Exam 1 ReviewExam 1 Review

09/23/200809/23/2008

Goal of the FirmGoal of the Firm

Shareholder Wealth Shareholder Wealth Maximization?Maximization?

this is the same as:this is the same as:

a) Maximizing Firm Valuea) Maximizing Firm Value

b) Maximizing Stock Priceb) Maximizing Stock Price

Legal Forms of BusinessLegal Forms of Business

1) Sole Proprietorship1) Sole Proprietorship

2) Partnership2) Partnership

-- General Partnership -- General Partnership

-- Limited Partnership-- Limited Partnership

-- Limited Liability Company (LLC)-- Limited Liability Company (LLC)

3) Corporation 3) Corporation

Primary MarketPrimary Market

Secondary MarketSecondary Market

Initial Public Offering (IPO)Initial Public Offering (IPO)

Seasoned New IssueSeasoned New Issue

The Corporation and The Corporation and Financial MarketsFinancial Markets

Financial Management AxiomsFinancial Management Axioms

1) Risk - return trade-off.1) Risk - return trade-off.

2) Time value of money.2) Time value of money.

3) Cash - not profits - is king.3) Cash - not profits - is king.

4) Incremental cash flows count.4) Incremental cash flows count.

5) The curse of competitive markets.5) The curse of competitive markets.

Financial Management AxiomsFinancial Management Axioms

6) Efficient capital markets. 6) Efficient capital markets.

7) The agency problem.7) The agency problem.

8) Taxes bias business decisions.8) Taxes bias business decisions.

9) All risk is not equal.9) All risk is not equal.

10) Ethical dilemmas are everywhere in 10) Ethical dilemmas are everywhere in

finance.finance.

SALESSALES

- - Cost of Goods SoldCost of Goods Sold

GROSS PROFITGROSS PROFIT

- - Operating ExpensesOperating Expenses

OPERATING INCOME (EBIT)OPERATING INCOME (EBIT)

- - Interest ExpenseInterest Expense

EARNINGS BEFORE TAXES (EBT)EARNINGS BEFORE TAXES (EBT)

- - Income TaxesIncome Taxes

EARNINGS AFTER TAXES (EAT)EARNINGS AFTER TAXES (EAT)

- - Preferred Stock DividendsPreferred Stock Dividends

- - NET INCOME AVAILABLENET INCOME AVAILABLE

TO COMMON STOCKHOLDERSTO COMMON STOCKHOLDERS

Income StatementIncome Statement

Balance SheetBalance SheetAssets Liabilities (Debt) & Equity

Current AssetsCurrent Assets CashCash

Marketable SecuritiesMarketable Securities

Accounts ReceivableAccounts Receivable

InventoriesInventories

Prepaid ExpensesPrepaid Expenses

Fixed AssetsFixed Assets Machinery & EquipmentMachinery & Equipment

Buildings and LandBuildings and Land

Other AssetsOther AssetsInvestments & patentsInvestments & patents

Current LiabilitiesCurrent Liabilities Accounts PayableAccounts Payable Accrued ExpensesAccrued Expenses Short-term notesShort-term notesLong-Term LiabilitiesLong-Term Liabilities Long-term notes Long-term notes MortgagesMortgagesEquityEquity Preferred Stock Preferred Stock Common Stock (Par Common Stock (Par value)value) Paid in CapitalPaid in Capital Retained EarningsRetained Earnings

Free Cash FlowsFree Cash Flows

Cash Flows from Cash Flows from AssetsAssets = Cash Flows from

Financing

Cash flows generated through the firm’s

assets=

Cash flows paid to - or received from - the

firm’s investors (creditors & stockholders)

TaxesTaxes

Marginal tax rate: the tax rate that would Marginal tax rate: the tax rate that would

be applied to the next dollar of taxable be applied to the next dollar of taxable

incomeincome

Average tax rate: taxes owned by a firm Average tax rate: taxes owned by a firm

divided by the firm’s taxable incomedivided by the firm’s taxable income

Always marginalAlways marginal

We will want to answer We will want to answer questions about the firm’squestions about the firm’s

LiquidityLiquidity

Efficient use of AssetsEfficient use of Assets

Leverage (financing)Leverage (financing)

ProfitabilityProfitability

Future and Present ValueFuture and Present Value

FV = PV (1 + i)FV = PV (1 + i)nn

FV = PV (FVIF FV = PV (FVIF i, ni, n ))

FV = PV (e FV = PV (e i*ni*n) -- ) -- continuous continuous

compoundingcompounding

PV = FV (PVIF PV = FV (PVIF i, ni, n ))

Annuity and Annuity DueAnnuity and Annuity Due

FV = PMT (FVIFA FV = PMT (FVIFA i, ni, n ))

FV = PMT{ [ (1 + i)FV = PMT{ [ (1 + i)nn – 1] / i – 1] / i }}

PV = PMT (PVIFA PV = PMT (PVIFA i, ni, n ))

PV = PMT { [1 - 1 / (1 + i)PV = PMT { [1 - 1 / (1 + i)nn ] / i ] / i } }

Perpetuity: PV = PMT / i Perpetuity: PV = PMT / i

Annual Percentage Yield Annual Percentage Yield (APY)(APY)

APY = APY = (( 1 + 1 + ) ) m m - 1- 1quoted ratequoted ratemm