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Financial Management (YB1027) Summary (+ALL EXERCISES & “theory questions”)

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  • Course
  • Financial Management (YB1027)
  • Institution
  • Thomas More Hogeschool (tmhs)

Summary of the Financial Management course given by Geert Kesteleyn & Eric Leurquin at Thomas More Mechelen. This is a summary of the powerpoints, the exercises and the lessons given. It contains the 15 chapters seen. The document is written in English, just like the course. This is a comprehensive...

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Document information

  • December 25, 2024
  • 134
  • 2024/2025
  • Summary

Subjects

  • funding
  • financial management
  • time value of money
  • stocks
  • debt
  • bonds
  • stock valuation
  • risk and return
  • the cost of capital

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  • Thomas More Hogeschool (tmhs)
  • Bedrijfsmanagement
  • Financial Management (YB1027)
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Financial Management (YB1027| 2024)
September 2024 – Januari 2025 (examen /2024)
Docent Geert Kesteleyn
Copyright 2019 Pearson Education, Ltd. All rights reserved.

Table of Contents
Formularium ............................................................................................................................. 1
1. The role of managerial finance ............................................................................................... 3
Finance and the firm.................................................................................................................. 3
Managing the firm ..................................................................................................................... 4
Organizational forms, taxation, and the principal-agent relationship ............................................ 5
Exercises chapter 1 .................................................................................................................... 7
2. The financial market environment .........................................................................................11
Financial institutions.................................................................................................................11
Financial markets .....................................................................................................................11
Regulation of Financial Markets and Institutions ........................................................................13
The securities issuing process....................................................................................................14
Financial Markets in crisis .........................................................................................................15
Exercises chapter 2 ...................................................................................................................16
3. Funding................................................................................................................................19
Exercise chapter 3 ....................................................................................................................21
4. Long and short term financial planning ..................................................................................23
The financial planning process...................................................................................................23
Measuring the firm’s cashflow ..................................................................................................23
Cash planning: cash budgets .....................................................................................................26
Profit planning: pro forma statements .......................................................................................29
Exercises chapter 4 ...................................................................................................................30
5. Time value of money ............................................................................................................33
The Role of Time Value in Finance .............................................................................................33
Single amounts: Future Value of a Single Amount.......................................................................34
Single amounts: Present Value of a Single Amount .....................................................................34
Annuities .................................................................................................................................35
Annuities: Future Value of an Ordinary Annuity..........................................................................35
Annuities: Present Value of an Ordinary Annuity ........................................................................35
Present value of a perpetuity ....................................................................................................36
Mixed streams: Future Value of a Mixed Stream ........................................................................36
Mixed streams: Present Value of a Mixed Stream .......................................................................37
Compounding Interest more frequently than annually................................................................37
Formularium ............................................................................................................................38
Exercises chapter 5 ...................................................................................................................38
6. Interest rates and bond evaluation ........................................................................................45
Interest rates and required returns............................................................................................45
Debt-specific risk premium components ....................................................................................47
Government and corporate bonds.............................................................................................47
Valuation fundamentals............................................................................................................48
Bond valuation .........................................................................................................................48
Exercises chapter 6 ...................................................................................................................52
Extra exercises (test 1) ..............................................................................................................56
7. Stock valuation .....................................................................................................................58
Differences between debt and equity ........................................................................................58

, Common and preferred stock....................................................................................................58
Common stock valuation ..........................................................................................................59
Decision making and common stock value .................................................................................62
Exercises chapter 7 ...................................................................................................................63
8. Risk & return ........................................................................................................................66
Risk and return fundamentals ...................................................................................................66
How do we measure the risk in finance? ....................................................................................67
Risk of a single asset .................................................................................................................67
Risk of a portfolio .....................................................................................................................67
Exercises chapter 8 ...................................................................................................................68
9. The cost of capital ................................................................................................................69
Overview of the cost of capital ..................................................................................................69
Cost of long-term debt..............................................................................................................69
Cost of common stock ..............................................................................................................70
Weighted average cost of capital...............................................................................................70
Exercises chapter 9 ...................................................................................................................71
10. Capital budgeting techniques ................................................................................................75
Overview of capital budgeting ...................................................................................................75
Payback period.........................................................................................................................76
Net present value (NPV) ...........................................................................................................76
What is “r” the discount rate.....................................................................................................77
Internal rate of return (IRR).......................................................................................................78
Net present value profiles .........................................................................................................79
Exercises chapter 10 .................................................................................................................80
Extra exercises (test 2 = chapter 7, 8 & 9)...................................................................................83
11. Capital budgeting cash flows .................................................................................................85
Relevant cash flows ..................................................................................................................85
The Basic Format for Determining Initial Investment (CFo) ..........................................................86
Finding the Initial Investment ....................................................................................................86
Finding the Operating Cash Flows = CF1; CF2; etc….....................................................................87
Finding the terminal cash flow ..................................................................................................88
Real options .............................................................................................................................89
Capital rationing .......................................................................................................................90
Capital rationing (THE GOOD METHOD) .....................................................................................90
Exercises chapter 11 .................................................................................................................91
12. Leverage and capital structure...............................................................................................95
What is leverage? .....................................................................................................................95
Leverage: Operating leverage....................................................................................................95
Leverage: Financial Leverage .....................................................................................................97
Leverage: Total leverage ...........................................................................................................98
Leverage: Relationship of Operating, Financial, and Total Leverage .............................................99
The Firm’s Capital Structure: Types of Capital........................................................................... 100
Basic Shortcoming of EBIT-EPS Analysis.................................................................................... 101
Choosing the Optimal Capital Structure ................................................................................... 102
Exercises chapter 12 ............................................................................................................... 102
13. Payout Policy...................................................................................................................... 107
The basics of payout policy ..................................................................................................... 107
The mechanics of payout policy............................................................................................... 107
Factors affecting dividend policy ............................................................................................. 108
Types of Dividend Policies ....................................................................................................... 109
Exercices chapter 13 ............................................................................................................... 110

,14. Current Liabilities Management........................................................................................... 113
Net working capital fundamentals ........................................................................................... 113
Cash conversion cycle ............................................................................................................. 113
Inventory management .......................................................................................................... 115
Accounts Receivable Management .......................................................................................... 117
Exercices chapter 14 ............................................................................................................... 120
15. Current Liababilities Management ....................................................................................... 123
ST liabilities ............................................................................................................................ 123
Spontaneous Liabilities ........................................................................................................... 123
Exercises chapter 15 ............................................................................................................... 125
16. Theory questions ................................................................................................................ 126

,Formularium

• Future value single amount:

• Present value single amount:

• Future value annuity:

• Present value annuity:

• Present value perpetuity:

• Future value mixed stream:

• Present value mixed stream: PV = CF0 + CF1/(1+r) + CF2 / (1+r)² + CF3 / (1+r)³ + etc…

• Compounding interest more frequently than annually:

• Discounting interest more frequently than annually:

𝑐𝑜𝑢𝑝𝑜𝑛 1 𝑀
• Value of a bond: 𝐵0 = ∗ (1 − )+ or B0 = (Coupon/r)*(1-(1/(1+r)^n)) + M/(1+r)^n
𝑟 (1+𝑟) 𝑛 (1+𝑟) 𝑛


• Yield to maturity: we use Excel of a financial calculator to solve the previous equation for ‘r’.

• Value of a share; basic:



o Zero growth:

o Constant growth: with D1 given or else D1 = D0* (1+g)

• Cost of capital (in case there is no preferred stock): 𝑟𝑤𝑎𝑐𝑐 = (𝑤𝑑 × 𝑟𝑑 ). (1 − 𝑇) + (𝑤𝑠 × 𝑟𝑠 )

o (and in case there are preferred stocks): 𝑟𝑤𝑎𝑐𝑐 = ( 𝑤𝑑 × 𝑟𝑑 ). ( 1 − 𝑇) + ( 𝑤𝑠 × 𝑟𝑠 ) + (𝑤𝑝 𝑥 𝑟𝑝 )

• Payback period (only in case of annuity) =initial investment / annual cash inflow
• Payback period (in case of mixed cash flows) : cumulate the cash flows
• NPV = CF1/(1+r) + CF2/(1+r)² + CF3 / (1+r)³ + … + CFn / (1+r) n - CF0
o NPV = present value of cashflows – initial investment

• Profitability index:



• IRR (solve for IRR):



• Operating breakeven point:




1

,• Degree of operating leverage (DOL): % change EBIT / % change sales:

• Financial breakeven point:

• Degree of financial leverage (DFL): % change EPS / % change EBIT:

• Degree of total leverage (DTL): % change EPS / % change sales:




• Cash conversion cycle:

• Operating cycle:

• Economic order quantity:


• Reorder point: days of lead time x daily usage

• Average inventory: Q/2 (Q = order quantity)

• Cost of giving up cash discount:




2

,1. The role of managerial finance
Finance and the firm
What is finance?
• Finance can be defined as the science and art of managing money
• At YOUR personal level finance is concerned with individuals’ decisions about:
how much of their earnings they spend, save, how they invest their savings.
• in a business context, finance involves:
- how firms raise money from investors
- how firms invest money in an attempt to earn a profit
- how firms decide whether to reinvest profits in the business or distribute them back to investors (allocation)

What is the goal of the firm?
• Maximize shareholder wealth => In most instances this is equivalent to maximizing the stock price
• Maximize Stakeholders’ Welfare?
- Some suggest a balanced consideration of the welfare of shareholders and other firm stakeholders
- Stakeholders = employees, suppliers, customers, inhabitants of the local community where a firm is located.
- managers should NOT ignore the interests of everyone connected to a firm
- to maximize shareholder value, managers must assess the long-term consequences of their actions
- managers must act within legal and ethical boundaries
• Does profit maximization lead to the highest possible share price? The answer is often no, because of:
Timing (see example), Cash Flows, Risk

Example of timing: Nick Dukakis, the financial manager of Neptune Manufacturing, a producer of marine engine
components, is choosing between two investments, Rotor and Valve. The following table shows the EPS Dukakis
expects each investment to earn over its 3-year life.




If Dukakis thought he should make decisions to maximize profits, he would recommend that Neptune invest in
Valve rather than Rotor because it results in higher total earnings per share over the 3-year period ($3.00 EPS
compared with $2.80 EPS).

The Role of Business Ethics
• Business ethics are the standards of conduct or moral judgment that apply to persons engaged in commerce
• The goal of such standards is to motivate business and market participants to adhere to both the letter and
the spirit of laws and regulations
• e.g. Volkswagen scandal (where engineers set up elaborate deceptions to get around pollution controls)
• Ethical Guidelines
- Does the action violate the moral or legal rights of any individual or group?
- Does the action conform to accepted moral standards?
- Are there alternative courses of action that are less likely to cause actual or potential harm?
- e.g. Google

The Managerial Finance Function
Financial Managers’ Key Decisions
• Investment decisions
• Capital Budgeting Decisions
• Financing Decisions
- Capital Structure Decisions: % of debt: the money that firms raise to finance their activities
- Working Capital Decisions: decisions that refer to the management of a firm’s short-term resources:
inventory, payables, receivables
3

, Financial Activities

Balance sheet: a financial statement that reports a
company’s assets, liabilities, and shareholder
equity at a specific point in time.




Managing the firm
The managerial finance function
• Principal–Agent Problem
- A problem that arises because the owners of a firm and its managers are not the same people and the agent
does not act in the interest of the principal
- Particularly important in large corporations
(with significant separation between owners
and managers)

• Organization of the Finance Function
- CEO
- CFO: Chief Financial Officer
- Treasurer (= cash management)
- Controller (= accounting)
- Director of Risk Management
- Director of Investor Relations
- Director of Internal Audit
- Foreign Exchange Manager

• Relationship to Accounting
- Accounting uses an Accrual Basis
o Recognizes revenue at the time of sale (30 or 60 days before cash is received) and recognizes
expenses when they are incurred (30 or 60 days before cash is paid)
- Cash Basis: Finance uses Cash Flows
o Recognizes revenues and expenses only with respect to actual inflows and outflows of cash.
- Decision Making
o Accountants devote most of their attention to the collection and presentation of PAST financial data
o Financial managers use the accounting statements, develop FORECASTS, and make decisions based
on their assessment of the FUTURE returns and risks
o Assessing risk ? Develop 3 scenarios: best case, worst case, base case

Example: Nassau Corporation sold one yacht for $1,000,000 in the calendar year just ended. Nassau originally
purchased the yacht for $800,000. Although the firm paid in full for the yacht during the year, at year’s end it
has yet to collect the $1,000,000 from the customer (i. o. w. the customer has not paid yet)
The accounting view and the financial view of the firm’s performance during the year are given by the following
income and cash flow statements, respectively.




In an accounting sense, Nassau Corporation is profitable, but in terms of actual cash flow, it has a problem. Its
lack of cash flow resulted from the uncollected accounts receivable of $1,000,000.
Without adequate cash inflows to meet its obligations, the firm will not survive, regardless of its level of profits.




4

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