FINA 4200 Exam 1

proprietorship

1 or a few owners who operate the firm (the only employees)

partnership

lots of partners also hire non-partner employees

corporation

owned by company stockholders, many employees

firm-life cycle

private firm to public firm: proprietorship; partnership corporation

How firms obtain financing throughout life cycle

founder's own funds and angel financing; venture cap and bank debt finance expansion, seasoned equity and other securities offerings

at the IPO

when do founders and VCs often sell their stakes?

angel financing

wealthy individuals who want to invest in private startups between 50,000 and 400,000

venture captial firms

limited to partnerships themselves, general partner is a VC and also help run firm, limited partner is just a VC

seasoned equity

when you are already public but want to sell more shares

shareholder wealth maximization, which translates into maximizing stock price (should focus on intrinsic value of stock price)

what is the primary objective of management?

how customer benefits from stock price maximization

efficient, low cost business that produce high quality products

how employees benefit from stock price maximination

increase employment, salary, and stock compensation

three aspects of cash flows that affect company value

amount of expected cash flows (averages across past scenarios), timing of the cash flow stream (TVM), risk of the cash flows

intrinsic value

the sum of all the future expected free cash flows when converted into today's dollars

FCF/(1+ WACC) + FCF/(1+WACC)^2 + ...

intrinsic value =

free cash flows

the cash flows that are available for distribution to all investors (stockholders and creditors)

sales revenues - operating costs - operating taxes - required investments in operating capital

FCF=

the average rate of return required by all of the companys investors

WACC

capital structure, interest rates, risk of the firm, investors overall attitude toward risk

what is WACC affected by?

agency relationship

when one or more individuals (called principals) hires another individual or organization, called an agent, to perform some service and delegates decision making authority to that agent

when there is separation of ownership and management

when does an agency relationship likely exist

agents, principals

in a corporation, the CFOs and CEOs are ___________ and shareholders are _________

principal, agent

in a lending relationship, the lender is the ___________ and the borrower is the _________

perquisite

private benefits (only for managers) like corporate jets, fancy office

stockholders and managers (who often own small percentage of the stock)

agency conflicts often exist between...

empire-building

managers are running a company with the goal of building an empire (growing size) instead of maximizing shareholder wealth (makes it harder for the company to be taken over)

over-investments

investing in many projects, even un-profitable ones (called pet projects)

costs of fixing the agency problem

paid for by stockholders, includes monitoring (auditing), organization (hiring outside board members), opportunity costs (prevent managers from taking timely actions)

ways to fix the agency problem

managerial compensation plans, direct intervention by shareholders, threat of firing, threat of takeovers

proxy fights

an outside group solicits existing shareholders' proxies (voting shares) to overthrow management and take control

shareholders like to invest in risky projects (asset substitution) because they would benefit from the potential return while debt holders would suffer

agency problems often exist between shareholders and debt holders because...

how creditors can protect themselves

having the loan secured or over collateralized, placing restrictive covenants in debt agreements, charging a higher than normal interest rate to compensate for risk

restrictive covenant

debt holder can tell shareholder they are only allowed to invest in certain things, a technical default would occur if this was violated

securitization in the home mortgage industry

lenders pt their mortgages into pools and sell the pools to securitizing firms (SPV of investment banks, fannie mae, freddie mac). After selling a pool, the lenders have funds to make new home loans

from the mortgage lenders to the securitizing firm

when home mortgages are securitized, the risk is shifted ....

investors

securitizing firms dont keep the mortgages, they sell shares of these pools as "mortgage backed securities" to investors, so risk is shifted to the....

more risk, higher return

investors have ________ risk and earn ______ return

collateralized debt obligations

some pay investors only the mortgage interest, others only the mortgage principal, some might mature quickly, some are "senior" and get paid before other securities in the pool, different ratings from ratings agencies

held onto it

after the collapse, surviving banks did what with their cash that dragged down the real economy?

balance sheet, income statement, statement of stockholder's equity, statement of cash flows

what does the annual report include

annual reports

report what has actually happened to assets, earnings, and dividends and used by investors to form expectations about future earnings and dividends

notes payable

usually due within 90 days

accruals

wages due to employees

balance sheet

snapshot of a firm's assets, liability and equity at a given time (left hand side in the order of liquidity, right hand side in the order of payment priority)

total liabilities + total equity

or

current assets + fixed assets

total assets=

current liabilities + long term liabilities

total liabilities=

common stocks + preferred stocks + retained earnings

total equity=

income statement

describes change within a period, flow concept

EBIT

what the company makes outside of operations, income before interest and taxes

net income

EBIT less interest, taxes, and preferred dividend

statement of retained earnings

new balance of retained earnings= previous balance of retained earnings + net income - dividends to common stock holders

cash

A company can have a lot of retained earnings and profits but it be in the form of assets other than....

net income + depreciation and amortization

net cash flow=

noncash revenues

sales on multi year service or products (i.e. magazine subscription)

noncash charges

deferred taxes

statement of cash flows

divided into operating activities, investment activities, and financing activities

operating assets

current assets that be be easily converted to cash, doesnt include short term investments because they arent directly tied to company's operations

EBIT with operating assets

to judge managerial performance, we needs to compare _______ with ________

operating current assets

cash, inventory, receivables

long term operating assets

plant, equipment

NOWC, net operating working capital

operating CA - operating CL

operating current liabilities

accounts payable + accruals, excludes notes payable because they are a part of financing activities

lower net income

higher debt leads to a ______ net income

nopat

the amount of profit assuming no debt

tax= EBT x t= (EBITDA - DA - Int) x t : DA decreases, so tax payment increases

NI= EBT x (t-t)= (EBITDA - DA - Int) x (1-t): DA decreases, so NI increases

NCF= NI + DA= (EBITDA - Int) x (1-t) - DA x (1-t) + DA, DA decreases, so net cash flow decreases

assume that a company currently depreciates its fixed assets over 7 years. Which of the following would occur if a tax law change forced the company to depreciate its fixed assets over 10 years instead?

free cash flow

the amount of cash available from operations for distribution to all investors (including stockholders and debt holders) after making the necessary investments to support operations

the amount of FCF it can generate

what does a company's value depend on?

pay interest on debt, pay back principal on debt, pay dividends, buy back stock, buy non-operating assets (i.e. marketable securities, investments in other companies)

what are the 5 uses of FCF?

net investment in operating capital=

current total net operating capital - previous total net operating capital

when it is because of negative NOPAT, not necessarily if it is because of high investment

when is negative FCF a bad thing?

did not add value because investors did not get the return they require

If ROIC is less than the cost of capital (WACC), then the operation....

negative, ROIC>WACC

High growth usually causes _______- FCF, but that is okay if....

EVA

tells you the dollar amount of profit, superior to account profit because it considers equity costs unlike net income, helps ensure that operation is consistent with maximizing shareholders value

MVA

forward looking, represent markets expectations

marginal tax rate

the rate paid on the last dollar of income

average tax rate

the average rate paid on all income

interest expenses

70% of dividend income

CAN be deducted from taxes

dividend payments

interest income

CANNOT be deducted from taxes

retained earnings

the reinvested earnings of stockholders that do not represent cash and in fact, represent a claim against the existing assets of the firm.

maintain the same operating income with less capital

what is one way to increase EVA?

financial ratios

standardized numbers that facilitate comparisons, compare the firms management and performance with peers

liquidity ratios

can we make required payments? are assets liquid enough to meet short term liabilities?

asset management ratios

do we have the right amount of assets for the level of sales? (not good to have a huge amount of assets to support sales)

debt management ratios

do we have the right mix of debt and equity

profitability ratios

do sales prices exceed unit costs? Are sales high enough?

market value ratios

do investors like what they see?

asset liquidity

how easy to convert to cash without loss in value, will the firm be able to pay off debts over the next year, uses current ratio

high

from a debtholder/creditor perspective, do you prefer a high or low current ratio?

just care about having enough CA to meet liabilities because assets dont do a lot for returns

from a shareholder perspective, do you prefer a high or low current ratio?

least

inventory is the _______ liquid current asset

inventory turnover ratio

how many times a firm's inventory is sold out over a year

days sales outstanding

how many days it takes for a firm to receive cash on a sale

high

You do not want a ________ DSO

fixed assets turnover ratio

how effectively a firm uses its plant and equipment

total assets turnover ratio

how effectively a firm uses its assets overall

you need to increase sales or identify inefficient assets

what does a low total asset turnover ratio mean?

debt management ratios

tells you have the firm is financed

increases them

what does debt do to shareholder returns

leverage

allows you to use other peoples money to make investments

debt, equity

_______ is less costly to raise than ________