Financial Management Textbook - Free Cash Flow, WACC, and More | PDF

Financial Management Chapter 1 3 types of business organizations: 1.​ sole proprietorship (family business) 2.​ Partnership (small business) 3.​ Corporation ← our focus Sole proprietorship: ease of formation, no corporate income taxes, limited life, difficult to rais...

Financial Management Chapter 1 3 types of business organizations: 1.​ sole proprietorship (family business) 2.​ Partnership (small business) 3.​ Corporation ← our focus Sole proprietorship: ease of formation, no corporate income taxes, limited life, difficult to raise capital money Partnership: pretty much the same as sole proprietorship Corporation: legal entity separate from owners and managers, unlimited life, easy transfer of ownership, limited liability, double taxation Initial Public Offering (IPO) of stock: -​ Raises cash -​ Allows founders and pre-IPO investors to “harvest” some of their wealth Principal vs. Agent Principal: Owner/ppl in charge Incentives ← how you get ppl to do what you want (sticks and carrots) Example: Trump imposing tariffs to get canada to do what he wants Agency Problem: Managers may act in their own interest and not on behalf of owners (stockholders) Objective of firms is to maximize the share price Agency problems and corporate governance -​ Shareholders elect board of directors 3 aspects of cash flow that affect an investments value (there's different types of cash flow) -​ We’re focusing on free cash flow -​ Flow meaning a period of time -​ What was happening to cash during that period? ​ Amount of expected cash flows (bigger is better) ​ Timing the cash flow stream (sooner is better) ​ Risk of the cash flows (less risk is better) FREE CASH FLOW (FCF) FCF = sales revenue - operating costs - operating taxes - required investments in operating capital ​ FCFs are the cash flows that are available (free) for distribution to all investors (stockholders and creditors) House worth 1 million (V value of assets) Owe bank $300,000 V is what I have L is what I owe E is what’s left V=L+E What is WACC (weighted average cost of capital) -​ WACC is what Tim Cook needs to earn on Apple’s assets to keep shareholders and creditors happy  -​ Average rate of return required by all the company’s investors -​ WACC is affected by -​ Capital structure -​ Interest rates -​ Risk of the firm -​ Investors overall attitude towards risk The lower the WACC the better Who are the providers (savers)(lenders) and users (borrowers) of capital? -​ Households: net savers -​ Non-financial companies; net borrowers -​ Financial companies(ex: banks): slightly net borrowers, but almost break even -​ Banks borrow from ppl who use the banks (account owners) Economic conditions that affect interest rates -​ Federal reserve policies ← domestic  -​ Budget deficits/surpluses ← domestic -​ Level of business activity (recession or boom) ← domestic → If the economy is doing well, you may want to increase interest rates -​ Foreign trade deficits/surpluses ← foreign Financial Instrument (security) ​ Contractual obligation providing a claim on some future cash flow/asset 1.​ US treasury bills 2.​ Commercial paper 3.​ Certificates of deposit (CDs)​ SAFE OR VERY SAFE (short term: 1 year or less) US t-bills are sold by gov’t and are 100% safe; CDs are sold by banks; commercial paper sold by commercial companies (disney, apple) 1.​ Commercial loans from banks 2.​ US treasury notes and bonds (10+ years) 3.​ Mortgages 4.​ Bonds a.​ Corporate bonds( from investment bank) b.​ Municipal bonds/munis (state/local gov’t) 5.​ Preferred stock (private companies) 6.​ Common stock (public companies) long term: more than 1 year What is a financial institution? -​ Company that is intermediary between providers of funds and users of funds -​ Facilitates transfers of capital -​ Twitter(x) needs money; they get it from wealthy people and institutions; investment banks (goldman sachs) Financial institutions:  ​ commercial banks ​ Investment banks (serious money, gov’t goes to investment bank when they need money) ​ Savings & loans, mutual saving banks and credit unions ​ Life insurance companies ​ Mutual funds ​ Exchange Traded funds (ETFs) (same as mutual funds) ​ Pension funds ​ Hedge funds (private equity/shares) ← shares in private companies Markets Locations where securities are bought and sold ​ A financial market is a method of exchanging one asset (usually cash) for another ○​ Physical assets vs financial assets ○​ Spot vs future markets (i want it now) ex: (spot markets: buying something at target) (future markets: agree on price/quantity now; delivery in the future; ordering pizza, getting it delivered later) ○​ Money vs capital markets (money markets are very safe short-term securities, capital markets are not so safe) ○​ Primary vs secondary markets Secondary market example: You own 100 shares of Nvidia; decide to sell; Molly wants to buy the shares so you sell them to her (broker is the middleman who gets a cut) Primary market example: If Nvidia gets money(is the seller), it’s secondary, if not, it’s primary If your company trades on NYSE you made it!! Chapter 2 ★​ Income Statement: Sales ​ COGS​ ​ Depreciation expense ​ Other expenses ​ ​ Total operation costs EBIT - earnings before interest and taxes Pretax earnings(ebt) (EBIT-interest) Taxes (25%) of ebt to the IRS Net income is what’s left → belongs to shareholders ★​ Balance Sheet: Assets = liabilities + equity Assets ​ ​ Cash ​ ​ S-T invest.(saving acct) ​ ​ A/R ​ ​ Inventories ​ ​ ​ Total (CA) current assets we have (liquid: easily converted to cash) ​ ​ Gross FA (fixed assets) ​ ​ Less(-) depr. ​ ​ Net FA (fixed assets) CA + NET FA = total assets  Liabilities + Equity CL + LTD = total liabilities ​ ​ A/P ​ ​ N/P ​ ​ Accruals ​ ​ ​ Total CL → what we owe ​ ​ Long-term debt ​ ​ ​ Total liabilities ​ ​ Common stock ​ ​ retained earnings ​ ​ ​ Total owners equity CA - CL = (net working capital; Net WC) SHOULD BE POSITIVE NUMBER!!! ★​ Statement of Cash Flows (operating, investing, and financing activities) Financing methods: Method 1: all equity (no borrowing) Method 2: borrow (using equity and debt) The amount of money the store make each day does not have an influence on the method of financing Operating activity vs Financing activity -​ Every company has operating activities -​ Very small companies may not have investing or financing activities Operating activities (how much you made for your business): ​ Net income ​ Adjustments ​ Depreciation ​ CHANGE in A/R ​ CHANGE in inventory ​ CHANGE in A/P ​ CHANGE in accruals ​ ​ (cash flow from ops)CFO: Net cash provided/used by operating activities: Investing activities ​ Cash used to acquire fixed assets (gross FA; not net FA) ​ Change in S-T invest ​ ​ CFI: Net cash provided/used by investing activities: ​ ​ Financing activities Change in notes payable Change in long-term debt Payment of cash dividends CFF: Net cash provided (used) by financing activities FCF (free cash flow) is the amount of cash available for distribution to investors 5 uses of FCF 1.​ Pay interest on debt 2.​ Pay back principal on debt 3.​ Pay dividends 4.​ Buy back stock (from shareholders) 5.​ Buy non-operating assets Chapter 3 Chapter 4