Financial Management

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Financial Management by Mind Map: Financial Management

1. Coverage

1.1. A. Principles of Valuation

1.1.1. Focus questions Is discount rate the same as discount factor? Opportunity cost of capital? How is risk factored into the time value of money? Why do capital markets ensure that all shareholders unanimously agree that NPV is a sensible criterion for evaluating projects? Value maximization assumes a well-functioning capital markets. What does "well-functioning" mean? In what ways does maximizing value conflict with shareholders' interests? Why is a reputation for honesty and fair business practice important to the financial value of the corporation?

1.2. B. Evaluating Projects

1.2.1. Capital Budgeting Process Step 1. Identifying potential investments Step 2. Analyzing those investments to identify which will create shareholder value Step 3. Implementing & monitoring the investments selected in Step 2

1.2.2. Project "ATIOCF"

1.2.3. Incremental Cash Flow

1.2.4. Focus questions 1. Determine initial, interim, and terminal period after-tax incremental operating cash flows associated with a capital investment project. 2. Explain the process of generating project proposals within the firm. 3. Explain why, when, and how sunk costs and opportunity costs should, or should not, be considered. 4. Understand why cash, not income, flows are the most relevant. 5. What are capital investments? What do the capital budgeting decision process involves?

1.3. C. Firm Valuation

1.3.1. Dividend discount model

1.3.2. Cash flows, profitability, & growth

1.3.3. Free cash flows

1.3.4. Profitability, financial ratios, & terminal value

1.3.5. Focus questions 1. Is free cash flow the same thing as earnings? 2. Is the earnings-price ratio a good measure of the cost of equity? Why or why not? 3. What is a two-stage DCF model? When would you want to use one? 4. What is meant by PVGO? Why do the shares of companies with valuable PVGO trade at low earnings-price ratios? 5. What is the Dividend Discount Model? 6. What is the general DCF formula for the value of a stock?

1.4. D. Risk & Returns

1.4.1. Portfolio Theory Portfolio risk & diversification Optimal portfolios Systematic vs. diversifiable risk Focus questions 1. Explain why diversification makes sense for an investor, but not generally for the firm itself 2. What are the formulas for the variance and standard deviation of returns? 3. What are the two types of risk? Which one can be reduced by diversification? 4. What is beta and what is its average value? 5. What is the general formula for calculating the risk of a portfolio?

1.4.2. CAPM Using the CAPM Estimating beta and the cost of capital Focus questions: 1. If stock returns are normally distributed, the distribution can be completely defined by two numbers. What are they? 2. State the Fama-French three-factor model 3. State the formula for the arbitrage pricing theory. What are the three steps involved in estimating expected returns using this formula? 4. What is meant by "the set of efficient portfolios?" 5. What is the Sharpe ratio? Why should investors attempt to maximize it? 6. Write down the capital asset pricing model

1.5. E. Market Efficiency

1.5.1. Debt, taxes, & the after-tax WACC Tax effects of financings Corporate taxes: Interest paid are treated as expense while dividends paid are not Personal taxes: Interest paid are deductible from income, dividends received are taxable Overall: debts have tax advantage Effect of taxes on WACC (link) Advantages of Debt Tax advantage Signaling Corporate control Lower issue costs

1.5.2. Financial distress Costs against debts Direct costs Indirect costs Value - Distress (link) Optimal Firm Value with Distress (link)

1.5.3. Focus questions 1. What are the forms of the efficient-market hypothesis? Give example and evidence of each 2. What are the six lessons of market efficiency? Give example of each 3. What is "prospect theory?" How does it differ from the assumptions used to develop the capital asset pricing model? 4. What is meant by a "random walk?"

1.6. F. Raising Capital

1.6.1. Overview of Corporate Financing Externally IPO Primary market transactions Secondary market transactions Financial market components Internally

1.6.2. Financing patterns & the stock market's reaction

1.6.3. Focus questions 1. How are venture capital funds organized? 2. How do financial intermediaries contribute to the functioning of the economy? Give two examples 3. How do rights issues work? 4. How is venture capital financing structures so as to ensure that the new business is a success? 5. What is meant by residual cash flow rights and residual control rights? 6. What is meant by the company's financial deficit? 7. What is the main source of funds for most companies?

1.7. G. Capital Structure

1.7.1. M&M Theorem

1.7.2. Leverage, risk, & WACC

1.7.3. Focus questions: 1. Financial innovation continues. Firms and financial institutions keep designing and issuing new types of debt, equity, or hybrid securities. Does financial innovation support or refute MM's propositions? 2. What is MM's proposition 1? 3. What is financial risk? How does it depend on the firm's capital structure? 4. What is the traditional position on the effects of debt financing on the weighted average cost of capital?

1.8. H. Dividend Policy

1.8.1. Payout Policy

1.8.2. Focus questions: 1. Define and discuss dividend reinvestment plans (DRIPs). 2. Define “stock repurchase” and explain why (and how) a firm might repurchase stock. 3. Define, compare, and justify cash dividends, stock dividends, stock splits, and reverse stock splits. 4. Explain the Modigliani and Miller (M&M) argument that dividends are irrelevant. 5. Explain the counterarguments to M&M – that dividends do matter. 6. Identify and discuss the factors affecting a firm’s dividend and retention of earnings policy. 7. Summarize the standard cash dividend payment procedures and critical dates. 8. Understand the dividend retention versus distribution dilemma faced by the firm.

1.9. I. Financial Management

1.9.1. Managing daily cash inflows & outflows

1.9.2. Forecasting cash balances

1.9.3. Building a long-term financial plan

1.9.4. Selecting the right mix of debt & equity

1.10. J. Corporate Governance

1.10.1. Hire & promote qualified, honest people, & structure employees' financial incentives to motivate them to maximize firm value

1.10.2. Dimensions of Corporate Governance Board of Directors SEC Sarbanes-Oxley Act of 2002

1.11. K. Risk Management

1.11.1. Identifying, measuring, & managing all types of risk exposures

1.11.2. Some risks are insurable and some risks can be reduced through diversification.

1.11.3. Financial instruments like forwards, futures, options, & swaps may also be used to hedge market risks such as interest-rate, price, and currency fluctuations.

1.11.4. Create value by managing risks.

2. FM Tasks

2.1. Daily

2.1.1. Credit management

2.1.2. Inventory control

2.1.3. Receipt & release of funds

2.2. Occasional

2.2.1. Stock issue

2.2.2. Bond issue

2.2.3. Capital budgeting

2.2.4. Dividend decision

2.3. Tradeoffs

2.3.1. Profitability vs. Risk

2.3.2. Influences Operational side Capital vs. Labor Product A vs. Product B Financial mix Business form

2.4. Goals

2.4.1. Establish right valuation approach Maximize stock price, not profits or EPS Why not profits or EPS?

2.4.2. Management & stockholder wealth

2.4.3. Social responsibility Attracts capital Provides employment Offers benefits to society Cost increasing activities Initially voluntary Consequentially mandatory

3. Concepts

3.1. Financing decisions

3.1.1. 1. Acquiring funds (Debt &/or Equity) Issue bonds or not Issue new stocks or not

3.1.2. 2. Assets Management

3.1.3. 3. Using funds (Investment decisions) Pay dividends or not Replace an asset or not Where to invest its money

3.2. Core principles

3.2.1. Time value of money

3.2.2. Compensation for risk

3.2.3. Don't put all your eggs in one basket

3.2.4. Markets are smart

3.2.5. No arbitrage

3.3. Evolution

3.3.1. 1900's

3.3.2. 1930's

3.3.3. 1950's

3.3.4. 1980's

3.3.5. Internet era Enabled e-commerce solutions Spurt new business models & companies

3.4. Basic Functions

3.4.1. a. 1900's

3.4.2. b. Capital Budgeting

3.4.3. c. Financial Management

3.4.4. d. Corporate Governance

3.4.5. e. Risk Management