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1-1 © 2002, 2012 Frank M. Werner and James A.F. Stoner
Exam I
♦ Chapters – 1 – 2 – 3
Chapter 1
What is Financial Managing?
1-3 © 2002, 2012 Frank M. Werner and James A.F. Stoner
What is Financial Managing?
♦ Introductory concepts – what is finance? ♦ The development of the finance discipline ♦ The purpose of the firm ♦ Concerns about shareholder wealth
maximization ♦ Emerging new approaches that begin re-
integrating societal and shareholder interests
1-4 © 2002, 2012 Frank M. Werner and James A.F. Stoner
What is Financial Managing?
♦ Introductory concepts – what is finance? ♦ The development of the finance discipline ♦ The purpose of the firm ♦ Concerns about shareholder wealth
maximization ♦ Emerging new approaches that begin re-
integrating societal and shareholder interests
1-5 © 2002, 2012 Frank M. Werner and James A.F. Stoner
What is Finance?
♦ The study and practice of how money is raised and used by organizations
♦ Finance derives in part from economics – The microeconomic “theory of the firm”
♦ Finance has many stakeholders – Product/service markets – customers,
employees, suppliers – Financial markets – lenders, investors – Governments and society
1-6 © 2002, 2012 Frank M. Werner and James A.F. Stoner
Money Flows of a Business
1-7 © 2002, 2012 Frank M. Werner and James A.F. Stoner
Organizing Finance by Academic Studies and Career Paths
♦ Financial managing ♦ Investments
– Investment analysis – Portfolio management – Derivatives and financial engineering
♦ Markets and institutions – Banks – Money and capital markets
1-8 © 2002, 2012 Frank M. Werner and James A.F. Stoner
Organizing Finance by Academic Studies and Career Paths
1-9 © 2002, 2012 Frank M. Werner and James A.F. Stoner
Organizing Finance Around the Concerns of Financial Managers
♦ The financial environment – Economic, political, legal, ethical, social, etc.
♦ Financial instruments – Securities – stocks, bonds – Investment bankers – Commercial bankers
♦ Financial managing
1-10 © 2002, 2012 Frank M. Werner and James A.F. Stoner
What is Financial Managing?
♦ Introductory concepts – what is finance? ♦ The development of the finance discipline ♦ The purpose of the firm ♦ Concerns about shareholder wealth
maximization ♦ Emerging new approaches that begin re-
integrating societal and shareholder interests
1-11 © 2002, 2012 Frank M. Werner and James A.F. Stoner
A Timetable of Financial Thought
1-12 © 2002, 2012 Frank M. Werner and James A.F. Stoner
The Development of the Finance Discipline ♦ The continuing evolution of financial
managing – Change is dramatic, rapid, and accelerating – Examples from the U.S.
• Banking industry • Automobile industry • Computer industry
1-13 © 2002, 2012 Frank M. Werner and James A.F. Stoner
The Development of the Finance Discipline ♦ Major forces for change
– Increased international cooperation, communication, and competition
– Revolutionary rates of improvement in the quality of goods and services
– Global sustainability – Increased diversity in organizations’ work
forces, customers, and suppliers – Rapid changes in information technologies – A shift from physical capital to human capital
1-14 © 2002, 2012 Frank M. Werner and James A.F. Stoner
The Development of the Finance Discipline Major forces for change (continued)
– Changes in ethical standards and expectations – Changes in the ways organizations are managed – Changes in governmental policies and actions
♦ Implications of these forces for financial managing – Life-long education – Seeing the organization as a system – Understanding the value in sustainable products
and production technologies
1-15 © 2002, 2012 Frank M. Werner and James A.F. Stoner
What is Financial Managing?
♦ Introductory concepts – what is finance? ♦ The development of the finance discipline ♦ The purpose of the firm ♦ Concerns about shareholder wealth
maximization ♦ Emerging new approaches that begin re-
integrating societal and shareholder interests
1-16 © 2002, 2012 Frank M. Werner and James A.F. Stoner
The Purpose of the Firm
♦ The need for goals ♦ The role of business in society
– Capitalist economic system
♦ The microeconomic goal: profit maximization – Efficient allocation of resources – Problems
• Accounting profits may not equal economic profits • Profits do not consider risk
1-17 © 2002, 2012 Frank M. Werner and James A.F. Stoner
The Purpose of the Firm
♦ The traditional finance goal: maximization of shareholder wealth – Equals share price plus dividends – Avoids many profit definition issues – In an efficient capital market, provides for
• Effective allocation of new investment funds • Evaluation of investment risks
– Investors provide feedback to (“signal”) management about risk and return levels
1-18 © 2002, 2012 Frank M. Werner and James A.F. Stoner
The Logic of Share-Price Maximization
1-19 © 2002, 2012 Frank M. Werner and James A.F. Stoner
What is Financial Managing?
♦ Introductory concepts – what is finance? ♦ The development of the finance discipline ♦ The purpose of the firm ♦ Concerns about shareholder wealth
maximization ♦ Emerging new approaches that begin re-
integrating societal and shareholder interests
1-20 © 2002, 2012 Frank M. Werner and James A.F. Stoner
Concerns About Shareholder Wealth Maximization ♦ Outcomes for society
– Income inequality – Failure to take socially responsible actions – Poorly directed business activities
♦ Actions within the firm – A useful measuring stick? – Creating the right image? – Inspiring commitment? – Encouraging ethics?
1-21 © 2002, 2012 Frank M. Werner and James A.F. Stoner
What is Financial Managing?
♦ Introductory concepts – what is finance? ♦ The development of the finance discipline ♦ The purpose of the firm ♦ Concerns about shareholder wealth
maximization ♦ Emerging new approaches that begin re-
integrating societal and shareholder interests
1-22 © 2002, 2012 Frank M. Werner and James A.F. Stoner
Emerging New Approaches
♦ Aligning goals throughout the organization – Using process-focused goals – Building on people’s integrity – Focusing on cross-functional relationships
1-23 © 2002, 2012 Frank M. Werner and James A.F. Stoner
Emerging New Approaches – A Sequence of Goals ♦ On a day-to-day basis
– Treat customers like royalty – Treat employees fairly – Treat suppliers and creditors with respect and courtesy – Treat neighbors as they would wish to be treated – Constantly strive to reduce costs, increase quality, and
add to market share in all aspects of the business
♦ On a long-term basis – Treat shareholders to the high returns that will come
from properly implementing the day-to-day actions
1-24 © 2002, 2012 Frank M. Werner and James A.F. Stoner
A Sequence of Goals – The Johnson & Johnson Company Credo
1-25 © 2002, 2012 Frank M. Werner and James A.F. Stoner
A Sequence of Goals – The Johnson & Johnson Company Credo
1-26 © 2002, 2012 Frank M. Werner and James A.F. Stoner
Emerging New Approaches – The UN Global Compact ♦ Human rights:
1. Businesses should support and respect the protection of internationally proclaimed human rights; and
2. make sure that they are not complicit in human rights abuses.
1-27 © 2002, 2012 Frank M. Werner and James A.F. Stoner
Emerging New Approaches – The UN Global Compact ♦ Labour:
3. Businesses should uphold the freedom of association and the effective recognition of the right to collective bargaining;
4. the elimination of all forms of forced and compulsory labour;
5. the effective abolition of child labour; and 6. the elimination of discrimination in respect of
employment and occupation.
1-28 © 2002, 2012 Frank M. Werner and James A.F. Stoner
Emerging New Approaches – The UN Global Compact ♦ Environment:
7. Businesses are asked to support a precautionary approach to environmental challenges;
8. undertake initiatives to promote greater environmental responsibility; and
9. encourage the development and diffusion of environmentally friendly technologies.
1-29 © 2002, 2012 Frank M. Werner and James A.F. Stoner
Emerging New Approaches – The UN Global Compact ♦ Anti-corruption:
10. Businesses should work against corruption in all its forms, including extortion and bribery.
1-30 © 2002, 2012 Frank M. Werner and James A.F. Stoner
Emerging New Approaches – Global Sustainability ♦ The simultaneous pursuit of financial/
economic success, environmental preservation, and social inclusion
Chapter 2
Data for Financial Decision Making
1-32 © 2002, 2012 Frank M. Werner and James A.F. Stoner
Data for Financial Decision Making ♦ Introductory concepts – the need for good
data ♦ Financial accounting data ♦ Financial ratios ♦ Managerial accounting data ♦ Other data
1-33 © 2002, 2012 Frank M. Werner and James A.F. Stoner
Data for Financial Decision Making ♦ Introductory concepts – the need for good
data ♦ Financial accounting data ♦ Financial ratios ♦ Managerial accounting data ♦ Other data
1-34 © 2002, 2012 Frank M. Werner and James A.F. Stoner
The Need for Good Data
♦ Good judgments require good data ♦ Theory precedes data
– Economic-finance theory teaches us to look at financial data – cash flow, profitability, liquidity, leverage, resource use
– Modern management theory teaches us to look at customer satisfaction and process performance
1-35 © 2002, 2012 Frank M. Werner and James A.F. Stoner
Data for Financial Decision Making ♦ Introductory concepts – the need for good
data ♦ Financial accounting data ♦ Financial ratios ♦ Managerial accounting data ♦ Other data
1-36 © 2002, 2012 Frank M. Werner and James A.F. Stoner
Financial Accounting Data
♦ Used to produce public financial statements – Balance sheet, income statement, statement of cash flows – Rules made by FASB, SEC
♦ The limitations of GAAP – Two different valuation methods mixed together
• Monetary items – cash value • Nonmonetary items – historical cost
– Alternative numbers for the same event – Important information omitted
1-37 © 2002, 2012 Frank M. Werner and James A.F. Stoner
Financial Accounting Data
♦ The need to compare numbers – Impossible to make a judgment with one number – Types of comparisons:
• Benchmark – comparison to a standard value • Competitive benchmark – comparison to best example • Time-series– comparison to previous values of the
same measure, a trend over time • Cross-section – comparison across peer companies at
a point in time
1-38 © 2002, 2012 Frank M. Werner and James A.F. Stoner
Data for Financial Decision Making ♦ Introductory concepts – the need for good
data ♦ Financial accounting data ♦ Financial ratios ♦ Managerial accounting data ♦ Other data
1-39 © 2002, 2012 Frank M. Werner and James A.F. Stoner
Ratios That Measure Profitability ♦ Profitability compared to sales
1-40 © 2002, 2012 Frank M. Werner and James A.F. Stoner
Ratios That Measure Profitability ♦ Profitability compared to assets
♦ Profitability compared to equity
1-41 © 2002, 2012 Frank M. Werner and James A.F. Stoner
Ratios That Measure Effective Use of Working Capital ♦ Working capital
– Refers to current assets and current liabilities – Mathematically:
♦ Measures of overall liquidity
1-42 © 2002, 2012 Frank M. Werner and James A.F. Stoner
Ratios That Measure Effective Use of Working Capital ♦ Measures of the effective use of accounts
receivable
♦ Measures of the effective use of inventories
1-43 © 2002, 2012 Frank M. Werner and James A.F. Stoner
Ratios That Measure Effective Use of Working Capital ♦ Measures of the effective use of accounts
payable
♦ The cash conversion cycle
1-44 © 2002, 2012 Frank M. Werner and James A.F. Stoner
The Cash Conversion Cycle
1-45 © 2002, 2012 Frank M. Werner and James A.F. Stoner
Ratios That Measure the Use of Fixed and Total Assets ♦ A measure of the productivity of fixed
assets
♦ A measure of the productivity of total assets
1-46 © 2002, 2012 Frank M. Werner and James A.F. Stoner
Ratios That Measure the Choice and Management of Funding ♦ Measures of the financing mix
1-47 © 2002, 2012 Frank M. Werner and James A.F. Stoner
Ratios That Measure the Choice and Management of Funding ♦ Measures of the ability to service debt
1-48 © 2002, 2012 Frank M. Werner and James A.F. Stoner
Ratios That Measure the Choice and Management of Funding ♦ Measures of payments against equity
1-49 © 2002, 2012 Frank M. Werner and James A.F. Stoner
Data for Financial Decision Making ♦ Introductory concepts – the need for good
data ♦ Financial accounting data ♦ Financial ratios ♦ Managerial accounting data ♦ Other data
1-50 © 2002, 2012 Frank M. Werner and James A.F. Stoner
Managerial Accounting Data
♦ Used for internal planning, analysis, decision making
♦ Cash flows vs. accrual accounting – Cash flow – real, tangible event; clearly
identifiable; has immediate value – Accrual numbers – based on accounting
conventions, depend on human-made rules – We use a cash flow spreadsheet to summarize
cash flows
1-51 © 2002, 2012 Frank M. Werner and James A.F. Stoner
Cash Flow Spreadsheet
Cash Flow Spreadsheet A company is trying to organize the following cash flows: Buy a machine for $25,000 in 2012. Increase cash inflows by $15,000 in 2013, 2014, and 2015. Pay additional taxes of $8,000 in 2014. Sell the machine for $10,000 in 2015. Question: Prepare a cash flow spreadsheet to summarize this information Solution:
Year 0 Year 1 Year 2 Year 3 Event 2012 2013 2014 2015 Buy machine (25,000) Additional cash inflows 15,000 15,000 15,000 Additional taxes (8,000) Sell machine 10,000 Net cash flows (25,000) 15,000 7,000 25,000
1-52 © 2002, 2012 Frank M. Werner and James A.F. Stoner
Types of Costs
♦ Total, average, marginal – Total – sum of the costs for all units made – Average – cost per unit – Marginal – cost of making one more unit
♦ Incremental – the change from taking an action
♦ Sunk – spent in the past, cannot change ♦ Opportunity – a lost benefit ♦ Variable, fixed – with respect to sales
1-53 © 2002, 2012 Frank M. Werner and James A.F. Stoner
A U-Shaped Cost Curve
1-54 © 2002, 2012 Frank M. Werner and James A.F. Stoner
Managerial Accounting Data
♦ Tax rates – Taxes are a cash flow, therefore important in
financial decision making – The government requires a company pay only
the taxes specified by law — paying more taxes takes value from other stakeholders
– While the tax code is complex, the textbook uses flat rates of 34% or 35% to simplify illustrations
1-55 © 2002, 2012 Frank M. Werner and James A.F. Stoner
Data for Financial Decision Making ♦ Introductory concepts – the need for good
data ♦ Financial accounting data ♦ Financial ratios ♦ Managerial accounting data ♦ Other data
1-56 © 2002, 2012 Frank M. Werner and James A.F. Stoner
Other Data
♦ Economic data – GNP growth, inflation, interest rates, foreign
exchange rates, etc. – Competitive actions, pressures within industry
♦ People data – customer and employee satisfaction
♦ Process data – Absolute number of failures – Relative number of failures – failures per
opportunity to fail, six sigma goal – Cycle time – time for a process or process step
1-57 © 2002, 2012 Frank M. Werner and James A.F. Stoner
Other Data
♦ ESG data – Environmental data – energy use and efficiency,
greenhouse gas emissions, water use, eco-friendly product innovation
– Social data – employee health and safety, diversity, human rights, community support, product safety
– Governance data –independence of board, transparency of public reporting, company code of conduct
Chapter 3
The Time Value of Money
1-59 © 2002, 2012 Frank M. Werner and James A.F. Stoner
The Time Value of Money
♦ Introductory concepts – the money rules ♦ The fundamental relationship ♦ Multiple cash flows – uneven flows ♦ Multiple cash flows – cash flows that
form a pattern
1-60 © 2002, 2012 Frank M. Werner and James A.F. Stoner
The Time Value of Money
♦ Introductory concepts – the money rules ♦ The fundamental relationship ♦ Multiple cash flows – uneven flows ♦ Multiple cash flows – cash flows that
form a pattern
1-61 © 2002, 2012 Frank M. Werner and James A.F. Stoner
The Money Rules
♦ Value depends on the AMOUNT – Choose to receive MORE, pay LESS
♦ Value depends on the TIMING – Choose to receive SOONER, pay LATER
♦ The value of a business deal involves a tradeoff between amount and timing
♦ Money flows can only be compared after being adjusted for time value
1-62 © 2002, 2012 Frank M. Werner and James A.F. Stoner
The Time Value of Money
♦ Introductory concepts – the money rules ♦ The fundamental relationship ♦ Multiple cash flows – uneven flows ♦ Multiple cash flows – cash flows that
form a pattern
1-63 © 2002, 2012 Frank M. Werner and James A.F. Stoner
The Fundamental Relationship
♦ Compound interest
♦ Solved for present value
1-64 © 2002, 2012 Frank M. Werner and James A.F. Stoner
Using a Time Value Table
1-65 © 2002, 2012 Frank M. Werner and James A.F. Stoner
Using a Financial Calculator
1-66 © 2002, 2012 Frank M. Werner and James A.F. Stoner
The Four Fundamental Calculations ♦ Finding future value (FV)
– Given PV, n, i
♦ Finding present value (PV) – Given FV, n, i
♦ Finding a time period (n) – Given PV, FV, i
♦ Finding an interest rate (i) – Given PV, FV, n
1-67 © 2002, 2012 Frank M. Werner and James A.F. Stoner
The Time Value of Money
♦ Introductory concepts – the money rules ♦ The fundamental relationship ♦ Multiple cash flows – uneven flows ♦ Multiple cash flows – cash flows that
form a pattern
1-68 © 2002, 2012 Frank M. Werner and James A.F. Stoner
Multiple Cash Flows – Uneven Flows ♦ To calculate the PV or FV of a “package”
of cash flows – Calculate the PV or FV of each flow – Add the PVs or FVs to get the total value
♦ Alternative method – use the “cash flow list” feature of your financial calculator – Input all cash flows and an interest rate – Obtain the total PV or FV with one calculation – Can also calculate an interest rate
1-69 © 2002, 2012 Frank M. Werner and James A.F. Stoner
The Time Value of Money
♦ Introductory concepts – the money rules ♦ The fundamental relationship ♦ Multiple cash flows – uneven flows ♦ Multiple cash flows – cash flows that
form a pattern
1-70 © 2002, 2012 Frank M. Werner and James A.F. Stoner
The Annuity
♦ Defined – a set of equal cash flows – Equal amounts – Equal direction of flow (all inflows or all
outflows) – Equal spacing in time (e.g., all at monthly
intervals)
1-71 © 2002, 2012 Frank M. Werner and James A.F. Stoner
Using a Financial Calculator
1-72 © 2002, 2012 Frank M. Werner and James A.F. Stoner
The Five Annuity Calculations
♦ Finding present value (PV) – Given PMT, n, i
♦ Finding the amount of an annuity (PMT) – Given n, i, and either PV or FV
♦ Finding future value (FV) – Given PMT, n, i
♦ Finding a time period (n) – Given PMT, i, and either PV or FV
♦ Finding an interest rate (i) – Given PMT, n, and either PV or FV
1-73 © 2002, 2012 Frank M. Werner and James A.F. Stoner
Ordinary Annuities vs. Annuities Due ♦ Payments at the END of the period
– Ordinary annuity – Annuity in arrears – END annuity
♦ Payments at the BEGINNING of the period – Annuity due – Annuity in advance – BEGIN annuity
1-74 © 2002, 2012 Frank M. Werner and James A.F. Stoner
Using a Financial Calculator
1-75 © 2002, 2012 Frank M. Werner and James A.F. Stoner
The Growing Cash Stream
♦ An infinitely long sequence of equally spaced cash flows
♦ Each flow is different from the previous one by a constant rate of growth (g)
♦ PV of a growing cash stream
1-76 © 2002, 2012 Frank M. Werner and James A.F. Stoner
The Perpetuity
♦ An annuity that continues forever ♦ (A growing cash stream with zero
growth) ♦ PV of a perpetuity
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