FUNDAMENTAL CONCEPTS

OF CORPORATE FINANCE
MMUGM
Meeting 1
Sources: Ch 1-3

Chapter 1
Overview of FM

Why is corporate finance

important to all managers?

Corporate finance provides the skills

managers need to:
Identify and select the corporate strategies and
individual projects that add value to their firm.
Forecast the funding requirements of their
company, and devise strategies for acquiring
those funds.

Becoming a Public Corporation

and Growing Afterwards

Initial Public Offering (IPO) of Stock

Raises cash
Allows founders and pre-IPO investors to
harvest some of their wealth

Subsequent issues of debt and equity

Agency Problems and Corporate

Governance
Agency problem: managers may act in
their own interests and not on behalf of
owners (stockholders)
Corporate governance is the set of rules
that control a companys behavior towards
its directors, managers, employees,
shareholders, creditors, customers,
competitors, and community.
Corporate governance can help control
agency problems.

What should be managements

primary objective?

The primary objective should be

shareholder wealth maximization, which
translates to maximizing the fundamental
stock price.
Should firms behave ethically? YES!
Do firms have any responsibilities to society at
large? YES! Shareholders are also members of
society.

What are some types of

markets?
A market is a method of exchanging one
asset (usually cash) for another asset.
Physical assets vs. financial assets
Spot versus future markets
Money versus capital markets
Primary versus secondary markets

Chapter 2
Financial Statements

Frinancial Statements
Balance Sheets
Income Statements
Cash Flow Statements

What are they?

Who are interested to know?
Why are they important?

What is free cash flow (FCF)?

Why is it important?
FCF is the amount of cash available from
operations for distribution to all investors
(including stockholders and debtholders)
after making the necessary investments to
support operations.
A companys value depends on the amount
of FCF it can generate.

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What are the five uses of

FCF?

Pay back principal on debt.

Pay dividends.
Buy back stock.
Buy nonoperating assets (e.g., marketable
securities, investments in other companies,
etc.)

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Step 1

Calculating Free Cash Flow in 5 Easy

Step 2
Steps

Earning before interest and taxes

X

(1 Tax rate)

Net operating profit after taxes

Operating current assets

Operating current liabilities
Net operating working capital
Step 3

Net operating working capital

+ Operating long-term assets
Total net operating capital
Step 5
Step 4

Net operating profit after taxes

Net investment in operating capital

Free cash flow

Total net operating capital this year

Total net operating capital last year
Net investment in operating capital
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What are operating current

assets?

Operating current assets are the CA needed

to support operations.
Op CA include: cash, inventory, receivables.
Op CA exclude: short-term investments, because
these are not a part of operations.

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What are operating current

liabilities?

Operating current liabilities are the CL

resulting as a normal part of operations.
Op CL include: accounts payable and accruals.
Op CL exclude: notes payable, because this is a
source of financing, not a part of operations.

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Chapter 3
Analysis of
Financial Statements

Financial Ratios

Ratios facilitate comparison of:

One company over time
One company versus other companies

Ratios are used by:

Lenders to determine creditworthiness
Stockholders to estimate future cash flows and
risk
Managers to identify areas of weakness and
strength

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Liquidity Ratios

Can the company meet its short-term

obligations using the resources it currently
has on hand?

Current and Quick Ratios:

CR = CA/CL
QR = (CA-Inv)/CL

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Asset Management Ratios

How efficiently does the firm use its assets?

Sales
ITO =Inventories
Receivables
DSO =
Average sales per day
Sales
FAT =
Net fixed assets

Sales
TAT =
Total assets
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Debt Management Ratios

Does the company have too much debt?
Can the companys earnings meet its debt
servicing requirements?

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Debt Ratio, TIE, and EBITDA

coverage ratio.
Total liabilities
Debt ratio = Total assets

TIE =

EBIT

Int.
expense
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EBITDA Coverage (EC)

EBIT + Depr. & Amort. + Lease payments

Interest
Lease
+ pmt.
+ Loan
expense
pmt.

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Profitability Ratios
Net profit margin (PM):
PM = NI
Sales
Operating profit margin
(OM):
EBIT
OM = Sales
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Profit Margins

(Continued)

Gross profit margin

(GPM):
Sales
GPM =
COGS
Sales

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Basic Earning Power (BEP)

EBIT
BEP =
Total assets

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Return on Assets (ROA)

NI
ROA =
Total assets

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Return on Equity (ROE)

NI
ROE =
Common Equity

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Market Value Ratios:

P/E, P/CF, and M/B ratios.

NI
EPS =
Shares out.
P/E =Price per share
EPS

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Com. equity
BVPS = Shares out.

Mkt. price per share

M/B =Book value per share

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Potential Problems and

Limitations of Ratio Analysis
Comparison with industry averages is
difficult if the firm operates many different
divisions.
Seasonal factors can distort ratios.
Window dressing techniques can make
statements and ratios look better.
Different accounting and operating
practices can distort comparisons.

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