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Week 1 Slides


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Week 1 Slides

  1. 1. Overview of Finance Week 1 – August 26 and 28, 2002
  2. 2. Financial Analysis, Functions, and Careers August 28, 2002
  3. 3. FBE 432 Objectives <ul><li>Analyze and communicate implications of financial theory using cases </li></ul><ul><li>Understand finance careers and functions </li></ul><ul><li>Refine and expand specific financial analytical skills </li></ul><ul><li>Responsibility for learning is with you </li></ul><ul><li>Requirements are clear: review, prepare, and participate </li></ul>
  4. 4. Financial Analysis <ul><li>Analyze performance of corporations (and projects) </li></ul><ul><ul><li>What should be the objective of financial management? </li></ul></ul><ul><ul><li>How do we determine whether management is good or bad? </li></ul></ul><ul><li>Focus in finance is on the future </li></ul><ul><ul><li>Who knows what will happen in the future? </li></ul></ul><ul><ul><li>How can we deal with our uncertainty concerning the future? </li></ul></ul>
  5. 5. Financial Functions <ul><li>All finance is concerned with value </li></ul><ul><li>Corporate decision-making </li></ul><ul><ul><li>Investments, including mergers and acquisitions and divestitures (disinvestment) </li></ul></ul><ul><ul><li>Growth and financing needs </li></ul></ul><ul><ul><li>Management of working capital </li></ul></ul><ul><li>Chief financial officer is responsible for these decisions </li></ul><ul><ul><li>Requires project analysts, treasury assistants </li></ul></ul>
  6. 6. Investment Banking <ul><li>Investment bankers assist corporations in their dealings with financial markets </li></ul><ul><ul><li>Issuing securities </li></ul></ul><ul><ul><ul><li>Initial public offerings (IPOs) or secondary offerings </li></ul></ul></ul><ul><ul><ul><li>Issuing debt or preferred stock to private investors (private placements) or to public markets </li></ul></ul></ul><ul><ul><li>Mergers and acquisitions </li></ul></ul><ul><ul><li>Advising and valuing firms </li></ul></ul><ul><li>This services are corporate finance or investment banking services </li></ul>
  7. 7. Investment Banking (continued) <ul><li>Investment bankers also buy and sell securities </li></ul><ul><ul><li>Brokers (retail and institutional) </li></ul></ul><ul><ul><li>Market makers </li></ul></ul><ul><ul><li>Asset management </li></ul></ul><ul><ul><li>Research </li></ul></ul><ul><li>Investment banks are classified in a variety of ways </li></ul><ul><ul><li>Full line </li></ul></ul><ul><ul><li>Boutique </li></ul></ul><ul><ul><li>Regional </li></ul></ul><ul><ul><li>“ Bulge bracket” </li></ul></ul>
  8. 8. Investment Banking (continued) <ul><li>Investment bankers need many types of financial skills </li></ul><ul><ul><li>Analysts for research </li></ul></ul><ul><ul><li>Analytical support in doing deals </li></ul></ul><ul><ul><li>Traders </li></ul></ul><ul><ul><li>Marketing securities to retail and institutional markets </li></ul></ul><ul><li>Investment banks hire junior analysts and associates at entry level </li></ul>
  9. 9. Investment Banking and Markets <ul><li>Investment bankers assist corporations (and governments) in designing securities for sale to public or private markets </li></ul><ul><li>Employees of investment banks are usually called are said to work on the sell side of a securities firm, or are called sell side analysts or sell side traders or brokers </li></ul>
  10. 10. Investors <ul><li>Individuals and institutions invest savings in securities (and other investments) </li></ul><ul><li>Individuals are usually divided into the retail market (small investors) and affluent investors (private banking) </li></ul><ul><li>Buying and selling securities in the retail market </li></ul><ul><li>Advising and investing for individuals is financial advising and asset management </li></ul><ul><li>Individuals often invest in mutual funds and save in pension plans </li></ul>
  11. 11. Institutional Investors <ul><li>Pension funds, mutual funds, insurance companies, and specialized investment vehicles for wealthy investors (e.g. hedge funds) are called institutional investors </li></ul><ul><li>Institutional investors require analysts and portfolio managers to invest funds </li></ul><ul><li>Employees of institutional investors are usually said to be on the buy side , as for example a buy-side analyst or a buy-side trader </li></ul>
  12. 12. Specialized Investment Vehicles <ul><li>Venture-capital firms provide financing to new firms, often firms in new technologies, requiring both technical and financial skills </li></ul><ul><li>Hedge funds are unregistered investment vehicles for wealthy investors’ or institutional funds, often using complex investment strategies requiring sophisticated financial analytical skills </li></ul>
  13. 13. Developments in Finance <ul><li>Financial theory has developed to value financial instruments like options and swaps </li></ul><ul><li>Technology has developed to enable accounting and trading for complex financial claims like collateralized mortgage obligations (CMOs) </li></ul><ul><li>Trading and valuing these instruments and advising corporations on how to use them to manage risk demands highly developed research departments </li></ul>
  14. 14. Commercial Banking <ul><li>Commercial banks make loans to corporations and individuals </li></ul><ul><li>Corporate commercial bankers provide a variety of services to corporations, including cash management and lending </li></ul><ul><li>Banks require financially trained individuals to call on corporations and analyze corporate customers </li></ul>
  15. 15. Finance Career Paths <ul><li>Many individuals move between financial functions in corporations and investment banking, asset management, commercial banking, and financial advising over the course of their careers </li></ul><ul><li>Research, marketing (selling), deal-making, and advising require varying levels of interpersonal skills </li></ul><ul><li>Risk tolerance and energy requirements vary in different finance career paths </li></ul>
  16. 16. Next Time – August 28 <ul><li>Review valuation approaches </li></ul><ul><li>Read for practice, The Union Carbide Deal (Abridged) </li></ul><ul><ul><li>Outline issues at issue in the case </li></ul></ul><ul><ul><li>What role do investment bankers play? </li></ul></ul><ul><ul><li>How are they compensated? </li></ul></ul>
  17. 17. Introduction to Valuation and Review August 28, 2002
  18. 18. Value and Valuation <ul><li>Finance objective function is to maximize owners’ value </li></ul><ul><li>Value is the present value of future cash flows at the risk-adjusted discount rate </li></ul><ul><li>Valuation principles are the same whether we are valuing stocks, bonds, real estate, or corporations </li></ul><ul><li>The challenge is to estimate the cash flows and choose a discount rate </li></ul>
  19. 19. Corporate Cash Flows <ul><li>Corporate cash flows are similar to all firms’ cash flows, that is, they come from cash revenues minus cash costs </li></ul><ul><li>Because of tax laws and standard reporting conventions, corporate cash flows are more standardized </li></ul><ul><li>Value of claims on corporations can be calculated separately (e.g. stock and bond valuation) or in the aggregate (so-called entity approach ) </li></ul>
  20. 20. Future Corporate Cash Flows <ul><li>Since value comes from future cash flows and the future is unknown, future cash flows must be estimated </li></ul><ul><li>The future is usually divided into two or more parts </li></ul><ul><ul><li>Forecast period and continuing value period </li></ul></ul><ul><ul><li>Rapid growth period and normal growth period </li></ul></ul><ul><li>Choice of division depends on case and data available </li></ul>
  21. 21. Cash Flow Determination <ul><li>Items From the Income Statement </li></ul><ul><ul><li>Revenues (R) </li></ul></ul><ul><ul><li>Cash Expenses (W) </li></ul></ul><ul><ul><li>Non-Cash Expenses (Dep) </li></ul></ul><ul><ul><li>Capital Expenditures (Capex) </li></ul></ul><ul><ul><li>Cost of Goods Sold (CGS): </li></ul></ul><ul><ul><ul><li>Excludes depreciation </li></ul></ul></ul><ul><ul><li>Interest Expense (Int) </li></ul></ul><ul><ul><li>Taxes (T) </li></ul></ul>
  22. 22. Cash Flow Determination <ul><li>Other Items </li></ul><ul><ul><li>Tax Rate (  ) </li></ul></ul><ul><ul><li>Repayment of Principal (P) </li></ul></ul><ul><ul><li>Changes in Net Working Capital (  NWC) </li></ul></ul><ul><ul><li>Permanent Debt (D) </li></ul></ul>
  23. 23. Definition of Earnings Components <ul><li>Earnings Before Interest & Taxes [EBIT] </li></ul><ul><ul><li>R-(W+Dep+CGS) </li></ul></ul><ul><li>Earnings Before Interest, Taxes, Depreciation (and Amortization) EBITD(A) </li></ul><ul><ul><li>EBIT+Dep+(Amort) </li></ul></ul>
  24. 24. Definitions of Earnings Components <ul><li>Pre-Tax Income </li></ul><ul><ul><li>[EBIT-Int] </li></ul></ul><ul><li>Tax Bill [T] </li></ul><ul><ul><li> (EBIT-Int) </li></ul></ul><ul><li>Net Income </li></ul><ul><ul><li>NI =Pre-Tax Income - T </li></ul></ul>
  25. 25. Cash Flow Definitions <ul><li>Levered Cash Flow [to equity] {LCF or FTE} </li></ul><ul><ul><li>Money that goes to stockholders account </li></ul></ul><ul><ul><li>[R-(W+Dep+CGS+Int)](1-  )+Dep-Capex-P-  NWC </li></ul></ul><ul><li>Unlevered Cash Flow {UCF} </li></ul><ul><ul><li>Cash flow that would occur if there was no debt </li></ul></ul><ul><ul><li>(1-  )EBIT+Dep-Capex -  NWC </li></ul></ul>
  26. 26. Next Week – September 4 <ul><li>Review valuation techniques and relate to case materials </li></ul><ul><li>Prepare Eskimo Pie Case </li></ul><ul><li>Form groups for group case analyses following Eskimo Pie </li></ul>