BEC Chapter 3
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Financial management includes the following five functions:
- 1. Financing function: Raising capital
- 2. Capital budgeting function: Selecting the best projects to invest firm resources.
- 3. Financial management function: Managing the firm’s internal cash flows and its capital
- structure to pay bills.
- 4. Corporate governance function: Developing an ownership and corporate governance system.
- 5. Risk-management function: Managing the firm’s exposure to all types of risk.
What are a business' Objectives?
To Maximize the wealth of its owners within the applicable legal and societal boundaries. Managers' are suppose to operate the business in the owners best interest.
Factors that may affect the stock price
1. External constraints such as law, regulations, and practices.
2. Sstrategic policy decisions such as those regarding dividends, degree of debt leverage, production method and types of good produced.
3. Economic activity and corpate taxes
4. Stock MArket conditions
4 stages of the life cycle of a product, industry, or entity
- 1. Infancy- may required addtional resource to get the new product started in the business. Called the Experimentation stage.
- 2.Growth- experience above normal profit increase
- 3. Maturity-profits are used to fund the next generation product as sales begin to decrease for that product.
- 4. Decline-Sales decrease and losses occur as replace product evolve.
List the different finanical markets
- Physical asset market -tangible like real estate, grains, computer
- Financial asset markets-claims on asset like stock, bonds, warrants, options, notes, mortgages.
- Spot market-delivery in days
- Futures market-delivery at a future date.
- money market-exchanes for short-term debt securities
- Capital market-exchanges for long tem debts.
- Debt market-exchanges bonds, notes, and loans
- Equity Market-exchange stock and other ownership interest
- mortage market-loans secured by real estate
- Consumer credit market-loan on consumer good such as education, vacation, and durable
wolrd, national, regional or local markets- categorized by location
- primary market- Newly issued securities
- secondary market- securities that were previously issused.
Different means of transferring finanical assets
- 1.Direct transfer
- 2.Facilitied Transfer
- 3.Repackaged transfers
- 4.Securities markets
Time value of money
- 1.future value of an amount (Lump sum)
- 2.Present value of a future amount
- 4.Non-annual Compounding period
Types of Annuities
- Ordinary annuities
- annuities due
Reasons the stock price may change
- 1. riskless rate of change due to changes in anticipated inflation.
- 2. stock beta coefficient changes
- 3. expected growth rate fluctuation
Expected rate of return
weighted average of the possible outcome. The sum of the possible outcome x its probability
What are the two catergories of risk connected to stock
1.Market risk- caused by the change in the stock markers at large. risk that can not be eliminated. only was to eliminated it is to stay out of the market.
2.Company risk-risk that a company will suffer loses.
Mixing investments of different risk to reduce the risk.
*diversification risk -unsystematice risk/non-market but firm specific.
* nondiversificable risk- systematic risk market related
1. Risk Indifferent behavior- attitude where increase in the level of risk would not result in require rate of return.
2. risk seeking behavior- increase in the risk will result in a decrease in required rate of return.
3. risk adverse behavior-increase in risk will result in increase in required rate of return.
Stock tendency to move with the market. Beta is the measurement of a stock volatility relative to the market average.
effects of a stock dividend
icreases th quantity of outstanding stock. and decrease the EPS . Moves equity from retained earnings to paid in capital.
Types of bonds
Floating-rate-bond has a varible interest rate that equals the market rate.
Common methods of computing cost of retained earnings
- 1. Capital asset pricing model
- 2. Discounted cashflow
- 3. Bond yield Plus Risk Premium
Managing cash so that companys can meet short-tem obligations. The primary focus of working capital management is managing inventories and receivables.
net working capital
- Measures the amount by which current assets exceed or cover current liability.
- current asset (CA) - current liability (CL)
best single indicator of the companys ability to meet short-term obligation.
current asset/current liability
Motives for holding cash
1. Transaction motives- Having enough cash to make payment.
2.speculative motive-having enought cash for opportunites. like trade discounts
3. precautionary motives- safety cushion.
disadvantage of a high cash level
- 1.lower returns on investment
- 2.increase attractiveness as a takeover target
- 3.investors won't be happy. no dividends paid
methods of speeding up cash collection
- 1. customer screening and credit policy.
- 2.prompt billing to customer
- 3.payment discounts
- 4. expedited deposits
- 5.concentration banking
- 6. acccount receivable turnover
360/(payperiod-discount period) x discount/(100-discount%)
method to delay disbursement
- 1.deferred payment
- 2. use of drafts or checks
- 3.line of credit
- 4. zero balance accounts
cash conversion cycle
The cash conversion cycle of a firm is the length of time between when the firm makes payments for its raw materials and when it receives cash inflows.
cash conversion cycle= inventory conversion period + receivable collection period-payable deferral period
Inventory conversion period=average inventory/average cost of sales per day.
receivable collection period=average receivable/average sales per day
Payable deferral period= average payable/average purchase per day
The two goals of inventory management
• To ensure adequate inventories to sustain operations.
• To minimize inventory costs, including carrying costs, ordering and receiving costs, and cost of running out of stock.
Supply chain management
Sharing of information from the point of sale to the final consumer back to the manufacturer, to the manufacturer’s suppliers, and to the suppliers’ suppliers.
Economic order quantity
The amount to be ordered is the EOQ. The EOQ minimizes the sum of the two primary costs: ordering and carrying costs.
Just-in-Time (JIT) Purchasing.
Justintime (JIT) is a demandpull inventory system which may be applied to purchasing so that raw material arrives just as it is needed for production. The primary benefit of JIT generally is reduction of inventories, ideally to zero.
Advantages of JIT Purchasing and Production
- • Lower investments in inventories.
- • Lower inventory carrying and handling costs.
- • Reduced risk of defective and obsolete inventory.
- • Reduced manufacturing costs.
- • Dealing with a reduced number (when compared with traditional systems) of reliable, quality oriented suppliers because of overreliance on too few suppliers.
- • JIT allows a simplified costing system called backflush costing. The lack of inventories in a JIT system makes choices about costflow (such as LIFO and FIFO) unimportant—all manufacturing costs are simply run through cost of goods sold.
common marketable securities
- 1. United States treaury bills
- 2. negotiable certification of deposit
- 3. bankers accptances
- 4. commercial paper
- 5. equity securities of public companies
Types of finanical risk
1. Maturity risk-compensation investors demand for bearing risk.
2. purchasing power risk-compensation investors demand for bearing risk that an asset that price levels will change and affect asset values.
3.liquid risk premium-compensation demanded that the assets will be sold at a deep discount with out notice.
4. Default risk-compensation demanded that the issuer will fail to repay principal and interest.
Required rate if return
real rate of return + the inflation premium+ risk premium
risk premium are the sum of financial risk.
Major types of short-term investments
- a. Treasury bills (T-bills): Short term obligations of the federal government. Tbills are popular short term investments because they are liquid and have no default risk. b. Certificates of deposit (CD): Savings deposits at financial institutions. Interest yields are higher on CDs than for government securities but CDs are not as liquid or as safe.
- c. Commercial paper: Large unsecured short-term promissory notes issued to the public by large creditworthy corporations. Commercial paper has a two to nine month maturity period and is usually held to maturity by the investor because there is no active secondary market.
- d. Banker’s acceptance: A draft drawn on a bank for payment when presented to the bank. Banker’s acceptances generally arise from payments for goods by corporations in foreign countries (trade credit). Banker’s acceptances involve slightly more risk than government securities but also offer slightly higher yields.
- e. Eurodollar certificate of deposit: Eurodollars are US dollars held on deposit by foreign banks and in turn lent by the banks to anyone seeking dollars. As an investment, Eurodollar certificates of deposit pay higher yields than treasury bills or certificates of deposit at large US banks.
- f. Money market funds: Shares in a fund that purchases higher yielding bank CDs, commercial paper, and other large denomination, higher yielding securities. Money market funds allow smaller investors to participate in these markets.
- g. Money market accounts: Similar to savings accounts, individual or business investors deposit idle funds in the accounts and the funds are used to invest in higher yielding bank CDs, commerh.
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