Corporate Finance - Notes ?

Download as docx, pdf, or txt
Download as docx, pdf, or txt
You are on page 1of 21

Chapter 1: The Role of Managerial Finance

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

Goal of the Firm Financial Manager’s Key Decisions

1. Maximize Shareholder Wealth o Investment Decisions


- The primary goal of managers should be to maximize the wealth o Capital Budgeting Decisions
of the firm’s owners o Financing Decisions
- In most instances this is equivalent to maximizing the stock price

Capital Structure Decisions


2. Maximize Profit
- Does profit maximization lead to the highest possible share price? - The money that firms raise to finance their activities
- For at least three reasons, the answer is often no:
Working Capital Decisions
o Timing
Principles that Guide Managers’ Decisions Cash Basis
o Cash Flows - Decisions that refer to the management of a firm’s short-term
o Risk
Time Value of Money - resources
Recognizes revenues and expenses only with respect to actual
o Tradeoff between Return and Risk inflows and outflows of cash
o Cash Is King
3. Maximize Stakeholders’ Welfare Figure: Financial ActivitiesOrganizations
o Competitive Financial Markets Legal Forms of Business
- Some suggest a balanced consideration of the welfare of
o Incentives Are Important 1. Sole Proprietorships
shareholders and other firm stakeholders
- To
Principal maximize
– Agent shareholder value, managers must necessarily assess
Problem - Businesses owned by one person and operated for his or her own
the long-term consequences of their actions profit
- A problem that arises because the owners of a firm and its o Unlimited Liability
managers are not the same people and the agent does not act in  The condition of a sole proprietorship, giving
the interest of the principal creditors the right to make claims against the
- owner’s personal assets to recover debts owed by
Organization of the Finance Function the business
- CEO
3. Corporations - Dividends
- Legal business entities with rights and duties similar to those of o Periodic distributions of cash to the stockholders of a firm
individuals but with a legal identity distinct from its owners - Board of Directors
- Stockholders o Group elected by the firm’s stockholders and typically
o The owners of a corporation, whose ownership, or equity, responsible for approving strategic goals and plans, setting
takes the form of common stock or, less frequently, general policy, guiding corporate affairs, and approving
preferred stock major expenditures
- Limited Liability - President or Chief Executive Officer (CEO)
o A legal provision that limits stockholders’ liability for a o Corporate official responsible for managing the firm’s
corporation’s debt to the amount they initially invested in day-to-day operations and carrying out the policies
the firm by purchasing stock established by the board of directors
- Stock
o A security that represents an ownership interest in a
corporation
Strengths and Weaknesses of the Common Legal Forms of Business Organization

Sole Proprietorship Partnership Corporation


 Owners have limited liability,
 Owner receives all
 Can raise more funds than which guarantees that they cannot
profits (and sustains all
sole proprietorships lose more than they invested
losses)
 Borrowing power enhanced  Can achieve large size via sale of
 Low organizational costs
by more owners ownership (stock)
Strengths  Income included and taxed on
 More available brain power  Ownership (stock) is readily
proprietor’s personal tax return
and managerial skill transferable
 Independence
 Income included and taxed on  Long life of firm
 Secrecy
partner’s personal tax return  Can hire professional managers
 Ease of dissolution
 Has better access to financing
 Owner has unlimited liability in  Taxes are generally higher because
that total wealth can be taken to corporate income is taxed, and
satisfy debts  Owners have unlimited liability dividends paid to owners are also taxed
 Limited fund-raising power tends and may have to cover debts of at a maximum 15% rate
to inhibit growth other partners  More expensive to organize than other
Weaknesses  Proprietor must be jack-of-all-  Partnership is dissolved when a business forms
trades partner dies  Subject to greater government
 Difficult to give employees long-  Difficult to liquidate or transfer regulation
run career opportunities partnership  Lacks secrecy because regulations
 Lacks continuity when proprietor require firms to disclose financial
dies results

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

Other Limited Liability Organizations Corporate Governance

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

External Corporate Governance Mechanisms


Individual versus Institutional Investors
Activist Investors
- Investors who specialize in influencing management
The Threat of Takeover

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

Financial Institutions Private Placement

- 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

Public Offering Quiet 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,

Going Public Selling Group

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

- The price of the firm’s shares as determined by the interaction of Securitization


buyers and sellers in the secondary market
- The process of pooling mortgages or other types of loans and then
Market Capitalization selling claims or securities against that pool in the secondary
market
- The total market value of a publicly traded firm’s outstanding
stock Mortgage-Backed Securities
- Market Capitalization = (Market Price of Stock × # of Shares of
- Securities that represent claims on the cash flows generated by a
Stock Outstanding)
pool of mortgages
IPO Market Price - A primary risk associated with mortgage-backed securities is that
homeowners may not be able to, or may choose not to, repay their
- The final trading price on the first day in the secondary market loans
IPO Underpricing Subprime Mortgages
- The percentage change from the final IPO offer price to the IPO - Mortgage loans made to borrowers with lower incomes and
market price, which is the final trading price on the first day in the poorer credit histories as compared to “prime” borrowers
secondary market; this is also called the IPO initial return
- IPO Underpricing = (Market Price − Offer Price) ÷ Offer Price

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

4. Statement of Retained Earnings Types of Ratio Comparisons


- Reconciles the net income earned during a given year, and any
Cross-Sectional Analysis
cash dividends paid, with the change in retained earnings between
the start and the end of that year - Comparison of different firms’ financial ratios at the same point
in time; involves comparing the firm’s ratios with those of other
3. Statement of Cash Flows firms in its industry or with industry averages
- Provides a summary of the firm’s operating, investment, and
financing cash flows and reconciles them with changes in its cash Benchmarking
and marketable securities during the period - A type of cross-sectional analysis in which the firm’s ratio values
are compared with those of a key competitor or with a group of
Total Asset Turnover = Sales ÷ Total Assets
- Indicates the efficiency with which the firm uses its assets to
generate sales

Quick (Acid-Test) Ratio = (Current Assets – Current Liabilities) ÷ Financial Leverage


Current Liabilities - The magnification of risk and return through the use of fixed cost
financing, such as debt and preferred stock
- A measure of liquidity calculated by dividing the firm’s current
assets less inventory by its current liabilities
Degree of Indebtedness
Fixed Payment Coverage Ratio = Return on Total Assets (ROA) = Earnings Available for Common
Stockholders/Total Assets
- Measures the overall effectiveness of management in generating
profits with its available assets; also called the return on
investment (ROI)
- Measures the firm’s ability to meet all fixed-payment obligations
Return on Equity = Earnings Available for Common
Stockholders/Number of Shares of Common Stock Outstanding

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)

Modified Dupont Formula


- Relates the firm’s return on total assets (ROA) to its return on
equity (ROE) using the financial leverage multiplier (FLM)
Financial Leverage Multiplier = Total Assets ÷ Common Stock

Chapter 4: Long and Short Term Financial Planning

Financial Planning Process EXAMPLE:


- Planning that begins with long-term, or strategic, financial plans Baker Corporation acquired a new machine at a cost of $38,000, with
that in turn guide the formulation of short-term, or operating, installation costs of $2,000. When the machine is retired from service,
plans and budgets Baker expects to sell it for scrap metal and receive $1,000. Regardless of
Long-Term (Strategic) Financial Plans its expected salvage value, the depreciable value of the machine is
$40,000: $38,000 cost + $2,000 installation cost.
– Plans that lay out a company’s financial actions and the
anticipated impact of those actions over periods ranging from 2 to
10 years
Short-Term (Operating) Financial Plans
Table: First Four Property Classes under MACRS
- Plans that specify short-term financial actions and the anticipated
Table: Rounded Depreciation Percentages by Recovery Developing the Statement of Cash Flows
Year Using MACRS for First Four Property Classes
1. Cash Flow from Operating Activities
- Cash flows directly related to sale and production of the firm’s
products and services
2. Cash Flow from Investment Activities
- Cash flows associated with purchase and sale of both fixed assets
and equity investments in other firms
3. Cash Flow from Financing Activities
- Cash flows that result from debt and equity financing
transactions; includes incurrence and repayment of debt, cash
inflows from the sale of stock, and cash outflows to repurchase
stock or pay cash dividends

Classifying Inflows and Outflows of Cash


EXAMPLE: o A decrease in an asset is an inflow of cash
o An increase in an asset is an outflow of cash
Baker Corporation acquired, for an installed cost of $40,000, a machine
o A decrease in a liability is an outflow of cash
having a recovery period of 5 years. Using the applicable percentages,
Baker calculates the depreciation in each year as follows: o An increase in a liability is an inflow of cash
Noncash Charge Cash Budget (Cash Forecast)
- An expense that is deducted on the income statement but does not - A statement of the firm’s planned inflows and outflows of cash
involve the actual outlay of cash during the period; includes that managers use to estimate its short-term cash requirements
depreciation, amortization, and depletion

Preparing the Statement of Cash Flows The Sales Forecast

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

Preparing the Cash Budget


Free Cash Flow (FCF)
Total Cash Receipts
– The amount of cash flow available to investors (creditors and
- All of a firm’s inflows of cash during a given financial period
owners) after the firm has met all operating needs and paid for
investments in net fixed assets and net current assets Total Cash Disbursements
FCF = OCF – Net Fixed Asset Investment – Net Current Asset - All outlays of cash by the firm during a given financial period
Investment
– Net Fixed Asset Investment = Change in Net Fixed Assets +
Depreciation
– Net Current Asset Investment = Change in Current Assets −
Change in (Accounts Payable + Accruals)

Table: The General Format of the Cash Budget Scenario Analysis


- Prepare several cash budgets, based on pessimistic, most likely,
Net Cash Flow
- The mathematical difference between the firm’s cash receipts and
its cash disbursements in each period
Ending Cash
- The sum of the firm’s beginning cash and its net cash flow for the Judgmental Approach
period
– A simplified approach for preparing the pro forma balance sheet
Required Total Financing
under which the firm estimates the values of certain balance sheet
- Amount of funds needed by the firm if the ending cash for the accounts and uses its external financing as a balancing, or “plug,”
period is less than the desired minimum cash balance; typically figure
represented by notes payable
Excess Cash Balance
- The (excess) amount available for investment by the firm if the
period’s ending cash is greater than the desired minimum cash
balance; assumed to be invested in marketable securities

You might also like