• Auction markets have entities called specialists, who make a market in at leas o e • T he role oflhe specialisl is to maintain afair and orderly ark t when Older imb a lances o cclir
Trang 1Sole Proprietorship
• The easiest type of business
·It is unincorporated and owned by on
• This individual has all the ri hts to all the profits and assumes all the firm's liabilites
• Therc is unlimited liability
TIP: Files Schedule C for tax purposes
Partnership
• An agreement between two or more people in a joint business
• General partners are responsible for the operations of the business and
p rsonally liable for the li
• Limited partners are limited to their investment
TIP: Files Form 1065 for tax purposes
Corporation
• A separate legal entity that is distinct/;,ol1J th e persons who own it
• Courts view a corporation as an "artificial person."
• It can:
· owe deb
· pay taxe
• It has limited liabilities and ease of ownership transfer
TIP: Files Form 1120 for tax purposes
S-Corporation
• S metimes called "Subchapter S," as it is a tax concept
• The IRS will allow most corporations with I 00 or fewer shareholders to enjoy the
benefits of incorporation without being taxed as if they were partnerships
TIP: Files Form 11205 for tax purposes
Limited Liability Company (LLC)
• An LLC has characteristics of a corporation as it offers some of the b ene fits ofa
c r p rat/on , particularly the limitation of an owner's liability
• It is also deemed a separate legal entity
• LLCs are preferred because they combine the limited liability protection of a
corporation and the pass-through taxation of a partnership
TIP: Forms filed for tax purposes vary
Financial Markets
Purpose of the Financial Markets
• A means of raising c pital for a firm's capital investments or for new start-ups
• This is accomplished via the issuance of stocks and bonds
Primary vs Secondary Markets
Primary Market
• The market in which se urities are sold by the company,
• Primary market includ
· public and private place
· U.S Securities & Exchange COJ1lmiss
· underwrit
• In this market, th firm raises capital
Seconda ry M arket
• The market in which se urities that have already b e n issu e d are traded among
investors
• Secondary market includes
· stock exchanges (e.g., New York Stock Exchange'- NYSE
· over-the-counter (OTC) market (e.g., NAS
• Alil/OlIgh a company sshares are t rade d in the s eco n { IIY marke t, th e company does
1/ 0 receive capital/i-om the Iransactions
Dealer vs Auction Markets
Dealer Market
• The market in which several traders carry an il/vent o,y and provid e prices at which
they stand ready to buy (bid) and sell (ask) the securities
TIP: The NASDAQ market is also an example of a dealer market
·
\uction Market
• A market with a phvsi c allocalioll whcre buyers and sellers arc matched, with
little d aler activit)'
• Auction markets have entities called specialists, who make a market in at leas
o e
• T he role oflhe specialisl is to maintain afair and orderly ark t when Older
imb a lances o cclir by {((king th opp osite side oj' the tran sac
· b uy or d rs gr eate r than se ll ord e r ,
· sell orde rs gr eate r than buy orders, the specia
Balance Sheet & Income Statement Balance Sheet
• Reports the company's resources (assets) and how those resources (liabilities and shareholders'
• Also called the Statement of Financial Position,
• Basically, the balance sheet gives a view of the firm 's financial condition at a point
in time
TIP: Liabilities & equity are the means of financing assets
Assets
• Represent the company's resources
• o qualify as an asset, the following requirements apply:
I company must own the resource
2 resource must be of value
3 resource must have a quantifiable (measurable) cost Liabilities
• Represent what the company owes to others
• To qualify as a liability, the following requirements apply:
I must be quantifiable (measurable)
2 occurrence must be probable Shareholders' Equity
• Represents sources offunds through:
I equity investment(s) or
2 retained earnings (what the company has earned through operations since its inception)
Valuation
• Currently the historical cost regime is the guiding principle under generall accepted accounting principles
• However, th concept offair value, as the supcrior method of valuation, is gaining momentum
Income Statement
• Demonstrates how much a company earns over a specific time period
• /t asso iates the custs alld exp nses with the earning o./Ih c tf ,.e enue
• Also called:
1 Consolidated Statement of" Earnings
2 Profit and Loss Statement (P&L)
3 Statement of Revenues and Expenses
• The major components of the income statement are:
1 revenues
2 expenses
3 gains
4 losses Revenues
• Actual or expected inflows of cash or other assets, OR reductions in liabilities,
resulting fro/11 prod c ing, delivering, O r providing go c!.l· O r sen 'i ces c ons tituting an entity 's ce ntral operations
Expenses
• Actual or exected outflows of cash or other assets, OR incurring liabilities,
resultingfrom produ c ing, delivering, Or p roviding g o s O r se r vi ce s co ns ritlltillg
all enti(Y:I' central operatiom
Gains
• Increases in equity or net assets from peripheral or incidental activities of an entity and from all other transactions except those resulting from revenues or investments
by shareholders or owners
TIP: Basically, net cash inflows that are NQ.I a direct re ult of the firm's line
of business
Losses
• Decreases in equity or net assets from peripheral or incidental activitie entity and from all other transactions exc pt those resulting frum cxpcns<.:s O distributions to shareholders or owners
TIP: Basically, net cash outflows that are NOT a direct result f the firm's line
of business
Cash Flow Cash Flow Statement
• Provides information about cash receipts and cash payments
• It can be summarized by various periods such as monthly, quarterly, and yearly
• It provides information concerning the sources and uses of cash to investors
• The ca~hfl()w sta tement is d e ~i n d to convert the accrual basis oj"a cc lJlIl1lil/g USl!d
to prepare the come statement and ba la ce sheel back to a cash basis
• The c sh flow statement is divided into three categories:
I Net cash flow from operating activities: Operating activities arc the daill' internal a ctivities ofa business thaI e ilher require cash IIr gen mt e il
TIP: They include cash collections from customers; cash paid to suppliers and
employees; cash paid for operating expenses, interest and taxes, and cash revenue from interest dividends
1
Trang 2Cash Flow (continued)
2 Net cash flow from investing activities: Investing activities
are discretionarv investmenlS made by
TIP:
3 Net cash flow from financing activities: Financing activities
are those external sources alld uses rf cash Ihal afJixI cash flow
TIP: These include sales of common stock, changes in short
or long-term loans, and dividends paid_
Free Cash Flow
• The cash flow that is available
• The cash flow that is available to all of the firm's suppliers of capital
• The higher the firm's free cash flow, the healthier the firm,
because the firm will have 1110re cash available for growth, debt
payments and dividends
• Some commonly used formulas representing free cash flow are:
Free Cash Flow (FCF) = EBIT * (I - tax rate) + Depreciation
-Change in NWC - Net Capital Expenditures
Free Cash Flow (FCF) = Cash Flow from Operations
Net Capital Expenditures (to maintain productive efficiency)
Free Cash Flow (FCF) = Cash Provided by Operations
Capital Expenditures - Dividends Paid
[NOTE: EBIT = Earnings Before Interest &
NWC = Net Work ing
Corporate Financial Planning Tools
Importance of Planning
• Corporations, just like individuals, need to regularly perform
financial planning in order to:
· provide a better understanding of the interactions between
investments and financing
· further a greater understanding of various real options
available, as
· delineate internal consistency
Financial Forecasting
• In dctermining the amount of external financing needed in order
to carryon the business operations, the Percentage of Sales
Method is utilized as a major financial forecasting approach,
which is based on the premise that lIlos1 balance sheel and
income sratemenl accounls V({/y with Sales
• The Percentage of Sales Method is utilized to prepare the Pro
Forma Financial Statements (i.e , forecasted), which then helps
the organization ascerlain IhefirJn :\ needsjiyr externalfinancing
• Particular balance sheet accounts that generally vary elosely with
Sales
· Accounts Receivable
·
· Accounts Payable
• Fixed Assets are also often tied closely to Sales, lin less Ihere is
excess c apaci~)l
• Retained Earnings on the balance sheet represent the cumulative
10lal of Ihefirm S earnings Ihal have be e n reinvesled in Ihefirm
TIP: Thus, the change in this account is linked to Sales; how
ever, the link comes from relationship between Sales growth
and Earnings
• The Notes Payable, Long-Term Debt, and Common Stock
accounts do 1101 vary aUlomalically wilh Sales
TIP: The changes in these accounts depend upon how the firm
chooses to raise the funds needed to support the forecasted
growth in Sales
Income Statement
• On the income statement, costs are expressed as a percentage
of Sales
• Since we are assuming that all eosts remain at a fixed percentage
of Sales, Net Income can be expressed as a percentage of Sales
TIP: This indicates the Profit Margin
• Taxes are expressed as a percentage of Taxable Income
• Dividends and Additions to Retained Earnings are expressed
as a percentage of Net Income in order to determine the Payout
and Retention Ratios, respectively
• To calculate the External Funds Needed (EFN) when the fixed
assets are being utilized at full capacity, use the formula:
EFN = ~(S, -So) - "- (S , -S,J - (PM )(S,)(b)
WHERE:
So = Current Sales
SI = Forecasted Sales = So(\ + Forecasted Growth Rate in Sales)
A\ = Assets (at time 0) that vary directly with Sales
L *0 = Liabilities (at time 0) that vary directly with Sales
PM = Profit Margin = (Net Income)/(Sales)
b = Retention Ratio = (Addition to Retained Earnings)I(Net Income)
Objective
• Ratio analysis facilitates financial statement interpretation
• This is basically achieved by reducing the large number of financial statement items to a relati ve l small set
• There arc certain caveats one should keep in mind when conducting such an analysis:
· A sin g l e ralio do e s 11 0 1 provid e suffic i e nl i njiJ rm al i onji"Ol n whi c h lojudge overall p lform allce
· Financial statements should be compared at the same point in time during the year
· Audited statements are prefe
· Maintain consistency in the accounti
· Consider the effects of inflation if comparing companies over long periods Benchmarking Tips
• Furthermore, in terms of benchmarking, the following tips are useful in deciding the health particular compan
I Avoid rules of thumb at all cost, as they can get you in trouble
TIP: For example, one rule states that the higher the current ratio, the better This might ot always be the case because too high a current ratio suggests a lack of asset utilization
2 Compare current year ratios to prior year ratios (time series analysis) for positive adverse tre
3 Compare current year ratios to those of your competitors (if data is available), and then to your industry as a whole This is also called cross-sectional analysis
Organizing Ratios
• While there are many ways to organize ratios, one approach is to group ratios by these four categories This methodology suggests the following:
1 Liquidity: Indicator of the firm's ability to me e l s shorl-l e rm/inallcial obli g ali o ns
2 Efficiency: Indicator of various aspects of operaliollal efficiency
TIP: Here, attention is focused on specific asse ts , rather than on the overall efficiency of asset utilization measured by the profitability ratios
3 Debt (Long-Term Solvency): Indicator of the firm's ability to meel bOlh fh prin C ipal and illler eS I paymenls on long-term obligations
4 Profitability: Indicator of the firm's effic i enc y in us in Ih e c apil a l commill e d by stockh ld ers
and lenders
[NOTE: The following are generic ratios mainly used by manufacturing organization s When performing financial analysis, one must seek specific ratios utilized by th industry For example, banks have very specific ratios for regulatory purposes As suchthose ratios are more relevant for analyzing banking organizations than are the ones presented here.]
Liquidity Ratios NetWorking Capital = Current Assets - Curren Current Ratio ~
Current Liabili Quick Ratio (Acid Test) = Current Assets - In
Current Efficiency Ratios
Inventory Turnover = Costs of Goods Sold (
Inve Average Collection Period = Accounts Receivable
Average Sales per Average Payment Period = Accounts Payable (A l
Average Purchases Fixed Asset Turnover =
Net
Total Asset Turnover =
Total Assets
TIP: It is important to match the average collection period ratio to the average payment period ratio for cash flow purposes
Debt Ratios Debt Ratio = Total
Debt-Equity Ratio = Long-Term
Stockholders' Times Interest Earned = Earnings Before Interest & Ta (a.k.a., Coverage Ratio) Interes Fixed-Payment Coverage Ratio = EB IT +
Interest + Lease Payments + {(principal + pref dividends) • [1 /( T)] Cash Coverage Ratio = EBIT +
Interest
TIP: An acceptable debt ratio is purely based upon industry standards and corporate manage ment's philosophy
• The Times Interest Earned Ratio mcasurcs the firm's ability to make contractual interest paymcnts and
the Fixed-Payment Coverage Ratio measures the firm's ability to meet all fixed payment obligations These two coverage ratios are akin to an individual's ability to pay credit cards, mortgages, etc
• The Cash Coverage Ratio attempts to measure the firm's ability to pay intcrest with available cash Profitability Ratios
Cross Profit Margin = Gross Prof Operating Profit Margin ~ Operating Profit Net Profit Margin ~ Net Profit after
Sale Return on Total Assets =
Trang 3Stockholde Earnings per Share = Earnings Available for Common Stockholde
N umber of Shares of Common Stock Outstandin PricelEarnings (PIE) Ratio = Market Price per Share of Common Stoc
Earnings per Share (EPS) ,.I! EG Ratio = PIE Ratio
r ' Annual EPS Growth
accounting-oriented ratios
olfthe PEG ratio is equal to I, it means that the market is pricing the stock to fully reflect the stock's
EPS growth This is "normal" in theory because, in a rational and efficient m ket, th PiE is supposed
to re ect a stock's future earnings growth
oIf the PEG ratio is greater than I, it indicates that the stock is possibly overvalued or that the market
expects future EPS growth to be greater than the current "in the Street" consensus number
o If the PEG ratio is less than I it is a sign ofa possibly undervalued stock or that the market oes not
expect the company to achieve the earnings growth that is reflected "in the Street" estimates
DuPont Formula
o A system used to dissect the financial health of an organization
o It states that the Return on Investment (ROI) = the Net Profit Margin (NPM) *Total Asset Turnover
(TAT) * Leverage (LEV)
ROI = Nct Profit aftcr Taxes * Sales Total Asset
*
Time Value of Money
Today vs Tomorrow
A dollar is worth more now than that same dollar will be worth in the future
o This, the basic tenet of the time value o/mone), is true because of at least three reasons:
1 I nflation reduces the purchasing power 0/the doll([l:
2 Because of the uncertainty surrounding the receipt of a dollar, an agreement 10 receive SOOllel;
rather than latC/; will increase the value of that dollar
3 Time values involve thc important concept of opportunity costs In other words, a dollar today is
worth more than a dollar in one year because the dollar today can be productivel)' invested and will
grow into more than a dollar in one year
Compounding
o The process of determining the future value of a present sum
Discounting-o The Discounting-oppDiscounting-osite Discounting-of cDiscounting-ompDiscounting-ounding it represents the present value Discounting-of the future sum
Annuities
·
Bonds
Bond Valuation
o A bond is a fixed-income security
o The holder o/,rhe hund receives a specified annual interest in come alld a specified amount at maturit)!
o In general the difference between a bond and other forms of indebtedness (such as loans and trade
credits) is that bonds are sold to the public
o A fter issuance the bonds can be traded by investors on exchanges
o Bonds possess certain characteristics,
Premium
o Whcn an investor pays more than the par value for the bond
o Premiums
o The opposite of a premium, this occurs when the market rate of interest exceeds the
coupon interest rate
Bond Price
o DeTermined by taking the present value (PV) of the sum of the coupon interest rate plus the present
value (PV) of the bond's par value
Price of Bond = (rV of Coupon Rate Interest) +
Stocks
Stock Valuat ion
Common S
,{olders of common stock receive two types of investment returns
I dividends
2 share appreciati
oln general though, common stock is valued based on three factors
I annual dividends
2 growth of dividends
3 discount rate
o The rate at which future dividends arc to be discounted is c lled the required rate of return
3
I no dividend growth assumption
2 constant dividend growth assumption
3 unusual dividend growth model
o In addition, multiples, such as the PIE Ratio, are common utili zed
o Furthermore in advancc valua on, discoullt;; are also taken t o
redu e the vallie o/, lIlaill ~V privatelv held COIllIllO II srock ( /'or tax pUl1)()S lj
o Examples would clude discounts for minoriy intercst and lack
of control
Valuing Stock with No Dividend Growth Price = Divi
Required Rate of Ret Valuing Stock with Constant Dividend Growth Price = Dividends
K - g
WHERE:
K = Required Rate of Return
g = Growth Rate of Dividends Capital As et Pricing Model (CAPM) oTo determ in the required rate o return, the Capital As Pricing Model (CAPM) is commonly usc
K \ = R+f3(K-R).1 1 I i l
WHER E
K = Require Rate of Re
R ; =Risk-Fr
f3 = Bct (measure of risk
K ", = Return on a Market Portfol Preferred Stock
o Holders o{preferred stock receiv a f Lred dividell dji'O lI1 th company on a regular basis
o There is no maturity date on preferred stock- it is like perpetual instrumen
o Preferred stock has characteristics similar to debt instruments, but it DOES NOT have an advantage during liquidation
o Also, un like with bonds while firms attempt to pay annual fixed dividends, they are not required to pay them if there are no
e rnings
TIP: This is not the case with bonds, where int erest payments
a re mandatory, Pricing Preferred Stock Preferred Stock Value = Constant Dividend
Discount Rate Dividends
o Dividends represent a return on a stockholder's investment
o Dividends play a significant portion of valuing stock
o It has been suggested rhar dividends sh o ul d olll\' be paid after all fi nancing a d i llves tment require ment ';,' are sali~fied
o In developing dividend policy corporate officers should
determine the potental for growth on future earnings as well
as the resiliency of the company's earnings during the various phases of the business cycle
TIP: Ultimately, compare the yi ds and payo uts of o th er
firms in your industry
Dividend Yield
o Equals the rate of return from a dividend relative t o the price ofa stock
Dividend Yiel Formula = Current Divi
Current Price of Dividend Pay ut Ratio = Dividends per S ar
Earnings per Rec
o The date that establishes which stockh lders of record will receive the dividend
Ex-Dividend Da
o Usually four business days prio to the record date establishes who is enti ed to the dividend
o When the stock goes ex,dividend the price of the stock declines
by the amount of dividend per share Payment Dat
oThe date when the firm mails dividend checks to stockholders Stock Dividends
o Dividends in the form of additional shares, NOT a dividend
de nds because the price of t he stock declines by the same percentage as the stock dividend
Stock Sp ts
o Simil r to stock dividends, but they usually involve the issuance
of even more shares
Trang 4Capital Budgeting Techniques
- The proc ss ofevalu at in g i nves tme nt pro p osals is call d
this task but, in general, the financial evaluation process
involves:
3 Comparing that gure to thc minimum acceptable
- While not exhaustive some techniques used in th
the project th t r e coup s y o r ori g i n l i n vest m e nt t he
qu i c ke s t (in the shortest time period)
TIP: This me thod h s many weaknesses, including,
recouping of the original investment
- A discounted payback method can also be performe
project; if ne ativ , it will reject it
TIP: A positive NPV ad ds value to the o rganization
-I f th He R i s gr eate r t h n /, th e ves tment is attr a ctiv e
TIP: A major purpose for using t he BCR is to equate
investments of different sizes in order to compare
1 0 a sce rt ai th e d isc o unt rat e t ha t m a k es t he d i fe r e n ce
IRR = PV of Cash Inflows - PV of Cash Outflows = 0
TIP: The NPV and t he !RR will usually provide the
because the results a re de scrib d in percentage
terms, as o posed to the dollar fi ure provided by
the NPY, t he N P V is tec h nic ally so under
own rs o lll y wh e n it s o p e ra ting in co m exceeds t he cos t of
ca pit al e mpl oyed
WHER E '
Creditors and Owners
Incremental Cash Flows
I initial investment
2
TIP: However, this simple definition can be mislead
ing because additional expenses needed to be
determined for the initial investment component
would incorporate packing and delivery costs, sales
from the existing equipment that is being replaced,
and taxes
TIP: The additional tax benefits from the deprecia
tion must be incorporated into this equation as well
TIP: The greater the volatility, the greater the risk
Measuring Risk
I level of risk
2
TIP: In other words, investing for a short period with no chance of lo s s is called risk-free
Standard Deviation (SD)
SO = JI(r, - r) ' P, WHER E
r , =
T = E
P i =
TIP; Furthermore, in order to compare the risk/return trade-offs of different invest
return, performs this task
Expected Returns Beta
the market
Securities Market Line
Arbitrage Pricing Theory (APT)
·
Option Valuation Methodologies
Black-Scholes Model
TIP: The value of a call rises as interest rates rise because a call option can be
TIP: While this seems counterintuitive, it makes sense because an option own e r
4
1 its
10 per
'C,
I cr
arncd the made
11 a ss et ' fial
le a se
ses
.UT,
Iced
to its
Ised as
use in editors mation
Trang 5Capital Concepts
• he rate of return afirm mus t pay i nve s tors t o i nduce th em t o purchase thefi nn :\' s t ocks
n ~ a nd
TIP: Investment projects must be able to ge nerate at least th is c
• The future receipts that in vesto r s a n ticipalejin m t he ir i nvest m ents ,
TIP: It co ld be viewed from the firm's perspective as well, insofar as thi s return is t he
• The minimum future receipts that an i nves t or w i ll accept in choosing an inv es tm e nt,
Cost & Yield Formulas
Cost of Debt = Annual Coupon on
Market Value of B Approximate Yield to Maturity = C + ( Par - p,,)
pI N
?'or = Par Value of $ ,000
TIP: The tax rate must be deducted from t he cost of debt, as interest payments
after-tax cost of debt = 12%( 1-40%) = 7,
Cost of Preferred Stock = Preferred Divid
(Market Price of Preferred) * (I - Flotation Costs)
INOTE: For Cost of Common Stock s ee Dividend Models, CAPM (under stock valuation),]
Cost of Retained Earnings = Q + G
p
D = Dividends ofCommon
P =Market Value ofCom111on
G = Constant Growth Rate of Dividen
• A mca~ ur e of a fi rm's overall cost of capital based on the percentage values of the co m ponents
(i,e" stocks, bonds, ctc,) c ompris i ng th e jinan c ial str u ct ur e ,
• A cri cal point concerns the eights used in computing the WACC
TIP: It is more practical, however, to use market value weights as they re present th e
• Also, from a financing perspective, the WACC represents the minim um r etu rn t ha t a jinll m ust
WACC = K , (~)+ K (p refe rr e d) + K ( C OIIIl/10
,,' D + P + S "D +P+S ' D+
WHERE
K = Cost of Particular Security (i,e" debt, preferred stock, common stock
P = Prefcrred Stoc
Underwriting
Basics of Underwriting
,COl issuingfinl/ at a lower price than that/or which he /s he plans to sell it
from the sale
WI
Private Placement
Th,
nd
Best Efforts Basis
)ric
TIP: The securities unable to be sold are not the problem of the investment banker,
Competitive Bidding
Negotiated Offering
Underwriting Syndicate
issue,
TIP: This reduces the risk of loss to any single firm,
5
Prospectus
• A portion of a security registration statement th a t d e t a ils
TIP: It must be filed with the SEC
Offering Memorandum
• Similar to a prospectus, but r e f e rs olliv to privatel v held ofF e rin g s,
Red Herring
• he first document released by an underwriter of a new issue to prospective investors,
may be changed before the final prospectus is issued
TIP: Because portions of the cover page of this preliminary prospectus are printed in red ink, it is popularly called the red herring
Shelf Registration
• Registration permitted by United States Securities &
company to register all issues it expects to sell within two
those two years,
• However, the corporation must still file the required
Blue Sky Laws
• State laws aimed at regulating the sale of securities within the state and thereby protecting investors from being left with "nothing but th e hlu e s ky,"
Spread
Financial Leverage
• Measures the effect of a change in earnings per shares
• It can also be viewed as the pra
TIP: Because interest is tax deductible, more of the operating income flows to the investors, at the risk
of having a heavy debt load
Unleveraged Firm
no debt
Leveraged Firm
• Finances part oj' its operation s through debt
Capital Structure
• Refers to the financing mix ofan organizatio ,
• Usually, it will consis ,
% change in E
TIP: In general, the more debt, the higher the degree
of financial leverage
• The amount f time that elapses from the point when the
firm b egins to build i nve nt olY to the I'o i nt when cas h is
Operating Cycle = Average Age of Inventory + Aver
• In addition to the o erating cycle, firms can measure the
the firm's cash is lied u p between pavmentIor production
inputs a d receipt ofpaymentjinlll th e sal e oIthe r eSU ltin g
TIP: To im prove CCC, the fo ilowing steps should
I, turn over inventory as qu i ckly as poss i ble
2, collect accounts receivable ( AiR ) as ,/u i ckl v as possible
3, pay accounts payable (A/P) a s lat e a s p ssibl e , without
Trang 6Balancing Inventory Levels
~ 0 The main purpose of inventory management is to d e/e r mine and maintain th e level o Hedging is a strategy designed to reduce investment risk using:
~ o/invenlOlY th at will e n sure that customer orders are fulfilled on timc
However, holding 100 lIluc h inventory is a n e xpe n se tha t a compa ny does not desire
Therefore, companies must achieve thc ideal balance between holding sufficient
W inventory and satisfying customer orders in a timely manner
A TIP: Reme mber, holding inventory precludes investing in other
Z 0
II opportunities
0 The level of inventory should be increased if the added benefits will be greater than
O the cost of maintaining additional inventory
" 0 In order to reach this ideal balance, a quantitative model called th Economic
Order Quantity is utilized
o The EOQ is the quantity of an item which, when ordered regularly, resul ts in
minimum ordering an d storage co s ts in order to e ns u r e e pro per levels a/inventory
EOQ = t:o
R = Required Number of Units per Time
W = Cost of Warehouse/Storag
Number of Orders per Year =Annual
EOQ
Currency Exchange Rate
o The amount it costs to purchase one unit o/,currency with another currency
o It may be viewed as the price of buying one unit of a foreign currency, stated in
terms 0 f a domestic currency
o Exchange rates fluctuate daily and are reported in major financial newspapers and
other media
~ TIP: A currency is considered strong when its exchange rate is rising
relative to most other currencies and as weak when its exchange rate
Zis falling reJative to most other currencies
IU Gains & Losses
• 0 Gains and losses, where foreign markets are concerned, depend upon two factors:
A I status as an importer or exporter
II 2
OTIP: Take U.S
o If the U.S dollar rises against another foreign currency, U.S importers will
suffer losses because more dollars are r e quired /0 pay the foreign debts while U.S
" exporters will obtain gains because their/oreign receivables become equivalent to
an increasing IIl1mber oidollars
o The reverse holds true when the dollar falls against another currency When the U.S
dollar falls, U.S importers will reap gains and U.S exporters will suffer losses
Florida Institutc of Finance (Joel M DiCicco, Ph.D.,
Rainford Knight, Ph
Customer Hotline #
1.800.230.9522
,1,.1 00858 ,,9
nU [l a ( ed ~ OT U tles at
qUICkSludY·Com
ISBN-13: 978-142320858-7
1
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9 ~~IJ~ 2 ~lllJlllllllllil1llr II1II1I
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© 2 00 9 BarCharts, Inc 0309
o A hedge can help lock in profits lIs fJlIIpose is to reduc e Ihe volatilitv 0/
portfolio by reducillg the risk o/,Ios
o Thus any loss on the original investment will be hedged (offset) by a
corresponding profitlinn! the hedging illstrument
o Rules for the treatment of hedges differ between accounting and taxes
TIP: The bottom line is that an item's designation as a hedge is based on its effectiveness
Hedging in Practice
o Consider the following example of hedging in practical use:
· Suppose it's July and a farmer expects an unfavorable drop in the selling price of corn by the time his anticipated 15.000 bushels are ready for sale
in September
· The current price as of July is $4.50 per bushel
· To hedge his risk of getting a low price for his corn, he sells three 5,000-bushel futures contracts on October corn for more than the current price at $5.00 per bushel
· When September arrives and he sells to the local grain elevator, prices have, indeed, fallen to $3.90 a bushel
· To offset this cash position, he is now able to buy, or extinguish, his October corn contract on the market, where prices have also fallen
· He pays $4.60 per bushel to lift his hedge
· Between his cash andliltures positiolls h e has effec/ivelv reduc e d his losses finm the price decline
· In the cash market, he earned $3.90 per bushel; in the futures market, he earned the difference between his selling and buying prices, or $0.40 per bushel
· This yields an effective selling price of$4.30 per bushel or $64,500.00 for the entire crop
· Although this is still $3, 111111.1111 less than he wOllld have made al JIIII' prices
($4.50 x 15,000 = $67,500.00), it is $6,000.00 more than he would have made had he not hedged ($3.90 x 15,000 = $58,500.00)
Leasing Leasing Basics
o In general, leases are good/or lessees because
· enable lessees to keep up with the latest technological advance
· permit flexible
o In general, leases are good/or lessors because they:
· enable lessors to benefit from depreciation and interest expense Lessee
o User of an asset that is l eased from 0!1Oiher party
Lessor
o Owner of the property that is leased ill anoiller parly
Capital Lease
o A longer-term lease than an operating lease
o It is noncancelable and obligates the lessee to ma k e paymentslor t ile li se a/an asset
ov er a pr e defined period of l im e
o The total payments over th e t e rm a/ th l ease are greater than Ihe l essor \ i lli!i(11
cos t of th l ease d asset(.s)
TIP: For accounting purposes, these are treated as assets
Operating Lease
o A cancelable contractual arrangement whereby the l e sse e agrees 10 mak e
periodiC payments to the lessor (often for 5 years or less)
oln ge n era l, th e total payments M e l' th e t e rm oj'tire l ease are less than th l esso r:s
initi a cos t of t h e l e ased ass e t (s)
o Normally, the asset still has a p()sitlve market value allil e rermil1111iol1 ofthe l ease
TIP: For accounting purposes, these are treated as operating expenses Synthetic Lease
o Has characteristics of both operating and capitallcasesjor reporting purpo se s
TIP: For book purposes, these leases are treated as operating leas!1s; BUT, for tal! purposes, they are treated as capital leases
Leveraged Lease
o Like any other lease EXCEPT that par t orill e asseT purchase price isjinallced
by th e l essor a n d th e lenders
NOTE TO STUDENT: Thi s guide i s intended for ill/ill'lIIC/1iollol pU/pos es Oil ' \' Due t o its condensed format, this guid e cannot cover every asp ect of the s ubject /lUI' s:/ lOli ld it be lIsed as
a substilUte Jor pro./essiollal/ i nan c ial Or tax-pr e parafion advi ce ; rather, it is int e nd e d r usc in conjunction with course work and assigned texts Ne ither B a rCharts, ]nc , s w riters edi tors
nor design staff , are in any way responsible or liable for the u se or mi s u se of' th e form a t ion contained in thi s guide
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