McGraw-Hill/Irwin© 2008 The McGraw-Hill Companies, Inc. All rights reserved. Financial Management and Securities Markets 16

Current Assets and Current Liabilities Current assets are short-term resources –Cash –Investments –Accounts receivable –Inventory Current liabilities are short-term debts –Accounts payable –Accrued salaries –Accrued taxes –Short-term bank loans

Managing Current Assets Managing cash Investing idle cash Maximizing accounts receivable Optimizing inventory

Managing Cash Effectively managing the firm’s cash flow is crucial –Transaction balances –Lockbox systems –Electronic funds transfer

Investing Idle Cash Marketable securities US Treasury bills (T-bills) Commercial certificates of deposit (CDs) Commercial paper International investments – the Eurodollar

Short-term Investment Possibilities for Idle Cash

Maximizing Accounts Receivable Each credit sale represents an account receivable--money owed to a business by credit customers –Typically due within 30, 60, or 90 days –1-2% discount if paid between 10 and 30 days –1-1.5% penalty charged if paid late

Optimizing Inventory The objective is to maximize inventory investment without production cutbacks because of materials shortfalls or lost sales due to insufficient finished goods inventories.

Maximizing Current Liabilities Accounts payable Bank loans Non-bank liabilities

Accounts Payable Money an organization owes to suppliers for goods and services –Trade credits Most suppliers offer trade discounts

Bank Loans Line of Credit –An arrangement by which a bank agrees to lend a specified amount of money to an organization upon request Secured Loans –Loans backed by collateral that the bank can claim if the borrowers do not repay the debt

Bank Loans Unsecured Loans –Loans backed only by the borrowers’ good reputation and previous credit rating Prime Rate –Interest rates commercial banks charge their best customers (usually large corporations) for short-term loans

Non-Bank Liabilities Short-term loans from insurance companies, pension funds, money market funds, or finance companies Factoring organization –Purchases accounts receivable at a discount Taxes and employees’ wages

Managing Fixed Assets Long-term (fixed) assets: –Plants –Offices –Equipment –Heavy machinery –Automobiles

Capital Budgeting and Project Selection Capital budgeting is the process of analyzing the needs of business and selecting the assets that will maximize its value –Assessing risk Every investment in capital assets has its own risk

Qualitative Assessment of Capital Budgeting Risk Introduce a New Product in Foreign Markets (risk depends on stability of country) Expand into a New Market Introduce a New Product in a Familiar Area Add to a Product Line Buy New Equipment for an Established Market Repair Old Machinery Highest Risk Lowest Risk

Pricing Long-term Money Factors to Consider: –How much cash will be generated –Cost of financing –Supply of funds available for investment –Accurately identifying opportunities with the greatest potential for ROI

Financing with Long-Term Liabilities Debts that will be repaid over a number of years –Long-term loans –Bond issues

Bonds: Corporate IOUs Debt instruments that larger companies sell to raise long-term funds. –Indenture: The bond contract specifying all terms of agreement between bondholder and the issuing organization

A Basic Bond Quote

A Basic Stock Quote

Types of Bonds Unsecured –Debentures, or bonds, that are not backed by specific collateral Secured –Bonds that are backed by specific collateral that must be forfeited in the event the issuing firm defaults Serial –A sequence of small bond issues of progressively longer maturity

Types of Bonds Floating-rate –Bonds with interest rates that change with current interest rates otherwise available in the economy Junk –Special type of high interest rate bond that carries higher inherent risks

Financing With Owners’ Equity Owners’ equity is the owners’ investment in an organization –Common stock –Preferred stock –Retained earnings

Estimated Common Stock Price-Earnings Ratio and Dividends for Selected Companies

Investment Banking The sale of stocks and bonds for corporations –Primary market New issue or initial public offering (IPO) –Secondary market Stock exchanges and OTC markets where investors trade securities with each other

The Securities Markets Securities markets provide a mechanism for buying and selling securities –Organized exchanges Central locations where investors buy and sell securities –Over-the-counter market (OTC) A network of dealers all over the country, and world, linked by computers, telephones, and teletype machines

Measuring Market Performance Indexes Averages Bull market Bear market

The 30 Stocks in the Dow Jones Industrial Average

Dow’s Milestones The Dow climbed from 860 in August 1982 to a high of 11,497 at the beginning of The worst drop in history ( points) was on September 17, 2001 after the markets were closed for 4 days following terrorist attacks on September 11 that destroyed the World Trade Center and parts of the Pentagon.

Solve the Dilemma 1.Normally, rapidly increasing sales is a good thing. What seems to be the problem here? 2.List the important components of a firm’s working capital. Include both current assets and current liabilities. 3.What are some management techniques applied to current liabilities that Glasspray might use to improve its working capital position?

Explore Your Career Options What types of skills would be most useful to a financial manager? –What are some of the most stressful aspects of the job?

Additional Discussion Questions and Exercises 1.Why would a business use a lockbox to receive payments? 2.What are the advantages of a firm using electronic funds transfer rather than traditional check-clearing procedures? 3.What is a junk bond? Why do investors buy junk bonds? 4.What do companies do with retained earnings? 5.Why is the prime rate of interest important for business firms?

Chapter 16 Quiz 1.Which one of the following is an example of a current liability? a.accounts receivable b.marketable securities c.wages payable d.inventory 2.Which of the following is an example of a current asset? a.Cash b.accounts payable c.accrued salaries d.short-term bank loans

Chapter 16 Quiz 3.Which of the following is where new issues of stocks and bonds are sold directly to the public? a.primary market b.secondary market c.over-the-counter market d.investment banks 4.Dividend yield refers to a.the dividend rate divided by the stock market average. b.dividends per share divided by stock price. c.the percentage of return an investor has earned on the original investment. d.the coupon rate on bonds that change with current interest rates.

Multiple Choice Questions about the Video 1.Stocks were first traded on the NYSE in a b c d e As interim chairman of the NYSE, John Reed earns a salary of a.$10 million. b.$1 million. c.100,000. d.10,000. e.$1.