INTRODUCTION TO CORPORATE FINANCE Laurence Booth • W Sean Cleary Contents • • • • • • • • • • • • • • • • • • • • • • • • CHAPTER 1: An Introduction to Finance 03 CHAPTER 2: Business (Corporate) Finance 38 CHAPTER 3: Financial Statements 80 CHAPTER 4: Financial Statement Analysis and Forecasting 136 CHAPTER 5: Time Value of Money 221 CHAPTER 6: Bond Valuation and Interest Rates 281 CHAPTER 7: Equity Valuation 353 CHAPTER 8: Risk, Return, and Portfolio Theory 410 CHAPTER 9: The Capital Asset Pricing Model (CAPM) (CAPM) 504 CHAPTER 10: Market Efficiency 618 CHAPTER 11: Forwards, Futures, and Swaps 663 CHAPTER 12: Options 717 CHAPTER 13: Capital Budgeting, Risk Considerations and Other Special Issues 781 CHAPTER 14: Cash Flow Estimation and Capital Budgeting Decisions 867 CHAPTER 15: Mergers and Acquisitions 937 CHAPTER 16: Leasing 992 CHAPTER 17: Investment Banking and Securities Laws 1015 CHAPTER 18: Debt Instruments 1042 CHAPTER 19: Equity and Hybrid Instruments 1088 CHAPTER 20: Cost of Capital 1153 CHAPTER 21: Capital Structure Decisions 1288 CHAPTER 22: Dividend Policy 1383 CHAPTER 23: Working Capital Management: General Issues 1457 CHAPTER 24: Working Capital Management: Current Assets and Current Liabilities 1531 CHAPTER - An Introduction to Finance www.bookfiesta4u.com 1-2 Contents CHAPTER An Introduction to Finance Lecture Agenda • • • • • • • • Learning Objectives Important Terms Finance Defined Real versus Financial Assets The Financial System Financial Instruments and Markets The Global Financial Community Summary and Conclusions – Concept Review Questions CHAPTER - An Introduction to Finance www.bookfiesta4u.com 1-4 Contents Learning Objectives What finance is and what is involved in the study of finance How financial securities can be used to provide financing for borrowers and simultaneously to provide investment opportunities for lenders How financial systems work in general The channels of intermediation and the role played by market and financial intermediaries within this system The basic types of financial instruments that are available and how they are traded The importance of the global financial system CHAPTER - An Introduction to Finance www.bookfiesta4u.com 1-5 Contents Key Terms • • • • • • • • • • • • • • • • • Bourse de Montréal brokers Canadian Trading and Quotation System Inc (CNQ) capital market securities common share corporate finance Crown corporations dealer or overover-the the counter (OTC) markets debt instruments equity instruments exchanges or auction markets finance financial assets financial intermediaries fourth market intermediation investments CHAPTER - An Introduction to Finance www.bookfiesta4u.com 1-6 Contents Key Terms • • • • • • • • • • • • • • • • • market capitalization market intermediary marketable financial assets money market securities New York Stock Exchange (NYSE) non marketable financial assets non Ontario Securities Commission preferred shares primary markets real assets secondary markets third market Toronto Stock Exchange (TSX) TSX Group Inc TSX Markets TSX Venture Exchange Winnipeg Commodity Exchange CHAPTER - An Introduction to Finance www.bookfiesta4u.com 1-7 Contents What Is Finance? • Finance is the study of how and under what terms savings (money) are allocated between lenders and borrowers – Finance is distinct from economics in that it addresses not only how resources are allocated but also under what terms and through what channels • Financial contracts or securities occur whenever funds are transferred from issuer to buyer CHAPTER - An Introduction to Finance www.bookfiesta4u.com 1-8 Contents The Study of Finance • The study of finance requires a basic understanding of: – Securities – Corporate law – Financial institutions and markets CHAPTER - An Introduction to Finance www.bookfiesta4u.com 1-9 Contents Real Versus Financial Assets • Real assets are tangible things owned by persons and businesses – – – – Residential structures and property Major appliances and automobiles Office towers, factories, mines Machinery and equipment • Financial assets are what one individual has lent to another – Consumer credit – Loans – Mortgages CHAPTER - An Introduction to Finance www.bookfiesta4u.com - 10 Contents Inventory Inventory Management Approaches • • • • ABC Approach Economic Order Quantity (EOQ) Model Materials Requirement Planning (MRP) Just Just in in time (JIT) Inventory systems www.bookfiesta4u.com CHAPTER 24 – Working Capital Management – Current Assets and Current Liabilities 24 - 1551 Contents Inventory Evaluating Inventory Management • Use of financial ratios can give some indication of the effectiveness of a firm’s inventory management • Ratios, however, not measure shortage costs, financing costs, etc • These ratios include: – Inventory turnover – Average day’s sales in inventory www.bookfiesta4u.com CHAPTER 24 – Working Capital Management – Current Assets and Current Liabilities 24 - 1552 Contents Productivity Ratios Inventory Turnover • Estimates the number of times, ending inventory was ‘turned over’ (sold) in the year Inventory Turnover = CGS INV [4- 18] • A ratio that involves both ‘stock’ and ‘flow’ values • Is strongly a function of ending inventory value…managers often try to improve this ratio as they approach year end through inventory reduction strategies (cash and carry sales/inventory clearance, etc.) www.bookfiesta4u.com CHAPTER 24 – Working Capital Management – Current Assets and Current Liabilities 24 - 1553 Contents Productivity Ratios Inventory Turnover • When Cost of Goods Sold is not available, it may be necessary to estimate inventory turnover using sales Inventory Turnover = Sales INV [4- 19] • Use of the sales figure is less valid than Cost of Goods Sold because Cost of Goods Sold is based on inventoried cost, but Sales includes a profit margin on top of inventoried cost www.bookfiesta4u.com CHAPTER 24 – Working Capital Management – Current Assets and Current Liabilities 24 - 1554 Contents Productivity Ratios Average Days Sales in Inventory (ADSI) • Estimates the number of days of sales tied up in inventory (based on ending inventory values) Average days sales in inventory (ADSI) = = www.bookfiesta4u.com INV ADS [4- 20] 365 Inventory turnover CHAPTER 24 – Working Capital Management – Current Assets and Current Liabilities 24 - 1555 Contents Short Term Financing Considerations Short • Investment in current assets tend to rise and fall with the volume of activity • Accruals and accounts payable (trade credit) are ‘spontaneous’ liabilities • Other sources of financing must be ‘negotiated’ and before using the firm must evaluate the cost effectiveness of alternative financing mechanisms www.bookfiesta4u.com CHAPTER 24 – Working Capital Management – Current Assets and Current Liabilities 24 - 1556 Contents Short Term Financing Considerations Short To estimate the annual effective rate of return or cost (k) of any financing alternative: [ 24-2] www.bookfiesta4u.com n-Day financing cos t 365 /n k = (1+ ) -1 Purchase p rice CHAPTER 24 – Working Capital Management – Current Assets and Current Liabilities 24 - 1557 Contents Short Term Financing Considerations Short Trade Credit • Often a very important source of short short term financing • Offers a number of advantages: – – – – Readily available Convenient Flexible Usually does not entail any restrictive covenants or pledges of security • There is no explicit cost associated with credit terms such as: – Net 30 – Net 40 www.bookfiesta4u.com CHAPTER 24 – Working Capital Management – Current Assets and Current Liabilities 24 - 1558 Contents Short Term Financing Considerations Short Trade Credit • There is usually a high implicit cost to a firm that forgoes discounts on early payment such as: – 2/10 Net 30 Example: assume (2/10 net 30) Approximate percentage cost = (2/98)(365/20) = 37.2% The firm is being charged 2% for the use of funds from day 10 to day 30 (20 days) www.bookfiesta4u.com CHAPTER 24 – Working Capital Management – Current Assets and Current Liabilities 24 - 1559 Contents Short Term Financing Considerations Short Bank Loans and Factor Arrangements Options include: – Operating loans / lines of credit • Secured by accounts receivable and inventory to a maximum percent of those assets • Interest only payments • Balance can be retired at the firm’s discretion – Factor arrangements www.bookfiesta4u.com CHAPTER 24 – Working Capital Management – Current Assets and Current Liabilities 24 - 1560 Contents Short Term Financing Considerations Short Money Market Instruments • Large firms with high credit ratings may be able to bybypass financial institutions and borrow directly from the money market • Two forms of money market instruments: – Commercial paper – Bankers’ acceptances • The firm pays a stamping fee, and is able to borrow based on their bank’s credit rating • Money market securities: – Sold at a discount from face value – Maturities at time of issue of 30, 60, 90 days – Face amounts of $100,000 or more www.bookfiesta4u.com CHAPTER 24 – Working Capital Management – Current Assets and Current Liabilities 24 - 1561 Contents Short Term Financing Considerations Short Money Market Instruments • The annualized yield on a money market instrument: [ 24-3] www.bookfiesta4u.com Approximate annual yield = Discount 365 × Market price Days to maturity CHAPTER 24 – Working Capital Management – Current Assets and Current Liabilities 24 - 1562 Contents Short Term Financing Considerations Short Securitizations • Special purpose vehicles (SPVs) are conduits for packaging portfolios of receivables and selling them to investors in the money market; a recent innovation in financing trade credit • Credit enhancements are actions taken to reduce credit risk, such as requiring collateral, insurance or other agreements • Asset Asset backed commercial paper (ABCP) is an example – The sub sub prime mortgage problems in the U.S has exposed the problems with ABCP where investors have become concerned about the underlying asset values (packages of receivables) and the market is actively repricing these money market instruments – In some cases the market has disappeared for some of these money market instruments www.bookfiesta4u.com CHAPTER 24 – Working Capital Management – Current Assets and Current Liabilities 24 - 1563 Contents Summary and Conclusions In this chapter you have learned: – That the optimal level of investment in cash, receivables and inventory occurs when the benefits balance the costs – The advantages, the disadvantages and associated effective annual costs of the most common shortshort-term financing options available to companies www.bookfiesta4u.com CHAPTER 24 – Working Capital Management – Current Assets and Current Liabilities 24 - 1564 Contents THANK YOU www.bookfiesta4u.com Lets Celebrate Knowledge www.bookfiesta4u.com Contents ... 1531 CHAPTER - An Introduction to Finance www.bookfiesta4u.com 1-2 Contents CHAPTER An Introduction to Finance Lecture Agenda • • • • • • • • Learning Objectives Important Terms Finance Defined... from issuer to buyer CHAPTER - An Introduction to Finance www.bookfiesta4u.com 1-8 Contents The Study of Finance • The study of finance requires a basic understanding of: – Securities – Corporate. .. An Introduction to Finance www.bookfiesta4u.com 1-7 Contents What Is Finance? • Finance is the study of how and under what terms savings (money) are allocated between lenders and borrowers – Finance