Select Page

Corporate Finance
University of North Carolina School of Law
Simkovic, Michael N.

Corp Finance – Fall 2014 – Simkovic – Outline
I.   Financial Statements
A.   Purpose: 
                        1.          Keep score
                        2.          Help managers identify, diagnose and correct problems
                        3.          Help investors (mandated by reg., state statutes, private investors)
                        4.          Assess taxes
B.    Three basic kinds of Financial Statements: 
                        1.          Balance Sheet, Income Statement, Cash Flow Statement
i.       Balance Sheet: 
a.    Static measure or snapshot. 
b.    Not equal to economic value = kept at cost
c.     Assets = Liab. + Equity
d.    Assets:     Cash, AR, Prepaids, PP&E, IP
e.    Liabilities:  AP, ST debt, LT debt, Taxes, Accrued Payroll
f.     ST v. LT – categorized by how quickly the asset can be converted into cash.
g.    Repo Agreements – ST loan > sell liabilities for cash and agree to buy those liab. back a short time later.
                                                                    I.          Decreases BS liab for a short time.  Treats the transactions as sales instead of loans.
                                                                  II.          Part of reason for Lehman Brothers collapse. 
ii.    Income Statement:
a.    Revenue – Expenses = Net Income (profits)
                                                                    I.          Net income is often expressed per share of stock outstanding – earnings per share
b.    Accrual v. Cash Accounting
                                                                    I.          Accrual = match revenues with expenses (GAAP)
A.   Income is reported when sale is made, even if on credit
                                                                  II.          Cash = revenue recorded when cash received
c.     Non-Cash Expenses:
                                                                    I.          Depreciation & Amortization – matches costs of acquiring asset to their projected lives.
A.   The discrepancy between real cash flows and the accounting often lead to deferred taxes being reported
                                                                  II.          Capital assets – ones which “earn” the company income
iii.  Cash-Flow Statement:
a.    Based only on cash inflow/outflow
b.    Reconciles the firm’s opening and closing cash balance for the same time period
c.     Cash flows from operations – Relate to a company’s business – what it does
d.    Cash flows from investing activities
                                                                    I.          purchase and sale of capital assets (property, plant, equipment)
                                                                  II.          Profits or losses on investments in – financial markets, operating subsidiaries
e.    Cash flows from financing activities – external financing of the company
                                                                    I.          Cash received by raising capital
A.   New stock issuances, Debt
                                                                  II.          Cash paid out to investors
A.   Dividends, Debt repayments
C.    Using Financial Statements to value a company
                        1.          Discount Cash Flow (DCF)
i.      Cash flow projections
ii.    Discount rate (lower better – depends on cost of capital)
iii.  Terminal value (last year, plus terminal growth assumptions)
                        2.          Leverage Ratios
i.      Total Debt Ratio = (Total Assets – Total Equity) / Total Assets
ii.    Debt to Equity = Total Liabilities / Total Shareholder’s Equity
iii.  Equity Multiplier = Total Assets / Total Shareholder’s Equity = 1 + Debt to Equity Ratio
iv.   Quick Ratio = Current Assets – (Inventory & Prepayments) / Current Liabilities
v.     Current Ratio = Current Assets / Current Liabilities
vi.   Cash Ratio = Cash / Current Liabilities
                        3.          Profitability Ratios
i.      Profit Margin = Net Income / Sales
ii.    Return on Assets = Net Income / Total Assets
iii.  Return on Equity = Net Income / Shareholder’s Equity
iv.   EBITDA Margin = EBITDA / Sales
v.     Earnings Per Share = EBITDA / # Shares
vi.   Return on Equity (ROE) = Net Income/Total Equity
vii. P/E Ratio: = Current Share Price/ Earnings Per Share OR Total Market Value / Net Income
                        4.          Common SEC Statements
i.      Form 10-K –
a.    Annual report, must be filed by companies which have registered securities under Section 12 of the 1934 Act
b.    Balance sheet, income statement, and statement of cash flows all must appear on the 10-K
ii.    Form 10-Q –
a.    Like 10-K, but quarterly
iii.  Form 8-K — Current report required to be filed when certain key events occur.
a.    Example: CEO resigns – must be disclosed in an 8-K
iv.   Form S-1 — The general form used for the registration of securities
v.     Form S-3 — A short form available to registrants which have complied with 1934 Act reporting requirement for at least 36 months
vi.   Form S-4 — A form that is used to register shares offered in connection with transactions
                        5.          Goals of Financial Fraud
i.      Goals
a.    Make profits look higher
b.    Make profits look smoother (“manage earnings”)
c.     For tax purposes, may want to make profits look lower
ii.    Motivations
a.    Help managers get bonuses or promotions tied to accounting performance
b.    Boost stock price (manager incentive compensation), perhaps ahead of a new issue or an acquisition
c.     Meet earnings expectations
d.    Borrow money more cheaply (look better to creditors)
                        6.          Common Types of Accounting Fraud
i.      Recognizing revenue
a.    too early (Various) – boost income ST
b.    too late (Fannie Mae / Freddie Mac)
ii.    “Stuffing the channel” – supplying too much inventory early-on to boost profits short-term
iii.  Understating costs
a.    i.e., capitalizing instead of expensing (Worldcom) (boost income ST)
iv.   Understating debt
a.    Off-balance sheet debt (Enron; Lehman Repo 105)
b.    Debt as revenue (Enron)
                        7.          Famous Accounting Scandals
i.      Lehman Repo 105 Transactions, Madoff Ponzi, Great Salad Oil Swindle, Options backdating
                        8.          Sarbanes-Oxley
i.      Audit committee of the BOD must have higher level of financial literacy
ii.    Company must evaluate “internal controls”
iii.  CEO & CFO must sign off on accuracy of financial statements (Creates risk of criminal liability

                                                      V.          10,000 / (1.48)             = C0 = $6,755.64
iv.   Example 2.2.2:
a.    What is the difference between
                                                                    I.          $100 in a five-year CD that pays 2 percent AND
                                                                  II.          the same CD that pays 2.5 percent,
                                                                III.          assuming monthly compounding?
b.    FV              = C0 * (1 + r)t
                                                                    I.          r monthly = r annual / 12
                                                                  II.          r monthly1 = 2 / 12
                                                                III.          r monthly1 = 0.00166666
                                                                IV.          r monthly2 = 2.5 / 12
                                                                  V.          r monthly2 = 0.002
c.     How many periods (t) do we need for 5 years?
                                                                    I.          5 years * (12 months / year ) = 60 months.
                                                                  II.          FV    = C0*(1 + r)t
                                                                III.          FV1   = $100 *(1 + 0.0016666)60 = $110.53
                                                                IV.          FV2   = $100 *(1 + 0.002)60 = $113.28
v.     Example 2.2.4:
a.    If you have a choice to earn on $100,000 [either]:
                                                                    I.          simple interest for three years at 10 percent, OR
b.    Annually compounded interest for three years at 9.5 percent
c.     Which one will pay more and by how much?
                                                                    I.          FV (simple interest)                  = C0*(1+rt)
                                                                  II.          FV (simple interest)                  = 100,000 * (1+.1(3)) = $130,000
                                                                III.          FV (compound interest)         = C0*(1+r)t
                                                                IV.          FV (compound interest)         = 100,000 * (1+.095)3
                                                                  V.          FV (compound interest)         = 100,000 * (1.095) 3
                                                                VI.          FV (compound interest)         = 100,000 * (1.31) = $131,293