Corporate Finance - Notes ?
Corporate Finance - Notes ?
Corporate Finance - Notes ?
Finance
Business Ethics
- The science and art of managing money
- The standards of conduct or moral judgment that apply to persons
engaged in commerce
Firm - The goal of such standards is to motivate business and market
- A business organization that sells goods or services participants to adhere to both the letter and the spirit of laws and
- Exist because investors want access to risky investment regulations concerned with business and professional practice
opportunities
Marginal versus Average Tax Rate Table: 2018 Tax Rate Schedule for Single Taxpayer
- The marginal tax rate represents the rate at which the next dollar
of income is taxed while the average tax rate equals taxes paid
divided by taxable income
Double Taxation
- A situation facing corporations in which income from the
business is taxed twice—once at the business level and once at the
individual level when cash is distributed to shareholders
Table: Pre-2018 Corporate Tax Rate Schedule
Ordinary
EXAMPLE: Income versus Capital Gains
Dan-Webster
Ordinary income
is the is income of
sole proprietor earned by aManufacturing.
Webster business through theyear
This sale Webster earned $80,000 before taxes from his business. Assuming that Dan has no
of goods or services while capital gains is income earned
other income, the taxes he will owe on his business income are as follows:by
selling an asset for more than it cost
Total taxes o
dueLimited
= (0.10 partnership
× $9,525) +(LP)
[0.12 × ($38,700 − $9,525)] + [0.22 × ($80,000 − $38,700)]
- The rules, processes, and laws by which companies are operated,
o S corporation (S corp)
= $953 + $3,501 + $9,086 controlled, and regulated
o Limited liability company (LLC)
= $13,540
o Limited liability partnership (LLP)
EXAMPLE:
Peter Strong is a partner in Argaiv Software, and from that business he earned taxable income of $300,000. Assuming that this is Peter’s only source of
income, from Table 1.2 we can see that based on Peter’s tax bracket, he faces a marginal tax rate of 35%. How much in tax does Peter owe, and what is his
average tax rate? Table 1.2 shows a base tax of $45,690 for individuals with income above $200,000 but below $500,000. Here’s where that base tax comes
from:
Base tax = (0.10 × $9,525) + (0.12 × $29,175) + (0.22 × $43,800) + (0.24 × $75,000) + (0.32 × $42,500)
= $953 + $3,501 + $9,636 + $18,000 + $13,600
= $45,690
Agency Costs
- Costs that shareholders bear due to managers’ pursuit of their own
interests
Internal Corporate Governance Mechanisms
Stock Options
- Securities that allow managers to buy shares of stock at a fixed
price
Restricted Stock
- Shares of stock paid out as part of a compensation package that
do not fully transfer from the company to the employee until
certain conditions are met
Government Regulation
Sarbanes-Oxley Act of 2002
- An act aimed at eliminating corporate disclosure and conflict of
interest problems
- Contains provisions concerning corporate financial disclosures
and the relationships among corporations, analysts, auditors,
attorneys, directors, officers, and shareholders
Chapter 2: The Financial Market Environment
- Intermediaries that channel the savings of individuals, businesses, - Involves the sale of a new security directly to an investor or group
and governments into loans or investments. of investors
- The key suppliers and demanders of funds are individuals, -
businesses, and governments. Going Public
- In general, individuals are net suppliers of funds, while businesses
and governments are net demanders of funds - A private company is offering its stock for sale to the public for
the first time
- Initial Public Offering (IPO)
Commercial Banks - One way of borrowing money
- Institutions that provide savers with a secure place to invest their
funds offer loans to individual and business borrowers Primary Market
- The financial market in which securities are initially issued; the
only market in which the issuer is directly involved in the
Investment Banks transaction
- Assist companies in raising capital advise firms on major - New security issues sold to initial buyers
transactions such as mergers or financial restructurings and - Typically involves an investment bank who underwrites the
engage in trading and market making activities offering
-
Figure: Banking
Shadow Flow of Funds
System Eurocurrency Market
Secondary Market
- A group of institutions that engage in lending activities, much like - International equivalent of the domestic money market
- Financial markets in which preowned securities (those that are not
traditional banks, but that do not accept deposits and therefore are - It is a market for short-term bank deposits denominated in U.S.
new issues) are traded
not subject to the same regulations as traditional banks dollars or other marketable currencies
- Securities previously issued are bought and sold
- The Eurocurrency market has grown rapidly mainly because it is
- Example include the NYSE and Nasdaq
unregulated and because it meets the needs of international
- Involves both brokers and dealers
Financial Markets borrowers and lenders
- Nearly all Eurodollar deposits are time deposits
- Forums in which suppliers of funds and demanders of funds can
transact business directly
Maturities
Short Term
Bonds Broker Markets
- Long-term debt instruments used by businesses and government - Securities exchanges in which the two sides of a transaction, the
to raise large sums of money, generally from a diverse group of buyer and the seller, are brought together to trade securities
lenders Dealer Markets
- Certificates of indebtedness
- Holders of bonds are bondholders - Markets, like the NASDAQ, in which the buyer and seller are not
brought together directly but instead have their orders executed by
Stocks securities dealers that “make markets” in the given security
- As compensation for executing orders, market makers make
- Certificates of ownership money on the bid/ask spread (ask price – bid price)
- Holders of stocks are stockholders o Ask Price: The lowest price a seller is willing to accept for
o When you buy, add charges a security
o When you sell, less charges o Bid Price: The highest price a buyer is willing to pay for a
security
Types of Stock
Common Stock
- Units of ownership interest or equity in a corporation
- Board of Directors consist of common stockholders
- Common stockholder has the right to vote of who will manage the Seller = order SMC Php10/share (lowest) 1,000 shares
corporation
Preferred Stock Situation = Php9 /share done or not done?
- A special form of ownership that has features of both a bond and 11/share done or not done? Php10.
common stock
EXAMPLE: International Capital Markets
Eurobond Market
Assume that the current bid price for Merck & Co. stock is $63.25 and
the ask price is $63.45. Suppose you have an E*TRADE brokerage - The market where corporations and governments typically issue
account that charges a $6.95 commission for online equity trades. What is bonds denominated in dollars and sell them to investors located
the current bid/ask spread for Merck? outside the United States
Bid/Ask Spread = Ask Price – Bid Price Foreign Bond Market
Bid/Ask Spread = $63.45 – $63.25 $0.20 - A market for bonds issued by a foreign corporation or
government that is denominated in the investor’s home currency
and sold in the investor’s home market
Inserting the current bid and ask prices, you find that the bid/ask spread
International Equity Market
for Merck is $0.20. What would your total transaction costs be if you
purchased 100 shares of Merck by submitting a market order via your - Allows corporations to sell blocks of shares to investors in a
E*TRADE account? Assume the trade is sent to a broker market for number of different countries simultaneously
execution, and the market maker matches your order with a 100-share
sell order for Merck from another investor. In this case your order will be The Efficient-Market Hypothesis
executed at the midpoint of the bid/ask spread ($63.35), so you will pay
only the brokerage commission. - Securities are typically in equilibrium, which means they are
fairly priced and their expected returns equal their required
Total Transaction Costs Brokerage Commission = $6.95 returns
- At any point in time, security prices fully reflect all information
available about the firm and its securities, and these prices react
Now what would your total transaction costs be if you purchased 100 swiftly to new information
shares of Merck by submitting a market order via your E*TRADE - Because stocks are fully and fairly priced, investors need not
account, and it is routed to a dealer market for execution? waste their time trying to find mispriced (undervalued or
Total Transaction Costs = (Number of Shares x 1/2 the Bid/Ask overvalued) securities
Regulations Governing Financial Institutions
6. Securities Exchange Act of 1934
1. Glass-Steagall Act - Regulates the trading of securities in the secondary market
- Prohibited institutions that took deposits from engaging in - Created the Securities Exchange Commission
activities such as securities underwriting and trading, thereby - Requires ongoing disclosure by companies whose securities trade
effectively separating commercial banks from investment banks in secondary markets (e.g., 10-Q, 10-K)
- Imposes limits on the extent to which “insiders” can trade in their
firm’s securities
2. Federal Deposit Insurance Corporation (FDIC)
- An agency created by the Glass-Steagall Act that provides 7. Securities and Exchange Commission
insurance for deposits at banks and monitors banks to ensure their - The primary government agency responsible for enforcing federal
safety and soundness securities laws
3. Gramm-Leach-Bliley Act
Private Equity
- Allows mergers between commercial banks, investment banks,
and insurance companies and thus permits these institutions to - External equity financing that is raised via a private placement,
compete in markets that prior regulations prohibited them from typically by private early-stage firms with attractive growth
entering prospects
4. Dodd-Frank Wall Street Reform and Consumer Protection Act Angel Investors (Angels)
- Realigns the duties of several existing agencies and requires
existing and new agencies to report to Congress regularly - Wealthy individual investors who make their own investment
- Nearly a decade after Dodd-Frank became law, the various decisions and are willing to invest in promising startups in
agencies affected or created by the new law were still writing exchange for a portion of the firm’s equity
rules specifying how the new law’s provisions would be
implemented Venture Capitalists (VCs)
- Formal business entities that take in private equity capital from
many individual investors, often institutional investors such as
5. Securities Act of 1933 endowments and pension funds or individuals of high net worth,
Organization Description
Corporations chartered by the federal government that can borrow at attractive
Small Business Investment Companies (SBICs) rates from the U.S. Treasury and use the funds to make venture capital
investments in private companies.
Subsidiaries of financial institutions, particularly banks, set up to help
Financial VC funds
Table: Organization of Venture Capital Investors young firms grow and, it is hoped, become major customers of the institution.
Firms, sometimes subsidiaries, established by nonfinancial firms, typically to
Corporate VC funds gain access to new technologies that the corporation can access to further its
own growth.
Limited partnerships organized by professional VC firms, which serve as the
general partner and organize, invest, and manage the partnership
VC limited partnerships
using the limited partners’ funds; the professional VCs ultimately liquidate the
partnership and distribute the proceeds to all partners.
Going Public
Initial Public Offering (IPO)
Private Placement - The first public sale of a firm’s stock, typically made by small,
- The firm sells new securities directly to an investor or group of rapidly growing companies
investors Red Herring
Rights Offering - A preliminary prospectus made available to prospective investors
- The firm sells new shares to existing stockholders during the waiting period
- The firm sells new shares to the general public - Period during which the law places restrictions on what company
officials may say about the company
Prospectus
Roadshow
- A series of presentations to potential investors around the country,
Investment Bank - A large number of brokerage firms that join the originating
investment bank(s); each accepts responsibility for selling a
- Financial intermediary that specializes in selling new security certain portion of a new security issue on a commission basis
issues and advising firms with regard to major financial
transactions
Underwriting
Figure: The Selling Process for a Large Security Issue
- The role of the investment bank in bearing the risk of reselling, at
a profit, the securities purchased from an issuing corporation at an
agreed-on price
IPO Offer Price
- The price at which the issuing firm sells its securities
Originating Investment Bank
- The investment bank initially hired by the issuing firm, it brings
other investment banks in as partners to form an underwriting
syndicate
Underwriting Syndicate
- A group of other banks formed by the originating investment
bank to share the financial risk associated with underwriting new
securities
Tombstone
- The list of underwriting syndicate banks, presented in such a way Going Public
to indicate a syndicate member’s level of involvement, located at Total Proceeds
the bottom of the IPO prospectus cover page
- The total amount of proceeds for all shares sold in the IPO
- Total Proceeds = (IPO Offer Price × # of IPO Shares Issued)
Market Price Financial Institutions and Real Estate Finance
EXAMPLE:
With baby boomers retiring and hitting the open roads of America in droves, the largest U.S. recreational vehicle dealer, Camping World, decided it was time
to go public. Its IPO took place on October 7, 2016, at which time the company sold 11.4 million shares at an IPO offer price of $22 per share. Checking
prices for Camping World on Yahoo! Finance, you can find that the IPO market price at the close of secondary market trading on October 7 was $22.50. With
this information you can calculate the IPO underpricing.
IPO Underpricing = (Market Price – Offer Price) / Offer Price
= ($22.50 – $22) / $22 = 0.0227 or 2.27%
Stock Investment Based on Risk and Earnings Potential
- Refers to the acquisition of stocks of other corporations to realize Blue Chips
profit upon their sale and for periodic income (in the form of
dividends) - These belong to large companies which have a long record of
earnings and dividend payments
- Also known as value stocks
Classification of Stocks GrowthRebound
Stocks
Based on their Marketability Technical
Based on Rights of Stockholders
Marketability of Stocks -- These belong
Occurs to corporations
when prices go up afterwith growth
going down rate
for afaster
numberthanofthat
daysof
Common Stock the general economy
- A stock investor prefers to buy shares that he can easily dispose Technical
- TheCorrection
growth may be in terms of revenue, net income, and
- Represents
of should he theneed
basiccash
ownership
so that in
hea buys
corporation
publicly listed stocks or productive
- When in the assets
absence of negative news about a corporation, the
- It carries with it the right to
those listed in the stock exchange vote on corporate matters, shares in
profits after providing for the shares of preferred stock therein, market
Cyclical price of its stock goes down after going up for a number
Stocks
andCitizenship
absorbs corporate losses before any portion thereof is charged of days
Based on of Investors - Their earnings and prices move with the changes in the national
to preferred stock Bullish economy
Stocks are classified into Czars A and Class B. Class A may be bought by
Preferred
Filipinos only.Stock
Foreign investors are allowed to buy Class B only due to -Defensive
When prices
Stocksincreasingly move upwards
the -prohibition
Refers to for
that foreigners
portion of to own more
owners’ equity than 40% equity
that enjoys in a
preferences - Arising from profit taking – technical rallies result in higher price
Philippine corporation. Thus, Class B stocks of a corporation should not - resistance
These earnings are not affected so much by changes in the
over common stock
exceed 40% ofmayits be
total economy
- These in number of common
the distribution shares outstanding
of earnings and/or distribution on - It is associated with investors’ optimism, economic recovery,
case of liquidation government
Speculative stimuli and political stability
Stocks
The restriction applies to foreign investors so that a Filipino citizen can
buy both Class A and Class B stocks. In case the holder of Class B stock Bearish
- These belong to companies that are not yet operating profitably
Based
decidesontothe Nature
sell of Business
his holdings but there is no buyer, they may be sold as but areare
- Prices expected to do
dropping so in the future
continuously
Class A o Banks and financial services
- Both price resistance and support continuously decline
o Industrial and commercial - on
It Market
is associated with pessimism, economic downtrend,
Based Capitalization
o Mining and oil government restraints and political instability
o Power and energy Market Capitalization
Chapter 3:oFinancial Statements
Transportation services and Ratio Analysis
- Refers to the market value of shares of stock listed in the stock
o Holdings firms exchanges.
General Accepted Accounting Principals (GAAP) The- 4 Key Financial
Classifies Statements
as first liners, second liners and third liners
– Authorized by the Financial Accounting Standards Board (FASB) - 1. Market
Income value forthe total number of shares outstanding of a
Statement
– A commonly recognized set of rules and procedures designed to corporation
- Provides a financial summary of the firm’s operating results
govern corporate accounting and financial reporting in the United during a specified period
States (US)
Dividends Per Share
– The US GAAP is a comprehensive set of accounting practices
that were developed jointly by the Financial Accounting
2. Balance Sheet
- Summary statement of the firm’s financial position at a given
point in time.
Current Assets
- Short-term assets, expected to be converted into cash within 1
year
Current Liabilities
- Short-term liabilities, expected to be paid within 1 year
Long-Term Debt
- Debt for which payment is not due in the current year
Paid-in-Capital in Excess of Par
- The amount of proceeds in excess of the par value received from
the original sale of common stock
Statement of Stockholders’ Equity
- Shows all equity account transactions that occurred during a given
year
Common-Size Income Statements - Measures the return earned on the common stockholders’
Dupont Formula
- Multiplies the firm’s net profit margin by its total asset turnover
to calculate the firm’s return on total assets (ROA)
o All cash inflows as well as net profit after taxes and - The prediction of the firm’s sales over a given period, based on
depreciation are treated as positive values external and/or internal data; used as the key input to the short-
o All cash outflows, any losses, and dividends paid are term financial planning process
treated as negative values External Forecast
- A sales forecast based on the relationships observed between the
Operating Cash Flow (OCF)
firm’s sales and certain key external economic indicators
- The cash flow a firm generates from its normal operations;
calculated as net operating profits after taxes (NOPAT) plus Internal Forecast
depreciation - A sales forecast based on a buildup, or consensus, of sales
- Net Operating Profit After Taxes (NOPAT) = EBIT × (1−T) forecasts through the firm’s own sales channels
OCF = NOPAT + Depreciation = [EBIT x (1-T)] + Depreciation