Corporate Finance Study Slides PDP

CORPORATE FINANCE

(Ref:Introduction to Accounting and Financa-Geoff Black)

Presenter:

This module will be lead-managed by Mr.Masilamani R He has about 3 decades of working, training & consulting experience His basic degree is in statistics & economics His MBA is in finance and economics He also has several professional accreditations, including performance management & project management
Corporate Finance-the agenda

A. Fundamentals of Financial Management B. Analysis of Financial Statements C. Time Value of Money D. Securities Valuation E. Risk & Return F. Capital Budgeting G. The Cost of Capital H. Dividend Policy
A. Fundamentals of Financial Manag

1. Definition of Financial Management The management of the finances of a business / organization in order to achieve financial
objectives.
2. Key Objective of Financial Management Create wealth for the business. Generate cash. Provide adequate return on investment
Master of Business Administration
A. Fundamental of Financial Manage

1. Key elements process of financial management a) Financial Planning Ensure enough funding is available at the right time. b) Financial Control Ensure that the business is meeting its objectives. c) Financial Decision Making Key aspects investment, financing and dividends.
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B. Analysis of Financial Statements Financil statement

analysis Comparative Analysis Horizontal Analysis Vertical Analysis
Ratio Analysis
1. Profitability Ratio 2. Liquidity Ratio 3. Activity Ratio 4. Gearing Ratio

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B. Analysis of Financial Statements

1. Comparative Analysis
Comparative Analysis involves the comparison against the companys past performance, against another companys performance or against the industry average. Comparison against a benchmark will enable users to make an informed and better decision. a) Horizontal Analysis Involves the comparison of items in the financial statements over a two year period or more. Comparison can be made against last years performance or against few years.
Master of Business Administration 6
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1. Comparative Analysis
a) Vertical Analysis As not all companies are of the same size, and comparing the absolute results of different businesses of dissimilar sizes will not provide an adequate picture. By turning the absolute figures into percentage, we could make a more meaningful interpretation of the data. We will compare percentages rather than the absolute figure (overcome the problems of companies with different sizes).
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1. Financial Ratio Analysis
Shows the relationship between an item in the income statement or balance sheet with another item.
Provide a meaningful data and will enable users to

understand the financial statement.
a) Profitability Ratios Measure the ability of a business entity to earn profits. Used as an indicator of how efficient and effective a company is in achieving its profit.

a) Profitability Ratios 1) Gross Profit Margin (Ratio) Measures the gross profit earned for every Ringgit sales. Higher gross profit ratio indicates strong performance as the company has more profit to pay for its sales & administrative expenses.
Gross Profit Ratio = ( Gross Profit / Net Sales) x 100
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a) Profitability Ratios 1) Net Profit Margin (Ratio) Measures the net profit earned for every Ringgit sales. Higher net profit ratio indicates strong performance as the company has more profit to pay dividends to shareholders.
Net Profit Ratio = ( Net Profit / Net Sales) x 100
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a) Profitability Ratios 1) Earning Per Share (EPS) Measures the earning that is earned by each ordinary share after paying for tax and preference shares dividend. The higher the earning per share the better it is. EPS = ( Earning after Tax Div for PS) / Total OS
PS Preference Share, OS Ordinary Share
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a) Liquidity Ratios
Liquidity refers to the ability to generate or raise cash. Measure the ability of a company to meet short term obligations or debts that might be unexpectedly demanded to be paid before its maturity dates. If a company fails to pay its debts, it could mean an end to the business.
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a) Liquidity Ratios 1) Current Ratio Measures the ability of a business entity to pay up current liabilities. A current ratio of 2:1 indicates strong ability to meet short term debts. The higher the current ratio, the more liquid the company is said to be.
Current Ratio = Current Assets / Current Liabilities
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a) Liquidity Ratios 1) Quick Ratio Also known as acid test ratio. Measures how many quick assets there are to cover quick liabilities. Comprises of cash, receivables and market securities and exclude inventory. Current Ratio = [CA (Inventory + Prepaid)] / CL
CA Current Asset, CL Current Liabilities
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a) Activity Ratios Measure the effectiveness and ability of a company in its resources. It can indicate how effective a companys inventory is
being used to generate sales or how efficient is the

collection of debts by a company.
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a) Activity Ratios 1) Accounts Receivable Turnover (ART) Measures how fast accounts receivable is collected. Indicates the effectiveness of a business entity in managing its accounts receivables. ART = Net Credit Sales / *Ave Account Receivable
*Ave Acc Rec = (Opening Acc Rec + Closing Acc Rec)/2
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a) Activity Ratios 1) Inventory Turnover Measures the ability of a business entity to sell its inventory. Indicates the number of times inventory is sold. Inventory Turnover = COGS / *Ave Inventory
COGS Cost of Good Sold
*Ave Inventory = (Opening Inventory + Closing Inventory)/2
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a) Activity Ratios 1) Total Assets Turnover (TAT) Measure the relationship between sales levels against the average total sales.
Measures the effectiveness of total sales which are

used in generating sales.
TAT = Net Sales / Average Total Assets

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a) Gearing Ratios Measure how much the assets of a company is financed by creditor rather than the owners. High proportion of shareholders fund indicates financial strength. Heavy reliance on borrowing indicates the risk to the investors as debts require repayments of loan principal
amount and the interest expenses.
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a) Gearing Ratios 1) Equity Ratios Measure the financial structure of a company. Higher equity ratios indicate stability. Equity Ratio = (*Total OS Fund / Total Assets) x 100
* Total Ordinary Shareholder Fund include retained earnings
and reserves but exclude preference shares
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a) Gearing Ratios 1) Debts Ratios
Measures the financial structure of a company.

Higher debt ratios indicate that a company face a higher risk in its ability to settle its debts.
Debt Ratio = *Total Debts / Total Assets) x 100
22 * Total debts = Total Liabilities + Preference S/holders Fund 6
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a) Gearing Ratios 1) Debts to Equity Ratios (DER) Measures how much of total debts are covered by equity. The lower ratio the better it is as indicates the amount owned by equity is more than liabilities. DER = *Total Debts / Total Shareholder Equity
* Total debts = Total Liabilities + Preference S/holders Fund
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No
Financial Ratios Example Category

Net Profit Margin
Analysis
Practical
Year 1 Year 2
Financial ratio
1.Profitability
Gross profit Margin
Earnings Per share

2.Lquidity Current Ratio Quick Ratio 3.Efficiency A/C Receivable T/O Receivables T/O
Total Assets T/O
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Financial Example Ratios
No
3.Viability.
Analysis
Practical
Category
Equity ratio Debt Ratio Debt/Equity Ratio
Financial ratio Year 1 Year 2
4.Other Analysis
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C. Time Value of Money

TVM
Interest
Future Value
Present Value
Amortization
Simple
Annuity
Compound
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1. The Interest Rate
Which would you prefer -- $10,000 today or $10,000 in 5 years? Obviously, $10,000 today. You already recognize that there is TIME VALUE TO MONEY!!
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Why is TIME such an important element in your decision? TIME allows you the opportunity to postpone consumption and earn INTEREST.
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a) Simple Interest Interest paid (earned) on only the original amount, or principal, borrowed (lent). b) Compound Interest Interest paid (earned) on nay previous interest earned, as well as on the principal borrowed (lent).
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Simple Interest - Formula SI = P0(i)(n)
Where SI =
Simple Interest
P0 =
Deposit Today (t=0)

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Simple Interest - Example Assume that you deposit RM1,000 in an account earning 7% simple interest for 2 years. What is the accumulated interest at the end of the 2nd year?
SI=P0(i)(n) =RM1,000(.07)(2) RM140

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a) Compound Interest When interest paid on an investment during the first period is added to the principal. During the second period, interest is earned on the new sum.
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a) Compound Interest - Formula CI = P(1 + i)n
Where CI =
Compound Interest
P =
Deposit Today
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a) Compound Interest Example David deposited RM100 into his saving account in Maybank for 5 years with interest of 5% per annum. What is the return that he is expected to receive at the end of 5th year?
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a) Frequency of Compounding - Formula
FVn =
PV0(1 + [i/m])mn
Where n =
Compounding Period per year
i =
Annual Interest Rate

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a) Frequency of Compounding - Example Suppose you deposit $1,000 in an account that pays 12% interest, compounded quarterly. How much will be in the account after eight years if there are no withdrawals?
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a) Frequency of Compounding - Question John deposit $1,000 in an account that pays 12% interest, compounded monthly. How much will be in the account after one year if there are no withdrawals?
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1. Future Value - Formula
FV = PV (1+i)n
Where FV =
Future Value
PV =
Present Value
i =
6
Rate of interest per compounding period

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1. Future Value - Example
If you invested $2,000 today in an account that pays 6% interest, with interest compounded annually, how much will be in the account at the end of two years if there are no withdrawals? 0 $2,000 FV
6%

1. Present Value - Question
John wants to know how large his $5,000 deposit will become at an annual compound interest rate of 8% at the end of 5 years. 0 1 2 3 4 5
8%
$5,000 FV5

1. Present Value - Formula
Since FV = PV(1 + i)n. PV = FV / (1+i)n.
Where FV =
Future Value
PV =
Present Value
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1. Present Value - Example Assume that you need to have exactly $4,000 saved 10 years from now. How much must you deposit today in an account that pays 6% interest, compounded annually, so that you reach your goal of $4,000?
0 6% $4,000 PV0
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1. Present Value - Question Joann needs to know how large of a deposit to make today so that the money will grow to $2,500 in 5 years. Assume todays deposit will grow at a compound rate of 4% annually.
0 4% $2,500 PV0

1. Annuities An Annuity represents a series of equal payments (or receipts) occurring over a
specified number of equidistant periods.
Examples of Annuities Include:
- Car Loan Payments - Insurance Premiums - Mortgage Payments
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1. Annuities a) Annuities Future Value - Formula
0
Cash flows occur at the end of the period 1 2 n i% . . .

R R R
n+1
R = Periodic Cash Flow
FVAn = R(1+i)n-1 + R(1+i)n-2 + ... + R(1+i)1 + R(1+i)0

FVAn
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1. Annuities a) Annuities Future Value - Question If one saves $1,000 a year at the end of every year for three years in an account earning 7% interest, compounded annually, how much will one have at the end of the third year?
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1. Annuities a) Annuities Present Value - Formula
0 Cash flows occur at the end of the period 1 2 n i% . . . R R R n+1
R = Periodic Cash Flow
PVAn
PVAn = R/(1+i)1 + R/(1+i)2 + ... + R/(1+i)n

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1. Annuities a) Annuities Present Value - Question If one agrees to repay a loan by paying $1,000 a year at the end of every year for three years and the discount rate is 7%, how much could one borrow today?
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1. Amortization - Example
Julie Miller is borrowing $10,000 at a compound annual interest rate of 12%. Amortize the loan if annual payments are made for 5 years. PV0 = R (PVIFA i%,n) $10,000 = R (PVIFA 12%,5) $10,000 = R (3.605) R = $10,000 / 3.605 = $2,774
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1. Amortization Example (Table)
[Last Payment Slightly Higher Due to Rounding]


1. Amortization Question
Supposed you borrow $6,655 to make repairs to your house, and the loan is considered a second mortgage. The term of the loan require you to make payments every three months I.e. quarterly for the next two years and the simple interest rate is 6 percent p.a. What is the amount that must be paid every three months?
D. Securities Valuation
Securities Valuation
Bonds
Stock
Common Stock
1. 2. 3. 4.
Mortgage Bond Eurobonds Zero Coupon Bonds Junk Bond
Preferred Stock
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Securities Valuation
Stock market
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1. Preferred Stock Preferred Stock is often referred to as a hybrid security because it has many characteristics of both common and bonds.
Like common stocks - No fixed maturity date. - Failure to pay dividends does not bring on bankruptcy.
Like bonds - Dividends are for a limited time.

1. Preferred Stock Features
a) Multiple series of Preferred Stock b) Preferred Stocks claim on asset & income c) Cumulative dividends d) Protective provisions e) Convertibility f) Retirement features
g) Callable
a) Multiple series of Preferred Stock
If a company desires, it can issue more than one series of preferred stock, and each series can have different characteristics. - Convertible - Protective provisions
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a) Claims on Assets and Income
Preferred stock has priority over Common Stock with regard to claim on assets in the case of bankruptcy. Honored before common stockholders, but after bonds. Must pay dividends to preferred stockholders before it pays common stockholder dividends.
a) Cumulative Dividends
Cumulative features requires that all past, unpaid preferred stock dividends be paid before any common stock dividends are declared. b) Protective Provisions Protective provisions generally allow for voting rights in the event of non payment of dividends.
a) Convertibility
Convertible preferred stock can, at the discretion of the holder, be converted into a predetermined number of shares of common stock. Almost one third of preferred stock issued today is convertible. Reduces the cost of the preferred stock to the issue
a) Retirement Features
Although preferred stock has no set maturity associated with it, issuing firms generally provide for some method of retiring the stock. b) Callable A call provision entitles a company to repurchase its preferred stock from their holders at stated prices over a given time Master of Business 61 period. 6 Administration
1. Preferred Stock
a) Valuing Preferred Stock

Where Vbs = The value of preferred stock D D = Vps =
The preferred dividend
kps = Example : Xeroxs Series C preferred stock pays an annual dividend of RM6.25 and the investors required rate of return is 5%
The required rate of return
kps
1. Common Stock Common stock is a certificate that indicates ownership in a corporation. Has no maturity date. Dividend payments will normally divided into Interim & Final Dividend In the event of bankruptcy, common stockholders will not receive any payment until the creditors, including the bondholders and preferred stockholders, have been satisfied. 6 Master of Business 63
Administration
1. Common Stock Features
a) Claim on income b) Claim on assets c) Voting rights d) Preemptive rights e) Limited liability
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a) Claim on income Common shareholders have the right to residual income after bondholders and preferred stockholders have been paid Can be in the form of dividends or retained earnings.
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a) Claim on assets Common stock has a residual claim on assets after claims of debt holders and preferred stockholders. If bankruptcy occurs, claims of the common shareholders generally go
unsatisfied.
a) Voting Rights Common shareholders are entitled to elect the board of directors. Most often are the only security holders with a vote. A proxy gives a designated party the temporary power of attorney to vote for the signee at the corporations annual general meeting.
1. Common Stock Features a) Preemptive Rights Preemptive right entitles the common shareholder to maintain a proportionate share of ownership in the corporation. Rights certificates issued to the shareholders giving them an option to purchase a stated number of shares of stock at a specified price during a two to ten week period.
a) Limited Liability Liability of the shareholder is limited to the amount of their investment. Limited liability feature aids the firm in raising funds.
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1. Common Stock
a) Valuing Common Stock
Where Vcs =
D1 g 0 V CS k CS g
D0 =
The value of common stock
The preferred dividend
Growth rate
kcs =
The required rate of return

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1. Common Stock
a) Valuing Common Stock Example Consider the valuation of a common stock that paid RM2.00 dividend at the end of the last year and is expected to pay a cash dividend in the future. Dividends are expected to grow at 10% and the investors required rate of return is 15%
1. Bond type of debt or long term promissory note, issued by a borrower, promising to its holder a predetermined and fixed amount of interest per year.
a) Types of Bonds i. Debentures Any unsecured long term debt. Viewed as more risky than secured bonds and provide a higher yield than secured bonds.
1. Bond
a) Types of Bonds i. Mortgage Bonds A bond secured by a lien on real property. Typically, the value of the real property is greater than that of the bonds issued. ii. Eurobonds Securities (bonds) issued in a country Master of Business 6 73 different from the one in whose Administration
1. Bond
a) Types of Bonds i. Zero Coupon Bonds Issued at a substantial discount from the RM1,000 face value with a zero coupon rate. Return comes from appreciation of the bonds. Advantages cash outflows dont occur with zero coupon bonds.
1. Bond
a) Types of Bonds
i. Junk Bonds (High Yield Bonds)

High risk debt with ratings of BB or below by Moodys and Standard & Poors. High yield typically pay 3% ~ 5% more than AAA grade long term
bonds. 6
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1. Bond
a) Terminology i. Claims on assets and income In the case of insolvency, claims of debt, including bonds are honored before those of common or preferred stock. ii. Par Value Face value of the bond, returned to the bondholder at maturity. Corporate bonds are issued at Master of Business 6 76 denomination of RM1,000 Administration
1. Bond
a) Terminology i. Coupon Interest Rate The percentage of the par value of the bond that will be paid out annually in the form of interest. ii. Maturity The length of time until the bond issuer returns the par value to the bondholder and terminates or redeem the bonds.
1. Bond
a) Terminology i. Convertibility May allow the investor to exchange the bond for a predetermined number of the firms shares of common stock. ii. Indenture The legal agreement between the firm issuing the bond and the trustee who represents the bondholders.
1. Bond a) Terminology i. Call Provision A provision such that if the prevailing interest rate declines, the firm may want to pay off the bonds early and reissue at a more favorable interest rate. Issuer must pay the bondholder at premium. There is also call protection period where the firm cant call for a specified Master of Business 6 79
Administration
1. Bond a) Valuation Assigning a value to an asset by calculating the present value of its expected future cash flows using the investors required rate of return as the discount rate. The value of a bond is combination of:- the amount and timing of cash flows to be received by investors. - the time to maturity of the loan. - the investors required rate of return. Master of Business 6 80
Administration
1. Bond a) Valuation - Formula

Where Vb =
n
Intrinsic value
I M V t b n 1b ) (k 1b ) t1 ( k
I =
Interest to be received
n =
Number of period to maturity
kb =
Required rate of return for bondholder
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1. Bond a) Valuation - Formula
Vb = I(PVIFAkb,n) + M(PVIFkb,n)
Where Vb =
Intrinsic value
I =
Interest to be received
n =
Number of period to maturity

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1. Bond a) Valuation Example
Consider a bond issued by Toyota with a maturity date of 2008 and a stated coupon of 5.5%. In December 2004, with 4 years left to maturity, Investors owning the bonds are requiring a 4% rate of return. Calculate the price of Toyota Bond.
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1. Bond a) Valuation 3 important relationships
First Relationships The value of a bond is inversely related changes in investors present required rate of return (interest rate). As interested rate increases (decreases), the value of the bond decreases (increases).
1. Bond a) Valuation 3 important relationships
Second Relationship The market value of a bond will be less than the par value if the investors required rate of return is above the coupon interest rate. However, it will be valued above par value if the investors required rate of return is below the coupon interest rate.
1. Bond a) Valuation 3 important relationships Third Relationship Long term bonds have greater interest rate risk than the short term bonds.
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E. Risk & Return

Risk & Return
Risk & Return?

Market Risk
Diversification
Summary
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E. Risk & Return

1. Risk & Return
a) What is Risk? The possibility that an actual return will differ from our expected return. Uncertainty in the distribution of possible outcomes. b) What is Return?
Expected Return - the return that an investor expects to earn on an asset, given its price, growth potential, etc. Required Return - the return that an investor requires on an asset given its risk.
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E. Risk & Return

1. Expected Return - Example
Probability State of Economy
(P) Company A Company B
Return
Recession
.20
4%
-10%
k = P(k1)*k1 + P(k2)*k2 + ...+ P(kn)*kn

k (OU) = .2 (4%) + .5 (10%) + .3 (14%) = 10% Normal .50 10% 14% k (OT) = .2 (-10%)+ .5 (14%) + .3 (30%) = 14% Boom
.30
14%
30%
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E. Risk & Return

1. How do we Measure Risk?
A more scientific approach is to examine
the stocks STANDARD DEVIATION of returns.

Standard deviation is a measure of the dispersion of possible outcomes. The greater the standard deviation, the greater the uncertainty, and therefore , the
greater the RISK.

E. Risk & Return

1. How do we Measure Risk? a) Formula for Standard Deviation
Where n =
The number of possible outcomes
n 2
P) ( k k i ) ( k i
t 1
ki =
The value of ith possible rate of return
P(ki) =
Probability that ith return will occur
k =
Expected value of the rate of return

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E. Risk & Return

1. How do we Measure Risk? - Example
Company A
Company B
Recession
(4% -10%)2 (.2) = 7.2
(-10% -14%)2(.2) = 115.2
Normal
(10% - 10%)2 (.5) = 0
(14% - 14%)2 (.5) = 0
Boom
(14% -10%)2 (.3) = 4.8 (30% - 14%)2 (.3) = 76.8

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E. Risk & Return

1. How do we Measure Risk? - Summary
Company A
Company B
Expected Return 10% 14% Which stock would you prefer? How would you decide?
Standard Deviation 3.46% 13.86% It depends on your tolerance for risk! Remember theres a tradeoff between risk and return.
E. Risk & Return

1. Diversification
Investing in more than one security to reduce risk. If two stocks are perfectly positively correlated, diversification has no effect on risk. If two stocks are perfectly negatively correlated, the portfolio is perfectly diversified. If you owned a share of every stock traded on the BSKL and Mesdaq, would you be diversified? YES! Would you have eliminated all of your risk? NO! Common Stock portfolios still have risk.
E. Risk & Return

1. Diversification Some risk can be diversified away and some can not. a) Market Risk is also called Non - diversifiable risk. This type of risk can not be diversified away.
Unexpected changes in interest rates. Unexpected changes in cash flows due to tax rate changes, foreign competition, and the overall business cycle.
E. Risk & Return

1. Diversification a) Firm-Specific risk is also called diversifiable risk. This type of risk can be reduced through diversification.
A companys labor force goes on strike.
A companys top management dies in a plane crash.

A huge oil tank bursts and floods a companys production area.
E. Risk & Return

1. Market Risk
As we know, the market compensates investors for accepting risk - but only for market risk. Firmspecific risk can and should be diversified away. So we need to be able to measure market risk. Beta: a measure of market risk. Specifically, it is a measure of how an individual stocks returns vary with market returns. Its a measure of the sensitivity of an individual stocks returns to changes in the market.
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E. Risk & Return

1. Market Risk
A firm that has a beta = 1 has average market risk. The stock is no more or less volatile than the market. A firm with a beta > 1 is more volatile than the market (ex: computer firms). A firm with a beta < 1 is less volatile than the market (ex: utilities).
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E. Risk & Return

1. Summary of Risk & Return
We know how to measure risk, using standard deviation for overall risk and beta for market risk. We know how to reduce overall risk through diversification. We need to know how to price risk so we will know how much extra return we should require for accepting extra risk.
F. Capital Budgeting
Methodology
Payback Period Net Present Value
Internal Rate Of Return
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1. Importance of Capital Budgeting
Capital budgeting is the process of evaluating proposed large, long-term investment projects. capital budgeting ensures that proposed
investment will add value to the firm. Effective capital budgeting can improve both the timing of asset acquisitions and the quality of assets purchased.
1. Capital Budgeting Decision Method
a) Payback Period (PBP)
PBP is the period of time required for the cumulative expected cash flows from an investment project to equal the initial cash outflows.
Formula for PBP :-
Unrecovered cost at start of yr

PBP = Year b4 full recovery + 6
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a) Net Present Value (NPV)
The present value of an investment projects net cash flows minus the projects initial cash outflow.
Formula for NPV :CF t NPV ) t ( k 1 t0
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NPVs values: NPV = 0, the firms overall value will not change if the new project is adopted.
NPV > 0, the firms overall value will increase.
NPV < 0, the firms overall value will be decrease.

NPVs Decision Rules: For independent projects : accept all independent projects having NPVs greater than or equal to 0.
For mutually exclusive projects : projects having highest positive NPV will be ranked first.
a) Internal Rate of Return (IRR)
IRR is the estimated rate of return for a proposed project, given the projects incremental cash flows.
Formula for IRR :CF t 0 ) t ( IRR 1 t0
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a) Internal Rate of Return (IRR) IRR Decision Rules: For independent project accept projects having IRRs greater than the hurdle rate. For mutually exclusive projects projects are ranked from highest to lowest IRR.
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a) Conflicting ranking between NPV & IRR
For Independent Projects Both the NPV and IRR methods will produce the same accept / reject indication. Accept projects having NPV > 0, IRR > the hurdle rate. For mutually exclusive projects Project having a higher NPV should be chosen instead of a higher IRR.
a) Conflicting ranking between NPV & IRR For mutually exclusive projects Reason for higher choosing higher NPV i. NPV method makes maximizing the firm value. ii. NPV method assumes that a projects cash flows can be reinvested at the cost of capital. iii. Whereas, IRR methods assumption on cash flows reinvestment is the IRR.
G. The Cost of Capital

WACC
Cost of PS
Cost of Debt
Cost of Equity
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When we say a firm has a cost of capital of, for
example, 12%, we are saying:-
The firm can only have a positive NPV on a

project if return exceeds 12%. The firm must earn 12% just to compensate
investors for the use of their capital in a project.

The use of capital in a project must earn 12% or more, not that it will necessarily cost 12% to borrow funds for the project.

1. Cost of Debt (Kd)
We use the after tax cost of debt because interest payments are tax deductible for the firm. Formula for Cost of Debt Kd after taxes = Kd (1 tax rate) Example : If the cost of debt for ABC Sdn Bhd is 10% and its tax rate is 40% then :-
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1. Cost of Preferred Stock (Kps)
Preferred Stock has a higher return bonds, but is less costly than common stock. WHY? In case of default, preferred stockholders get paid before common stockholders. However, in case of bankruptcy, the holders of preferred stock get paid only after short and long term debt holder claims are satisfied. Preferred stock holders receive a fixed dividend and usually cannot vote on the firms affairs.

1. Cost of Preferred Stock (Kps)
Formula for Cost of Preferred Stock
Example : If = kps ABC Sdn Bhd is issuing preferred stock at $100 per share, with a stated dividend of V $12, then the cost ofpspreferred stock :-
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1. Cost of Equity (Kcs)
The cost of equity is the rate of return that
investors require to make an equity investment in

a firm.
CAPM (Capital Asset Pricing Model)

- The CAPM is one of the most commonly used ways to determine the cost of common stock.
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1. Cost of Equity (Kcs)
Formula for Cost of Equity
kcs = krf + (km krf)
Example :kABC The risk free rate = 1.6. The risk Where rf = Sdn Bhd has a free on T-bills is currently 4% and the market return has averaged 15%:Master of Business Administration
6= The firms beta
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1. Weighted Average Cost of Capital (WACC)
Formula for WACC
WACC = wd (Cost of Debt) + wcs (Cost of Equity) + wps (Cost of PS) Example : ABC Sdn Bhd maintains a mix of 40% debt, 10% preferred stock, and 50% common stock in its capital structure. The WACC is :-
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H. Dividend Policy
Dividend Policy
Types
Chronology
Impact Alternatives
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H. Dividend Policy
1. Types of Dividend Policy a) Constant Payout Ratio b) Constant Nominal Dividend (Regular) c) Special Dividend Payout d) Cash Dividend Payment 2. Chronology of Date of Dividend Payment a) Declaration Date b) Ex Dividend Date c) Record Date d) Payment Date
H. Dividend Policy
1. Impact of Dividend Policy Firm Value
a) Arguments for Irrelevancy Theory Signaling Effect Clientele Effect b) Arguments against Irrelevancy Theory Bird in the Hand Theory Taxes
Floatation Costs
H. Dividend Policy
1. Alternative Dividend Policy
a) Stock Dividend Firms sometimes tend to distribute additional shares in the form of dividends to a firms shareholders investment. rather than giving cash
dividends, which are kept in the firm for
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H. Dividend Policy
a) Stock Dividend Example A firm has 10 million shares outstanding. Currently the market value of the firm is RM20 million. Therefore, price per share is to be RM2.00. Assume that the firm is to issue another 1 million shares as a stock dividend. The total number of shares outstanding will be 11 million. Hence, given the market value of the firm, the new price per share will be?
H. Dividend Policy
a) Stock Split Stock Split involve issuing of additional shares to firms stockholders. The investors percentage ownership in the
firm remain unchanged.

The investor is neither better nor worse off before the stock split.
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H. Dividend Policy
a) Stock Split Example YTM Bhd. Is planning a two for one stock split. You own 5,000 shares of YTM Bhds stock that is currently selling for RM12.00 per share. What
is the value of your YTM Bhd. Stock now, and

what will it be after the split?
124
H. Dividend Policy
a) Stock Repurchase It is a common practice for developed and developing markets for a firm to buy back stock from its shareholders.
Reasons for repurchase :- an effective substitute for dividends. - the price of stocks are undervalued. - Provide internal investment opportunity.
H. Dividend Policy
a) Stock Repurchase Example
UEB Bhd. Has RM0.8 million in cash for its next dividend. However, it is considering a repurchase of its own shares instead of paying dividends. The firm has 10 million shares outstanding, currently selling at RM2.00 per share. The P/E is 10 times and the firms EPS is RM0.20. What will be the firms dividend per share? If stock is repurchased, how many shares will be remain outstanding and what will the new EPS be?
Accrual Accounting
What is accrual accounting?
Revenue and expenses reported for an accounting period are the revenue earned and expenses matched to or incurred in generating that income regardless of whether the income has actually been received or cash paid for the expenditure. For Example Where we have performed some work for a client and invoiced this client, we would include this revenue in our reporting for the period, regardless of whether we have actually received payment or not. On the expense side, we would include expenses such as electricity and gas consumed during the period even if the bill is not due for payment until the following period.
127
Brief Introduction to Accounting

contd.
So why are some reports cash and some accrual? It really depends on the needs of the users. Reporting Types
There are two types of accounting or reporting: 1. Financial Accounting 2. Management Accounting
128
Thank You

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CORPORATE FINANCE

(Ref:Introduction to Accounting and Financa-Geoff Black)

Corporate Finance-the agenda

A. Fundamentals of Financial Manag

Master of Business Administration

A. Fundamental of Financial Manage

B. Analysis of Financial Statements Financil statement

1. Profitability Ratio 2. Liquidity Ratio 3. Activity Ratio 4. Gearing Ratio

Master of Business Administration

B. Analysis of Financial Statements

B. Analysis of Financial Statements

B. Analysis of Financial Statements

Provide a meaningful data and will enable users to

Master of Business Administration

B. Analysis of Financial Statements

Gross Profit Ratio = ( Gross Profit / Net Sales) x 100

Master of Business Administration

B. Analysis of Financial Statements

Net Profit Ratio = ( Net Profit / Net Sales) x 100

Master of Business Administration

B. Analysis of Financial Statements

Master of Business Administration

B. Analysis of Financial Statements

Master of Business Administration

B. Analysis of Financial Statements

Current Ratio = Current Assets / Current Liabilities

Master of Business Administration

B. Analysis of Financial Statements

B. Analysis of Financial Statements

being used to generate sales or how efficient is the

Master of Business Administration

B. Analysis of Financial Statements

Master of Business Administration

B. Analysis of Financial Statements

*Ave Inventory = (Opening Inventory + Closing Inventory)/2

Master of Business Administration

B. Analysis of Financial Statements

Measures the effectiveness of total sales which are

TAT = Net Sales / Average Total Assets

B. Analysis of Financial Statements

amount and the interest expenses.

Master of Business Administration

B. Analysis of Financial Statements

and reserves but exclude preference shares

Master of Business Administration

B. Analysis of Financial Statements

Measures the financial structure of a company.

Debt Ratio = *Total Debts / Total Assets) x 100

Master of Business Administration

22 * Total debts = Total Liabilities + Preference S/holders Fund 6

B. Analysis of Financial Statements

Master of Business Administration

B. Analysis of Financial Statements

Financial Ratios Example Category

Gross profit Margin

Earnings Per share

Total Assets T/O

B. Analysis of Financial Statements

Financial ratio Year 1 Year 2

Master of Business Administration