Ch 19 Lease Financing

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Ch 19 Lease Financing Powered By Docstoc
					CORPORATE FINANCIAL
   MANAGEMENT

  PART I INTRODUCTION
        (chapter 1-2)
Course objectives


   to enable you to develop the analytical, interpretive,
   and judgmental abilities required of a financial
   manager
   to provide a solid understanding of financial
   markets and how they operate
   to provide a wide range of realistic illustrations of
   financial analysis and management
Course objectives


   to demonstrate the relationship and
   integration of the finance function of an org
   with its other essential elements

   to demonstrate how the financial manager
   communicates the results of financial
   analysis to decision makers and shareholders
   within the org framework
schedule

   Part I Introduction
   – Ch.1 The Role and Objective of Financial
     Management
   – Ch.2 The Domestic and International Financial
     Marketplace
   Part II Determinants of Valuation
   – Ch. 4 The Time Value of Money
   – Ch. 5 Analysis of Risk and Return
   – Ch. 6-7 Valuation of Financial Assets
schedule

  Part III The Capital Investment Decision
  –   Ch.8 Capital Budgeting and Cash Flow Analysis
  –   Ch.9 Decision Criteria and Option Considerations
  –   Ch.10 Capital Budgeting and Risk
  –   Ch.11 The cost of Capital
  Part IV The Capital Structure and Dividend Policy
  – Ch. 12 Capital Structure Concept
  – Ch. 13 Capital Structure Management in Practice
  – Ch. 14 Dividend Policy
schedule

  Part V Working Capital Management
  – Ch.15 Financial Forecasting and Working Capital Policy
  – Ch.16 The Management of Cash and Marketable Securities
  – Ch.17 Management of Accounts Receivable and Inventories
  Part VI Advanced Topics
  – Ch. 19 Lease Financing
  – Ch. 20 Financing With Derivatives
Assessment


  Homework      10%
  Quizzes       10%
  Project       20%
  Final exam    60%
  Total        100%
Chapter 1



  The Role and Objective of the

   Financial Management
Introduction

  1.   Definition of Financial management
  2.   Forms of business organization
  3.   Objective of financial management
  4.   Organization of the financial management
       function
  5.   Financial management and other
       disciplines
1. Definition of Finance

    Financial management is concerned with the
    maintenance and creation of economic value or
    wealth/responsibilities and activities of financial
    managers
    Responsibilities of financial managers: acquiring
    funds needed by a firm and for directing those
    funds into projects that will maximize the value of
    the firm for its owners
2. Forms of business organizations


  1)   Sole proprietorship
  2)   Partnership
  3)   Corporation
  4)   Factors related to optimal forms of
       organization
  5)   Agency problems in corporation
1) Sole Proprietorship


    Owned by one person
    Easy formation            advantage
    Unlimited liability       disadvantage
    Difficulty raising funds disadvantage
    Represent 75 percent of all businesses
    Account for less than 6% of the dollar volume
2) Partnership

    Owned by two or more persons
    Classified as general or limited
     – General Partner
       Has unlimited liability for all obligations of the business
       disadvantage
     – Limited Partner
       Liability limited to the partnership agreement
       advantage
    Partnership dissolves when a general partner dies or
    withdraws, a new partner entries.    disadvantage
3) Corporation

     – Legal entity composed of one or more actual
       individuals or legal entities

    Limited liability
    Flexibility, Easy marketability of shares of
    ownership                          All advantages
    Permanency
    Ability to raise capital
4) Optimal form of organization
   influenced by

     Cost
     Complexity
     Liability
     Continuity
     Raising capital
     Decision making
     Tax considerations
5) Agency problems in corporation

      Stockholders elect a board of directors
      Board of directors then elect the officers
       – Chairman of the board
       – Chief executive officer (CEO)
       – Chief operating officer (COO)
       – President
       – Chief financial officer (CFO)   Management
       – Vice presidents
       – Treasurer
       – Secretary
                                  ...continued


Board of directors      Management makes most
deals with broad        of the decisions
policy

3 to 5 year strategic   Day-to-day decisions
plan                    following the strategic
                        plan
                                                ...continued


Agency relationship
   – The principals hire the agents to perform a service on
     behalf of the principles.
Agency problems
   – Inefficiencies that arise because of agency relationship
Agency costs
   – The costs incurred to minimize agency problems
a. Owners and management
     Problems created by separation of owners
     and management
      – Management may maximize its own welfare [higher
          compensation,more leisure time and lower risk] instead of
        the owners’ wealth.
      e.g. job security, the consumption of on-the-job
        perquisites./ moral hazard, adverse selection
     Agency costs [Min.]
      –   costs to motivate
      –   costs to monitor
      –   bonding expenditure
      –   the opportunity cost of loss profits
b. Owners and creditors

     Problems created by different returns
     offered to owners and creditors
     – investment of higher risk approved by stockholders
     – new debt issuing approved by stockholders
     Agency costs
     – protective covenants in bond indentures
     e.g. limitation on dividend, debt issuing,
       in(di)vestment and certain ratios, poison put, etc.
     – a higher fixed return
     e.g. RJR Nabisco was required by KKR
3. Objective of financial management



  1) Profit maximization

  2) Shareholder wealth maximization
                 the primary goal

  3) Social responsibility concerns
1) Profit maximization


    MC=MB
    Lacks a time dimension
    – offers no explicit basis for comparing
      long-term and short-term profits.
    Definition of profit (GAAP)
    – Total amount / ROE / EPS        p13
    Not considers the risk
2) Shareholder Wealth Maximization


  shareholder wealth
  = market price of common stock
  (firm value)
  = present value of the expected future returns
     to owners
a. SWM objective benefits


    Considers the timing and risk of the benefits
    from stock ownership
    Determines that a good decision increases
    the price of the firm’s common stock (C/S)
    Is an impersonal objective
b. SWM is a market concept



    Maximizing Net Present Value of Cash
    Flows

    Measured by Market Value of Common
    Stock
(1) Cash flow


   king
   vital
   central
   important
   to the prosperity and survival of a firm
Figure 1.1
A Firm’s Cash Flow Generation Process   ...continued




                                               27
                                   ...continued

          Cash Flows
 Accounting profit (earnings)

CF is an unambiguous, clear measure used for
evaluating performance and making decisions.

CF avoids short-term manipulation by managers
and conduces to take a long-term perspective in
decision making.
(2) NPV of an Investment

   = PV of future cash flows - cash outlays

The NPV of an investment represents
the contributions of that investment
to the value of the firm and passes on to SWM.

      – a framework for evaluating future cash flows
        from an investment or a firm
      – a bridge between CF and SWM
(3) Market value of common stock

  Three Basic Factors Determine ~

   Amount of

   Timing of            Expected cash flows

   Risk of
                                    ...continued


External Conditions Affecting ~

  Economic environment factors
  Political environment factors
  Conditions in financial markets
                                   ...continued


Competitive Forces Influencing ~

 New entrants
 Substitute products
 Bargaining power of buyers
 Bargaining power of suppliers
 Rivalry among current competitors
    ...continued




—
3) Social responsibility concerns
       Run business in the interests of
       stakeholders
       –   customers
       –   suppliers
       –   employees
       –   creditors
       –   community
       –   government
       –   stockholders, etc.
       Be a good citizen; contribute to SWM
Small business

   Characteristics
    – grow rapidly
    – raise capital difficultly
    – lack the depth of managerial talent
   More rely on accounting-based measures
   Agency problems only exist in relation
   between owners and creditors
4. Organization of the FM function


    CFO / Vice-president of finance
    Controller & Treasurer
Figure 1.2
Organization of the FM function          Board of Director               Finance Committee

                                      Chief Executive Officer
                                              (CEO)



   VP-Human                  VP-            VP- Finance             VP-               VP-
   Resources              Marketing            (CFO)            Engineering      Manufacturing


                        Controller                           Treasurer

                 Financial Accounting                Cash /M&S Management

                                                   Capital Budgeting Analysis
                    Cost Accounting
                                                        Financial Planning
                    Internal Auditing
                                                          Credit Analysis
                     Tax Accounting
                                                        Investor Relations
                   Accounts Payable
                                                 Risk and Insurance Management
                 Information Systems
                                                   Pension Fund Management
5. Disciplines impacting finance

                Economics
               Accounting
                Marketing
                Production   Finance
       Human Resources
     Quantitative Analysis
                     MIS
Chapter 2



  The Domestic and International

    Financial Marketplace
Introduction


   1.   An overview of the U.S. financial system
   2.   The structure and operations of U.S.
        security markets
   3.   Market efficiency
   4.   Income taxes and financial management
   5.   Ten axioms that form the bases of
        financial management
1. the U.S. financial system



   The vehicle that channels funds from saving
   units to investing units
Figure 2.1
Flow-of-Funds Diagram   ...continued




                               42
Financial market                              ...continued


  The vehicles through which financial assets are
  traded.

    Money Market
     – dealing in short-term securities having maturities of one
       year or less.
    Capital Market
     – dealing in long-term securities having maturities
       greater than one year.
                                      ...continued


Primary Market
– Market where new securities are sold
– Money goes to the issuer
– Sold through a prospectus
Secondary Market
– Market for existing securities are traded among
  investors
2. the U.S. security markets
     Secondary Market
       Listed exchanges (e.g. NYSE)
       – Designated place of business
       – Requirements of securities listed or traded
       Over-the-counter (OTC) market
       – Networks connected by communications
       – Dealers post prices to buy and sell
     Stock market indexes
       – DJIA, DJTA, S&P 500, NASDAQ
                                     ...continued

Regulations
 Federal
  – Securities Act of 1933
  – Securities Exchange Act of 1934
  – Securities & Exchange Commission (SEC)
      Regulates disclosure of information in new
      securities and all publicly traded firms
      Example: Insider trading
        – SEC attempts to prevent profiting from
          unpublished information.
3. Capital market efficiency

      Capital markets are efficient
      – if stock prices provide an unbiased estimate of
        the true value of an enterprise.
      – if prices instantaneously and fully reflect all the
        risk and economically relevant information
        about a security’s prospective returns.


      “Glue” that bonds the PV of a firm’s net
      cash flow to shareholders’ wealth
1) Three degrees of market efficiency


  a. Weak form

  b. Semi-strong form

  c. Strong form
a. Weak form


     – Security prices fully reflect all historical
      information.


     – No investor can earn excess returns
      using historical prices or returns.
                 ‘technical analysis’
b. Semi-strong form


    – Security prices fully reflect historical and
      publicly available information.

    – No investor can earn excess returns based
      on an investment strategy using public
      information.
               ‘fundamental analysis’
c. Strong form


    – Security prices fully reflect all historical,
      public, and private information.

    – No investor can earn excess returns using
      public and private information.
2) Market efficiency implications for
financial managers

    Timing or gambling
    An expected NPV of zero – (i.e. expected return
    equals required return)
    Corporate diversification - unnecessary
    Security price adjustment – reflect expected cash
    flows and risk of the cash flows
    Behavioral finance perspective – anomalies show
    investors may not be fully rational
Holding period return ( HPR)


    – The return from holding an investment for
      one period
    – holding period yield, realized or ex post
      rate of return


    Ending price – Beginning price + Distributions
                                                   × 100%
                    Beginning price
4. Income taxes                                  Appendix A



    Implications for financial managers
     – Capital structure policy
        Debt or equity financing
     – Dividend policy
        Paying dividends or retaining earnings
     – Capital budgeting
        After-tax cash flows
     – Lease or buy decision
        Leveraged leases p730
                                ...continued

Taxable income
= Revenues - Tax deductions
– Operating or ordinary income
– Capital gains income
– Dividend income
– Loss carrybacks and carryforwards
Income tax rates
– marginal tax rate
– average tax rate
S corporation
                                         ...continued

Depreciation methods
MACRS                      For tax purpose
– Asset class [ Recovery period ]
     3, 5, 7, 10, 15, 20 / 27.5, 31.5(or 39) years
– Depreciation methods
    200%DB, 150%DB / Straight-line method
    Half-year convention / Mid-month convention
    Expected salvage value is ignored.
– Depreciation allowances
    affect income tax owed, then cash flows available
    to shareholders
5.Ten axioms



1   The risk-return trade-off
      – we won’t take on additional risk unless we
       expect to be compensated with additional return.
expected return
                  The risk-return relationship




                                            expected return
                                            for taking on
                                            added risk


                     expected return for delaying consumption

                                                       risk
Ten axioms



2   All risk is not equal
          – Some risk can be diversified away, and some
           cannot
     re                              Asset A
     tu
     rn                              Combination of asset A and B

                                      Asset B
                                         time
Ten axioms



3   The time value of money
      – A dollar received today is worth more than a
       dollar received in the future
Ten axioms



4   Cash- not profits- is king
Ten axioms


5   Incremental cash flows
      – It’s only what changes that counts
Ten axioms


6   Taxes bias business decisions
Ten axioms


7   The curse of competitive markets
      – Why it’s hard to find exceptionality profitable
        projects
Ten axioms


8   Efficient capital markets
      – The markets are quick and the prices are right.
      – In the efficient market, the speed with which
        securities prices reflect all available
        information is so quick that there are no
        opportunities for investors to earn excess profit
        from the available information.
Ten axioms



9   The agency problem
      – Managers won’t work for the owners unless it’s
       in their best interest
Ten axioms


10Ethical consideration the right thing, and
    – Ethical behavior is doing
        ethical dilemmas are everywhere in finance.
Ten axioms




 3: 1995   “327”

				
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