The Corporation: en genomgång

730g32 HT 2012Fundamentals of Corporate Finance

BMMLecture 4: Chap. 1, 2, 3 & 4: Financial decisions,

Financial institutions, and performance measures

LEARNING OBJECTIVES

Chapter 1• Understand the definition of a corporation• The role of the financial manager in a

corporation.• Functions of financial markets.• Principal-agent problems, agency costs and

information asymmetries.

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Corporations • two types of financial decisions that are made

in a corporation: investment decisions and financing decisions.

• Financial managers are responsible for both decisions!

Investment decisions

Financing decisions

Financial Market

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Corporation

• Corporation– A business organized as a separate legal entity owned

by stockholders. – Or a nexus of contract between legal entities.

• Types of Corporations– Public Companies– Private Corporations, sole proprietorships– Partnerships– Etc.

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Organizing a BusinessSole

Proprietorship Partnership Corporation

Who owns the business? The manager Partners Stockholders

Are managers and owners separate? No No Usually

What is the owner's liability? Unlimited Unlimited Limited

Are the owner and business taxed

separately?No No Yes

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Corporate Structure

Sole Proprietorships

Corporations

Partnerships

Limited Liability

Corporate tax on profits +

Personal tax on dividends

Unlimited Liability

Personal tax on profits

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Who is The Financial Manager?

• Chief Financial Officer (CFO)– Oversees the treasurer and controller and sets

overall financial strategy.• Treasurer

– Responsible for financing, cash management, and relationships with banks and other financial institutions.

• Controller– Responsible for budgeting, accounting, and taxes.

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Who is The Financial Manager?

Chief Financial Officer

Treasurer Controller

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Definitions

Capital Budgeting Decision– Decision to invest in tangible or intangible assets.

…also called the Investment DecisionFinancing Decision

– The form and amount of financing of a firm’s investments.

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Capital Structure (D/E ratio)

• Capital StructureThe proportion of debt vs. equity financing.1.Debt/Equity ratio, a multiple of debt over equity. Can be tricky when equity becomes small.2.D/(E+D) debt asset ratio measures the indebtedness of the company. ranging from 0 to 100%.Market capitalization: the company´s total amount of shares outstanding times the share price.

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Distinguishing Real Assetsand Financial Assets

• Real Assets– Assets used to produce goods and services.– examples: Patents, Machines, a new pipeline, etc

• Financial Assets– Financial claims to the income generated by the

firm’s real assets.– Examples: stocks, bonds, bank loans

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The Goals of the corporation• Firm Value maximization: I. Anglo-America model: shareholder interests II. Continental European model: Stakeholder interests

which include all claimants who has a vested interest in the company, for example, the supplier, the workers union, the local government, tax authority, etc.

Is it just a conceptual dispute? Most firms do maximize Firm value taken into

consideration of the stakeholder interests: That is to say, Corporate Social Responsibilities, ethics

of corporation add value to the firm.

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Corporate governanceand Agency problems

• Shareholder oriented model: US, UK1. Professional managers, principal-agency problems,

agency costs, 2. Monitoring type: Shareholder meeting, institutional

ownership, specialist monitoring3. Market for corporate control: hostile takeovers

• Stakeholder oriented model: continental Europe1. Big shareholder control, long term ownership, Less

agency costs, Less problem of investor protection, specialist

2. Bank monitoring, Shareholder Meeting, friendly takeover

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Asymmetric information and Principal agency problem

Managers know more about the corporation including:•Stock price movement and returns•Issues of shares and other securities•Dividends decision•Financing Managers may have their own goals other than shareholders´.

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Agency Problem Solutions

1 – Management Compensation plans2 - Board of Directors3 – Market for corporate control:

Takeovers4 - Specialist Monitoring5 - Legal and Regulatory Requirements

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Chap 2. Financial Markets and Institutions

Learning objectives•The Importance of Financial Markets and Institutions•The Flow of Savings to Corporations•Functions of Financial Markets and of Financial Intermediaries•Value Maximization and the Cost of Capital

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Financial Markets

Primary

Markets: issuing stocks, bonds

Secondary

Markets: trading

stocks, bonds

OTC

Markets: forex

trading

Money

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Financial Markets

Company

Issue Securities

Cash

InvestorsCash Reinvested

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Corporation

Investment in real assets

Investorsworldwide

Financial markets

Stock marketsFixed-income marketsMoney marketsMarkets for Commodities Foreign exchange Derivatives

Financial Intermediaries:

Mutual Funds Pension funds

Financial Institutions

Banks Insurance companies

Reinvestment

Financial Markets

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Financial InstitutionsCompany

IntermediariesBanks

Insurance Cos.

Brokerage Firms

ObligationsFunds

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Financial InstitutionsIntermediaries

InvestorsDepositors (sparare)

Policyholders (försäkringstagare)

Investors

ObligationsFunds

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Financial Markets

Funds

Funds

Banks

Insurance Cos.

Brokerage Firms

Obligations

Depositors

Policyholders

Investors

Obligations

Company

Intermediary

Investor

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Financial Markets

Banks

Depositors

$2.5 m

Cash

Loan

Deposits

Company

Intermediary

Investor

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Financial Market: some definitions• Financial Market is a market where securities are

issued and traded.• A security is a traded financial asset. Shares,

bonds, asset backed securities, options, etc.• Fixed income market: market for debt securities,

for example, treasury bills, corporate bond, etc.• Capital market: market for long term financing,

e.g. stocks, long term bonds, etc.• Money market: market for short term financing,

less than 1 year.

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Function of Financial Markets

• Transporting cash across time• Risk transfer and diversification• provide Liquidity• Payment mechanism• Provide useful information for all: commodity

price, cost of capital, interest rate, exchange rate, share price, etc.

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U.S. Financing

Information Provided by Financial Markets• Commodity prices• Interest rates• Company values Credit Rating Interest Rate

AAA 5.71%AA 5.78A 6.38BBB 7.12BB 9.84B 10.82

Source: Bloomberg Composite Corporate BondIndexes.

Interest rates on 30-year corporate bonds,February 2008.

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Opportunity cost of capital(alternativ kapitalkostnad)

• Opportunity cost of capital: the best possible investment forego by the investor is the opportunity cost of capital for the firm.

• Cost of capital: minimum acceptable rate of return on capital investment for the investor.

• The investors can invest in financial market and get expected rate of return on the investment at a similar risk level. This expected rate of return in the market determines the firm´s cost of capital.

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Chapter 4 Measuring corporate performance

Important issues! Very relevant for business lawyers.•Measuring Profitability•Measuring Efficiency•Analyzing the Return on Assets: The Du Pont System•Measuring Leverage•Measuring Liquidity•Interpreting Financial Ratios

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Importance of accounting data

Performance evaluationFinancial decisions Financial decisions

Accounting data Accounting data

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Value and Value Added

• Market CapitalizationTotal market value of equity, equal to share price times number of shares outstanding.

• Market Value AddedMarket capitalization minus book value of equity.

share)per (priceshares) (# tion CapitalizaMarket

ValueBook Equity -tion CapitalizaMarket MVA

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Value and Value AddedPepsiCo Balance Sheet (December 31, 2006) $Millions

Pepsico Income Statement (year end 2006) M$

Net Sales 35,753Cost Of Goods Sold 15,762Selling, G&A expenses 11,530Depreciation expense 1,406EBIT 7,055Net interest expense 66Taxable Income 6,989Income Taxes 1,347Net Income 5,642Allocation of net incomeDividends 1854

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Market-to-Book Ratio: performance measure

– Ratio of market value of equity to book value of equity.

7636815$457102$

equity of book valueequity of uemarket valratiobook -to-Market

.,,

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Pepci´s common stock closed at the end of 2006 at $62,55 per share. There are 1,638 million shares outstanding. So, the total market capitalization =62,55*1,638= $102,457 million

Market-to-Book Ratio• Stock market measures of company performance, 2006.

Companies are ranked by market value added. (dollar values in millions)

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Measuring Profitability

• Economic Value Added (EVA)– Net income minus a charge for the cost of capital

employed. Also called residual income.• Residual Income

– Net Dollar return after deducting the cost of capital

Equity Equity ofCost - IncomeNet Income Residual

EVA

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Measuring Profitability

• Economic Value Added (EVA) of PepsiCo

Equity Equity ofCost - IncomeNet Income Residual

EVA

million $4,527

14,251.095 - 5,642Income Residual

EVA

Obs: the equity figure is the from the end of 2005, because this was the equity employed in the year 2006.

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Measuring Profitability• Return on Equity (ROE)

– Net income as a percentage of shareholders’ equity

• Return on Capital (ROC)– Net income plus Interest as a percentage of long-term

capital.• Return on Assets (ROA)

– Net income plus interest as a percentage of total assets

Svenska termer räntabilitet på eget kapital, se nästa slides

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Lönsamhets nyckeltal

Det totala kapitalets räntabilitet ---- RT

Resultat Mått: Rörelseresultat + finansiella intäkterEllerResultat efter finansiella poster + finansiella kostnaderKapital mått: genomsnittligt totalt kapital=(T0 +T1 )/2

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Rörelseresultat + Finansiella intäkter RT = x 100%

Genomsnittlig Balansomslutning

lönsamhets nyckeltalRT

ROA= Räntabilitet på totala kapital = AVKASTNING på Totala Kapital

RT =VP x KOH Resultat efter finansiella intäkter * Omsättningar

Omsättningar Totalt kapital RT =

Du Pont modellen: RT =VP x KOHDet Totala Kapitalets Räntabilitet RT = vinst marginal x Kapitalomsättningshastighet

Tumregel 7~8% (*statsobligations avkastning + riskpremie)

RT Return on Assets ROA

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RsyssAvkastning (Rsyss) på sysselsatt Kapital=

Rörelseresultat + finansiella intäkterx 100%

Genomsnittligt Sysselsatt Kapital

Sysselsatt kapital = Balansomslutning - Ej räntebärande skulder (till Leverantörer)- Latenta skatteskulder (på obesk. reserver)

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RE ROE Return on EquityAvkastning på Eget Kapital=

Rörelseresultat efter fin. netto x (1-τ) Genomsnittligt justerat eget kapital*

*: Eget kapital + obeskattade reserver *(1- τ) τ : skattesats. Bolagsskatten år 2012 är 26,3 %

Den mäter ett företags effektivitet att generera vinster för varje krona av nettotillgångar (Tillgång-skulder)

X 100%

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Effektivitet i Kapitalanvändning

Kapitalomsättningshastighet (KOH)KOH= Omsättning / Total kapitalTumregel 1,5 för KOH.Ränta Betalningsförmåga:Räntetäckningsgrad = resultat efter finansiella intäkter / finansiella kostnader Tumregel är 2, men minst 1.

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Rörelseresultat

Rörelsemarginal = rörelseresultat / omsättning

Vinstmarginal (VP)Brukar kallas KapitalersättningsmarginalDe vanligaste definitionerna är: Resultat före finansiella kostnader Omsättning

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Measuring Profitability• Accounting measures of company performance, 2006.

Companies are ranked by return on equity.

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Measuring Profitability (kursbok exempel)

396.14,2515,642

equityincomenet =equityon Return

185.31,727

2395,642=assets total

Interest IncomeNet =assetson Return

355.564,16

2395,642equity debt termLong

Interest IncomeNet =capitalon Return

PepsiCo Profitability Measurements

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Measuring Efficiencyyear ofstart at assets total

Sales=ratioover Asset turn

assets totalAverageSales=ratioturnover Asset

OR

13.131,72735,753

year ofstart at assets totalSales=ratioover Asset turn

16.12/)930,29(31,727

35,753assets totalAverage

Sales=ratioover Asset turn

OR

For PepsiCo

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Measuring Efficiency

sold/365 goods ofcost year ofstart at inventory =Inventoryin Days Average

year ofstart at inventory sold goods ofcost =ratioturnover Inventory

salesdaily averageyear ofstart at sreceivable=period collection Average

year ofstart at sreceivablesales=Turnover sReceivable

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The DuPont model

total sales Net Income interest paid ROA= xassets total sales

Assetturnover

Operating Profitmargin

Net Income interest paidROA=assets

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Measuring Leverage

equity+debt termlongdebt termlong=ratiodebt termLong

equitydebt termlong=ratioequity Debt

Skuldsättningsgrad (S/E) = Debt-to-equity ratio (D/E)

Skuldsättningsgrad (S/E) skulder + skatt på obeskattade reserver = eget kapital + obeskattade reserver med avdrag för skatt 50

Measuring Leverage

EBIT+depreciation Cash coverage ratio=interest payments

Räntetäckningsgrad = (EBIT+ avskrivningar)/ räntekostnader

Justerat Eget Kapital (JEK)SOLIDITET =

Totalt Kapital

JEK= Eget kapital + (1 – skattesats) x obeskattade reserver

Equity ratio = shareholders funds/ total assets =shareholders funds/(debt+equity)

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Return on Equity

interestIncomeNet IncomeNet x

salesinterestIncomeNet x

assetssalesx

equityassets=ROE

leverageratio

assetturnover

Operating profitmargin

debtburden

ROA

Kom ihåg: Du Pont modellenRT =VP x KOH

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The DuPont Model

• A breakdown of ROE and ROA into component ratios

salesInterest IncomeNet =MarginProfit Operating

sales IncomeNet =MarginProfit

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Measuring Liquidity

Net working capital Net working capital=to total assets ratio Total assets

current assetsCurrent ratio=current liabilities

sliabilitiecurrent -assetcurrent capital gNet workin

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Liquidity Ratios

sliabilitiecurrent securities marketable+cash=ratioCash

sliabilitiecurrent sreceivable+securities marketable+cash=ratioQuick

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Sustainable Growth

ratiopayout -1=earnings

dividends-earnings=ratioPlowback

earningsdividends=ratioPayout

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Interpreting Financial Ratios• PepsiCo Ratios

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Interpreting Financial Ratios• PepsiCo Ratios (continued)

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Interpreting Financial Ratios• Selected 2006 financial ratios for industry groups in Standard & Poor’s

Composite Index

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Accounting information and market information are important

• The market demand transparency of company information!

• this is to ensure fairness for all the market participants to make informed decision.

• Efficient market is characterized of efficient information revealing.

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Next topic: Valuing stocks!

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