Chapter 1 Corporate finance and financial manager Valuation principle how to make the costs and benefits of a decision comparable so that we can weigh them properly Sole proprietorships run by 1 person most common type of firm Easy to set up No separation between firm and owner Owner has unlimited personal liability for firm s debts Difficult to transfer ownership Life limited to life of owner Partnerships run by more than 1 owner All partners liable for firm s debt Ends when death withdrawal of any single partner Partners can avoid liquidation if agreement specifies buyout of withdrawn partner Limited partnership has general partners and limited partners General partners personally liable for firm s debt obligations Limited partners have limited liability liability limited their investment Limited partner has no mgmt authority Limited liability company limited partnership with no general partner Corporations Setting up costly Corporate charters specify initial rules Owners not liable for any personal obligation of its owners No limit on who can own the stock Corporation s profits are subject to taxation separate from its owners personal taxes shareholders pay taxes twice S corporations exempt from double taxation because they elect subchapter S tax treatment Firm s profits are not subject to corporate taxes but allocated directly to shareholders based on their ownership share C corporations are subject to double taxation most corporations are C corporations Stock entire ownership is divided into shares stock Equity collection of all outstanding shares Shareholder owner of share of stock Dividend payments made to tis equity holders Financial manager Makes investment decisions decides which investments qualify as good uses of the money Makes financing decisions whether to raise money by selling more stock or to borrow from stockholders have invested in bonds or debt Manages short term cash needs managing working capital Goal is to maximize wealth of owners stockholders Board of directors elected by shareholders CEO runs the corporation by obeying rules set by board of directors Each share of stock gives shareholder 1 vote in the election Agency problem when managers put their own self interest ahead of shareholders So shareholders tie manager compensation to corporation s profits or stock price Hostile takeover when one buys large portion of corporation s stock and uses the votes to replace CEO Private corporation few owners no organized market for its shares Public corporation has many owners trades in organized market at the stock market Primary market corporation issuing new shares of stock and selling them to investors Secondary market shares continue to trade between investors without involvement of coronation Market makers they match buyers with sellers at the stock exchange Bid price price at which market makers is willing to buy a security Ask price price at which market makers is willing to sell a security Ask price bid price bid ask spread Financial institutions entities that provide financial services such as taking deposits managing investments brokering financial transactions and making loans Also help move money through time loans and spread risk across large investor bases Financial cycle 1 People invest 2 Money from loans stock flows to companies generating profits 3 That money flows back to investors Chapter 2 Intro to financial analysis Balance sheet lists firm s assets liabilities snapshot of financial position at one point in time Assets L cash inventory property plant equipment Liabilities R accounts payable notes payable short long term debt Stockholders equity common stock retained earnings Stockholders equity firm s net worth that represents difference between assets and liabilities Assets Liabilities Stockholders equity Marketable securities short term low risk investments easily converted to cash Depreciation yearly deduction on value of fixed assets over time Book value asset s acquisition cost minus accumulated depreciation Current liabilities liabilities that will be satisfied within a year Net working capital capital available in short term to run business Current assets current liabilities Market capitalization market price per share x number of shares Liquidation value value of firm after its assets and sold and liabilities are paid Value stocks firms with low market to book ratios Growth stocks firms with high market to book ratios Leverage how much firm relies on debt as source of financing Debt to equity ratio used to asses firm s leverage Income statement lists firm s revenue s expenses over period of time Gross profit revenue from sales of products minus costs Operating income gross profit minus operating expenses Net income last line of income statement Earnings Before Interest and Tax Earnings per share net income shares outstanding Average daily sales sales 365 Convertible bonds form of debt that can be converted into shares of common stock Dilution increase in total number of shares that will divide a fixed amount of earnings Gross margin ability of firm to sell a product for more than its costs Gross profit sales cost of goods sold Operating margin how much a firm has earned from each dollar of sales before taxes Operating income gross profit admin expenses r d deprc Net profit margin fraction of each dollar in revenues that s available to equity holders after the firm pays expenses taxes Net income operating income taxes Asset turnovers low value indicate that firm is not generating much sales per dollar of assets Account receivable days DSO how long it takes to receive the money for the sale EBITDA Earnings Before Interest Taxes Depreciation Amortization Times interest earned ratio TIE how easily firm will be able to cover its interest payments Return on equity ROE measure of return that firm has earned on its past investments Dupont identity ROE profit margin x asset turnover x equity multiplier Equity multiplier total assets total equity Price to earnings ratio to assess whether a stock is over under valued Statement of cash flows how much firm has used the cash earned during a set period Operating depreciation accts rcv accs pay inventory Investment capital expenditures Financing any cash firm received from sale of stocks cash spent repurchasing its own stock Retained Earnings Net income Dividends Payout ratio dividends net income Off balance sheet transactions transactions that can have a material impact on firm s future