even if some of it can’t be avoided?

Beta

Risk that can’t be avoided; measures the market-wide risk that cannot be eliminated through diversification because it happens to everybody

Capital Asset Pricing Model

A financial model that calculates the expected rate of return for an asset or investment

Risk Free Interest Rate

The return an investor would expect from an absolutely risk-free investment over a specific period of time

Risk Free Rate Equation

= Expected Inflation + the Time Value of Money (around 5%, lower when inflation is low)

Lenders

If a business fails, who is owed the money first, if at all?

Expected Return Equation =

Risk Free Rate + Beta of a Stock (Market Return - Risk Free Rate)

Market Premium Equation

Market Return - Risk Free Rate =

Security

Investments like stocks, bonds, notes, debentures, limited partnership interests, oil and gas interests, and investment contracts

Risk Premium

Rate of return greater than the risk-free rate. Investors want a higher risk premium when taking on more risky investments

Expected Return

The expected return of a capital asset over time; the long term assumption about how an investment will play out over its entire life.

Risk Free Rate

Typically equal to the yield on a 10 year US bond.

Cash has zero beta risks, banks have large beta risks

Examples of Beta Risks

Investors

Who do you have to pay to take on risks?

Equity Investment

An investment in the shares of a company; more risky

Equity Risk Premium

The extra amount you expect to earn on your investment because you are investing in risky assets

more expected return

More anticipated risk means…

Capital Structures

Mixing borrowing and owner investment used to finance the purchase of an asset

Using personal savings in cash for all of it, use some of your personal savings and mortgage the rest

2 Types of Financing

Short Term Financing

Financing that comes from suppliers and local banks

Long Term Financing

Financing for land, buildings, machines, etc

More debt = more pressure on performance

Does capital structure impact the value of the company?

Optimal Capital Structure

higher tax rates = more borrowing, collateral quality = more borrowing

It affects the cost of a company’s capital

Why is capital structure important?

Cost of Capital

Cost of obtaining financing

High Cost of Capital =

Increased risk = a higher required return for investors

Cost of Borrowing

Interest rate for loans

Cost of Equity Investment

Necessary expected return (for investors to expect); computed by CAPM; cost of capital should not be higher than project returns

Cost of Capital Equation

(Investment x Return Rate)

Equity Cushion

A form of adequate protection for a secured debt; exists if the value of the collateral available to the creditor is larger than the creditor’s claim

Net Debt - Cash

How to find the equity cushion?

Weighted Average Cost of Capital (WACC)

the rate that a business is expected to pay to finance its assets; the blended cost of capital across all sources

WACC Equation

Cost of Equity + Cost of Debt (after tax)

WACC Equation Again

(Market Cap / Total Value of Capital x Cost of Equity) + (Percentage of Capital that Is Debt x Cost of Debt) x (1- Tax Rate)

Market Capitalization

the most recent market value of a company’s outstanding shares; is equal to the current share price multiplied by the number of shares outstanding

Market Capitalization Equation

Current Market Price of Share x Total Outstanding Shares

Shares Outstanding

the number of shares of a company calculated after adjusting for changes in the share capital over a reporting period; not constant and may change throughout the year

the expected operating returns

WACC cannot be greater than….

Stock

Evidence that a stakeholder is the owner of a part of the company that issued the stock

Bond

evidence that the beholder is owed money by the company that issued the bond

Stock Market

physical or virtual place for people to trade stocks

Sovereign bonds

government bonds issued by countries

Municipal bonds

government bonds issued by cities, provinces, states, or government agencies

Corporate Bonds

Bonds issued by companies

Asset Backed Bonds

Bonds backed by a set of assets (accounts recievable, mortgages on homes, etc)

Public Debt

company bonds publicly traded

Private Debt

Borrowed directly from bank or groups of banks

Bond Complexity

One company might have many bonds; each bond might vary by interest rate, maturity date, and more

Market Share Price

Price point for a stock where buyer and seller agree

Supply and demand, future expectations, economic, industry or company information

What sets the price of a stock?

Going Public

Listing your share in a public stock exchange

Initial Public Offering (IPO)

First time company sells shares in markets; no active buying or selling before shares are publicly listed

IPO is too low

Undersubscribed IPO = Bad Publicity

IPO is too high

Original shareholders lose potential earnings