FINANC 3000 1st Edition Exam # 1 Study Guide Lectures: 1 - 6Lecture 1 Introduction to Financial Management- What is Finance?o The study of applying specific value to things we own, services we use, and decisions we make.- Three main principles of financeo Cash flowo Timing of those flowso Risk of those flows- Finance vs. Accountingo Accounting tracks what happened to the firm’s money in the pasto Financial Management combines historical figures and current information to determine what should happen with the firm’s money now and in the future- Business Form typeso Sole proprietorshipso General Partnershipso Corporationso Hybrids (LLC, LLP, LP)- Agency theoryo Problems arise when principal (shareholder) hires agent (manager) to operate firm but cannot monitor the agent’s actions Manager’s interests may not be aligned with shareholder’s goals 3 ways to minimize this conflict of interest- Ignore if effect is minimal- Use accountants, debt holders to monitor managers- Provide incentives to managers- What is Corporate Governance?o Set of laws, policies, incentives, and monitors designed to handle issues arising from the separation of ownership and controlLecture 2 Reviewing Financial Statements- Annual report = four basic financial statementso Balance sheetReports firms assets, liabilities, and equity at a point in time- Assets = liabilities + equityo Income statement Firm’s total earned revenues and total incurred expenses over a period of time- Income statement top line = revenues- Expenses listed below revenues- Bottom line = difference between revenues and expenseso Statement of cash flows Financial statement that shows firm’s cash flows over a given period of time Two main sources of difference:- GAAP Accounting Principles- Noncash income statement entries Cash flows from operation activities- Cash flows that result directly from producing and selling the firm’s products Cash flows from investing activities- Represents cash flows associated with buying or selling fixed or other long-term assets- Reflects the firm’s investment in or disposal of fixed assets Cash flows from financing activities- Cash flows from debt and equity financing transactionso Statement of retained earnings Details changes in retained earnings during reporting period Reconciles net income and dividends paid with changes in retained earnings from one period to the next- (beginning retained earnings + net income for period) – cash dividends paid = ending retained earnings- Net Working Capitalo = current assets – current liabilitieso It is the measure of a firm’s ability to pay obligations- Liquidityo The ability to convert assets into cash at Fair Market Value (FMV)o current assets = most liquido fixed assets = less liquid- Debt vs. Equity Financingo Financial leverage = debt securities Magnifies gains and losses  Debt holders -- fixed claim on firm’s cash flows (interest paid on securities) Stockholders – claim on remaining cash flow- Book Value vs. Market Valueo Book value (Historical cost) Assets listed on balance sheet at purchase priceo Market Value Assets listed at value if sold in today’s market- Earnings per Share for Common Stockholderso (net income – dividends on preferred stock)/ average outstanding shares- Corporate Income Taxeso Average tax rate Percentage of each dollar of taxable income that the firm pays in taxes- Average tax rate = tax liability/taxable incomeo Marginal tax rate Taxes paid for each dollar of firm’s additional taxable incomeLecture 3 Time Value of Money: Analyzing Single Cash Flows Pt. 1- Time Value of Money (TVM) Basic Concepto $1 today is worth more than $1 next year Inflation reduces the value- Organizing Cash flowso Inflow = cash received Positive numbero Outflow = cash going out Negative number- Compound Interesto the interest on both the principal and its unpaid interest added to it at stated intervals- Compounding and Future Valueo Interest is earned on both principal and interest FVN = PV x (1+i)^N- Compounding at different rateso FVn = PV x (1+iperiod 1) x (1+iperiod 2) x (1+iperiod n)- Compound interest: Compounding Periodso There are alternatives to annual compounding Many corporate and government bonds pay interest twice a year and have semiannual compounding Most mortgage loans and auto loans have monthly payments and thus monthly compounding FV = PV x [1 +(i/m)]^nxm- Present valueo Discountingo Value today of sum expected to be received in future PV = FV/(1+i)- Present Value over multiple periodso Reverse of compounding over multiple periods PV = FVN x [1/(1+i)^N]- = FVN/(1+i)^N- Present Value with Multiple Rateso Value today of sum expected to be received in future –variable rates of interest over time PV = FVN/(1+iperiod 1) x (1+iperiod 2) x (1+iperiod 3)x….x(1+iperiod N)Lecture 4 Time Value of Money: Analyzing Single Cash Flows Pt. 2- Moving Cash flowso Use PV calculation when cash flow is moved to an earlier dateo Use FV calculation when cash flow is moved to a later date- Rule of 72o How much time for an investment to double? Approximate number of years to double an investment- =72/interest rate- Finding the Interest rateo i= [(FVt/PV)^(1/t)]-1- Return assymetrieso You bought a gold coing for $700 a year ago, now it’s worth $350. How much did you lose? (750/350)/700 = 0.5 or 50%o How much do you need to earn to get back to $700? (700-350)/350 =1 or 100%Lecture 5Time Value of Money: Analyzing Multiple Cash Flows Pt. 1- Multiple cash flowso Regular, evenly spaced Car loans and home mortgage loans Saving for retirement Companies paying interest on debt Companies paying dividends- FV – Multiple Cash Flowso Value in the futureo Different cash flows paid at different times FVN = {PMTm x [(1+i)^(N-m)]} + {PMTn x [(1+i)^(N-n)]} + {PMTp x [(1+i)^(N-p)]}- FV – Level Cash Flowso Each cash flow is the same and occurs every year – “annuity” Occurs at the end of first year and continues every year to the last year Same cash flows paid in every period- FVAN = {PMT x [(1+i)^(N-1)]} + {PMT x [(1+i)^(N-2)]} + {PMT x [(1+i)^(N-3)]}- FVAN = PMT x {[(1+i)^N]-1}/i- PV – Multiple Cash Flowso Car loans and home mortgage loanso Determining value of business opportunitieso Uneven cash flows PV = {PMTm/[(1+i)^(N-m)]}