Monday, January 29, 2007

overview unit 3

Overview of Risk and Return, Time Value of Money, Cost of Capital

To date we have examined the role that financial statements - especially pro forma statements - play in mapping out the future course for a company. Before we start talking about the key decision issues at the corporate level, however, we still need to learn about one more set of tools; risk and return, the time value of money, and cost of capital.

Risk and Return

Risk and return are the back bone of finance. Without them, it is impossible to make any rational business decision. Return in its simplest form can be defined as income (or better, net cash inflow) divided by investment. For example, if you buy a house for $100,000 and sell it for $110,000 a year later, your one-year return is 10,000 divided by 100,000 or 10%. We can more or less use the same concept to calculate multi-period returns. We also have the Capital Asset Pricing Model (CAPM) at our disposal for calculating required rates of returns.

Risk, however, needs more explanation. In finance, risk can be discussed both at the corporate level and investment level. For corporations, there are two types of risk; business and financial. For investors, there is only portfolio risk. Business or operating risk has to do with the use of fixed assets by a firm. The more fixed assets a company has in its possession, the more its operating risks. Financial risk has to do with the use of debt by a company; the more debt, the higher the financial risk. The reason for this is simple. In times of economic downturn, companies experience difficulty paying their fixed commitments such as interest or fixed operating costs. This places the company's continuing operation in jeopardy. Portfolio risk on the other hand, also called beta, occurs when we consider investments by either individuals or institutions. Beta is, is in fact, a key component of the CAPM.

Time Value of Money

The basic principle of the time value of money (TVM) is that a dollar received today is worth more than a dollar received tomorrow. The reason for this is the opportunity cost of money - or interest rate. In other words, one could invest an amount today and start collecting interest as time goes on. TVM, closely related to the concept of risk and return, allows us to get a clear sense of financial trade-offs involved in any form of financial transaction such as long-term corporate investments (capital budgeting) at the business level or home loan mortgages at the individual level.

Cost of Capital

Capital is referred to as the right-hand side of the balance sheet - mainly the sum of liability and equity. Cost of capital (COC) is the cost of financing a company’s operations or assets - the left-hand side of the balance sheet. Furthermore, COC is the minimum rate of return that a company’s owners (stockholders) require. If the minimum rate is not achieved by a firm, then the owners will divest their money and invest elsewhere, driving that company’s stock price down and placing the future of the company at risk. In other words, COC is a cost item to companies, and a return item to investors - including bondholders.

financial management - chapter 7 summary

the prices of each share of a firm's common stock is the value of each ownership interest. Although common stockholders typically have voting rights, which indirectly give them a say in management, they are only significant right is their claim on the residual cash flows of the firm. This claim is subordinate to those of vendors, employees, customers, lenders, the government (for taxes), and preferred stockholders. The value of the common stockholders claim is embodied in the cash flows they are entitled to receive from now to infinity. The present value of those expected cash flows is the firms share value.

to determine this present value, forecast cash flows are discounted at a rate that reflects their risk. Riskier cash flows are discounted at higher rates, resulting in lower present values than less risky expected cash flows, which are discounted at lower rates. The value of the firm's common stock is therefore driven by its expected cash flows (returns) and risk (certainty of the expected cash flows.)

in pursuing the firm's goal of maximizing the stock price, the financial manager must carefully consider the balance of return and risk associated with each proposal and must undertake only those actions that create value for owners -- that is, increased share price. By focusing on value creation and by managing and monitoring the firms cash flows and risk, the financial manager should be able to achieve the firm's goal of share price maximization.

Debt versus equity capital
Holders of equity capital (common and preferred stock) are owners of the firm. Typically, only common stockholders have a voice in management. Equity holders claims on income and assets are secondary to creditors claims, there is no maturity date, and dividends paid to stockholders are not tax deductible, as is interest paid to debt holders.

Common and preferred stock
The common stock of a firm can be privately owned, closely owned, or publicly owned. It can be sold with or without a par value. Preemptive rights allow common stockholders to avoid dilution of ownership when new shares are issued. Not all shares authorized in the corporate charter are outstanding. If a firm has treasury stock, it will have issued more shares than are outstanding. Some firms have two or more classes of common stock that deferred mainly in having on equal voting rights. Proxies transfer voting rights from one party to another. The decision to pay dividends to common stockholders is made by the firm's board of directors. Firms can issue stock in foreign markets. The stock of many foreign corporations is traded in the form of American depositary receipts (ADRs) in US markets.

Preferred stockholders have preference over common stockholders with respect to the distribution of earnings and assets. They do not normally have voting privileges. Preferred stock issues may have certain restrictive covenants, cumulative dividends, a call feature, and a conversion feature.

Issuing stock
The initial non-founder financing for business startups with attractive growth prospects typically comes from private equity investors. These investors can be either angel capitalists or venture capitalists (VCs). VCs usually invest in both early stage and later stage companies that they hope to take public so as to cash out their investments.

The first public issue of the firm's stock is called an initial public offering (IPO). The company selects an investment banker to advertise it and to sell the securities. The lead investment banker may form a selling syndicate with other investment bankers. The IPO process includes getting SEC approval, promoting the offering to investors, and pricing the issue.

Stock quotations provide information on calendar year change in price, 52 week high and low, dividend, dividend yield, P/E ratio, volume, closing price, and net price change from the prior trading day.

Market efficiency
Market efficiency as soon set the quake reactions of rational investors to new information cause the market value of common stock to adjust upward or downward quickly. The efficient market hypothesis (EMH) suggests that securities are fairly priced, that they reflect fully all publicly available information, and that investors should therefore not waste time trying to find and capitalize on mispriced securities. Behavioral finance advocates challenged this hypothesis by arguing that emotion and other factors play a role in investment decisions.

The value of a share of common stock is the present value of all future dividends it is expected to provide over an infinite time horizon. Three dividend growth models -- 0 growth, constant growth, and variable growth -- can be considered in common stock valuation. The most widely cited model is the constant growth model.

models and approaches
The free cash flow valuation model values start ups, firms that have no dividend history, or operating units of a larger public company. The model finds the value of the entire company by discounting the firms expected free cash flow at its weighted average cost of capital. The common stock value is found by subtracting the market values of the firm's debt and preferred stock from the value of the entire company.

relationships among financial decisions, return, risk, and the firm's value
In a stable economy, any action of the financial manager that increases the level of expected return without changing risk should increase share value; any action that reduces the level of expected return without changing risk should reduce share value. Similarly, any action that increases risk will reduce share value; any action that reduces risk will increase share value. An assessment of the combined effect of return and risk on stock value must be part of the financial decision-making process.

financial management -- Chapter 7 -- terms

capital -- the long-term funds of a firm; all items on the right hand side of the firm's balance sheet, excluding current liabilities
debt capital -- all long-term borrowing incurred by a firm, including bonds
equity capital -- the long-term funds provided by the firm's owners, the stockholders
privately owned stock -- all common stock of a firm owned by a single individual
closely owned stock -- all common stock of a firm and by a small group of investors (such as a family)
publicly owned stock -- common stock of a firm's owner by a broad group of unrelated individuals or institutional investors
par value stock -- a relatively useless value for a stock established for legal purposes in the firm's corporate charter
preemptive right -- allows common stockholders to maintain their proportionate ownership in the corporation when new shares are issued
dilution of ownership -- occurs when a new stock issue results in each president shareholder having a claim on a smaller par of the firm's earnings than previously
rights -- financial instruments that allow stockholders to purchase additional shares at a price below the market price, in direct proportion to their number of owned shares
authorized shares -- the number of shares of common stock that a firm's corporate charter allows it to issue
outstanding shares -- the number of shares of common stock held by the public
treasury stock -- the number of shares of outstanding stock that have been repurchased by the firm
issued shares -- the number of shares of common stock that have been put into circulation; the sum of outstanding shares and treasury stock
supervoting shares -- stock that carries with it multiple votes per share rather than a single vote per share typically given on regular shares of common stock
nonvoting common stock -- common stock that carries no voting rights; issued when the firm wishes to raise capital through the sale of common stock but does not want to give up its voting control
proxy statement -- a statement transferring the votes of a stockholder to another party
proxy battle -- the attempt of a nonmanagement group to gain control of the management of a firm by soliciting a sufficient number of proxy votes
American depositary receipts (ADRs) -- claims issued by a representing ownership of shares of a foreign company's stock held on deposit by the US bank in the foreign market and issued in dollars to US investors
par value preferred stock -- preferred stock with a stated face value that is used with the specified dividend percentage to determine the annual dollar dividend
no par preferred stock -- preferred stock with no stated face value but with a dated annual dollar dividend
cumulative (preferred Stock) -- preferred stock for which all passed (unpaid) dividends in arrears, along with the current dividend, must be paid before dividends can be paid to common stockholders
noncumulative (preferred Stock) -- preferred stock for which passed (unpaid) dividends do not accumulate
conversion feature -- a feature of convertible preferred stock that allows holders to change each share into a stated number of shares of common stock
venture capital -- privately raised external equity capital used to fund early-stage firms with attractive growth prospects
venture capitalists (VCs) -- providers of venture capital; typically, formal businesses that maintain strong oversight over the firms they invest in and that have clearly defined exit strategies
angel capitalists -- wealthy individual investors who do not operate as a business but invest in promising early-stage companies in exchange for a portion of the firm's equity
initial public offering (IPO) -- the first public sale of a firm's stock
prospectus -- a portion of a security registration statement that describes the key aspects of the issue, the issuer, and its management and financial position
red herring -- a preliminary prospect is made available to prospective investors during the waiting period between the registration statements filing with the SEC and its approval
investment banker -- financial intermediary that specializes in selling new security issues and advising firms with regard to major financial transactions
underwriting -- the role of the investment banker in bearing the risk of reselling, at a profit, the securities purchased from an issuing corporation at an agreed-upon price
underwriting syndicate -- a group formed by an investment banker to share the financial risk associated with underwriting new securities
selling group -- a large number of brokerage firms that join the originating investment bankers; each accepts responsibility for selling a certain portion of a new security issue on a commission basis
expected return -- the return that is expected to be earned on a given asset each period over on infinite time horizon
efficient market hypothesis (EMH) -- theory describing the behavior of an assumed "perfect" market in which:
  • securities are typically in equilibrium
  • security prices fully reflect all public information available and react swiftly to new information
  • because stocks are fully and fairly priced, investors need not waste time looking for mis-priced securities
Behavioral finance -- a growing body of research that focuses on investor behavior and its impact on investment decisions and stock prices. Advocates are commonly referred to as "behaviorists."
Zero growth model -- an approach to dividend valuation that assumes a constant, non growing dividend stream
constant growth model -- a widely cited dividend valuation approach that assumes that dividends will grow at a constant rate, but a rate that is less than the required return
Gordon model -- a common name for the constant growth model that is widely cited in dividend valuation
variable growth model -- a dividend valuation approach that allows for a change in the dividend growth rate
free cash flow valuation model -- a model that determines the value of an entire company as the preset value of its expected free cash flows discounted at the firm's weighted average cost of capital, which is its expected average future cost of funds over the long run
book value per share -- the amount per share of common stock that would be received if all of the firm's assets were sold for their exact book value and the proceeds remaining after paying all liabilities, including preferred stock, were divided among the common stockholders
liquidation value per share -- the actual amount per share of common stock that would be received if all of the firm's assets were sold for their market value, liabilities were paid, and any remaining money were divided among the common stockholders
Price/earnings multiple approach -- a popular technique used to estimate the firm's share value; calculated by multiplying the firms expected earnings per share (EPS) by the average price/earnings (P/E) ratio for the industry

financial management - chapter 5 summary

a firm's risk and expected return directly affect its share price. Risk and return are the two key determinants of the firm's value. It is therefore the financial managers responsibility to assess carefully the risk and return of all major decisions so as to ensure that the expected returns justify the level of risk being introduced.

The way the financial manager can expect to achieve the firm's goal of increasing its share price is to take only those actions that earn returns at least commensurate with their risk. Clearly, financial managers need to recognize, measure, and evaluation risk -- return trade-offs to ensure that their decisions contribute to the creation of value for owners.

risk, return, and risk preferences
Risk is that chance of loss or, more formally, the variability of returns. a number of sources of a firm specific and shareholder specific risks exist. Return of any cash distributions plus the change and value expressed as a percentage of the initial value. Investment returns vary both overtime and between different types of investments. Managers may be risk-averse, risk indifferent, or risk seeking. Most financial decision-makers are risk averse. They generally prefer less risky alternatives, and they require higher expected returns in exchange for taking on greater risk.

Assessing and measuring the risk of a single asset
The rest of a single asset is measured in much the same way as the risk of a portfolio of assets. Sensitivity analysis and probability distributions can be used to assess risk. The range, the standard deviation, and the coefficient of variation can be used to measure risk quantitatively.

Measurement of return and standard deviation for a portfolio
The return of a portfolio calculated as the weighted average of returns on the individual assets from which it is formed. The portfolio standard deviation is found by using the formula for the standard deviation on a single asset.

Correlation -- the statistical relationship between any two series of numbers -- can be positive, negative, or uncorrelated. At the extremes, the series can be perfectly positively correlated or perfectly negatively correlated.

Risk and return characteristics
Diversification and involves combining assets with low correlation to reduce the risk of the portfolio. The range of risk and a two asset portfolio depends on the correlation between the two assets. If they are perfectly positively correlated, the portfolio is risk will be between the individual's assets risks. If they are uncorrelated, the portfolio's risk will be between the risk of the more risky asset and the amount less than the risk of the less risky asset but greater than zero. If they are perfectly negatively correlated, the portfolio's risk will be between the risk of the more risky asset and zero.

International diversification can be used to reduce the portfolio's risk farther. Foreign assets have the risk of currency fluctuation and political risks.

Capital asset pricing model (CAPM) and security market line (SML)
The capital asset pricing model (CAPM) uses beta to relate an assets risk relative to the market to the assets required return. The graphical depiction of CAPM is the security market line (SML), which shifts overtime in response to changing inflationary expectations and/or changes in investor risk aversion. Changes in inflationary expectations result in parallel shifts in the SML. Increasing risk aversion results in a deepening on the slope of the SML. Decreasing risk aversion reduces the slope of the SML. Although it has some shortcomings, CAPM provides a useful conceptual framework for evaluating and linking risk and return.

financial management - chapter 5 vocab

Portfolio -- a collection, or group, of assets
risk -- the chance of financial loss or, more formally, the variability of returns associated with a given cost
return -- the total gain or loss experienced on an investment over a given period of time; calculated by dividing the assets Cash distributions during the period, plus change in value, by a its beginning of period investment value

Sources of risk
firm specific risks
business risk -- the chance at the firm will be unable to cover its operating costs. Level is driven I the firm's revenue stability and the structure of its operating costs (fixed versus variable)
financial risk -- the chance that the firm will be unable to cover its financial obligations. Level is driven by the predictability of the firms operating cash flows and its fixed cost financial obligations
shareholder specific risks
interest rate risk -- the chance that changes in interest rates will adversely affect the value of investment. Most investments lose value when the interest rate raises and increases in value when it falls
liquidity risk -- the chance that an investment cannot be easily liquidated at a reasonable price. Liquidity is significantly affected by the size and depth of the market in which an investment is customarily traded
market risk -- the chance that the value of investment will decline because of market factors that are independent of the investment (such as economic, political, and social event's). In general, the more a given investments value response to the market, the greater its risk; the less it responds, the smaller the risk
firm and shareholder risks
event risk -- the chance that a totally unexpected event will have a significant effect on the value of the firm or a specific investment. These infrequent events, such as government mandated withdrawal of a popular prescription drug, typically affect only a small group of firms or investment
exchange rate risk -- the exposure of future expected cash flows to fluctuations in the currency exchange rate. The greater the chance of undesirable exchange-rate fluctuations, the greater the risk of the cash flows and therefore the lower the value of the firm or investment
purchasing power risk -- the chance that changing price levels caused by inflation or deflation in the economy will adversely affect the firms or investments Cash flows and value. Typically, firms or investments with cash flows that move with general price levels have a little purchasing power risk, and those with cash flows that do not move with general price levels have a high purchasing power risk
tax risk -- the chance that on terrible changes in tax laws will occur. Firms and investments with values that are sensitive to tax law changes are more risky

Risk indifferent -- the attitude toward risk in which no change in return would be required for an increase in risk
risk averse -- the attitude toward risk in which an increase return would be required for an increase in risk
risk seeking -- the attitude toward risk in which a decreased return would be accepted for an increase in risk
sensitivity analysis -- an approach for assessing risk that uses several possible return estimates to obtain a sense of variability among outcomes
range -- a measure of an assets risk, which is found by subtracting the pessimistic outcome from the optimistic outcome
probability -- the chance that a given outcome will occur
probability distribution -- a model that releases of abilities to the associated outcomes
bar chart -- the simplest type of probability distribution; shows only a limited number of outcomes and associated probabilities for a given event
continuous probability distribution -- a probability distribution showing all the possible outcomes and associated probabilities for a given event
standard deviation -- the most common statistical indicator of an assets risk; it measures the dispersion around the expected value
expected value of return -- the most likely return on a given asset
normal probability distribution -- asymmetrical probability distribution to shape resembles a bell shaped curve
coefficient of variation (CV) -- a measure of relative dispersion that is useful in comparing the risks of assets with differing expected returns
efficient portfolio -- a portfolio that maximizes return for a given level of risk or minimizes risk for a given level of return
correlation -- a statistical measure of the relationship between any two series of numbers representing data of any kind
positively correlated -- describes two series that move in the same direction
negatively correlated -- describes two series that move in opposite directions
correlation coefficient -- a measure of the degree of correlation between two series
perfectly positively correlated -- describes to positively correlated series that have a correlation coefficient of +1
perfectly negatively correlated -- describes to negatively correlated series that have a correlation coefficient of -1
uncorrelated -- describes two series that lack any interaction and therefore have a correlation coefficient close to zero
diversification -- combining negatively correlated assets to reduce, or diversify, risk
political risk -- risk that arises from the possibility that a host government will take actions harmful to foreign investors or that political turmoil in a country will endanger investments there
capital asset pricing model (CAPM) -- the basic theory that links risk and return for all assets
total risk -- the combination of a securities nondiversified risk and diversifiable risk
diversifiable risk -- the portion of an assets risk that is attributable to firm specific, random causes; can be eliminated through diversification. Also called unsystematic risk
beta coefficient (b) -- a relative measure of nondiversifiable risk. An index of the degree of movement of an assets returned in response to a change in the market return
market return -- the return on the market portfolio of all traded securities
risk-free rate of return -- the required return on a risk-free asset, typically a three-month U.S. Treasury bill
U.S. Treasury bills (T-bills) -- short-term IOUs issued by the U.S. Treasury; considered the risk-free assets
security market line (SML) -- the depiction of the capital asset pricing model (CAPM) as a graph that reflects the required return in the marketplace for each level of nondiversifiable risk (beta)
efficient market -- a market with the following characteristics: many small investors, all having the same information and expectations with respect to securities; no restrictions on investment, no taxes, and no transaction costs; and rational investors, who views securities similarly and are risk averse, preferring higher returns and lower risk

Tuesday, January 23, 2007

managerial finance: Unit 1 Lesson Notes

Objectives of income taxation

  • Raise revenues for government expenditures
  • achieve socially desirable goals
  • economic stabilization

Types of taxpayers
Individuals
  • employees, self-employed, members of partnerships
  • report income on personal tax returns

corporations

  • separate legal entity
  • report income on corporate tax return
  • distributed dividends taxed to shareholders

fiduciaries

  • Estates and trusts
  • pay taxes on undistributed income

Computing taxable income
taxable income
  • Gross income less tax-deductible expenses, plus interest income and dividends income
  • gross income dollar sales from a product or service less cost of production or acquisition
  • tax deductible expenses operating expenses "marketing, depreciation, administrative expenses" and interest expense dividends paid are not deductible

Formula for computing taxable income
sales minus cost of goods sold equals gross profit minus operating expenses equals operating income plus other income minus interest expenses equal's taxable income

Corporate tax rates
$0 -- $50,000 = 15%
$50,001 -- $75,000 = 25%
$75,001 -- $10,000,000 = 34%
over $10,000,000 = 35%

Additional surtax:
5% on income between $100,000 and $335,000
3% on income between $15 million and $18,333,333

marginal tax rates

  • rates applicable to next dollar of income
  • used in financial decision-making

other corporate tax considerations
dividend exclusion -- a corporation may typically exclude 70% of any dividend received from another corporation
depreciation expense -- a corporation may expense of assets cost over its useful life
capital gains and losses -- capital gains tax as ordinary income. Capital losses cannot be deducted from ordinary income

10 principles of form the foundations of financial management

principle 1: the risk return trade-off
we won't take on additional risk unless we expect to be compensated with additional returns
investment alternatives have different amounts of risk and expected returns
the more risk of investment has, the higher its expected return will be

principle 2: the time value of money
a dollar received today is worth more than a dollar received in future
because we can earn interest on money received today, it is better to receive money earlier rather than later

principle 3: Cash -- not profits -- is king
cash flow, not accounting profit, is used as our measurement tool
Cash flows, not profits, are actually received by the firm and can be reinvested

principle 4: incremental cash flows
it is only what changes that counts
the incremental cash flow is the difference between the projected cash flows if the project is selected, versus what they will be, if the project is not selected

principle 5: the curse of competitive markets
it is hard to find exceptionally profitable projects
if an industry is generating large profits, new entrants are usually attracted. The additional competition and added capacity can result in profits being driven down to the required rate of return
product differentiation, service and quality can insulate products from competition

principle 6: efficient capital markets
these markets are quick and the prices are right
the values of all assets in securities at any instant in time fully reflect all of available information

principle 7: the agency problem
managers won't work for the owners unless it is in their best interest
the separation of management and ownership of the firm creates an agency problem
managers may make decisions that are not in line with the goal of maximization of shareholder wealth

principle 8: taxes bias business decisions
the cash flows we consider are the after-tax incremental cash flows to the firm as a whole

principle 9: all risk is not equal

principal 10: ethical behaviors
ethical behavior is doing the right thing, and ethical dilemmas are everywhere in finance
each person has his or her own set of values, which forms the basis of personal judgments about what is the right thing

Finance and the multinational firm
US corporations are looking to international expansion
collapse of communism
acceptance of free-market system developing and third world countries
technology and the Internet
freer access to international markets

Wednesday, January 17, 2007

Managerial accounting -- in Chapter 3

summary

Cash flow, the lifeblood of the firm, is a key determinant of the value of the firm. The financial manager must plan and manage -- create, allocate, conserve, and monitor -- the firm's cash flow. The goal is to insurer affirms solvency by beating financial obligations in a timely manner and to generate positive cash flow for the firm's owners. Both the magnitude and the risk of the cash flows generated on behalf of the owners determine the firm's value.

To carry out the responsibility to create value for owners, the financial manager uses tools such as cash budgets and pro forma financial statements as part of the process of generating positive cash flow. Good financial plans should result in large free cash flows that fully satisfy creditor claims and produced positive cash flows on behalf of owners. Clearly, the financial manager must use the liver and careful planning and management of the firm's cash flows to achieve the firm's goal of maximizing share price.

Tax depreciation
Depreciation is an important factor affecting a firm's cash flow. The depriciable value of an asset and its depriciable life are determined by using the method accelerated cost recovery system (MACRS) standards in the federal tax code. MACRS group's assets (excluding real estate) into six property classes based on length of recovery. -- 3, 5, 7, 10, 15, and 20 years -- and can be applied over the appropriate period by using a schedule of yearly depreciation percentages for each period.

The firm's statements
The statement of Cash flows is divided into operating, investment, and financing flows. It reconciles changes in the firm's cash flows with changes in cash and marketable securities for the period. Interpreting the statement of Cash flows requires an understanding of basic financial principles and involves both the major categories of cash flow in the individual items of Cash inflow and outflow. From a strict financial point of view, a firm's operating cash flow is defined to exclude interest; the simpler accounting view does not make this exclusion. Of greater importance is a firm's free cash flow, which is the amount of cash flow available to creditors and owners.

Financial planning process
The two key aspects of the financial planning process are cash planning and profit planning. Cash planning involves the cash budget or cash forecast. Profit planning relies on the pro forma income statement and balance sheet. Long-term (strategic) financial plans act as a guide for preparing short-term (operating) financial plans. Long-term plants tend to cover periods ranging from two to 10 years and are updated periodically. Short-term plans most often cover a one to two year period.

The cash planning process
Cash planning process uses the cash budget, based on sales forecast, to estimate short-term cash surpluses and shortages. The cash budget is typically prepared for a one-year period divided into months. It net cash receipts and disbursements for each period to calculate net cash flow. Ending cash is estimated by adding beginning cash to the net cash flow. By subtracting the desired minimum cash balance from the ending cash, the firm can determine required total financing or the excess cash balance. To cope with uncertainty in the cash budget, the sensitivity analysis or simulation can be used. A firm must also consider its pattern of daily cash receipts and cash disbursements.

Pro forma statements
A pro forma income statement can be developed by calculating pass percentage relationships between certain cost and expense items and the firm sales and then applying these percentages to forecasts. Because this approach implies at all costs and expenses are variable, it tends to understate profits when sales are increasing and to overstate profits when sales are decreasing. This problem can be avoided by breaking down costs and expenses into fixed and variable components. In this case, the fixed components remain unchanged from the most recent year, and the variable costs and expenses are forecast on a percentage of sales basis.

Under the judgmental approach, the values of certain balance sheets accounts are estimated, some as a percentage of sales and others by management assumption, and the firm's external financing is used as a balancing, or "plug" figure. A positive value for "external financing required" means that the firm will not generate enough internal financing to support its forecast growth in assets and will have to raise funds externally or reduced dividends. A negative value for "external financing required" indicates that the firm will generate more financing internally then it needs to support its forecast growth in assets and funds will be available for use in repaying debt, repurchasing stock, or increasing dividends.

Simplified approaches for preparing pro forma statements a sing that the firm's past financial condition is an accurate indicator of the future. Pro forma statements are commonly used to forecast and analyzed the firm's level of profitability and overall financial performance said that adjustment can be made to planned and operations to achieve short-term financial goals.

Managerial accounting -- Chapter 3

vocabulary

Depreciation -- the somatic charging of a portion of the costs of fixed assets against annual revenues over time
modified accelerated cost recovery system (MACRS) -- system used to determine the depreciation of assets for tax purposes
depriciable life -- time period over which an asset is depreciated
recovery period -- the appropriate depriciable life of a particular asset as determined by MACRS
operating flows -- Cash flows directly related to sale and production of the firm's products and services
investment flows -- Cash flows associated with purchase and sale of both fixed assets and business interests
financing flows -- Cash flows that result from debt and equity financing transactions; include incurrence and repayment of debt, cash inflow from the sale of stock, and cash outflows to pay cash dividends or repurchase stock
non-cash charge -- an expense that is deducted on the income statement but does not involve the actual outlay of cash during the period; includes depreciation, amortization, and depletion
operating cash flow (OCF) -- the cash flow a firm generates from its normal operations; calculated as net operating profit after taxes (NOPAT)
net operating profits after taxes (NOPAT) -- a firm's earnings before interest and after taxes, EBITx(1-T)
free cash flow (FCF) -- the amount of cash flow available to investors (creditors and owners) after the firm has met all operating needs and paid for investments in net fixed assets and net current assets
financial planning process -- planning that begins with long-term, or strategic, financial plans that in turn guide the formulation of short-term, or operating, plans and budgets
Cash planning -- involves preparation of the firm's cash budget
profit pleading -- involves preparation of pro forma statements
long-term (strategic) financial plans -- lay out a company's planned financial actions and the anticipated impact of this actions over periods ranging from two to 10 years
short-term (operating) financial plans -- specify short-term financial actions and the anticipated impact of those actions
cash budget (cash forecast) -- a statement of the firm's planned inflows and outflows of cash that is used to estimate its short-term cash requirements
sales forecast -- the prediction of a firm's sales over a given period, based on external and/or internal data; used as the key input in the short-term financial planning process
external forecast -- a sales forecast based on the relationships observed between the firm sales and certain key external economic indicators
internal forecast -- a sales forecast based on a buildup, or consensus, of sales forecast through the firm's own sales channels
Cash receipts -- all of a firm's inflows of cash during a given financial period
Cash disbursements -- all outlays of cash by the firm during a given financial period
net cash flow -- the mathematical difference between the firm's cash receipts and its cash disbursements in each period
ending cash -- the sum of the firm's beginning cash and its net cash flow for the period
required total financing -- amount of funds needed by the firm if the ending cash for the period is less than the desired minimum cash balance; typically represented by notes payable
excess cash balance -- the excess amount available for investment by the firm if the period's ending cash is greater than the desired minimum cash balance; assumed to be invested in marketable securities
pro forma statements -- projected, or forecast, income statements and balance sheets
percentage of sales method -- a simple method for developing the pro forma income statement; it forecasts sales and then expresses the various income statement items as percentages of projected sales
judgmental approach -- a simplified approach preparing the pro forma balance sheet under which the values of certain balance sheet accounts are estimated, some as a percentage of sales and others by management assumption, and the firm's external financing is used as a balancing, or "plug," figure
external financing required ("plug" figure) -- under the judgmental approach for developing a pro forma balance sheet, the amount of external financing needed to bring the statement into balance. He can be either a positive or negative value

Managerial finance -- Chapter 2

summary

Focus on value

Financial managers review and analyze the firm's financial statements periodically, both to uncover developing problems and to assess the firm's progress toward achieving its goals. These actions are aimed at preserving and creating value for the firm's owners. Financial ratios enable financial managers to monitor the pulse of the firm and its progress toward its strategic goals. Although financial statements and financial ratios rely on accrual concepts, they can provide useful insights into an important aspects of risk and return (cash flow) that affect share price, which management is attempting to maximize.

financial statements

The annual stockholders report, which publicly owned corporations must provide to stockholders, documents the firm's financial activities for the past year. It includes the letter to stockholders and various subjective and factual information, as well as for key financial statements: the income statement, the balance sheet, the statement of stockholders equity, and the statement of Cash flows. Notes describing the technical aspects of the financial statements follow. Financial statements of companies that have operations whose cash flows are denominated in one or more foreign currencies must be translated into dollars in accordance with FASB Standard No. 52.

Ratios

Ratio analysis enables stockholders and lenders and the firm's managers to evaluate the firm's financial performance. It can be performed on a cross sectional or a timeseries basis. Benchmarking is a popular type of cross sectional analysis.
Key cautions for applying financial ratios are as follows:
  • ratios with a large deviations from the norm merely indicate symptoms of a problem

  • a single ratio does not generally provide sufficient information

  • the ratios being compared should be calculated using financial statements dated at the same point in time during the year

  • audited financial statements should be used

  • data should be checked for consistency of accounting treatment

  • inflation and different asset ages can distort ratio comparisons


Liquidity and activity

liquidity, or the ability of the firm to pay its bills as they come due, can be measured by the current ratio and the quick (acid test) ratio. Activity ratios measure the speed with which accounts are converted into sales or cash -- inflows or outflows. The activity of inventory can be measured by its turnover; that of accounts receivable by the average collection.; and that of accounts payable by the average payment period. Total asset turnover measures the efficiency with which the firm uses its assets to generate sales.

Debt, financial leverage and ratios

The more debt a firm uses, the greater its financial leverage, which magnifies both risk and return. Financial debt ratios measure both the degree of indebtedness and the ability to service debts.a common measure of indebtedness is the debt ratio. The ability to pay fixed charges can be measured by Times interest earned and fixed payment coverage ratios.

Firm profitability, market value and ratios

The common size income statement, which shows all items as a percentage of sales, can be used to determine gross profit margin, operating profit margin, and net profit margin. Other measures of profitability include earnings per share, return on total assets, and return on common equity. Market ratios include the price/earnings ratio in the market/book ratio.

DuPont system/ratio

A summary of all ratios -- liquidity, activity, debt, profitability, and market -- can be used to perform a complete ratio analysis using cross sectional and timeseries analysis. The DuPont system of analysis is a diagnostic tool used to find the key areas responsible for the firm's financial performance. It enables the firm to break the return on common equity into three components: profit on sales, efficiency of asset use, and use of financial leverage.

Tuesday, January 16, 2007

managerial finance -- Chapter 2

vocabulary

Generally accepted accounting principles (GAAP) -- the practice and procedure guidelines used to prepare and maintain financial records and reports; authorized by the Financial Accounting Standards Board (FASB)
Financial Accounting Standards Board (FASB) -- the accounting profession's rule setting body, which authorizes generally accepted accounting principles (GAAP)
Public Company Accounting Oversight Board (PCAOB) -- a nonprofit corporation established by the Sarbanes-Oxley Act of 2002 to protect the interests of investors and further the public interest in the preparation of informative, fair, and independent audit reports
Securities and Exchange Commission (SEC) -- the federal regulatory body that governs the sale and listing of securities
stockholders report -- annual report that publicly owned corporations must provide the stock orders; it summarizes and documents the firm's financial activities during the past year
letter to stockholders -- typically, the first element of the annual stockholders report and the primary communication for management
income statement -- provides a financial summary of the firm's operating results during a specified period
dividend per share (DPS) -- the dollar amount of cash distributed during the period on behalf of each outstanding share of common stock
balance sheet -- summary statement of the firm's financial position at a given point in time
current assets -- short-term assets, expected to be converted into cash within one year or less
current liabilities -- short-term liabilities, expected to be paid within one year or less
long-term debt -- debts for which payment is not do in the current year
paid in capital in excess of par -- the amount of proceeds in excess of the par value received from the original sale of common stock
retained earnings -- the cumulative total of all earnings, net of dividends, that have been retained and reinvested in the firm since its inception
statement of stockholders equity -- shows all equity account transactions that occurred during a given year
statement of retained earnings -- reconciles the net income earned during a given year, and any cash dividends paid, with the change in retained earnings between the start and the end of that year ( an abbreviated form of the statement of stockholders equity)
statement of Cash flows -- provides a summary of the firms operating, investment, and financing cash flows and reconciles them with changes in its cash and marketable securities during the period
Notes to the financial statements -- footnotes detailing information on the accounting policies, procedures, calculations, and transactions underlying entries in the financial statements
Financial Accounting Standards Board (FASB) Standard No. 52 -- mandates that US-based companies translate their foreign-currency denominated assets and liabilities into dollars, for consolidation with the parent company's financial statements. This is done by using the current rate (translation) method
current rate (translation) method -- technique used by US-based companies to translate their foreign-currency denominated assets and liabilities into dollars, for consolidation with the parent company's financial statements, using the year end (current) exchange rate
ratio analysis -- involves methods of calculating and interpreting financial ratios to analyze and monitor the firm's performance
Cross sectional analysis -- comparison of different firms financial ratios at the same point in time; involves comparing the firm's ratios to those of other firms in the same industry or to industry averages
benchmarking -- a type of cross-sectional analysis in which the firm's ratio now use are compared to those of a key competitor or group of competitors that it wishes to emulate
timeseries analysis -- evaluation of the firm's financial performance over time using financial ratio analysis
liquidity -- a firm's ability to satisfy its short-term obligations as they come due
current ratio -- a measure of liquidity calculated by dividing the firm's current assets by its current liabilities
quick (acid test) ratio -- a measure of liquidity calculated by dividing the firm's current assets minus inventory by its current liabilities
activity ratios -- measure the speed with which various accounts are converted into sales or cash, inflows or outflows
inventory turnover -- measures the activity, or liquidity, of a firm's inventory
average age of inventory -- average number of days sales in inventory
average collection period -- the average of amount of time needed to collect accounts receivable
average payment period -- the average amount of time needed to pay accounts payable
total asset turnover -- indicates the efficiency with which the firm uses its assets to generate sales
financial leverage -- the magnification of risk and return introduced through the use of fixed cost financing, such as debt and preferred stock
degree of indebtedness -- measures the amount of debt relative to other significant balance sheet amounts
ability to service debt -- the ability of a firm to make the payments required on a scheduled basis over the life of a debt
coverage ratios -- ratios that measure the firm's ability to pay certain fixed charges
debt ratio -- measures the proportion of total assets financed by the firm's creditors
Times interest earned ratio -- measures the firm's ability to make contractual interest payments; sometimes called the interest coverage ratio
fixed payment coverage ratio -- measures the firms ability to meet all fixed payment obligations
comment size income statement -- an income statement in which each item is expressed as a percentage of sales
Gross profit margin -- measures the percentage of each sales dollar remaining after the firm has paid for its goods
operating profit margin -- measures the percentage of each sales dollar remaining after all costs and expenses other than interest, taxes, and preferred stock dividends are deducted; the pure profits earned on each sales dollar
net profit margin -- measures the percentage of each sales dollar remaining after all costs and expenses, including interest, taxes, and preferred stock dividends, have been deducted
return on total assets (ROA) -- measures the overall effectiveness of management in generating profits with its available assets; also called the return on investment (ROI)
return on common equity (ROE) -- measures the return earned on the common stockholders investment in the firm
market ratios -- relate a firm's market value, as measured by its current share price, to certain accounting values
Price/earnings (P/E) ratio -- measures the amount that investors are willing to pay for each dollar of a firm's earnings; the higher the P/E ratio, the greater the investor confidence
market/book (M/B) ratio -- provides an assessment of how investors view the firm's performance. Firms expected to earn high returns relative to their risk typically sell at higher M/B multiples
DuPont system of analysis -- system used to dissect the firm's financial statements and to assess its financial condition
DuPont formula -- multiplies the firms net profit margin by its total asset turnover to calculate the firm's return on total assets (R0A)
modified DuPont formula -- relates the firm's return on total assets (R0A) to its return on common equity (ROE) using the financial leverage multiplier (FLM)
financial leverage multiplier (FLM) -- the ratio of the firm's total assets to its common stock equity

Friday, January 05, 2007

The role and environment of managerial finance summary

Finance, its major areas and opportunities, and the legal forms of business organization

Finance is the art and science of managing money. It affects the life of every person and of every organization. Major opportunities in financial services exist within baking and related institutions, personal financial planning, investments, real estate, and insurance. Managerial finance is concerned with the duties of the financial manager in the business firm. It offers numerous career opportunities. The recent trend toward globalization of business activity has created new demands and opportunities in managerial finance.

The legal forms of business organization are the sole proprietorship, the partnership, and the corporation. The corporation is dominant in terms of business receipts and profits, and its owners are its common and preferred stockholders. Stockholders expect to earn a return by receiving dividends or by realizing gains through increases in share price.

Managerial finance function and its relationship to economics and accounting

All areas of responsibility within a firm interact with the finance personnel and procedures. The financial manager must understand the economic environment and relies heavily on the economic principle of marginal cost benefit analysis to make financial decisions. Financial managers use accounting a concentrate on cash flows and decision-making.

Primary activities of the financial manager

The primary activities of the financial manager, in addition to ongoing involvement in financial analysis and planning, are making investment decisions and making financial decisions.

Goal of the firm, corporate governance, the role of ethics, and the agency issue

The goal of the financial manager is to maximize the owner's wealth, as evidenced by stock price. Profit maximization ignores the timing of returns, does not directly consider cash flows, and ignores risk, said it is an inappropriate goal. Both return and risk must be assessed by the financial manager who is evaluating decision alternatives. The wealth maximizing actions of financial managers should also reflect the interests of stakeholders, groups that have a direct economic link to the firm.

The corporate governance structure is used to direct and control the corporation by defining the rights and responsibilities of key corporate participants. Both individual and institutional investors hold the stock of most companies, but the institutional investors tend to have a much greater influence on corporate governance. The Sarbanes-Oxley Act of 2002 (commonly called SOX) was passed to eliminate fraudulent financial disclosure and conflict of interest problems. Positive ethical practices help a firm and its managers to achieve the firm's goal of owner wealth maximization. SOX has provided impetus toward such practices.

An agency problem results from managers, as agents for owners, placed personal goals ahead of corporate goals. Market forces, in the form of shareholder activism and the threat of takeover, tend to prevent or minimize agency problems. Institutional investors often exert pressure on management to perform. Firms incur agency costs to maintain a corporate governance structure that monitors manager's actions and provides incentives for them to act in the best interests of owners. Stock options and performance plans are examples of such agency costs.

Financial institutions and markets, and the role they play in managerial finance

Financial institutions serve as intermediaries by channeling into loans or investments the savings of individuals, businesses, and governments. The financial markets are forums in which suppliers and demanders of funds can transact business directly. Financial institutions actively participate in the financial markets as both suppliers and demanders of funds.

In the money market, marketable securities (short-term debt instruments) are traded, typically through large New York banks and government securities dealers. The Eurocurrency market is the international equivalent of the domestic money market.

In the capital market, transactions in long-term debt (bonds) and equity (common and preferred stock) are made. The organized securities exchanges provide secondary markets for securities. The over-the-counter (OTC) exchange offers a secondary market for securities and is a primary market in which new public issues are sold. Important international debt and equity markets are the Eurobond market and the international equity market. The security exchanges create continuous liquid markets for needing financing and allocate funds to their most productive uses.

Business taxes and their importance in financial decisions

Corporate income is subject to corporate taxes. Corporate tax rates are applicable to both ordinary income (after deduction of allowable expenses) and capital gains. The average tax rate paid by a corporation ranges from 15 to 35%. Corporate taxpayers can reduce their taxes to certain provisions of the tax code: intercorporate dividend exclusions and tax-deductible expenses. A capital gain occurs when an asset is sold for more than its initial purchase price; they are added to ordinary corporate income and taxed at regular corporate rates.

Managerial finance -- Chapter 1

Finance -- the art and science of managing money
financial services -- the area of finance concerned with the design and delivery of advice and financial products to individuals, business, and government
managerial finance -- concerns the duties of the financial manager in the business firm
financial manager -- actively manages the financial affairs of any type of business, whether financial or nonfinancial, private or public, large or small, profit seeking or not-for-profit

Sole proprietorship
-- a business and by one person and operated for his or her own profit
unlimited liability -- the condition of a sole proprietorship (or general partnership) allowing the owner's total wealth to be taken to satisfy creditors
partnership -- a business and by two or more people and operated for profit
articles of partnership -- the written contract used to formally establish a business partnership
Corp. -- an artificial being created by law (often called a legal entity)

Strengths and weaknesses of the common legal forms of business organization

Sole proprietorship
Strengths
  • The owner receives all profits (and sustains all losses)
    low organizational costs
  • income included and taxed on proprietors personal tax return
  • Independence
  • secrecy
  • ease of dissolution
Weaknesses
  • Owner has unlimited liability -- total wealth can be taken to satisfy debts
  • limited fundraising power tends to inhibit growth
  • proprietor must be Jack of all trades
  • difficult to give employees long-run career opportunities
  • lacks continuity when proprietor dies

Partnership
Strengths
  • Can raise more funds than the sole proprietorship
    borrowing power enhanced by more owners
  • more available brainpower and managerial skill
  • income included and taxed on partners personal tax return
  • Owners have limited liability, which guarantees that they cannot lose more than they invest
Weaknesses
  • Owners have unlimited liability and may have to cover debts of other partners
  • partnership is dissolved when a partner dies
  • difficult to liquidate or transfer partnership
Corp.
Strengths
  • can achieve large size via a sale of ownership (stocks)
    ownership is readily transferable
  • Long life of firm
  • can hire professional managers
  • has better access to financing
  • can offer a tract of retirement plans
Weaknesses
  • Taxes generally higher, because corporate income is taxed, and dividends paid to owners are also taxed at a maximum 15% rate
  • more expensive to organize than other business forms
  • subject to greater government regulation
  • lacks secrecy, because stockholders must receive financial reports
Stockholders -- the owners of a corporation, whose ownership, or equity, is evidenced by either common stock or preferred stock
common stock -- the purest and most basic form of corporate ownership
dividends -- periodic distributions of earnings to the stockholders of a firm
Board of Directors -- group elected by the firm's stockholders and typically responsible for developing strategic goals and plants, setting general policy, guiding corporate affairs, approving major expenditures, and hiring/firing, compensating, and monitoring key officers and executives
president or chief executive officer (CEO) -- corporate official responsible for managing the firm's day-to-day operations and tearing out policies established by the board of directors

Limited partnership (LP) -- a partnership in which one or more partners have limited liability as long as at least one partner (the General partner) has unlimited liability. The limited partners cannot take an active role in the firm's management; they are passive investors
S Corporation (S. Corp.) -- a tax reporting entity that (under subchapter S. of the Internal Revenue Code) allow certain corporations with 100 or fewer stockholders to choose to be taxed as partnerships. It's stockholders receive the organizational benefits of a corporation and the tax advantages of a partnership. But S corps lose certain tax advantages related to pension plans.
Limited liability corporation (LLC) -- permitted in most states, the LLC gives its owners, like those of S corps, limited liability and taxation as a partnership. But unlike an S. Corp., the LLC can end more than 80% of another corporation, and corporations, partnerships, or non-US residents can own LLC shares. LLC’s work well for corporate joint ventures or projects developed through a subsidiary.
Limited liability partnership (LLP) -- a partnership permitted in many states; governing statutes vary by state. All LLP partners have limited liability. They are liable for their own ask of malpractice, but not for those of other partners. The LLP is taxed as a partnership. LLP's are frequently used by legal and accounting professionals.

Career opportunities in managerial finance (examples)
financial analyst
-- primarily prepares the firm's financial plans and budgets. Other duties include financial forecasting, performing financial comparisons, and working closely with accounting
capital expenditures manager -- a value weights and recommends proposed asset investments. Maybe involved in the financial aspects of implementing approved investments
Project finance manager -- in large firms, arranges financing for proved asset investments. Coordinates consultants, investment bankers, and legal counsel
cash managers -- maintains and controls the firm's daily cash balances. Frequently manages the firm's cash collection and disbursement activities and short-term investments; coordinates short-term borrowing and banking relationships
credit analyst/manager -- administers the firm's credit policy by a value waiting credit applications, extending credit, and monitoring and collecting accounts receivable
pension fund managers -- and large companies, oversees or manages the assets and liabilities of the employees pension funds
foreign exchange manager -- manages specific foreign operations and the firm's exposure to fluctuations in exchange rates

Treasurer -- the firm's chief financial manager, who is responsible for the firm's financial activities, such as financial planning and fundraising, making capital expenditure decisions, and managing cash, credit, the pension fund, and foreign exchange
controller -- the firm's chief accountant, who is responsible for the firm's accounting activities, such as corporate accounting, tax management, financial accounting, and cost accounting
*note* the treasurer's focus tends to be more external, the comptroller's focus more internal
foreign exchange manager -- the manager responsible for monitoring and managing the firm's exposure to loss from currency fluctuations
marginal cost benefit analysis -- economic principle that states that financial decisions should be made and actions taken only when the added benefits exceed the added costs

Accrual basis -- in preparation of financial statements, recognizes revenue at the time of sale and recognizes expenses when they are incurred
Cash basis -- recognizes revenues and expenses only with respect to actual inflows and outflows of cash

Earnings per share (EPS) -- the amount earned during the period on behalf of each outstanding share of common stock, calculated by dividing the period's total earnings available for the firm's common stockholders by the number of shares of common stock outstanding
risk -- the chance that actual outcomes may differ from those excepted
risk-averse -- seeking to avoid risk
stakeholders -- groups such as employees, customers, suppliers, creditors, owners, and others who have a direct economic link to the firm
corporate governance -- the system used to direct and control Corporation. Defines the rights and responsibilities of key corporate participants, decisions he procedures, and monitor its objectives
individual investors -- investors to buy relatively small quantities of shares so as to meet personal investment goals
institutional investors -- investment professionals, such as insurance companies, mutual funds, and pension funds, that are paid to manage other People's Money and that trade large quantities of securities

Sarbanes-Oxley act of 2002 (SOX) -- an act aimed at eliminating corporate disclosure and conflict of interest problems. Contains provisions about corporate financial disclosures in the relationships among corporations, analysts, auditors, attorneys, directors, officers, and shareholders
SOX focus:
  • establish an oversight board to monitor the accounting industry
  • tightened audit regulations and controls
  • toughened penalties against executives who commit corporate fraud
  • strengthend the accounting disclosure requirements and ethical guidelines for corporate officers
  • established corporate board structure and membership guidelines
  • established guidelines with regard to analyst conflicts of interest
  • mandated instant disclosure of stock sales by corporate executives
  • increased securities regulation Authority and budgets for auditors and investigators
Ethics -- standard of conduct or moral judgment
considering ethics --
  • is the action arbitrary or capricious? Does it unfairly single out one individual or group?
  • Does the action violate the moral or legal rights of any individual or group?
  • Does the action conform to accepted moral standards?
  • are there alternative courses of action that are less likely to cause actual or potential harm?
  • Are the rights of any stakeholder being violated?
  • Does the firm have any overwriting duties to any stakeholder?
  • Will the decision benefit any stakeholder to the detriment of another stakeholder?
  • If there is detriment to any stakeholder, how should it be remedied, if at all?
  • What is the relationship between stockholders and other stakeholders?
An ethics program can produce a number of positive benefits:
  • reduce potential litigation and judgment costs
  • maintain a positive corporate image
  • build shareholder confidence
  • gain the loyalty, commitment in respect of the firm's stakeholders
  • provide employment integrity
Agency problem -- the likelihood that managers may place personal goals ahead of corporate goals
agency costs -- the costs borne by stockholders to maintain a governance structure that minimizes agency problems and contributes to the maximization of owner wealth
incentive plans -- management compensation plans that tend to time management compensation to share price; the most popular incentive plan involves the grant of stock options
Stock options -- an incentive allowing managers to purchase stock at the market price at the time of the grant
performance plans -- plans the time management compensation to measures such as EPS, growth in EPS, and other ratios of return. Performance shares and/or cash bonuses are used as compensation under these plans
Cash bonuses -- Cash paid to management for achieving certain performance goals

Financial institution – an intermediary that channels the savings of individuals, businesses, and governments into loans or investments
Major financial institutions in the US economy -- commercial banks, savings and loans, credit unions, savings banks, insurance companies, mutual funds, and pension funds
financial markets -- forums in which suppliers of funds and demanders of funds can transact business directly
Private placement -- the sale of a new security issue, typically bonds or preferred stock, directly to an investor or group of investors
public offering -- the nonexclusive sale of either bonds or stocks to the general public
primary market -- financial market in which securities are initially issued; the only market in which the issuer is directly involved in the transaction
secondary market -- financial market in which pre-and securities (those that are not new issues) are traded
money market -- a financial relationship created between suppliers and demanders of short-term funds
marketable securities -- short-term debt instruments, such as U.S. Treasury bills, commercial paper, and negotiable certificates of deposit issued by government, business, and financial institutions, respectively
Federal funds -- led transactions between commercial banks in which the Federal Reserve banks become involved
Eurocurrency market -- international equivalent of the domestic money market
London Interbank Offered Rate (LIBOR) -- the best rate that is used to price all Eurocurrency loans
capital market -- a market that enable suppliers and demanders of long-term funds to make transactions
Bond -- long-term debt instrument used by businesses and government to raise large sums of money, generally from a diverse group of lenders
preferred stock -- a special form of ownership having a fixed periodic dividend that must be paid prior to payment of any dividends to common stockholders
securities exchanges -- organizations that provide the marketplace in which firms can raise funds through the sale of new securities and purchasers can resell securities (often miss labeled stock markets)
organized securities exchanges -- tangible organizations that act as secondary markets were outstanding securities are resold (New York Stock Exchange (NYSE), American Stock Exchange (AMEX) -- regional exchanges Chicago Stock exchange and Pacific exchange)
over-the-counter (OTC) exchange -- an intangible market for the purchase and sale of securities not listed by the organized exchanges
Eurobond market -- the market in which corporations and governments typically issue bonds denominated in dollars and sell them to investors located outside the United States
foreign bond -- bond that is issued by a foreign corporation or government and is denominated in the investors from currency and sold in the investors how market
international equity market -- a market that allows corporations to sell blocks of shares to investors in a number of different countries simultaneously
efficient market -- a market that allocates funds to their most productive uses as a result of competition among wealth maximizing investors that determines and publicize his prices that are believed to be close to their true value

Business taxes
ordinary income
-- income earned through the sale of the firms goods or services
average tax rate -- a firm's taxes divided by its taxable income
marginal tax rate -- the rate at which additional income is taxed
double taxation -- occurs when the already once taxed earnings of a corporation are distributed as cash dividends to stockholders, who must pay taxes of up to a maximum rate of 15% on them
intercorporate dividends -- dividends received by one corporation on common and preferred stock held in other corporations
capital gain -- the amount by which the sale price of an asset exceeds the assets of initial purchase price