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CHAPTER 1: AN OVERVIEW OF FINANCIAL MANAGEMENT
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 Accountants-provide info regarding the likely size of those cash flows
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 Chief Financial Officer(CFO)- Accounting, Treasury ,credit, legal, capital
budgeting & investor relations
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Security analysis-deal with finding the proper values of
individual securities( stocks & bonds)
II
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III
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IV
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SUZARIMA

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Forms of Business Organization
 Sole proprietorships
 Unincorporated business
 Owned by 1 individual
 3 advantage:
I
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They are subject to few government regulations
III
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Have unlimited personal liability for the business’s debts-can lose
more than the amount money they invested in the company
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The life of the business is limited to the life of the individual who
created it, & to bring in new equity, investors require a change in the
structure of the business
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Used primarily for small businesses
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 Established relatively & inexpensively
 Corporation
 Legal entity created by state & it is separate & distinct from its owners and
managers
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 Limited liability company(LLCs)
 New type of organization that is hybrid between a partnership &
corporation
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Limited liability-reduces the risks borne by investors
II
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III
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SUZARIMA

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 The value of any asset is the present value of the stream of cash flows the
asset provides to its owners
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 Marginal investor
 An investor whose views determine the actual stock price
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Important business trends
 The point discussed in the preceeding section have led to profound changes in
business practices
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Business ethics
 A company’s attitude & conduct towards employees, customers, & stockholders
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-That will cause the intrinsic value to be high &
-the actual stock price to remain close to the intrinsic value over time
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 Stockholders- do better when the company does better
 Conflict arises over the use of additional debt
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Financial statemants & reports
 Annual report
 A report issued annually by a corporation to its stockholders
 It contains basic financial statements as well as management’s analysis of the
firm’s past operations & future prospects
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Verbal section-letter from the chairperson, describe the firm’s
operating results during the past year
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II
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b) Income statement- shows the firm’s slaes & costs( & thus profits) during the some
past period
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d) Statement of stockholders’ equity- shows the amount of equity the stockholders
had at the start of the year, the items that increased/ decreased equity, & the equity
at the end of the year
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The balance sheet
 Balance sheet-A statement of a firm’s financial position at specific point in time
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 Long term assets:
-assets expected to be used for more than 1 year
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 Liabilities:
 Money that company owes to others
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-long terms debt- bonds that mature in more than a year
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SUZARIMA

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SUZARIMA

Balance sheet equation
 Asset = liabilities +net worth
 Current assets
I
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II
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Account receivables- money owed to a company by customers for
products & services provided on credit
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Inventory-raw materials, work in process, finished products for
sale
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Cash & cash equivalents:
a) Cash- physical currency
b) Cash equivalents- asset that can be easily converted into
cash
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Company hold equipment, buildings, & furniture
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Not expected to be converted into cash in 1 year
III
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IV
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Depreciation :
-deduction from the original value of the fixed assets
-has no cash flow effect
-Help to reduce taxable income & the amount for income tax
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Tangible asset:
- assets held for business use to generate income
-not expected to be converted to cash in a year
-building, real estate, equipment & furniture
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Liabilities that must be repaid in 1 year
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Short-term loans, trade credits, dividends & interests payable,
consumer deposits, unpaid taxes, & long term debt that are due
within 1 year
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Legal obligations require future payments of cash/ services/ the
creation of other liabilities as a result of past transactions
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They are trade-related liabilities
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They are due within 1 year
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Company obligations due more than 1 year into the future
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2 types:
-Long-term debts
-Long-term accrued liabilities
 Owners’ equity
I
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Difference between value of all assets & liabilities
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IV
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Retained earnings
=retain net income after distributing dividends to
shareholders
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Cash vs asset
 Asset are reported in dollar terms,only cash & equivalents a/c
represents actual spendable money
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Working capital
 Assets “turn over”
 Used & then replaced throughout the year
 Current assets
III
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Other sources of funds
 Finance their assets with a combination of current liabilities, long
term debt, and common equity
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Depreciation
 2 sets of financial statement
 1
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Generally Accepting Accounting Principles (GAAP)-Reporting
investor
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Market value vs book value
 Common stock equity=total assets-liabilities-preferred stock
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The time dimension
 The balance sheet is a snapshot of the firm’s financial position at
a point in time
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Income statement
 Income statement:
 A report summarizing a firm’s revenues, expenses, & profits
during a reporting period, generally a quarter / a year
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(EBIT)
 EBIT=Sales revenues-operating costs
 Earning per share=EPS= Net income ÷ common shares outstanding
SUZARIMA

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Dividends per share=DPS=Dividends paid to common stockholders ÷ common
shares outstanding
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 Amortization:
 A non cash charge similar to depreciation except that it is used to write off
the costs of intangible assets
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4
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a) Operating activities- items that occur as part of normal ongoing
operations
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d) Increase in inventories-to make / buy inventory items
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f) Increase in account payable-represent a loan from suppliers
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i) Long term investing activities- long term assets
j) Additions to property,plant, & equipment- sold some fixed asset,
cash inflow
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m) Increase in notes payable- TGE borrowed from bank(cash inflow),
TGE repays the loan(cash outflow)
n) Increase in bonds(long term debt)- TGE repaid debt to long term
investors this year(outflow) ex issued bonds, TGE issued this
year(inflow)
o) Payment of dividends to stockholders- dividends are paid in
cash(negative amount)
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r) Net increase in cash- the net sum of the operating activities,
investing activites,& financing activities are shown here
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Statement of stockholders’ equity
 Statement of stockholders’ equity:
 A statement that shows by how much firm’s equity changed during the
year & why this changed occur
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Free cash flow
 Free cash flow(FCF):
 The amount of cash that could be withdrawn from a firm without harming
its ability to operate & to produce future cash flows
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 EBIT(1-T)
 Would exist if firm had no debt, no interest payments
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Income taxes
A
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 The personal income tax in US , which ranges from 0% on the lowest
incomes to 35% on the highest incomes, is progressive
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 Average tax rate:
 Taxes paid divided by taxable income
 Capital gain /loss:
 The profit(loss) from the sale of a capital asset for more(less) than its
purchase price
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B
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 A-T income= B-T income(1-T)
 Interest & dividends paid by a corporation:
 Finance its operations with either debt/stock
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 If firms uses stock, it expected to pay dividends
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SUZARIMA

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SUZARIMA

Corporate loss carry-back & carry-forward:
 Ordinary corporate operating losses can be carried backward for 2 years &
carried foward for 20 years tp offset taxable income in a given year
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 Allows the losses of 1 company to be used to offset the profits of another
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CHAPTER 3: ANALYSIS OF FINANCIAL STATEMENTS
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SUZARIMA

Show how the statement are used
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 5 categories:
I
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II
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III
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IV
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V
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Liquidity ratios:
 Liquid asset-an asset that can be converted to cash quickly w/ot having to
reduce the asset’s price very much
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 Current ratio- this ratio is calculated by dividing current assets by current
liabilities
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 Current ratio= current assets/current liabilities
 Industry average=
 Quick/ acid test, ratio- this ratio is calculated by deducting inventories
from current assets & then dividing the remainder by current liabilities
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 Inventory turnover ratio- measure how many times the inventory is
turned over a year
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 Day sales outstanding(DSO)= (receivables/average sales per
day)=(receivables/annual sales/365)
 Fixed asset turnover ratio- the ratio of sales to net fixed assets
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 Total asset turnover ratio(TATO)=sales/ total assets

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SUZARIMA

Debt management ratios:
 Debt management ratios- a set of ratios that measure how effectively a
firm managers its debt
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 Total debt to total assets= total debt/total assets
 Times –interest earned ratio(TIE)- The ratio pf earnings before interest &
taxes(EBIT) to interest charges; a measure of the firm’s ability to meet iits
annual interest payments
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 Operating margin- the ratio measures operating income/ EBIT, per dollar
of sales; it is calculated by dividing operating income by sales
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 Profit margin= net income/sales
 Return on total assets (ROA)- the ratio of the net income to total asset
 Return on total assets=net income/total assets
 Basic earning power ratio(BEP)- this ratio indicates the ability of the firm
to generate operating income; it is calculated by dividing EBIT by total
assets
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 Return on common equity( ROE)= net income/common equity
Market value ratios:
 market value ratios- ratios that relate the firm’s stock price to its earning
& book value per share
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 Price/earnings ratio= price per share/earnings per share
 Market/book ratio- the ratio of a stock’s market price to its book value
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The DuPont Equation:
 ROE= Profit margin * total asset turnover* equity multiplier
 (net income)/(sales)* (sales)/(total assets)* (total assets)/(total common
equity)
Ratios in different industries

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SUZARIMA

Summary of TGE’s Ratios
Benchmarking –ratio analysis involves comparisons with industry average figures,
but TGE & many other firms also compare themselves with the top firms in their
industry
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 A focus on ROE can cause managers to turn down profitable projects
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Overall, it is
management's goal to optimize capital allocation so that it generates as
much wealth as possible for its shareholders
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Spot markets- the market in which assets are bought/sold for ‘on
the spot’ delivery
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Futures markets- the markets in which participants agree today
to buy / sell an asset at some future date
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Money markets- the financial markets in which funds are
borrowed / loaned for short periods (less than 1 year)
IV
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Primary markets- markets in which corporations raise capital by
issuing new securities
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Secondary markets- markets in which scurities & other financial
assets are traded among investors after they have been issued by
corporations
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Private markets- markets in which transactions are worked out
directly between 2 parties
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Public markets- markts in which standardized contracts are
traded on organized exchanges
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Derivatives-any financial asset whose value is derived from the
value of some other ‘underlying’ asset
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 Commercial bank- the traditional department store of finance serving a
variety of savers & borrowers
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 Mutual funds- organization that pool investor funds to purchase
instruments & thus reduce risks through diversification
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The stock market:
 The prices of firms’ stocks are established
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 Over the counter market(OTC) – a large collection of brokers & dealers,
connected electronic by telephones & computers, that provided for
trading in unlisted securities
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The market for common stock:
 Closely held corporation- corporation that owned by a few individuals
who are typically associated with firm’s management
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 Types of stock market transactionsI
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II
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III
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 Going public- The act of selling stock to the public at large by a closely held
corporation or ots principal stockholders
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Stock market & returns:
 Expected & realized prices & returns
 Stock market reporting
 Stock market return
Stock market efficiency:
 Market price- the current price of a stock
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 Equlibrium price- the price that balances buy & sell orders at any given
time
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CHAPTER 6: INTEREST RATES
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SUZARIMA

The cost of money: factors affecting Production opportunities
 Time preferences for consumption
 Risk
 Inflation
Interest rate levels:
 Borrowers bid for the available supply of debt capital using interest rate
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 r*= the real risk-free rate of interest, rate that would exist on a riskless
security in a world where no inflation was expected
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 DRP= default risk premium
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 LP= liquidity(or marketability)
 The real risk-free rate of interest, r*:
I
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S
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II
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The rate of return that corporations & other borrowers expect to
earn on productive assets
IV
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 The nominal/quoted
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The nominal/quoted
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The rate of interest on a security that is free of all risk, rRF is
proxied by the T-bill rate/ the T-bond rate, rRF includes an
inflation premium
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A premium equal to expected inflation that investors add to the
real risk-free rate of return
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rT-bill=rRF= r+ IP
 Default risk premium(DRP):
I
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S Treasury bond
and a corporare bond of equal maturity & marketability
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A premium added to the equlibrium interest rate on a security if
that security cannot be converted to cash on short notice & at
close to its “fair market value”

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SUZARIMA

 Interest rate risk:
I
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A premium that reflects interest rate risk,
 Reinvestment rate risk:
I
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The term structure of interest rates:
 The relationship between bond yields & maturities
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 Normal yield curve- an upward-sloping yield curve
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 Humped yield curve- yield curve where interest rates on medium-term
maturities are higher than rates on both short-and-long-term maturities
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 Expected return on 2-year series= rate on 2-year bond –MRP
Macroeconomic factors that influence interest rate levels:
 Federal reserve policy
 Federal budget deficits/surpluses
 International factors
 Business activity
Interest rates & business decisions:

CHAPTER 7 :RISK AND RATES OF RETURN
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Stock prices over the last 20 years:

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Investment return=

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Investmet risk=probability of earning a low/negative actual return
Stand-alone risk:
 Risk =the chance that some unfavorable event will occur
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 Statistical measures of stand-alone riskI
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II
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𝑁
 r^=∑ 𝑖=1 𝑃R
III
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IV
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Coefficient of variation(CV):
 The standardized measure of the risk per unit of return
 Calculated as the standard deviation divided by the
expected return
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𝝈
𝒓^

Risk averrsion & required return:
 Expected rate of return=

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SUZARIMA

𝑒𝑥𝑝𝑒𝑐𝑡𝑒𝑑 𝑒𝑛𝑑𝑖𝑛𝑔 𝑣𝑎𝑙𝑢𝑒−𝑐𝑜𝑠𝑡
𝑐𝑜𝑠𝑡

 Risk premium(RP)-The difference between the expected
rate of return on a given risky asset 7 that on a less risky
asset
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 Expected portfolio returns, r^p:
I
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𝑁
II
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

SUZARIMA

realized rate of return,r-= the return that was actually earned
during some past period
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 Portfolio risk:
 Corellation coefficient,𝝆= a measure of the degree of relationship
between 2 variables
...
This
risk is a
...
a company specific, or unsystematic risk
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This a
...
a non diversifiable/
systematic/beta risk
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 Risk in a portfolio context:the beta coefficient
 Relevant risk- the risk that remains once a stock is in a diversified
portfolio is its contribution to the portfolio’s market risk
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 Beta coefficient, β- a metric that shows the extent to which a given
stock’s returns move up & down with the stock market
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𝑁
 Bp=∑ 𝑖=1 𝑤𝑏
The relationship between risk & rates of return:
 r^i= expected rate of return on ith stock
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 r-=realized after fact return
 rRF= risk free rate of return
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 rM= required rate of return on a porfolio consisting of all stocks, which is
called the market porfolio
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 RPi=(rM-rRF)bi=(RPM)bi =risk premium on the ith stock
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 RPM=rM-rRF ( Market risk premium)
 Risk premium for stock L= RPi =(RPM)bi
 Required return on a stock= risk free return+ premium for the stock’s risk
 Security market line(SML) equation= an equation that shows the relationship
between risk as measured by beta & the required rates of return on
individual securities
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Future values:
 Future Value(FV)= the amount to which a cash flow or series of cash flows will
grow over a given period of time when compounded at a given interest rate
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 Compounding= the arithmetic process determining the final valu of a cash
flow / series of cash flows when compound interest is applied
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 CFt=cash flow, can be positive/negative
 I=interest rate earned per year
 INT= dollars of interest earned during the year=beginning amount x I
 N= number of periods involved in the analysis
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 FVAN=PMT(1+i)N-1PMT(1+i)N-2
Future value of an annuity due:
 FVAdue=FVAordinary(1 +I)
Present value of an ordinary annuity:
 The presnt value of an annuity of N periods
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 Perpetuity= A stream of equal payments at fixed intervals expected to
continue forever
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 Payment( PMT)= the term designates equal cash flows coming at regular
intervals
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Semiannual & other componuding periods:
 Annual compounding- The arithmeticnprocess of determining the final value
of a cash flow / series of cash flows when interest is added once a year
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𝑠𝑡𝑎𝑡𝑒𝑑 𝑎𝑛𝑛𝑢𝑎𝑙 𝑟𝑎𝑡𝑒
=I/M
𝑜𝑓 𝑝𝑎𝑦𝑚𝑒𝑛𝑡 𝑠 𝑝𝑒𝑟 𝑦𝑒𝑎𝑟

 Periodic rate(1PER)= 𝑛𝑢𝑚𝑏𝑒𝑟
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SUZARIMA

Comparing interest rate:
 Nominal(quoted,or stated) interest rate, INOM=The contracted(or quoted or
stated)interest rate
...

 Effective(equivalent)annual rate(EFF% or EAR) =the annual rate of interest
actually being earned , as opposed to the quoted rate
...

 Effective(equivalent)annual rate(EFF% or EAR)=(1+INOM/M)M-1
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 Amortization schedule= a table showing precisely how a loan will be repaid
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