Part 6 Financing the Enterprise © 2015 McGraw-Hill Education.

CHAPTER 14 Accounting and Financial Statements CHAPTER 15 Money and the Financial System CHAPTER 16 Financial Management and Securities Markets 16-2

Learning Objectives LO 16-1Describe some common methods of managing current assets. LO 16-2Identify some sources of short-term financing (current liabilities). LO 16-3Summarize the importance of long-term assets and capital budgeting. LO 16-4Specify how companies finance their operations and manage fixed assets with long-term liabilities, particularly bonds. LO 16-5Discuss how corporations can use equity financing by issuing stock through an investment banker. LO 16-6Describe the various securities markets in the United States. 16-3

Managing Current Assets and Liabilities 16-4 Working Capital Management The managing of short-term assets and liabilities  Since short-term assets and liabilities continually flow through an organization, they are said to be “working”  The terms current and short-term are used interchangeably  Current assets: cash, investments, accounts receivable and inventory – goal is maximize return on these assets  Current liabilities: accounts payable, accrued salaries, accrued taxes and short-term bank loans

Managing Current Assets 16-5 Idle cash does not make money and managers try to keep just enough to pay bills as they fall due Transaction Balances Cash kept on hand by a firm to pay normal daily expenses, such as employee wages and bills for supplies and utilities Lockbox An address, usually a commercial bank, at which a company receives payments in order to speed collections from customers

Managing Current Assets 16-6 Sometimes cash comes in faster than needed to pay bills Marketable Securities Temporary investment of “extra” cash by organizations for up to one year in U.S. Treasury bills, certificates of deposit, commercial paper, or Eurodollar loans Treasury Bills (T-Bills) Short-term debt obligations the U.S. government sells to raise money T-bills are considered risk free

Short-Term Investment Possibilities for Idle Cash 16-7

Method Is a Green Company in More Ways than One 16-8  Method sells eco-friendly household supplies and also generates more that $100 million in annual revenues. Method  Thanks to companies such as Method, finance executives are beginning to realize the financial benefits of going green.Method  Method aligns its environmental objectives with its cost- savings goals. Method  The operations and finance departments routinely work together to look at what ingredients and processes would save money while reducing Method’s environmental impact.Method’s

16-9 Managing Current Assets Certificates of deposit issued by commercial banks and brokerage companies, available in minimum amounts of $100,000 which may be traded prior to maturity Commercial Certificates of Deposit (CDs) A written promise from one company to another to pay a specific amount of money Commercial Paper A market centered in London for trading U.S. dollars in foreign countries Eurodollar Market

Managing Current Assets  Many businesses make a majority of sales on credit, so managing receivables is important  Discounts for early payment and extending credit comes at the cost of lowered profits  Credit ratings can be provided by credit bureaus, credit-rating agencies such as Dun and Bradstreet and industry trade groups

Managing Current Assets  Financial managers have to coordinate inventory purchases to manage cash flows  Optimal inventory levels are determined mainly by method of production  Excess inventory ties up money unnecessarily but inventory shortages could drive a customer to a competitor – forever

Managing Current Liabilities Averting a cash shortfall with short-term funds Trade Credit is extended by suppliers for the purchase of their goods and services Accounts Payable Most suppliers offer discounts for early payment, offered as “1/10 net 30,” meaning a 1% discount if given is paid in 10 days and the full amount is due in 30 days

Managing Current Liabilities Most organizations obtain short-term funds from banks An arrangement by which a bank agrees to lend a specified amount of money to an organization upon request Line of Credit Loans backed by collateral the bank can claim if the borrowers do not repay them Secured Loans Loans backed only by the borrowers’ good reputation and previous credit rating Unsecured Loans The interest rate commercial banks charge their best customers (usually large corporations) for short-term loans Prime Rate

Managing Current Liabilities Banks are not the only source of short-term funds Factor A finance company to which businesses sell their accounts receivable – usually for a percentage of the total face value o Other nonbank liabilities include: taxes owed to the government and wages owed to employees o Taxes and employees’ wages represent debt obligations and the financial manager must plan to meet them as they come due

Managing Fixed Assets Long-Term (Fixed) Assets Production facilities (plants), offices, and equipment – all of which are expected to last for many years  Modern facilities and equipment are expensive, requiring long-term financing  Options include capital leases and operating leases, where a company pays a fee for usage rather than owning an asset

Managing Fixed Assets Capital Budgeting The process of analyzing the needs of the business and selecting the assets that will maximize its value  This process continues after purchase as all assets and projects must be continually reevaluated against the company’s needs  Budgeting is not an exact process and managers must be flexible

Assessing Risk Introduce a New Product in Foreign Markets Expand into a New Market Introduce a New Product in a Familiar Market Add to a Product Line Buy New Equipment for Established Market Repair Old Machinery Highest Risk Lowest Risk

Assessing Risk Pharmaceutical companies spend millions of dollars developing new drugs without knowing if the drug will pass FDA approval and have a significant margin of risk

Assessing Risk Every investment carries some risk »The longer a project or asset is expect to last, the greater its potential risk as it may become obsolete or wear out prematurely »Risk is also affected by the stability and competitive nature of the marketplace and the world economy

Pricing Long-Term Money  Returns from any project must cover not only operating costs but interest expenses on the debt used to finance the project  The most efficient and profitable companies attract the lowest-cost funds because they typically offer reasonable returns for low relative risk  New companies have a strong motivator to use financial resources wisely because they will, over time, reduce the costs of their funds and increase profit

Financing with Long-Term Liabilities Two common sources for long-term funds: Attracting new owners (equity financing) Long-term liabilities (debt financing) Long-Term Liabilities Debts that will be repaid over a number of years, such as long-term loans and bond issues These take many different forms but the in the end, the key word is debt Heavily indebted companies may not make it through a recession and be forced into bankruptcy

Financing with Long-Term Liabilities Bonds Debt instruments that larger companies sell to raise long-term funds o Bondholders enter into a contract, or indenture, with the bond issuer o Bondholders receive regular interest payments and the face value of the bond on or before the maturity date o The annual interest rate (often called coupon rate) is the percentage of face value the company pays yearly

Types of Bonds Debentures, or bonds that are not backed by specific collateral Unsecured Bonds Bonds backed by specific collateral that must be forfeited in the event the issuing firm defaults Secured Bonds A sequence of small bond issues of progressively longer maturity Serial Bonds Bonds with interest rates that change with current interest rates otherwise available in the economy Floating-Rate Bonds A special type of high interest-rate bond that carries higher inherent risks Junk Bonds

Financing with Owners’ Equity Corporate owners own shares of the company and stockholders’ equity includes common stock, preferred stock and retained earnings Retained Earnings Earning after expenses and taxes that are reinvested in the assets of the firm and belong to the owners in the form of equity Retained earnings are the only long-term funds the company can generate internally

Venture Firm Focuses on Smaller Cleantech Investments Robert Fenwick-Smith prefers smaller clean-tech companies that are capital efficient, can reach profitability more quickly, and yield smaller but still profitable returns. He founded the venture capital firm Aravaipa Ventures in 2008 to invest in several smaller firmsAravaipa Ventures Invests in four key areas: transportation efficiency, building efficiency, water efficiency, and location efficiency Spreads out the risk so the failure of one company will not lead to enormous losses Invests only in firms that need no more than $5 million in funding and have the ability to generate revenue within the next year and a half Won the Governor’s Award for Excellence in Cleantech Leadership in 2012

16-26 A Basic Stock Quote

16-27 Dividend Yield The dividend per share divided by the stock price Estimated Common Stock Price-Earnings Ratios and Dividends for Selected Companies

Investment Banking Primary Market The market where firms raise financial capital Secondary Markets Stock exchanges and over-the-counter markets where investors can trade their securities with others Investment Banking The sale of stocks and bonds for corporations

High Frequency Trading High Frequency Trading has become popular over the last several years and has dramatically changed the landscape of the securities markets. High frequency trading is made possible by proprietary algorithms created to allow computers to automatically trade stocks and securities in a matter of seconds. Since the advent of this method, there have been severe crashes in the market due to failure of the technology or mistakes made by the computers. These mistakes are usually corrected just as quickly as they occur, however, it does make some wonder if replacing a human trader with an automated one is worth the risk. SOURCE: Richard Finger. “High Frequency Trading: Is it A Dark Force Against Ordinary Human Traders and Investors?”. September 30,

Securities Markets Securities Markets The mechanism for buying and selling securities » In the broadest sense, stocks and bonds markets are providers of liquidity » Without liquid securities markets, investors would not risk their savings on securities

Stock Markets May lead to inflation – a continuing rise in prices May lead to recession – a decline in production, employment and income Stock markets exist around the world; the two biggest U.S. stock markets are the New York Stock Exchange (NYSE) and the NASDAQ market Both exchanges are now publicly traded organizations, no longer not-for-profit Electronic trading is faster and less expensive than floor trading and now accounts for most of the stock trading done worldwide NASDAQ was traditionally an electronic market and the NYSE was traditionally a floor-traded market

Social Media Companies Face Obstacles Going Public  Facebook made a major debut as a public company with an initial offering of $38 a share. Facebook  Within four months its stock had slid 45%, leading to a number of investor lawsuits claiming that they had been misled about Facebook’s future growth prospects.investor lawsuits  The social gaming company Zynga saw its stock drop 70% in less than a year.Zynga ? Why might a company’s stock be overvalued? ? Why are these social media companies performing poorly compared to their original hype?

Securities Markets Over-The-Counter (OTC) Market A network of dealers all over the country linked by computers, telephones and Teletype machines  Most corporate bonds and all U.S. securities are traded over the counter  Therefore, the OTC accounts for the largest total dollar value of all the secondary markets

Measuring Market Performance  Investors and financial managers need to know how a companies’ securities are performing compared with competitors’  Performance measures – averages and indexes – are very important to many different people  An index compares current stock prices with those in a specified base period  An average is the average of certain stock prices and some are weighted averages

The 30 Stocks in the Dow Jones Industrial Average 16-35

Measuring Market Performance  The Dow Jones Industrial Average gained 10 times from August 1982 to the beginning of 2000  This was the Internet bubble and they are difficult to see until they burst  Before the housing bubble burst in October 2007, the Dow Jones hit an all time high  For investors to make sound financial decisions, it is important that they stay in touch with business news, markets and indexes

Discussion ? How can companies use equity to finance their operations and long-term growth? ? What were some of the principle causes of the most recent recession? 16-37