9 BUSN Finance: Acquiring and Using Funds to Maximize Value ©2011 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part ©2011 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part Finance: Acquiring and Using Funds to Maximize Value • How does maximizing financial value relate to social responsibility? • How financial managers use key ratios? • How financial managers use budgeted financial statements and cash budgets? • Why is working capital management important? • How financial managers evaluate capital budgeting proposals? • How financial managers determine the firm’s capital structure? BUSN ©2011 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part Finance: Acquiring and Using Funds to Maximize Value What Motivates Financial Decisions? What types of assets we need to achieve goals? How we get the funds we need? • Evaluate financial performance • Plan financial resources • Manage working capital • Evaluate investment opportunities • Determine appropriate strategy BUSN ©2011 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part Finance: Acquiring and Using Funds to Maximize Value Shareholder Value and Social Responsibility: Does Good Behavior Pay Off? • Historically, the goal of the firm has been to: Maximize the value of the firm to its owners • Publicly traded firms aim to maximize their stock price • The emphasis on shareholder value may seem to conflict with social responsibility • But, a long-term perspective can balance value with responsibility BUSN ©2011 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part Finance: Acquiring and Using Funds to Maximize Value Evaluating Current Conditions: Where Do We Stand? • Financial ratios provide insight into financial strengths and weaknesses % • Use financial data from balance sheet and income statement • Companies can compare their ratios with other businesses BUSN ©2011 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part Finance: Acquiring and Using Funds to Maximize Value Key Financial Ratios RATIO TYPE Current Liquidity: ability to pay short-term liabilities Inventory Asset Management: how firm is using Turnover assets to generate revenue Debt-to-equity Leverage: extent to which a firm relies on debt BUSN HOW IT IS COMPUTED Current Assets Current Liabilities Cost of Good Sold Average Inventory Total Debt Total Owner’s Equity ©2011 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part Finance: Acquiring and Using Funds to Maximize Value Key Financial Ratios RATIO TYPE Debt-to- Leverage: measures the extent to assets which a firm relies on debt HOW IT IS COMPUTED Total Debt Total Assets Return on Profitability: compares the amount of equity profit compared to resources invested Net Income – Preferred Div Avg Common Stock Equity Return on Profitability: compares the amount of assets profit compared to resources invested Net Income Average Total Assets Earnings per Profitability: compares the amount of share profit compared to resources invested Net Income – Preferred Div Avg # of Shares Out BUSN ©2011 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part Finance: Acquiring and Using Funds to Maximize Value Choose Your Poison: Toxic Assets as Executive Bonuses Credit Suisse suffered from toxic assets of bad mortgages as well as public backlash against bonuses paid to top management They created a three step strategy: Remove toxic assets from balance sheet to a new fund called Partner Asset Facility Pay bonuses to its top managers by giving them shares in the fund Pay bonuses from the fund over a period of years dependent on long-term performance BUSN ©2011 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part Finance: Acquiring and Using Funds to Maximize Value Financial Planning: Providing a Road Map for the Future • What assets must be obtained? • How much additional financing is needed? • How much can the firm generate Internally? Externally? • When will external financing be required? BUSN ©2011 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part 9 Finance: Acquiring and Using Funds to Maximize Value Basic Planning Tools: Budgeted Financial Statements and Cash Budget Budgeted Income Statement – forecasts the sales, expenses and net income Budgeted Balance Sheet – forecasts the types and amounts of assets a firm will need to carry out plans BUSN Cash Budget – detailed projection of cash flows to determine when cash shortages and surpluses will occur ©2011 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part 10 Finance: Acquiring and Using Funds to Maximize Value Short-term Financing: Arranging for Quick Cash • Spontaneous Financing Trade Credit • Short-Term Bank Loans Line of Credit Revolving Credit Factoring Commercial Paper BUSN â2011 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part 18 Finance: Acquiring and Using Funds to Maximize Value Capital Budgeting: In It for the Long Haul • Replace machines and equipment • New machines and equipment • A new factory, warehouse or office • Introduce a new product line BUSN Capital Budgeting a systematic evaluation of a firm’s major long-run capital investment opportunities ©2011 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part 19 Finance: Acquiring and Using Funds to Maximize Value Evaluating Capital Budgeting Proposals: Time Value of Money Managers must evaluate costs and benefits of investment that occur over a period of many years Time Value of Money – a dollar received today is worth more than a dollar received in the future BUSN Compounding – earning interest in the current period on interest from previous periods ©2011 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part 20 Finance: Acquiring and Using Funds to Maximize Value Evaluating Capital Budgeting Proposals: Net Present Value • Managers must compare the amount of cash an investment generates and when it generates the cash • Time value of money – a dollar received today is worth more than a dollar received in the future BUSN Present Value – How much a given amount of cash received in a future period is worth today, given the time value of money ©2011 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part 21 Finance: Acquiring and Using Funds to Maximize Value Using Net Present Value to Evaluate Capital Budgeting Proposals Net present value is the present value of all cash flows associated with an investment, including the initial (negative) cash flow of the investment BUSN ©2011 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part 22 BUSN Finance: Acquiring and Using Funds to Maximize Value How a Present Value of $1,000 Grows to a Future Value in years ©2011 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part 23 Finance: Acquiring and Using Funds to Maximize Value Why You Should Have a Personal “Interest” in the Time Value of Money Net present value is an important to for personal finance and understanding how to grow your nest egg • The longer your money has to work for you, the stronger the results • You earn interest on the amount you contribute and on the accumulated interest— COMPOUNDING Investing early pays! BUSN ©2011 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part 24 Finance: Acquiring and Using Funds to Maximize Value Choosing the Sources of Long-term Capital: Loaners vs Owners Capital Structure – the mix of equity and debt financing a firm uses for financing needs Debt Financing – creditors Equity Financing – owners BUSN ©2011 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part 25 Finance: Acquiring and Using Funds to Maximize Value Pros and Cons of Debt Financing  Debt is a legally binding agreement to repay the money plus interest  Debt requires fixed payments  Many lenders require collateral which lenders can use to recover balance  Interest payments are tax-deductible  Avoids additional investment of stockholders  Some lenders impose covenants on the borrower BUSN ©2011 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part 26 Finance: Acquiring and Using Funds to Maximize Value Meet Uncle Sam – Your Friendly New Neighborhood Banker • Under the 2008 credit meltdown, the Obama administration announced a program called the Capital Assistance Plan • The goal of the plan was to get credit flowing to businesses and consumers • The plan allowed shareholders to convert stock from preferred to common • The strategy saved the banks money from dividend payments but it also gave the government voting rights • Many believed the actions were necessary, others wondered if this was a step toward nationalizing the financial system BUSN ©2011 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part 27 Finance: Acquiring and Using Funds to Maximize Value Pros and Cons of Equity Financing • Equity financing:  Money invested from newly issued stock  Earning the company reinvested • No required payments—dividend payments can be skipped • Does not yield tax benefits • Dilutes ownership Does not provide leverage BUSN â2011 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part 28 Finance: Acquiring and Using Funds to Maximize Value Financing Leverage: Using Debt to Magnify Gains (And Losses) • Heavy debt in capital structure • Potential high returns to owners Increased risk BUSN â2011 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part 29 BUSN Finance: Acquiring and Using Funds to Maximize Value How Financial Leverage Affects the Return of Equity ©2011 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part 30 Finance: Acquiring and Using Funds to Maximize Value Will Leverage in the Movie Business Lead to “Marvelous” Returns? • Marvel Comics entered into a $525 million debt financing deal using its film rights to its superhero characters as collateral • The company plans to produce its own movies instead of partnering with other firms and gaining low returns • Moviemaking is risky, if the gamble pays off their financial leverage will produce Marvel-ous Returns… BUSN ©2011 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part 31 Looking Back • How does maximizing financial value relate to social responsibility? • How financial managers use key ratios? • How financial managers use budgeted financial statements and cash budgets? • Why is working capital management important? • How financial managers evaluate capital budgeting proposals? • How financial managers determine the firm’s capital structure? BUSN ©2011 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part 32 ... of the investment BUSN ©2011 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part 22 BUSN Finance: Acquiring... • Increased risk BUSN ©2011 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part 29 BUSN Finance: Acquiring... with social responsibility • But, a long-term perspective can balance value with responsibility BUSN ©2011 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted