1. J. K. Dietrich - FBE 432 – Fall, 2002 Overview of Finance Week 1 – August 26 and 28, 2002

2. J. K. Dietrich - FBE 432 – Fall, 2002 Financial Analysis, Functions, and Careers August 28, 2002

3. J. K. Dietrich - FBE 432 – Fall, 2002 FBE 432 Objectives u Analyze and communicate implications of financial theory using cases u Understand finance careers and functions u Refine and expand specific financial analytical skills u Responsibility for learning is with you u Requirements are clear: review, prepare, and participate

4. J. K. Dietrich - FBE 432 – Fall, 2002 Financial Analysis u Analyze performance of corporations (and projects) –What should be the objective of financial management? –How do we determine whether management is good or bad? u Focus in finance is on the future –Who knows what will happen in the future? –How can we deal with our uncertainty concerning the future?

5. J. K. Dietrich - FBE 432 – Fall, 2002 Financial Functions u All finance is concerned with value u Corporate decision-making –Investments, including mergers and acquisitions and divestitures (disinvestment) –Growth and financing needs –Management of working capital u Chief financial officer is responsible for these decisions –Requires project analysts, treasury assistants

6. J. K. Dietrich - FBE 432 – Fall, 2002 Investment Banking u Investment bankers assist corporations in their dealings with financial markets –Issuing securities »Initial public offerings (IPOs) or secondary offerings »Issuing debt or preferred stock to private investors (private placements) or to public markets –Mergers and acquisitions –Advising and valuing firms u This services are corporate finance or investment banking services

7. J. K. Dietrich - FBE 432 – Fall, 2002 Investment Banking (continued) u Investment bankers also buy and sell securities –Brokers (retail and institutional) –Market makers –Asset management –Research u Investment banks are classified in a variety of ways –Full line –Boutique –Regional –“Bulge bracket”

8. J. K. Dietrich - FBE 432 – Fall, 2002 Investment Banking (continued) u Investment bankers need many types of financial skills –Analysts for research –Analytical support in doing deals –Traders –Marketing securities to retail and institutional markets u Investment banks hire junior analysts and associates at entry level

9. J. K. Dietrich - FBE 432 – Fall, 2002 Investment Banking and Markets u Investment bankers assist corporations (and governments) in designing securities for sale to public or private markets u Employees of investment banks are usually called are said to work on the sell side of a securities firm, or are called sell side analysts or sell side traders or brokers

10. J. K. Dietrich - FBE 432 – Fall, 2002 Investors u Individuals and institutions invest savings in securities (and other investments) u Individuals are usually divided into the retail market (small investors) and affluent investors (private banking) u Buying and selling securities in the retail market u Advising and investing for individuals is financial advising and asset management u Individuals often invest in mutual funds and save in pension plans

11. J. K. Dietrich - FBE 432 – Fall, 2002 Institutional Investors u Pension funds, mutual funds, insurance companies, and specialized investment vehicles for wealthy investors (e.g. hedge funds) are called institutional investors u Institutional investors require analysts and portfolio managers to invest funds u Employees of institutional investors are usually said to be on the buy side, as for example a buy-side analyst or a buy-side trader

12. J. K. Dietrich - FBE 432 – Fall, 2002 Specialized Investment Vehicles u Venture-capital firms provide financing to new firms, often firms in new technologies, requiring both technical and financial skills u Hedge funds are unregistered investment vehicles for wealthy investors’ or institutional funds, often using complex investment strategies requiring sophisticated financial analytical skills

13. J. K. Dietrich - FBE 432 – Fall, 2002 Developments in Finance u Financial theory has developed to value financial instruments like options and swaps u Technology has developed to enable accounting and trading for complex financial claims like collateralized mortgage obligations (CMOs) u Trading and valuing these instruments and advising corporations on how to use them to manage risk demands highly developed research departments

14. J. K. Dietrich - FBE 432 – Fall, 2002 Commercial Banking u Commercial banks make loans to corporations and individuals u Corporate commercial bankers provide a variety of services to corporations, including cash management and lending u Banks require financially trained individuals to call on corporations and analyze corporate customers

15. J. K. Dietrich - FBE 432 – Fall, 2002 Finance Career Paths u Many individuals move between financial functions in corporations and investment banking, asset management, commercial banking, and financial advising over the course of their careers u Research, marketing (selling), deal-making, and advising require varying levels of interpersonal skills u Risk tolerance and energy requirements vary in different finance career paths

16. J. K. Dietrich - FBE 432 – Fall, 2002 Next Time – August 28 u Review valuation approaches u Read for practice, The Union Carbide Deal (Abridged) –Outline issues at issue in the case –What role do investment bankers play? –How are they compensated?

17. J. K. Dietrich - FBE 432 – Fall, 2002 Introduction to Valuation and Review August 28, 2002

18. J. K. Dietrich - FBE 432 – Fall, 2002 Value and Valuation u Finance objective function is to maximize owners’ value u Value is the present value of future cash flows at the risk-adjusted discount rate u Valuation principles are the same whether we are valuing stocks, bonds, real estate, or corporations u The challenge is to estimate the cash flows and choose a discount rate

19. J. K. Dietrich - FBE 432 – Fall, 2002 Corporate Cash Flows u Corporate cash flows are similar to all firms’ cash flows, that is, they come from cash revenues minus cash costs u Because of tax laws and standard reporting conventions, corporate cash flows are more standardized u Value of claims on corporations can be calculated separately (e.g. stock and bond valuation) or in the aggregate (so-called entity approach)

20. J. K. Dietrich - FBE 432 – Fall, 2002 Future Corporate Cash Flows u Since value comes from future cash flows and the future is unknown, future cash flows must be estimated u The future is usually divided into two or more parts –Forecast period and continuing value period –Rapid growth period and normal growth period u Choice of division depends on case and data available

21. J. K. Dietrich - FBE 432 – Fall, 2002 Cash Flow Determination u Items From the Income Statement –Revenues (R) –Cash Expenses (W) –Non-Cash Expenses (Dep) –Capital Expenditures (Capex) –Cost of Goods Sold (CGS): »Excludes depreciation –Interest Expense (Int) –Taxes (T)

22. J. K. Dietrich - FBE 432 – Fall, 2002 Cash Flow Determination u Other Items –Tax Rate (  ) –Repayment of Principal (P) –Changes in Net Working Capital (  NWC) –Permanent Debt (D)

23. J. K. Dietrich - FBE 432 – Fall, 2002 Definition of Earnings Components u Earnings Before Interest & Taxes [EBIT] R-(W+Dep+CGS) u Earnings Before Interest, Taxes, Depreciation (and Amortization) EBITD(A) EBIT+Dep+(Amort)

24. J. K. Dietrich - FBE 432 – Fall, 2002 Definitions of Earnings Components u Pre-Tax Income –[EBIT-Int] u Tax Bill [T] –  (EBIT-Int) u Net Income –NI =Pre-Tax Income - T

25. J. K. Dietrich - FBE 432 – Fall, 2002 Cash Flow Definitions u Levered Cash Flow [to equity] {LCF or FTE} Money that goes to stockholders account [R-(W+Dep+CGS+Int)](1-  )+Dep-Capex-P-  NWC u Unlevered Cash Flow {UCF} Cash flow that would occur if there was no debt (1-  )EBIT+Dep-Capex -  NWC

26. J. K. Dietrich - FBE 432 – Fall, 2002 Next Week – September 4 u Review valuation techniques and relate to case materials u Prepare Eskimo Pie Case u Form groups for group case analyses following Eskimo Pie