Corporate Finance I

Professor Heitor Almeida

Welcome to Corporate Finance I

Welcome to Corporate Finance I

My name is Heitor Almeida, I'm a professor of corporate finance at the University of

Illinois at Urbana-Champaign. I've been teaching corporate finance to MBAs, PhDs and
undergraduate students since 2001 and I also spend a lot of time researching
corporate finance topics that we will discuss in this course, such as liquidity
management, corporate investments and mergers and acquisitions.
I am originally from Brazil, so this explains the song I always play in the beginning. It
also explains my accent. I came to the US in 95 to work on my PhD in economics from
the University of Chicago, I managed to graduate in 5 years. So, I've graduated from
the University of Chicago in 2000. My first job was at New York University. I've spent
seven years teaching and doing research at NYU before I've moved to Champaign-

Urbana in 2007.
Why did I get into corporate finance? As with many paths in life, it was a little bit by
accident and I want to share the story with you. This was about January of 1998 and
at that point, I had finished all my course work, I had finished my exams in the PhD.
And I was thinking about what am I going to do for my research? What is my
dissertation going to be about? Remember, I was an economics PhD, so I wasn't really
studying finance at that point. Finance is one of the topics we study in economics, but
there are many other topics.

Macroeconomics, labor economics and I was really trying to think what I was going to
do. Corporate finance was not even crossing my mind at that point. What happened is
that I decided to take a course, a course that really changed the course of my life. It
was a corporate finance course that was taught at the Chicago Business School by a
professor named Raghuram Rajan. If you are from India, you probably heard his name.
He's currently the Central Bank governor of the Indian government, so I'm sure you've
heard his name or other people might have heard about him as well. He was the chief
economist of the IMF some years ago. But in any case, that course was great. I really
enjoyed learning about corporate finance and it got me thinking about how companies
make financial decisions? How companies make investment decisions? I became
fascinated with this topics.

And in particular, I became really interested in understanding why corporate finance

matters for the economy as a whole? What is the link between corporate finance and
macroeconomics and issues like that? After that course, I never really looked back. I
started research corporate finance, I got my first job. I started teaching corporate
finance and I've been doing that ever since. The morale of this story is that a single
course can change your life. So this is my office. This is where I do my research and
where I prepare my classes. It's the typical office of a professor. It's not very special,
not particularly organized. The real reason I brought you here is because the office of
a professor is like a visual resume, you can look up my resume on the web. But it's
nice to actually be here, so I can show you some things. So here's where I have the
prizes that I won for my research and for my teaching.

For example, I have this prize that I won in 2008 for the best paper published in The
Journal of Finance. That year, The Journal of Finance is considered to be the best
journal in our profession. So, I'm very proud of that one. I have the medal that I won
when I became a chair professor at University of Illinois. You can see that it's a very
heavy medal, so people don't go around wearing that medal, we just keep it here in
our office for people to see. And I have this really cool prize that I liked, it's a
basketball, as you can see that I actually won a year ago from my executive MBA
students when I was elected professor of the year. And as you can see here, it's
signed. All the students signed the ball. In that program, we have about 40 students,
so it fits in a regular basketball. And as we are starting this, I was thinking about if
we're doing an online class, there are maybe thousands of students. I was thinking
how big the ball should be, if all the students would have to sign in, that would
probably end up being bigger than this office.
In this course, we will learn how companies make financing and investment decisions
that create value for shareholders, okay. Some of the issues that we will study are
how to use accounting statements to how to measure the financial health of a
company.

We're going to learn that accounting is the language of finance and we're going to
learn that language, then we're going to learn how to manage a companies short and
long term need for liquidity. We're going to cover models that allow us to forecast and
manage a company's liquidity needs, then we're going to learn tools that are going to
allow us to measure the contribution of a new project or a new acquisition to
shareholder value. We're going to learn the very important concept of net present
value, which is the tool that is going to allow us to do that. After we do that, we're
going to learn how to incorporate risk and uncertainty into investment valuation
decisions. And finally, we will learn how to measure the performance of existing
investments or divisions of a company. We are going to learn tools that are going to
allow us to measure whether a division or whether an investment is generating value
for a company or not.
This course is divided in four modules. Each module has certain topics. So in module
one, we're gonna talk about goal of the company; financial ratios, then we're going to
do financial planning in module two. We're going to talk about investments in module
three. Module four is about mergers and acquisitions, risk and performance

evaluation. So here, you know all the topics we're going to cover in each module.

A very important point that I want to discuss is that each module has three sets of
problems and they are a little bit different from each other. The practice quizzes are
simple, direct questions that allow you to practice the concepts that we learn as we
learn them. So as you see, the practice quizzes are going to be introduced within the
module and are going to cover certain topics that we just learned. All the practice
quizzes are going to come with solutions and immediate feedback. So as you do a
question, you get immediate feedback whether it's right or wrong and you get the
solution as well.

So you can understand why your answer was right or wrong. Then at the end of
module, there is a quiz. The difference is that for this quiz, you will get feedback on
whether your answer is right or wrong, but there will be no explanation. There will be
no solution to the end of module quiz. If you want to understand why your answer is
right or wrong, what you should do is go back and look at the practice quizzes. The
end of module quizzes are going to be very similar to the practice quizzes. And then
at the end of the module, there's going to be an assignment.

The difference between the quizzes and the assignment is that the quizzes are
simpler, more direct questions whereas the assignments are going to be more
complex, deeper questions that are going to allow us to dig deeper in the concepts
that we learn in the course. So for example, the assignments are going to have some
mini cases that I wrote where you're going to have to analyze real world companies
and look at the data analysis of some of the topics we discussed during this course.
Make sure you work on all of them. It's important to do all of these assignments. After
all, practice makes perfect. Both with guitar playing and with corporate finance.

Corporate Finance I
Professor Heitor Almeida

Module 1
Lesson: 1-1 Objectives And Overview
Heitor Almeida: The fourth model is about a goal and the language of corporate
finance, okay? Being from Brazil I thought I had to start the course with football or
soccer ball depending on where you come from, right? Unfortunately through the
language of corporate finance is not Portuguese like I learned when I was a kid.
The language of corporate finance happens to be accounting, okay? So what we will
learn in this model is how to use financial statements, how to use accounting data to
really understand what's going on with companies, okay? We're going to use financial
ratios to measure concepts like liquidity, profitability, leverage and we're going to try
to understand how companies are generating and spending cash using the cash flow

statement, okay?
In terms of the goal the important thing to realize is that in corporate finance we're
going to be studying and investment decision that are made by companies as opposed
to studying investment decisions made by people we're going to shift the focus and
talk about companies, okay? So before we can think about the financial investment
decisions we have to discuss the objective of the corporation, right? What is their
goal? When they are making the financial investment decisions what are companies
maximizing, right?

So in this model we're going to discuss this key, this really important idea of
shareholder value, right, the concept of shareholder value maximization, right? Why
does this make sense, right, to maximize shareholder value but also the problems, the
potential problems that companies may encounter when they are maximizing
shareholder values, okay?
And specifically we will talk about why maximizing the stock price is a reasonable
goal for companies and better than alternative goals such as maximizing current
profits, okay? But we're also going to talk about the potential problems that this may
create, okay? So there are conflicts between stock price maximization and social
responsibility with stake holder such as employees and with the government so we're
going to be talking about those as well. Really drill down and try to understand this
concept of shareholder value maximization, okay? And then finally we're going to talk
about the agency problem.

The fact that managers may not necessarily maximize shareholder value and how
corporate governance practice can help with that, okay? Then we're going to move on
and talk about the language. We will learn how to use information from the
accounting statements to measure key corporate finance concepts such as liquidity,
solvency. Then we're going to look at the income statement to measure profitability
and we're going to look at the cash flow statement to understand how a company is
generating and spending cash. Finally, we're going to talk about valuation ratios from
a corporate finance point of view right, valuation ratios such as market-to-book value
over profit. We're going to calculate and discuss what these ratios mean.
 Corporate Finance I
Professor Heitor Almeida

Module 1
Lesson: 1-2 Why Maximizing Stock Price Is a Reasonable Goal For a

Company
In this course, we will talk about many corporate decisions-- investment decisions
financing decisions, acquisition decisions, okay? So, at this point, it's very important
for us to discuss what is the objective of the firm. Right? What is the objective of the
company. If they're making these decisions, which variable are the companies
maximizing. Which variable are they looking at. Okay? You know, an idea seems to
make sense is that since companies are owned by shareholders, they should be
maximizing shareholder wealth, or in other words, maximizing the stock price. Okay?
So maximizing the stock price is the objective of the corporation. What I want to do
now it, is to really discuss his idea with you and think about whether that makes sense
or not.
Okay? The first thing that you might be thinking is that maximizing a stock price
seems to be a little bit shortsighted. Right? The stock price is a current measure; it's a
measure of the current value of the firm, whereas, if you are concerned about
shareholder wealth, you might also be worried about the future. What's going to
happen in the future? If we maximize the current stock price, perhaps were not
maximizing shareholder wealth. Okay? The think about the following: what
determines the stock price. This is something that you might have covered in a
previous course or if not, that's the right time for us to discuss this. It's a very
important idea in finance. Okay?

The stock price should be that discounted sum of all future cash flows. So the stock
price of a company today should depend of everything that is going to happen in the
future. So the stock price should reflect all the consequences of any decision that a
company takes today. It's the forward-looking measure. Okay? So that is why if you
think about it, you know, even though it's a current measure, it also reflects the
future, right? So it makes more sense once you think of stock prices as the discounted
sum of future cash flows, it starts making more sense that companies can look at
stock price. Okay? Let's think about this idea.
Do stock prices really reflect information about the future? Okay? So, that is the idea
we just posed. Is there a way we can look at data to see that? A very useful example
to consider is the market reaction to merger announcements. Okay, let me give an
example here that is an example were going to talk about more in our module for
when we discuss acquisitions. Okay? So, on September 4 of 2001, Hewlett-Packard
announced it was going to buy Compaq. Okay? So it's an announcement. It announces
to the financial press; to analysts that this merger is going to happen. The merger
hasn't happened yet.

In fact, this merger was highly contested. Okay? The shareholders of Hewlett-Packard
were not happy about that merger, okay? And the merger ended up being completed
almost a year later. Okay? But check this graph. Right on September 4, when the
merger was announced, this is what happened to stock price. Okay? So this is the date
of our September 4, okay? The stock price immediately dropped. Okay? It is a current
measure, but the moment that this new information came in to the market, the stock
price reacted to that. Okay? Why did the stock price drop? The stock price drop
because, as we just discussed, shareholders did not like the merger. Right? They
thought that the merger was not going to add to the value of the company.

With the market does is the market reacts immediately to that piece of information.
They are not waiting for future profits to come in, the markets not waiting to try to
figure out what's happened, you're immediately reacting to any corporate decision.
Okay? So that is, you know, this is the support this idea that stock prices really reflect
future, and it's a variable that managers should be looking at.

Okay? An important notion here is the role of efficient markets. So, the-- this idea
that we just posed that the stock price reflects any-- all consequences of any decision
that a company takes today, it relies on the assumption that markets are efficient.
Right? If the market is efficient than the stock price should be exactly equal to that.
Of course markets are not perfectly efficient. Right? So the stock price is not always
going to be a perfect measure of shareholder value. There is going to be a
discrepancy between stock prices and shareholder wealth. So at this point, we have

to think about are there good alternatives? Is there something else we can look at?
Okay? Let's talk about earnings-per-share. This is a commonly reported measure of
profitability for companies. What it is, it's just the current earnings; the current net
income of the company divided by the number of shares outstanding. Okay? So, you're
looking at current profits and dividing current profits by shares outstanding. Right?
And the question I want you to think about is can it that replace a stock price? Okay.
Will maximizing earnings per share maximize current shareholder wealth or not? Or
are there problems with earnings-per-share?

If you think about this for a while, you will see that the answer is no. Okay? Now were
going to have a problem of short-term [inaudible]. Right? Earnings-per-share are only
going to measure current profits. Okay? So if you're maximizing current earnings-per-
share, then you are completely ignoring the future. There's no way you can capture
future profits just by looking at earnings-per-share. Okay? Later on in this module, we
are going to talk about profitability measures. Right? And actually, one concept that
going to learn is that there may even be better measures of profitability. There are
problems with earnings-per-share that make it in my view, that make it a problematic
measure of profitability. Okay? So on top of this problem that it ignores future, EPS is
also problematic as a measure of profit. So, it's definitely not you know, an adequate
alternative.
And here is an interesting example. Again from the merger world. Okay? So, that's a
more recent merger on July 2015, the Celgene, which is a biotech company,
announced a deal to buy another company called Receptos, okay. And this deal was
welcomed by the market. So the market liked this one. Okay? The stock market
reacted positively to the deal; Celgene stock price went up substantially, okay. $115
to 135, but at the same time, the management announced that the deal was going to
reduce earnings-per-share. For several years, for four years, I would take four years
for this deal to generate profit. Still, the stock price went up. Okay? So think about
that. What is that mean? Right? It means that the market really is considering this
long-term effects of the merger in order to figure out whether this merger is adding
value to the company or not. Okay? EPS, the fact that EPS is going to go down now,
seems to not matter as much when the stock market is trying to estimate the value of
this deal. Okay? So that's an example of situation where stock prices and EPS are
really departing from each other.
Another alternative you might think about is the book value per share, okay? So the
book value of equity, you know, one advantage may be that this is an accounting
value, right? So it goes to all the things [phonetic]. It's a number that is easy to verify
okay. The problem of course, is going to be similar to earnings-per-share. The book
value of equity does not reflect future profits. Okay? The book value equity reflects
mostly what happened in the past not the future so if we maximize the book value of
equity, again, we are going to be completely missing this future, you know, it's going
to leave the short term [inaudible] it might lead to wrong decisions. Okay? Bottom
line is that you know, maximizing stock prices is the lesser evil even if markets are
not perfectly efficient, at least you have a hope that the stock price is capturing
information about the future. Okay? That doesn't mean the stock price is a perfect
measure, as were going to talk now, there are problems. These problems arise mostly
because maximizing shareholder wealth may not be come patentable with the welfare
of society as a whole and other stakeholders in the firm. So that's the next topic we're
going to discuss.

Corporate Finance I
Professor Heitor Almeida

Module 1
Lesson: 1-3 Conflicts Between Stock Price Maximization and Society
Let us now think about this conflict. Right? We just discussed the notion of
shareholder value right, shareholder wealth; maximizing the stock price; that seems
to be a reasonable objective for the corporation if you are thinking strictly about
shareholders. Right? But what about society as a whole? The first issue that we can
talk about is social responsibility, right? And before we get into the problems, let's
talk about a few actions that companies make that are actually socially responsible.
Right? So you know, there are necessarily complex all the time. Right? For example,
companies invest in human capital. Right? If an employee works in a company for a
long time, and learns new skills, right? Some of these value is not going to be
captured by the company, but it's going to be captured by the employee. So
investments in human capital is something that benefits society as a whole, not only
the company. Right? Sustainability is another issue. Many companies are trying to
develop products that are better for the environment, right? And that make the
environment more sustainable. Again, that is an example of a socially responsible
corporate action. Okay? And philanthropy, right, many companies engage in donations
and actions that benefit the communities and the society as a whole. Right? So there
are examples of socially responsible corporate actions, but of course that doesn't
always happen. Right?
There are conflicts as well. And it's very easy to think about a situation in which
maximizing shareholder wealth may not be consistent with social responsibility. Right?
For example, right, if you want to take some time to think about some examples you
can, but let's just go on and talk about a few, right. There are some products that are
bad for our health, right. Some companies produce tobacco, junk food, it is well
known that these are not great for people, but people value them, right. So
companies can create profits by selling these products. This might be-- these is good
for shareholders, but it may not be good for society. So there are some conflicts
there. Right? Pollution is another classic example. Right?

Companies' incentives are to reduce costs, to produce things as cheaply as possible, to

increase profits and therefore increase shareholder value, but these may not be the
best thing for the environment, right. Technologies that are cheap, but pollute the
environment are not going to be great for society as a whole. Right. Another example
you might think of is outsourcing of labor. Right? Hiring employees in other countries
of course going to be great for those countries but it might not be good for the local
labor market. This is another issue that is being discussed a lot these days.
One issue that you might not have thought of as an example of a conflict is taxes.
Right? Should companies minimize their tax abuse? Right? The answer seems to be
obvious, right? Minimizing taxes increases profits and therefore should increase stock
prices. Right? If taxes go down, both your current and your future profits are higher.
Right? But there is a downside. Minimizing taxes is also going to reduce tax collection.
Right? The government is going to receive less money, right? The government will
have less money to invest in infrastructure, to invest in social projects, right? This is

going to increase budget deficits. It might not be best for society as a whole. Okay?
One example that the financial press is talking about these days okay is the fact that
multinational companies around the world of really, but this example uses U.S.
companies, are holding a lot of cash abroad. Okay? So U.S. multinational companies
are holding a large amount of cash in countries that are outside the U.S. So here there
is a chart for you to look at. You can see the example of Apple for example, that
holds $157 billion of cash outside of the U.S. Okay? You might have heard about this
before. Let's talk about this for a while. Why is this related to taxes?
Okay? It's because of this notion of repatriation taxes. Right. So suppose-- take Apple
for example. Apple has some operations in Ireland. Okay? The corporate tax rate in
Ireland is just 10 percent. Okay? So if Apple generates $1 billion of profits in Ireland,
you're going to generate a tax bill of 100 million. Okay? That's the Irish tax. The U.S.
corporate tax rate is much higher. It's 35 percent. Okay? So the U.S. firm Apple in this
case, in our example, would have to pay an extra $250 million to bring the cash back
home. You know, guess what? They're not bringing. Right? The cash is staying abroad,
okay? Why is this a problem? The problem is that this foreign cash cannot be used for
dividends and it also cannot be used for investments in the U.S. without generating
these repatriation taxes.

So if Apple wants to invest the money in the U.S., it has to bring the money back to
the U.S. and pay that tax. Guess what? You know, this multinationals are not bringing
the cash back home. So even the government has got into this. The current U.S.
president, Barack Obama is trying to come up with a plan to force multinationals to
bring the cash back home of course that is not something that is easy to do. Okay?
And that shows a general point, you know, every time there is a conflict there is a
conflict, between shareholder value maximization and society as a whole, there is a
potential role for the government to try to improve the situation. Okay? I'm not saying
that it's right for Obama to tax U.S. companies on their profits held abroad, but the
general point is that these are situations where typically the government comes in;
tries to intervene, and improve the situation. Pollution for example can be regulated,
outsourcing of labor can be regulated if the government wants, so there is a potential
role for the government to play a role. Okay? Next topic.
Let's think about conflicts between shareholder wealth with other stakeholders. Right?
This is related to what we've been talking about, but now it's think more specifically
about stakeholders like employees, suppliers, and debt holders, bondholders. Okay?
Does a high stock price also benefit these other people? That's the question I want you
to think about for a while. And then will talk about in a second. [ Silence ] And the
answer is yes, right? There isn't necessarily a conflict if you think about it in the
following way. Right? A more valuable firm, a firm with a higher stock price is going to
be able to pay higher wages, right? Is going to improve career prospects, right, if
you're a manager working for a successful company, that is going to improve your
[inaudible], right? It's going to be good for the employee as well. Right? It's also good
for suppliers because increases profits for suppliers. It makes the company more
stable, and it lowers the risk for debt holders. Okay? So there is-- there are many
reasons why a stock price is also good for other stakeholders.
The problem of course is that this congruence does not always hold. Okay? A very, you
know, commonly discussed example of a potential conflict is actually mergers and
acquisitions, which we discussed a little bit already, and we will discuss more later on
in the course. Okay. M&A can of course make some jobs obsolete. Right? If two
companies merge, some jobs may not make sense anymore, so there is some evidence
that M&A's related to employment cuts. Right? If you work for a company that has
undergone M&A activity that is always a very stressful time for employees. Right? In
the name of improving operating efficiency, is common that M&A will result in lower
employment. Right? And something you might not have thought about yet is that
M&A's sometimes financed with large amounts of new debt. Okay? This is a leverage
buyouts that we are going to talk about in module four. This new issuance can of
course heard existing bondholders. Right? If you hold a bond in a company that
undergoes a leveraged buyout, you know, it's very likely that the value of your bond is
going to go down because leverage is increasing so much. Okay? So this is an issue we
will discuss later in the course we talk about mergers and acquisitions and leverage
buyouts.
 Corporate Finance I
Professor Heitor Almeida

Module 1

Lesson: 1-4 The Agency Problem and Corporate Governance

Heitor Almeida: Let us talk now about corporate governance, okay? The idea then that
we've been discussing is that companies should try to maximize shareholder wealth.
The problem is that companies are managed by managers, right? Managers have to
make these decisions. Shareholders may not be able to make the decisions on their
own. They have to rely on managers, right? And the problem is that managers of
course are going to maximize their own wealth, right? Managers' incentives may not
be to always maximize shareholder's wealth, right? And there is a name for this in
corporate finance. We call this the agency problem, okay, managers, the fact that
there may be a conflict between what managers are maximizing and what
shareholder's want. Okay, so this is a different problem. Notice that this has nothing
to do with social responsibility or stakeholders. It really is a problem that is, that
belongs to the company, right? It's a conflict between managers and shareholders,
right?
What's sort of a conflict are we thinking about here, okay? For example, stealing, you
know stealing is not [inaudible] in a developed economy like the U.S. but it does
happen, right? Even in the U.S. and it happens in other countries as well. Sometimes
managers steal from companies, right? Employing family members, right a family
member may not necessarily be the best manager, right? But if you are a CEO you
probably have a lot of power to decide who you are going to employ especially if you
own the company as a whole, right? So if you own a lot of stock in the company and
you are the CEO you might decide to employ a family member instead of hiring a
manager in the labor market that might be a better manager, right? That's going to be
bad for shareholders but it's going to be good for the CEO.

Not working hard enough is another problem, right? Shareholders of course want
managers to work hard, create value but managers may be lazy and not want to put
on the hours, right? And over spending the company's money, right which is sort of
related to stealing but a more soft version of stealing. You know one issue that we
talk about is corporate jets, right? So a corporate jet might make sense but in some
cases a corporate jet might be, the usage of a corporate jet may be a little bit
excessive and not be great for shareholder value, okay? So these are some general
examples of what with we think of as agency problem, okay?
So how do companies slow agency problems? Right? So how can you align incentives of
managers and shareholders? The answer is very simple. It's probably something that
you have thought about before. It's compensation, right? If you want managers to
maximize the value of the stock the easy way to do it is to give stock to managers,
right? That is why you know, managers own so much stock in companies. Stock
managers like CEOs, CFOs, you know the top five to ten managers of a company would
typically be owning a significant chunk of the stock, okay? And if you think about this
practice it does make sense, right because if you want managers to maximize the
stock price it's a good way for, this is a good way to do it because even if managers
are maximizing their own wealth they are going to end up maximizing the stock price.
So this is the idea, however, this practice of giving stock to managers has been the
object of a very heated debate recently, okay? There are many observers, analysts,
academics who claim that stock compensation might have gone too far, okay? This is
just some data for you to think about. CEO pay in the U.S. has grown by a lot more
than the average pay of an employee, right, so the average pay of an employee in the
U.S. in the period of 1982 to 04 which is in this graph hasn't grown by much whereas
you know this CEO pay has grown by 8.5% a year, okay? It's also higher than the GDP
growth rate and higher than the growth rate in corporate profits which is 2.9%, okay?
So this kind of data you know we know that executives get paid a lot, CEO pay has
also increased a lot in recent years so this kind of data has generated this debate you

know on whether top executives are paid too much or not, okay?
There are two sides in this debate. Some of them exclaim that you know this is a
market of outcome. We shouldn't mess with it, okay? Companies want to pay, if
companies want to pay a lot to hire a CEO they should be able to do it. High pay is
just the consequence of a demand for talent, okay? But on the other hand the people
who want to curb CEO pay what they claim is that this argument doesn't really work
because pay is determined by the board of directors and the board of directors does
not always work independently from the CEO, right? The board of directors may be
composed of people who are friends of the CEO, who are not truly independent and
that may lead to the CEO to get paid too much, okay?
A possible solution for this problem is to rely on corporate governance, right? To rely
on other governance mechanisms other than compensation, right? So we think of
corporate governance as any sort of mechanisms that companies have to solve this
conflict between managers and its shareholders. For example, having a truly
independent board of directors may help, right? If the problem is that the board of
directors is not really independent from the CEO what companies can do is to get
some independent directors, right? A very common and recent trend in the U.S. is the
role of institutional investors, right? Institutional investors have larger take in firms
and they can come, you know people who own a lot of stock in firms can come and try
to change corporate practice like CEO compensation, okay?

And finally, there is pressure from M and A market again, M and A matters a lot,
mergers and acquisitions. If a company is in inefficient, if you're paying the CEO too
much and profits are going down, shareholder value is going down you know, you
might eventually die out, either be swallowed by your competitors or disappear, go
bankrupt, okay? So there are ways to control this problem. There may be a role for
the government as well.
The last observation here following the recent financial crisis of 2007-2009, the U.S.
government introduced a new law, okay? According to it, shareholders now have to
vote to approve executive compensation. This law is being implemented now, slowly
being implemented so it may be a little bit too early to figure out whether this law
has had an effect on compensation or not. Academics are currently studying this
issue. What we see so far is that in a vast majority of cases the shareholders ended up
approving the compensation that was proposed by the board, okay? Perhaps this
means that the compensation packages we are not wrong, were not excessive, okay or
perhaps it means something else. It's a little bit early for us to say. I think we have to
wait a little to be able to figure out whether "Say on Pay" is going to have an effect on
executive compensation or not.
 Corporate Finance I
Professor Heitor Almeida

Module 1

Lesson: 1-5.1 Balance Sheet Ratios: Introduction

As we talked about in the introduction this module, accounting is the language of
corporate finance. Right? So we're going to learn now is how to use financial ratios to
measure key corporate finance concepts. we're going to be dealing with the major
financial statements: the balance sheet, the income statement, and the cash flow
statement. And then we're going to try to really put words to the numbers and make
the financial statements live and really try to think about what can we see there.
Okay? What sort of important corporate finance concepts can we learn by looking at
initial statements.
Let's start with balance sheets. Okay? So that's going to be the first set of financial
statements we're going to be looking at. we're going to spend quite a bit of time
thinking about balance sheets. Okay? Before we get into real world examples, which is
really how I want to do this, I want to do this calculations using data from real-world
companies, but before we do that, let's just start with a simplified example where we
are comparing three firms here. We have Firm A, Firm B, and Firm C, okay. And here
you can see all their-- a snapshot of their balance sheets, right? A real world balance
sheet is going to have many more items than that, here we just have the basic items.

Assets, liabilities, and assets and liabilities are split into current and noncurrent, and
we also have information on the equity which is the difference between assets and
liabilities. Okay? So ask yourself what kind of information can we get by looking at a
balance sheet? Okay? The first thing you notice is that the balance sheet will give you
information on, you know, how large the company is. How much-- you know, how
much assets does it have? Right. In this case, the three firms have $500,000 or $500
million. Let's say $500 million in assets. Okay? And then we can look at the liability
side, right? And here you can notice that there are some differences. Right? So if you
look at this, Firm A has $200 million in current liabilities; Firm B has just $50 million.
Okay? Both companies have the same amount of total liabilities, but Firm A has more
current liabilities. Okay? So, one thing we're going to do this lecture in this module, is
to think about what does that mean for the liquidity of the company. Okay? So, and
that we look at Firm C, the main difference is that Firm C has fewer liabilities then
Firm A and Firm B. right?

So another concept we are going to talk about is solvency which is going to be a

difference between Firm B and the other two firms. Okay? So, these are the key
concepts we're going to be talking about, liquidity and solvency. And rather than using
these simplified example and made of examples, what I want to do is to use data
from three real-world companies to illustrate these key concepts.

Okay? So we're going to take two companies that are competitors. The first one is
Cablevision which is a leading telecommunications company here in the U.S., right?
They provide mostly digital television; also high-speed Internet, okay? And one of
Cablevision's major competitors which is DirecTV, which again is a major provider of
digital television, actually DirecTV is more of an international company, right? They
are a U.S. company; they are also operate mostly in Latin America. It has more than
37 million customers around the world. Okay?

And for reasons that you will understand soon, we're going to talk but a third company
in a completely different industry, which is B/E Aerospace. What BE Aerospace does is
they make aircraft cabin interior products. Things like seats, you know, aircraft seats.
They make those both for commercial and business jets. Okay? So of course it is a
completely different company; you will see why we have that in the analysis we start
talking about liquidity ratios. So those are the three companies we are going to
analyze, and now we are really going to try to get into the financial ratios and see
what we can learn about these companies by reading their accounting statements.
 Corporate Finance I
Professor Heitor Almeida

Module 1

Lesson: 1-5.2 Balance Sheet Ratios: Liquidity

The first set of ratios that we're going to talk about are the liquidity ratios. Okay? So
those are the ratios that allow us to measure how liquid the balance sheet of a
company is. Okay? So, the first liquidity ratio that we're going to compute and analyze
is what we think-- what we call the current ratio. Okay? So the current ratio is very
simple. It's just the ratio of current assets divided by current liabilities. Okay? As a
way of illustration, let us compute this ratio for Cablevision, and for B/E Aerospace.
Okay? So let's go here to the balance sheet.
Here you can see that you have-- here you actually have the real balance sheet for
Cablevision for three years. Okay? We're going to do is we're going to focus only on the
recent year for now, but if you are doing this, you know, for another application like
you may want to analyze a liquidity for more years, for our teaching purpose we're
just going to focus on the most recent data. Okay? So let's go here. And think about
how we would compute the liquidity-- the current ratio, right? So that should be
really very simple. You have here the date of the most recent data on the company's
total current assets, and you have the most recent data on the company's current
liabilities. So the current ratio is simply the ratio of current assets by current
liabilities which is 788 [phonetic] divided by 73-- 1737, okay? So this is in the millions,
so this means that Cablevision has $1.8 billion in current assets and $1.7 billion in
current liabilities, so this ratio is approximately equal to one. Okay? So Cablevision

has the same amount of current assets as they have current liabilities.
Okay? So now let's go to B/E Aerospace, all right? Same information. You have the
balance sheet for the last three years, okay? Okay let's focus on the latest information
we have. Okay? And here you have information on the current assets; current
liabilities okay? So, again, we can compute to the ratio current assets divided by
current liabilities would be 1723 again this is in millions, so that it means that they
have $1.8 billion in current assets. And $800 million in current liabilities, so you would
get a current ratio of approximately 2.15.

So here we have done the calculation, right? Now let's think about it. B/E Aerospace
seems to have a much larger current ratio then what Cablevision has. Right? So it's
2.15, significantly larger, right? Does that mean that B Aerospace has more liquidity
than Cablevision? Right? Now what we need to do is we have to start thinking about
the details a little bit more. Okay? And which will soon realize is that the main reason
why B/E Aerospace has as high liquidity ratio is because they have quite a bit of
inventory. Right? Out of the $1.7 billion in current assets that they have, $970 million
is inventory. Okay? So let's take that information and think about the following
question: right, so why is B/E's ratio so high, right? Inventory, you know, it does this

really measure liquidity?

Okay, right? Is inventory a really illiquid asset? Does it, you know, does regulation
mean that B/E has more liquidity than Cablevision has? [ Silence ] So what we need to
think about is, what is liquidity, right? What are we trying to measure? Right? And so
the notion of liquidity, that something very important in finance of course, right?
Liquidity measures how easy it is to transform an asset into cash. Right? So how fast
can we generate cash from an asset, how easy it is, how much cash are we going to
get for an asset? Okay? So that's the notion of liquidity, right? So really what we're
trying to understand is whether a company like B/E Aerospace has sufficient current
assets to cover its current liabilities. Okay? Right? So, is inventory really illiquid asset?
Okay, so if you think about that, right? Of course, companies can try to sell inventory.
Right, if you run into a liquidity problem, you know you have some inventory, you can
use that to raise cash, but you might have problems. Right? Liquidating inventory to
raise cash is going to disrupt the business. Think about B/E Aerospace for example.
The reason they have inventory, right, is because they have to keep seats, you know,
aircraft seats for example, to sell to airlines, right? And if they have to liquidate
inventory, you know, that's going to disrupt their business and in addition, the
company may not really get the good price when it does that.

Right? The inventory, you know, the aircraft seat they may be some very specific to,
you know, a particular airline, if you're going to sell it to a different airline, you may
not get a lot of cash that. Okay? Actually, there is some evidence in the corporate
finance literature this very interesting paper by Berger, Ofek, and Swary, which was
published a few years ago, what these authors did is they gathered data on how much
money the amount that firms we're able to obtain when they sold their assets. Okay?
When they had to sell assets because they were discontinuing operations. So these are
companies that went bankrupt, for example, and what they did is they looked at how
much did they get for their current assets? All right? You know, intuitively, right,
cash, right, is one.
Okay? So if you liquidate cash, you know cash is cash, so they got one for that.
Receivables they got $.72 per dollar. So what this number means is that for each
dollar of receivables that they had, they were able to raise 72-- 72 percent. Okay? So
if they had $100 million in receivables, they raised $72 million in cash. Inventory was
the lowest, right? So inventory just generated $50 million in cash out of $100 million.
So 55 percent. Okay? So, you know, inventory is somewhat liquid, but it's not
perfectly liquid. Right? So that's why we have to think about additional liquidity
ratios.
Okay? So we have some liquidity ratios that take this illiquidity of inventory into
account, okay? There are two ratios we're going to think about. The first one is the
quick ratio, which uses only cash and receivables. And then we're going to have the
cash ratio, which looks only at cash. Okay? You're ignoring even receivables since
receivables are not perfectly liquid, let's just take the most liquid asset which is cash,
and think about that. Okay? So, recalculating these ratios using these different
measures, what we do, now you have DirecTV by the way, right?
So now you have DirecTV's balance sheet here. Okay? In addition to Cablevision. So
what you would do for example, to calculate the quick ratio, is just take the first two
numbers, cash plus receivables, okay? And divide it by total current liabilities. Okay?
And, so notice that really what you're doing is you're ignoring everything else that is in
the balance sheet. You're assuming that is not liquid. Okay? You only take the assets
that you know are going to be generating some liquidity for you. That's the idea.
Okay? Of computing this quick ratio. So here you have an example, right, so if you do
this for the DirecTV using that data that I just gave, okay? Here's what you should
find. That DirecTV's quick ratio should be about 0.9. Okay? If you just take cash in
receivables and divide by current liabilities, right.

So that means that DirecTV has, you know, 90 percent of its current liabilities in cash
and receivables. Okay? We're going to talk about later what does that mean. Okay. So
here are all the calculations using that data, and you know, I encourage you to do it
on your own, and check to make sure you can get the same numbers. We have the
cash ratio, the quick ratio, and the current ratio for Cablevision and DirecTV. We're
not going to talk about the B/E Aerospace anymore, you know, the reason why it was
there is just to illustrate that inventory issue. Now let's compare these two companies
that are in the same industry okay? So those are the liquidity ratios. Right? You can
see that if you look at this comparison, it's easy to see that DirecTV has a higher
ratios; has more liquidity then Cablevision has.
Okay? Since we're talking about that, let's think about the following question: what is
a good ratio? Okay? Remember, the question we are asking is can the company pay for
short-term liabilities without relying on cash flow? Right. Just looking at balance
sheet items. What that means, is that, you know, one is a reasonable standard to look
at. Okay? Current ratios should be above one. Right? That means you have more assets
and liabilities. Okay? Quick ratios should also be close to one at least close to one
why? Because we don't want to rely too much on inventory. Right? So inventory is
tricky, so what we conclude is that quick ratios should also be close to one. Ideally,
you don't want your quick ratio to fall too much below one. The cash ratio, you know,
how large the cash ratio needs to be, that's a more complicated question. Depends on
how liquid the receivables are and some other considerations on Module 2, we're
going to be talking more about short-term cash management.

I think we're going to have more to say about that, but you know, of course the
general ideas that are high cash ratio is a good thing in terms of liquidity, but perhaps
it doesn't have to be quite above one. Okay? How does liquidity deteriorate? If you say
company with low liquidity, how can that happen? Right? I mean, if you think about it,
liquidity is about comparing short-term liabilities to short-term assets, right? So one
way that a company can reduce its liquidity is by increasing short-term debt to invest
in long-term assets. Right? So if you raise short-term debt and invest in long-term
assets, you're going to lower your liquidity, or if you use of your cash, right? If you
take some of your cash to invest in a capital expenditure, you're again going to lower
your liquidity, and that's an issue we're going to go back to in one of the examples in
Module 2. So is coming up as well.. We're going to talk about one example where that
consideration is going to be important. And finally, performance. Right? Performance
is going to be related to everything. So if a company does poorly, cash holdings are
likely to go down, liquidity's going to go down, and the company may have to think
about readjusting its liquidity ratios.

Corporate Finance I
Professor Heitor Almeida

Module 1

Lesson: 1-5.3 Balance Sheet Ratios: Solvency

So now we we'll talk about solvency ratios, or leverage ratios. Those two are
synonyms. You can use either term. Okay? And the first thing we need to talk about is
that there are several debt ratios and in particular there is one specific debt ratio
that is commonly used that I recommend that we do not use it, but I so want to talk
about it in this introduction. Okay? So the three ratios we'll talk about our debt over
assets. That divided by debt plus equity and liabilities plus assets. Every time we use
the term "debt", you should think of that as the sum of short-term and long-term
debt. So we are considering both short-term and long-term liability. Okay?
To understand the difference between these leverage ratios, the best way to do this
is to look at a simplified balance sheet. Which is what you have here. Okay? So you
have debt, you know, and other liabilities in the right hand side, that you have the
assets on the left-hand side. In particular you have to-- we have to think about the
liability side. Okay? So notice that total liabilities of a company are going to be the
sum of the debt which you can think of as a financial liability plus other liabilities like
pensions and accounts payable, okay? Which we talked about when we discussed our
liquidity ratios for example. So their other liabilities. Right? In the balance sheet. It's
not just debt. Right? So one way to think about is that total assets if you look at the
left-hand side and the right-hand side of the balance sheet, total assets are going to

be equal to debt plus other liabilities, plus equity.

Okay? So the problem is that if you use ratio number one, debt over assets-- okay,
what the problem is that dividing debt over assets is going to ignore the other
liabilities such as pensions, right? Other liabilities are part of assets, right? Assets
equals debt plus other liabilities plus equity. But you're not including it in the
numerator. Okay? So that over assets may underestimate leverage for some
companies if a company has a lot of accounts payable, or if a company has many, you
know, large value of pensions, that the company owes to its employees, then we

might be underestimating leverage and we might be overestimating solvency. Okay?

For that company. So what I do is I usually prefer to look at two and three. So you
either divide debt by debt plus equity, okay, so here what you're doing is essentially
ignoring the other liabilities, but both in the numerator and in the denominator.
Right, so we're not including other liabilities in the numerator; we're not including
other liabilities of the denominator. Okay? Or, the other thing you could do is to
include everything. Right? So that would be ratio number three where we divide total
liabilities by total assets. Okay? So, my recommendation is that we look at ratios two
and three, but I wanted to discuss debt over assets because that is a commonly used
debt ratio that you might encounter in-- if you are reading about the companies in
another source or in a textbook, so I thought it was important that we discuss that. So
let's focus on two and three and as we did for the first section, I want to talk about
the calculation of these leverage ratios using data for real-world companies.
So here we are going to focus on Cablevision as we did when we discussed the
liquidity ratios, okay? And then think about how much leverage does Cablevision have?
Okay we-- so this is the data here on the left-hand side. You have data on the current
capitalization of Cablevision, so you have data on the current stock price and the
current market capitalization, so that is the market value of equity. Okay? You also
have data on total debt, and other right-hand side, what I did is I gave you a
simplified version of the balance sheet of the company okay? So we have assets and
liabilities. The first thing to notice here if you look at this data for a while, okay, is
that Cablevision has more liabilities than assets. Okay? Right, so right? Look at this,
you know, for all years that we have here, Cablevision ends up having more liabilities

than assets. Right? So what's the, you know, there is something strange here, right?
So Cablevision seems to have more debt than assets, okay? And if you check later, the
data for DirecTV, you're going to see the same thing, okay? So here's the question for
you to think about: can a company have negative assets? Right, can we have liabilities

greater than assets? Right, can a company have negative equity?

Okay? And the answer is no, okay. A company that has negative equity, a company
that has more liabilities than assets is effectively bankrupt. That means you do not
have sufficient assets to pay for your liabilities. Right? So that is not a stable
situation, right? And it means that you know, that this company should actually
disappear, it should be sold off. Something should happen. Okay? And if you look at
the data, you will see that Cablevision and DirecTV are actually not bankrupt. Right?
They have a positive market value. They are trading, you know, these are operating
companies, so there's something wrong here. Right? What's going on? The problem as
going to learn now, is book equity.

Okay? So, we can-- it turns out that it-- we cannot use the book equity to compute--
to calculate leverage ratios. And the reason is because of something we actually
discussed in the previous module in Module 1, right, which is the idea that the book
value equity does not reflect the future. Okay? Does not include future cash flows.
The book value of the equity depends on, you know, what happened up to this point
of time. Okay? It only includes what happens in the past it does not include the value
of future cash flows. And if you want to know whether a company's solvent or not, you
need to think about the entire value of the company not just the book equity. Okay?
So to measure leverage, we need to do is we really need to use the market value of
equity rather than the book value. And when we think about market value of equity,
we're going to be thinking about the stock price times shares outstanding, which is
one way that you can compute the market value of equity for a company that is
publicly traded. Okay? So, this example shows the importance of calculating leverage
ratios based on market value.

All right you would-- your answer would not make any sense if you were using book
values. So, these are the ratios that we are actually going to think about. Okay? So,
instead of using book equity, we're going to use the market value of equity, so it's
going to be debt divided by debt plus the market value of equity, and then the second
ratio is going to be total liabilities divided by the market value of assets, okay? And so
what's the definition of market value of assets, that's very simple. All you need to do

is to add total liabilities to the market value of equity and you would get that.
Okay? So let's look at an example. Here is the data for DirecTV that I mentioned a few
minutes ago. Okay? So again, here you have the market capitalization for DirecTV.
That is the current market value of equity for the company, okay? You also have the
data on total debt that we're going to need, okay? And you have the data on total
liabilities. As we did for the liquidity ratios, let's do these calculations using the most
recent data. Okay? Especially for leverage ratios, I really make sense to use the most
recent data because we are using data on the market value of equity so we need
current data. We need data that reflects the value of the firm as of today. Right?

So here on the bottom you have the calculations for you. The market value of equity
which we are pulling out directly from the data, and then the market value of assets
right which is just the sum of total liabilities which you have here with the market
value of equity. Okay? So with those numbers, it should be very simple to compute
the leverage ratios, right, for both DirecTV and Cablevision, okay? So for example, the
liabilities over assets for DirecTV would be 0.38, right? All you need to do is to divide
the liabilities from the balance sheet by the market value of assets that we calculated
in the previous slide. Okay? So and you can do a similar calculation for Cablevision.
Here in the bottom, I put the value of the market value of assets of Cablevision for
you for your reference, so again, you to do is to divide the total liabilities by the
market value of assets or divide that plus-- divide debt by the sum of debt plus
equity. Okay? And you would get these ratios here. Right? So what is a good leverage

ratio?
As we just discussed, definitely below one. Right? A leverage ratio higher than one
means that a company is effectively bankrupt. Right? So a company cannot have
leverage ratio greater than one. You know, it might actually disappear. Okay. The
average leverage ratio in U.S. companies is between 25 to 30 percent. So how much
leverage should a specific company have? That is a very
important corporate finance topic that we are not going to talk that much about in
this course, it's a topic that goes beyond what we can cover in this course, so let's just
keep these two numbers in mind when we think about leverage ratios. The average
leverage ratio in U.S. companies is thought of [phonetic] 30 percent, and you know,
you definitely cannot have leverage higher than one or getting very close to one.

Okay? So, how does leverage get high?

As we discussed with the quiddity, it's important to understand what the decisions
would make a leverage get high. Right? So every time a company issues debt to do
something, you're running the risk that your leverage may increase. Right? So if you
issue debt to repurchase equity, that is a decision that would definitely increase your
leverage ratio. Okay? If you issue debt to invest in projects then it may be-- right?
Remember we are using the market value of equity to computer leverage ratios. You
invest in a new project, you know, the market value of equity may increase. That's
something we're going to talk about in Module 3. So, your leverage ratio may go up or
down, but if the market value of assets doesn't increase that much, then you are--
your leverage ratio may end up higher. Okay? And finally, poor performance is always
a reason why a leverage may increase. Right? So if the company does poorly, equity
value goes down, right, and the leverage ratio is going to increase mechanically. So
poor performance, again, is a reason why your leverage might get too high.

Corporate Finance I
Professor Heitor Almeida
Module 1

Lesson: 1-6 Income Statement Ratios: Profitability

Let's move on now and think about the income statement. Okay? So now we're going to talk
about financial ratios that we're going to calculate using data from the income statement. The
first thing we need to think about is what does the income statement measure? Okay? Here
you have an example of an income statement for DirecTV, okay. First thing is there is this term
LTM. Which is defined here in the bottom. What this means is that it's the data for the latest 12
months. So if this is March 31, 2015, this means is that you have the data from April 1 of 2014
to March 31 of 2015. Okay? So it's a year, right? And so in many cases the most current data
that you can get is going to be the latest 12 month figure. Right? So essentially what you have
an income statement is data on profits and costs. So you have revenue, right? You have cost,
your profits, right? And so the key formation really that you can get from the income statement
is profitability. How profitable a company is. Okay? The income statement is the statement that
was going to give you that information.
Right? There are for profitability ratios that we are going to discuss. The asset turnover, they
are defined here. Asset turnover, net profit margin, return on assets, and return on equity, and
you can see that for some of these ratios we are going to use this important measure which I
call OPAT. Okay? Which is operating profit after taxes. OPAT is defined as operating income
minus taxes. Okay? And as we are going to discuss next, OPAT is a really good measure to use
when you're trying to figure out how profitable a company is. Okay? The return on equity
measure which is measure number 4 uses net income instead of OPAT. That we're going to talk-
- the first thing for us to talk about is what is the difference between OPAT and net income, and
to do that let's look at
Cablevision's income statement again.? Okay? So here you have the latest 12 month figures.
Okay, let's use those. Right? You have revenues, costs, profits, operating income is here. It's at
the top of the income statement. Okay? That's the key thing. Operating income is right there at
the top so it only includes operating revenues and costs. Okay? So revenues and costs that we
really have to do with the business. Right? For a company that Cablevision, they sell digital TV
and Internet, right? So these are the revenues that they get from their customers and those of
the cost of operating the company. Right? Operating income is going to be a measure of that.
And then after that we're going to have the non-operating expenses and revenues.

Right? So we have interest expense, we have interest income, okay? And you can see here that
there is a net interest expense. That's the amount of interest that the company paid. So your
net income is going to be a profit figure that is reported after interest payments and other non-
operating items. Net income is at the bottom of the income statement. Okay? If you work out
the math here, right, what would be your OPAT, your OPAT would be the operating income
minus taxes, right? I've done the calculation there for you, so the OPAT for Cablevision in this
latest 12 month period would be $764 million. Right? And if you do the math, you know, the
interest is 100-- sorry, the interest is $580 million so you can check that in and come is
approximately OPAT minus interest. The difference between OPAT and net income is mostly
that net income is in after interest measure.
Okay? So, was the right way to think about that we if you think about OPAT and ratios that are
based off of Pat like ROA, what you're going to keep doing is measuring profitability for the
company as a whole. Right? So they're up there and income statement for Cablevision for
example, you're measuring the profit for the entire company. If you use net income, or return
on equity, you're going to be measuring profitability from the perspective of shareholders only.
Okay? Because net income is a profit measure that is reported after interest and ROE is a
financial ratio that is based off of net income, so we're not going to be including-- essentially,
we're going to be deducting interest payments and other non-operating stuff from your profit
measure. Okay? So, this might be okay, but as we Artie discussed a little bit in this course, net
income is at the bottom of the income statement so one problem is that net income is busily
affected by accounting manipulation and one-time items. Right?

So if the company has a one-time expense, you know like a legal settlement, for example, if
Cablevision gets sued in a given year, that has to be reported in your income statement, and it's
going to reduce your net income, right? And there are many ways that companies can
manipulate the accounts to change your net income. Operating income is usually a more solid
measure. Okay? So for many companies, ROA is going to be a better measure of profitability
then net income because of these two reasons. Okay? It's based-- it computes profits for the
entire company and since it's at the top of the income statement, it's a measure that is a little
bit harder to manipulate then net income.
And here comes a question for you. All right? We talked about using the market value of assets
and the market value of equity to compute leverage ratios, right? We just did leverage ratios,
and that if you want to figure out how solvent a company is, we have to use the market values.
Okay? Now we are computing profitability ratios. Right? So, for example, you know, just to give
an example here for you to understand what we're talking about, ROA is going to be defined as
OPAT assets, right? And the question is should you use the market value of assets, right, or the
book value to compute profitability ratios. Okay? So think about that for a while. [ Silence ] The
answer might be a bit surprising, but it makes a lot of sense once you think about it. To
compute profitability ratios you actually want to use book values. Okay? Why you want to
compare profits to capital that is invested in the company. Okay? And remember that a
company's market value is going to measure the company's total value, right. It also increase
the value of future cash flows.

Okay? So it's not really a measure of how much capital has been invested in that company, it's
not a measure of how many dollars investors putting in that company, really is a measure of the
value of the company. Okay? One way to think about this, let me go back here, because this is
an important idea, okay? If you use market values to measure profitability, what you would be
doing, right, so in the numerator you have current profits. [pause] In the numerator you to have
something like current profits. If you use market value, remember the market value of assets is
going to depend mostly on future profits. Okay? So you're going to be dividing current profits
by future profits. Does that make sense? Not to me. Right? So a company that is-- you know,
suppose you find a company that has a lot of future profits. Okay? That, you know, and you use
market value of assets, this companies going to have low profitability ratios, but it would be
unfair to call this an unprofitable company. Okay? So this is a ratio that really does not make
that much sense to me.

Okay? If you want to compute profitability of the company, you have to use book value of
assets and book value of equity if you can in the denominator. Okay? Let us now give some
examples for Cablevision and DirecTV. Here I have a simplified snapshot of the Cablevision
balance sheet for you. Again, so you can see the value of assets. We already computed OPAT,
which is down there, right, OPAT for Cablevision is $764 million. Right? So what you need to do
is divide OPAT by the total value of assets if you want to compute ROA. So the assets, the value
of assets is here. It should be really simple. Cablevision ROA should be 0.11. And you can get
the data that I provided and of course I will provide these calculations as well for you, see you
can get the data and verify that you can get these numbers. Which should be really easy to

compute. All of them using the most recent data, asset turnover, net profit margin, ROA, okay?
Let's think about ROE. Right? ROE. Let's go back here again, okay. ROE is what? ROE is net
income divided by equity, and remember, do we use market equity or book? Book. Right? We
just learned that. So you would need to use book equity. But we know that book equity for
these companies is negative. Okay? Book equity for these companies is negative. So you really
could not use ROE to measure profitability for our Cablevision and DirecTV. So it's a measure
that does not make much sense. It would be very useful for you. Okay? And it's, you know, this
is a common problem. Book equity is a problematic figure to use.

And that is why in general, I prefer, okay I prefer to look at profitability measures that measure
profits for the company as a whole, like ROA. ROE is going to prompt. Okay? Finally, let's talk
about earnings-per-share. Okay? This is a profit measure that we talked about in the beginning
of this module already, right? Is essentially net income divided by shares outstanding. It looks
like a stock price, right? But it's based off of net income instead of the market value of equity.
Okay? And we discussed already some of the problems with net income, okay? So, of course,
you're going to have some of the same problems as ROE because you're basing all profitability
on that income which is after interests, so it does not compute profits for the company as a
whole, it is subject to manipulation and all that.

It's affected by one-time items, okay? In addition to that, there is an additional problem which
is that you are dividing net income by shares outstanding. Okay? And as we already discussed,
shares outstanding can be easily manipulated. It's very easy to change the number of shares
outstanding that a company has with something as simple as a stock split. Okay? And then, of
course, the one thing you could do is to just your profitability measures. Try to get at the actual
profits, but, you know, it's much simpler just to not use earnings-per-share to compare
profitability across firms. Okay? You know, so my recommendation is that we do not use
earnings-per-share to compare profitability, you know, since the number of shares can be easily
changed. You know, it's not-- we're not going to be able to say that a company that has higher
EPS than another company is more profitable. Okay? So EPS is not a great measure of
profitability, at least the way I see it.
 Corporate Finance I
Professor Heitor Almeida

Module 1
Lesson: 1-7 Cash Flow Statement Ratios: Profitability
Let's talk now about the statement of cash flows. I think this is actually probably the
most important statement for us to look at. It's my favorite. That's where we can get
the most information about what's going on with companies. It does tend to be
ignored sometimes, okay? So I really want to emphasize that we can get a lot of

information from the cash flow statement, okay?

Let's look at a cash flow statement here to try to figure out, what does a cash flow
statement measure? So you have DirectTV, again, for the latest 12 months and for the
two previous years. So here the first item in the cash flow statement is gonna be net
income. Okay, so you're gonna start from the bottom of the income statement. And
then you are going to start adding and subtracting items. And there is a very
important rule that you should remember. Don't forget this.

The sign of a number in the cash flow statement is very meaningful, okay. So for
example, let me go here to emphasize this. So here you have a change in accounts
receivable. That's just use that example, okay? This is -189, okay? What this means is
that accounts receivable provided a cash flow of -189 million in that period. Okay, so
189 million of cash came out of DirecTV in that year because of accounts receivable.
And you can use the same rule for everything. So for example, if you look at debt
issued, that has a positive sign, right, which means that that came into the company,
so cash came into the company in that year. So the signs mean a lot.

So here you have, there are three parts in the cash flow statement, as you can see
here. There is the operating cash flow part, which is the top of the cash flow
statement. So you get to a measure of operating cash flow. That tells you how much
cash flow the company has generated from operations, okay? And then we have
investing cash flow, okay? So investing cash flow which will generally be negative. You
can see here that it's -3.3 billion for DirecTV. Okay, so that means what? Remember
just the sign, right, it means that DirecTV invested 3.3 million in that year, okay? And
then at the bottom, you're going to have the financing cash flow.
Cash is going to go in and out of the company as well because of financial decisions
like dividends, okay? You can see here that DirecTV is not paying any dividends, okay?
But they are issuing debt, repaying debt, issuing stock, repurchasing stock. So at the
end, you are going to get a total cash from financing in this case it's -1.7 billion, okay?
So again, what does that mean? It means that DirecTV paid $1.7 billion of cash to
investors in that year. And then at the end, you're going to have the net change in
cash, which is the the sum of everything. So that's the total amount of cash that the
company generated in that year, after taking into account operating, investment, and
financing activities, okay? So just by this discussion you see there is a lot of
information in the cash flow statement, right, a lot of useful information about what's
going on with the company, okay.

For you to understand that better, okay, I actually want you to work with an example.
A simplified example, before we go back to the cash flow statements for DirectTV and
Cablevision, let's think about what's going on with these companies. We have four
companies here, A, B, C, and D. Okay, and I gave you the main items that you see in a
cash flow statement, operating, investment, and financing cash flows. Okay, and the
question that I want you to think about, using what we just learned about the cash
flow statement is, which of these companies is likely to be a startup, a new company
that is growing that is being started up now? Okay, which of these, A, B, C, or D is

likely to be a startup?
I mean if you look at that data, right, it should be clear that the company that is most
likely to be a startup is company C. Right, why? Because company C is generating
negative cash from operations. It's investing and raising money from investors. Okay,
let me go back here to the table just to make sure that you understand that. Okay, so
here Company C, right, has negative cash from operations, -400, okay? It's investing,
right, -200, let's say million. The unit doesn't matter much, let's say million. And it is
raising cash from investors, right? So that is a typical situation of a startup company.
You're borrowing money, you're not profitable yet, but you're investing in the business
because you probably expect to become profitable in the future.

Okay, so that's how we can use the cash flow statement to really drill down and think
about what's happening to companies. So the other companies, we can talk about
them as well. Company B is a mature company that is downsizing. Right, how do you
know it's downsizing? Because the cash from investment is positive. So instead of
investing in the business, Company B is generating cash by selling off investments,
okay. Company A is a profitable company, right. How do we know? Because it's
generating cash from operations, but it is also raising additional financing. And
finally, if you look at Company C, it has a negative change in cash, okay?

So in that year, company D did not generate any cash, it lost some cash. What will
happen to the company? Is that bad? Let's go back here, think about that. Not
necessarily, right? So cash went down for that year. What will happen is that there
will be a reduction in the amount of cash that the company has in their balance
sheet, okay? So this company has to be able, you know it should be able to use its
cash that is in the balance sheet to finance this, okay? And if it's not, then the
company has to plan some additional financing. This is something we're going to be
talking about in module two when we talk about financial planning. That's going to be

a very important idea.

That's going to be how we're going to figure out whether a company needs new
external financing or not, okay? So the profitability ratios that we can compute using
the cash flow statement are similar to the income statement ratios we talked about,
but they are based on cash profits. The most important ratio is really is the only one
that we're going to emphasize here, is what we call the cash profitability ratio, okay?
It's just the operating cash flow divided by total assets, right? So it's very similar to
ROA, but instead of OPAT, you're using operating cash flow, okay?
So here is a calculation for you for Cablevision, again, using the latest 12 month
period. Okay, you have cash from operations here, which is 1.3 billion. This ratio is
very simple. You just have to divide cash from operations by total assets. For
Cablevision this would be 0.20, okay. And you can do the same thing for DirectTV. You

should get a ratio of 0.26, right.

So both of these companies seem to be generating a cash flow from operations, right.
They are cash profitable, right. And in addition, if you look at the cash flow
statements for Cablevision and DirecTV, what you'll see is that both of these
companies have negative cash flow from investments, right, and have negative cash
flow from financing. So let's apply what we just learned about the cash flow
statement. What does that mean, right? It means that both of these companies are
investing in the business, but they are not raising new financing from investors. They
are returning cash to investors, okay? So if you go back here and look at the cash flow
statement for Cablevision, okay.

You will see that Cablevision, for example, is issuing new debt, 1.3, but is also
repaying a lot of debt, okay? In addition, they are repurchasing stock, okay? So, on
average in the latest 12 months there was no new financing entering the company.
The net amount of cash from financing is negative, meaning that Cablevision actually
paid off a cash to investors, okay, which is a common situation for US companies
these days. We're gonna talk more about that when we discuss our assignment.
 Corporate Finance I
Professor Heitor Almeida

Module 1

Lesson: 1-8 Valuation Ratios

Heitor Almeida: So we've done a lot of work, right? We computed liquidity ratios. We
computed leverage ratios. We computed profitability ratios. We looked at cash flow
statements. And if you think about what we've done, you know, we really learned a
lot about what's going on with Cablevision and DIRECTV -- this specific example we
looked at, right? And, of course, you can use the, a similar calculation, similar
techniques to think about any company that you're interested in, right? Here's the
summary of what we discovered for Cablevision and DIRECTV, right? Cablevision has
higher leverage and lower profitability than DIRECTV.

DIRECTV seems to be a more profitability company, right? DIRECTV also has liquidity
ratios that are a little bit higher, okay. And if you look at the cash flow statement,
what you see is that both companies are investing in operations and are returning
cash to invest, right. They have positive, they have negative, sorry, negative cash
flow from investment and negative cash flow from finance, okay. So how have the
companies performed in recent years? Let's look at what happened to stock prices,
okay. As we discussed earlier in this module, the stock price really is the key summary
of the value of, of shareholder value, right. And it should be somewhat related, right.
If these ratios make sense, then the stock price would be somewhat related to what

we discovered here.
And if you look at the stock price performance or DIRECTVision and Cablevision in the
recent time period -- we are looking here at the last five years, okay -- what you see
is that DIRECTV, which is the red line, so this is DIRECTV here. Cablevision is the blue
line, okay. DIRECTV has performed significantly better than Cablevision in the last
five years, okay. So this stock price chart is consistent with the analysis we've done,
right. We learned that DIRECTV is more profitable, it has lower leverage. As we
learned, poor performance can result in higher leverage, right, so this, you know, just
from this, doing this quick analysis, it does make sense that DIRECTV has performed
better than Cablevision in the last five years, all right? Since we're talking about stock

prices, this is a good time for us to think about valuation ratios, okay.
This is the last set of financial ratios that we're going to discuss in this module, right.
And these ratios are ratios that summarize the company's current market valuation.
And there are going to be two versions that we're going to use, but both of them are
going to use market values in the numerators. So the market value's going to be in the
numerator, and then in the denominator of these ratios, we're going to have either
book value or profits, current profits, okay. So let's go back here and think about what
these ratios mean.

So we have market divided by current profits, for example. Market value divided by
current profits, okay. And we've learned already, right, that the market value of a
company is a measure of everything, right -- current, but also future cash flows. The
market value should reflect all the cash flows, right, so really what you're doing is
dividing the future, okay, by today, right. This is how we should interpret the
valuation ratios. It's the measure of future relative to what you have today. It's also
true when you look at book values, right. As we already learned, the book value of
assets essentially reflects what happened to the company up to this point. It does not
capture the future. So if you compute a valuation ratio, this really is what you're
doing, okay. So remember this idea.
It's a very important idea I think in finance. So the market to book ratio, let's talk
about that one first. It's the ratio that uses book values in the denominator, okay. This
ratio can be based either on assets or equity. What do you, what do I mean? So there
are two versions. We can use the market values of assets and the book value of assets
or you can use the market value of equity and the book value of equity, okay. And we
already learned in this module that book equity can be a problematic measure. For
example, for Cablevision and DIRECTV, you would not be able to compute the market
to book ratio because they have negative equity, okay. Because of that reason, I think
it's better, I prefer when I'm computing these ratios, I prefer to use assets to compute
market to book ratios. So instead of using equity, I prefer to use assets, okay. I'm
going to show you an example in a second.
In terms of value over profits, again, we can do this either based off assets or based
off equity, okay. So as we learned already, right, OPAT is a measure of profits for the
company as a whole, right. Operating profit after taxes measures profits for the
company as a whole. Net income measures profits for shareholders, okay. So ratio
number one divides the market value of assets, the entire company, by profits,
current profits for the company as a whole, whereas ratio number two, which is the
well-known price to earnings ratio, looks at equity only. So it's the market value of
equity divided by net income.

These ratios capture very similar information, right, because you're dividing market
values by current profits, right. But you might guess that at this point, I think you
probably, can probably guess the ratio that I prefer, okay. I, you know, I really prefer
to look at ratio number one, right. Why? Because it's based off asset values and profits
to the entire company, so we are looking at the entire company instead of looking
just at equity, okay. And because we are, we avoid using net income, right.
Remember, the key difference between OPAT and net income is that OPAT is at the
top of the income statement and net income is at the bottom, so net income is a
number that is easier to manipulate, okay.
So I, my recommendation is that we focus mostly on assets over OPAT instead of the
price to earnings ratio when we're analyzing companies for corporate finance
purposes, okay. Cablevision. So it should be very simple to compute these ratios. All
of these numbers were computed in previous slides, okay, so it should be really
straightforward for you to do these calculations. For example, the market to book
ratio should be just the market value of assets divided by the book value of assets,
right. So you can see that this ratio is going to be a little bit below three for
Cablevision and you can do the calculation for DIRECTV as well, and which, you know,
the data is here.

To make it easy for you, you can compute the other ratio for our Cablevision, and
that is the answer you would get, okay. So Cablevision has market to book ratio of
2.7. The DIRECTV has a market to book ratio of 3.1. Cablevision has a higher value to
OPAT ratio, okay, which seems to be an interesting observation, right. So it appears
that Cablevision is valued more, right. If you think about valuation ratios that way,
right, it might seem that Cablevision is valued more by the market than DIRECTV,
okay. So let's think about that for a while. Is this finding, right, does the, is this
consistent what we've done so far, right? We learned that DIRECTV has performed
better, right. It is more profitable and all that, so, you know, what about this ratio
that we found now? How can this be consistent with what we've done? That's the
question for you to think about for a while.
And the answer is yes, okay. It has to be, right. This is the real data. It has to be
consistent, okay. Why, remember, valuation ratio, what it's measuring is future over
present or even future over past, right. The book value of assets reflect what
happened in the past as well, right. DIRECTV is more profitable, currently is more
profitable and has performed better in recent years, okay, so it's not surprising that a
greater, really what you're finding is that a greater portion of Cablevision's value is
lying in future, depends on future profits, okay. The value of Cablevision depends
more on what's going to happen in the future whereas DIRECTV is more profitable
today, okay.

That's how you would conciliate this higher value OPAT ratio with the analysis we've
done so far, okay. And just a final observation here. Sometimes future values can
come not from organic growth, but they can come from mergers, which is going to be
one of the topics that we will discuss in a future module, right. There is a rumor going
on that Cablevision might be acquired by another company, right. And, of course, an
acquisition can definitely change the future prospects of a company. Perhaps that is
the reason why investors are boosting the valuation of Cablevision in the expectation
that this merger is going to improve the financial situation of the company.
 Corporate Finance I
Professor Heitor Almeida

Module 1

Module 1 Review
This module was about the growth and the language of corporate finance. In terms of
the goal, we talked about why maximizing the stock price is a reasonable objective
for companies, right? And why it's better than alternatives such as earnings per share
and the book value of equity, okay? However, reasonable doesn't mean perfect, so we
also discuss the problems. The conflicts that may arise between stock price
maximization and social responsibility, other stakeholders like employees and the
government, okay? And finally, we talked about the agency problem, right? The fact
that managers may not maximize shareholder value and how corporate governance
can help with that, okay? Then we started talking about the language of corporate
finance, right? The fact that we can use information from the accounting statements
to learn a lot about companies, okay? We use the information from the balance sheet
to measure liquidity and solvency, okay? And we made comparisons across companies,
right? We work with a specific example, okay? We use information from the income
statement to measure profitability. And again, to make comparisons across
companies, okay? Then we looked at the cash flow statement, okay? The cash flow
statement allowed us to understand how companies are generating and expanding
cash, okay? And finally, we looked at valuation ratios, right? Such as the market-to-
book ratio. We calculated and we discussed the meaning of a valuation ratio. Like
that very important idea, that a valuation ratio measures future divided by present,
okay?

Corporate Finance I
Professor Heitor Almeida

Module 1

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Corporate Finance I
Professor Heitor Almeida
Honors Assignment 1

Assignment 1 Overview
I want to talk about the objective of assignment 1. This assignment will have open
question and numerical problems. The goal of the open questions is to allow you to
discuss, in your own words, some of the key ideas that we talked about in this
modules, such as shareholder value and other ideas. Okay? And in addition to these
open questions, we have an important numerical problem. Okay? And this problem is
about calculation and analysis of financial ratios. If you remember the lectures in
Module One, we talked about ratios that describe the financial health of a company.
What you're going to do in assignment one is to apply what you learned to analyze two
companies in the footwear industry, Nike and V.F. Corporation.
So let me talk a little bit about the goals and what I expect you to do here. Okay? So,
what I will do is I will provide the data that you need to calculate the financial ratios
for Nike and V.F. Corporation. Okay? The difference between the assignment and the
lecture notes is that the data for the assignment will be in what I call a raw format,
okay. This means that the data will be exactly as you would find it in Yahoo Finance,
Google Finance, or any other similar source, or Capital IQ, okay. My goal is to force
you to sort through this data and find a formation that you need to compute the
financial ratio. Okay, so this is a real world exercise where you're gonna get the raw
data from the financial statements and compute variations.

Okay? After you that, make sure that you report the ratios in the way that can be
easily read by your peers. And then question nine is again, an open question where
you're going to spend some time thinking about what you learned. In a similar way to
what we did in class for the Cable Vision and DirecTV, what you need to do here, is to
think about the numbers and compare these two companies. So this is, again, an open
question where you're going to do this, compare the financial ratios for Nike and V.F.
in your own words and summarize what you learned. I will provide my own solution of
the assignment but make sure that you work on the assignment and prepare your
solution before you see mine. And that's an important condition for you to take as
much as possible from assignment one and all the other assignments in the course.
 Corporate Finance I
Professor Heitor Almeida

Honors Assignment 1

Assignment 1 Discussion
So this is the solution to assignment one. Starting with Question 1, where the question
was for you to discuss why maximizing current shareholder wealth is a reasonable
objective for the company, okay? And the important idea that we discussed in the
lecture is that the stock price should reflect all future consequences of current
corporate decision, right? Stock price should reflect all future cash flows and
therefore it's likely to be a much better objective than alternatives such as earnings
per share and book value per share which only measure current profits, disregard the
future, and therefore can definitely lead the company to become short-termist.
Remember though as we discussed in the lectures that reasonable doesn't mean
perfect. Right? Maximizing stock prices relies on the assumption of market efficiency.
Right? And it can lead to conflicts between shareholder value in society. Okay.
Question 2 really is an application of this idea of shareholder value, okay? So, if you
think about the differences between bonus-based compensation and stock-based
compensation, the key difference is that a bonus-based compensation is going to be a
function is going to be based on current profits. So executives will be paid more if
they increase current profits, right? So guess what? What tends to happen is that this
will lead to short-termism. Right, so if you tell executives that they're going to be
paid more if current profits are higher, guess what? What they're going to do is try to
maximize current profits. And might take actions that are bad for shareholders in the
long term. Okay? Stock-based compensation is not a perfect solution, but it does, it
may help alleviate this problem, okay? As we discussed in the lecture, there are some
issues, for example, many academics and practitioners are concerned that stock
based compensation has gone too far, and executives are paid too much. But
definitely, if I had to choose between stock versus bonus, I believe that stock is
definitely a more reasonable way to set compensation for real world companies.
Question three asks you to compute liquidity ratios, and the example here is a Nike
and VF Corporation, which are two competitors. The solution is here, all the numbers,
you can check your calculations to make sure you've done it right. In terms of the
analysis, the two points to note are that first of all, both companies seem to have
appropriate liquidity. The ratios are high enough. Second, Nike appears to have higher
liquidity than VF Corporation. So those are the two points you should have noted in
your analysis.
Question 4 asks you to compute leverage, or solvency ratios. Remember the key idea
here is to use market values. Okay? We do not use book value of assets, book value of
equity, we use the market value. The market value of equity is the market
capitalization, which is just the stock price times the number of shares outstanding,
that was directly in the data, okay, both for V.F. and Nike, right? And to compute the
market value of their assets, all you need to do is add liabilities to the market value
of equity, as we learned in the lecture and all, okay? So these are the values that you
should have, using the latest data. As we discussed in the assignment for this
question, you only need need to do it using the latest data. Given this, the leverage
ratios should be easy to compute, right. Debt divided by debt plus equity and
liabilities over assets, these are the numbers you should have found. And if you look
at these numbers, you'll see that both companies have relatively low leverage ratios.
Right?
Nike has lower leverage ratios than V.F. Corporation, okay? And we move on to
profitability, as we discussed in the lecture notes, the key starting point here is to
compute OPAT, right? We want to compute profitability for the business, profitability
for the company as a whole, so the best measure is a measure that considers sales
and costs and takes taxes out, right, rather than looking at net income which is
affected by interest payments, which is affected by one time items and a bunch of
other things that may not be relevant if you want to measure the profitability of the
company. This is something we discussed in your lecture notes. And you should have
used the idea here to compute OPAT. Okay? So you start from OPAT and then you
compute the profitability measures, right? Asset turnover, profit margin and ROA,
those are the three key measures that we focused on in our lecture notes. What you
should have found is that both companies appear to have similar profitability. So if
you look at ROA for example, the ROA ratios are very similar across Nike and V.F.

Corporation.
In terms of cash profitability, the difference is that here we start from cash flow from
operations instead of OPAT, divided by assets. And again, these are the numbers that
you should have found. These should have come directly from the cash flow
statement and the balance sheet, okay. And again, what we see is that both
companies have a significant profit, a cash profitability. Perhaps, Nike has a little bit
higher cash profitability. Okay?
In terms of the cash flow statement analysis as we discussed in the lecture notes, we
can learn a lot by looking at the cash flow statement, right? So I pulled out the main
items here, right? As I discussed in the instructions for the assignment, one of my
goals was to force you to try to find this data, so I hope everybody I found the most
important items, which are the cash flow from operations, the cash flow from
investment, and the cash flow from financing, and of course the net change in cash at
the end. In addition to this I pulled out the stock repurchase item, that, to allow me
to talk about one issue here, okay? So if we look at these cash flow statements, they
are, in terms of the signs, they look very similar, right?

So both Nike and V.F. Corporation are generating positive cash flow from operations,
right, and they are investing in the business, right, and returning cash to investors. So
rather than borrowing more or issuing stock, what Nike and V.F. Corporation are
doing, is to return cash to investors through stock repurchase. That's why I pulled out
the stock repurchase figure here just to show you that this is a very common way that
companies are using these days to return cash to investors, okay? And notice that if
we compare the dollar figures of this estimate, you know like capital expenditures,
the cash flow from these estimates with stock repurchase, stock repurchase are

significantly higher. We'll talk more about that at the end, okay?
Finally, the valuation ratios. Remember, the key thing to remember here is that we
are focusing on valuation ratios that reflect value and profits for the company as a
whole. So rather than doing price earnings ratios, for example, we are looking at
Value/OPAT. I prefer these valuation ratios because they don't use net income, which
is a problematic measure. And they reflect valuation for the company as a whole.
Market/Book refers to market value of assets divided by the book value of assets.
That avoids problems with negative book value of equity, for example. Those are the
numbers you should have found. What we see is that Nike has a higher valuation ratio.

Right?
So what's the overall analysis? This was an open question so there are several possible,
reasonable, good answers here. This is what I learned by doing this analysis. Overall,
the companies look quite similar, right? They are both profitable. They both have
adequate liquidity. They both have low leverage, right? Perhaps Nike has a little bit
high liquidity and a little bit lower leverage than the other corporations so you could
have mentioned that, right? It was interesting that both companies are repurchasing
stock and investing in the business, but if you take a look at the numbers repurchases
are larger. Okay? So these companies are mostly returning cash to investors rather
than investing cash to grow the business, and this is related to this recent debate
about investment in the U.S. economy, right, that we mentioned in the lecture notes
briefly, right?

So, there are many practitioners and even the government that are concerned with
the low rates of investment in the US economy. Many companies are spending more
money repurchasing stock than investing in the business, so Nike and V.F. Corporation
seem to be more additional examples of that. And comparing the valuation ratios,
what we saw is that Nike has greater future opportunities as we discussed in the
lecture notes. The valuation rates essentially measure future over past or future over
present, right? So the fact that Nike has higher valuation ratios means that investors
expect future cash flows for Nike to be higher relative to V.F. Corporation, compared
to current month.