Economics 434 Professor Burton Fall 2014 August 28, 2014

Questions about value What determines value? How is valued traded from one person to another? How should I “invest” to increase value in an optimal way? Value comparisons – Balance Sheet, Income Statement, Stock August 28, 2014

Balance Sheets define “Book Value” for a business at a specific point in time August 28, 2014 AssetsLiabilities + Net Worth Balance Sheet for XYZ Corporation, August 28 th, 2014

“Book Value” is Net Worth (can be negative) LHS of Balance Sheet is “operational” RHS of Balance Sheet is “financial” If there are no liabilities, value of Assets is Book Value Value of a business is not Net Worth Value of a business is Liabilities + Net Worth August 28, 2014 AssetsLiabilities + Net Worth Balance Sheet for XYZ Corporation, August 28 th, 2014

What is bankruptcy? Bankruptcy means owners of liabilities (creditors) take over company Only the RHS of the balance sheet will change initially August 28, 2014 Can’t pay interest on debt (liabilities) Default Owners of liabilities (creditors) take over company

What happens in bankruptcy? Net Worth is zero and the Creditors take over Equity holders wiped out Next steps August 28, 2014 Chapter 7 Chapter 11 Liquidation of assets Proceeds paid to creditors Liabilities converted to new debt + new equity (recapitalization) Emerge from bankruptcy as Newco or

Assets Liabilities Balance Sheet for XYZ Corporation, August 28 th, 2014 With Chapter 11, becomes Assets Liabilities* + Net Worth* Balance Sheet for Newco Corporation, August 29 th, 2014 August 28, 2014 After bankruptcy Emerging from bankruptcy

Key takeaways about bankruptcy Equity becomes zero Owners of debt/liabilities take over Most importantly, assets are unchanged (they don’t disappear or become worthless) Two outcomes: – Either liquidation (Chapter 7) or – Recapitalization (Chapter 11) August 28, 2014

Remember this about balance sheets LHS is “operational” side RHS is “corporate finance” side August 28, 2014 AssetsLiabilities + Net Worth Balance Sheet for XYZ Corporation, August 28 th, 2014 Operational Corporate Finance

What is an Income Statement? Compared to Balance Sheets which show asset positions “at a point in time”, Income Statements show revenue “over a period of time” I/S connects two balance sheets together (or “updates” a balance sheet) Income is a “flow”, assets are a “stock” Typical corporate time periods: – for a quarter (e.g. three months ending Sept 30 th ) – annual (e.g. year ending Dec 31 st ) August 28, 2014 Balance Sheet 2013 Balance Sheet 2014 Income Statement

How does income relate to the Balance Sheet? Income is earnings remaining after “debt service.” Debt service is any fixed payments to liabilities (e.g. bank loans, corporate bonds, etc.) Equity (net worth) owners own the income Income can be positive or negative Updating Balance Sheet affects both LHS and RHS August 28, 2014 AssetsLiabilities + Equity Balance Sheet for XYZ Corporation, August 28 th, 2014 Debt Service Income

What is common stock? Common stock owns the “Net Worth” section of the balance sheet. Common stock can become more valuable (capital gain) or less valuable (capital loss) Common stock can receive dividends August 28, 2014

Public vs Private Stock Public Stock Public stock is what you buy through a brokerage firm Never might know who the buyer/seller on the other side of the transaction is Trading is on an exchange Issuance and trading (buying and selling) is regulated by the Securities and Exchange Commission (SEC) Only registered representatives of broker-dealers can make offers to buy and sell Private Stock Not germane to our course; buy through private placement Always know who the buyer/seller on the other side of the transaction is No wide-open exchange Not as heavily regulated because not bought by or sold to public August 28, 2014

Public Stock Main subject of this course Anonymous purchase and sale using a broker-dealer registered with SEC Return has two main components August 28, 2014 Capital Gain Increase in stock value P t+1 - P t Dividend Cash payments Usually every 3 months D t Where P is price, t is time, D is dividend at time t

August 28, 2014