FORELÆSNING 1

INSTITUT FOR CHRISTOFFER THIMSEN

ØKONOMIAARHUS UNIVERSITET POST DOC
KORT OM MIG
• PhD i finansiering fra Aarhus Universitet.
• Post Doc (Aarhus Universitet) forskningsbevilling fra Spar Nord
Fonden på DKK 2,2 mio. (80% forskningstid, 20% undervisningstid):
• Forsker indenfor:
• Klassisk corporate finance (kapitalstruktur etc.)
• Regulering af finansielle institutioner (herunder bankregulering)
• Forudsigelse af finansielle/økonomiske udfald via kunstig intelligens
(machine learning).
FAGETS OPBYGNING OG FORVENTNINGER

• Pensum -> udvalgte kapitler i lærebogen som fremgår af

forelæsningsplanen.
• 24 forelæsninger -> 22 der omhandler nyt materiale, 2 der samler op.
• 10 holdundervisninger –> udvalgte opgaver fra bogen (dækker kun et
udvalg af pensum)
• FRIVILLIGT: 1 hjemmeopgave i grupper af fire (4) med skriftlig
feedback. Kan bruges som eksamensforberedelse.
FORVENTNINGER TIL JERES INDSATS

• Jeres samlede studietid per uge i dette fag -> 15 timer.

• I får dækket ca. 5 timer hver uge via forelæsninger/holdundervisning ->
10 timers selvstudie hver uge.
• Ikke alt pensum kan dækkes på forelæsninger eller holdtimer.
• Det forventes at I ejer bogen og arbejder med pensum (læser og
løser opgaver).
EKSAMEN

• 4 timers skriftlig med alle hjælpemidler.

• Eksamens sværhedsgrad på niveau med opgaverne i lærebogen.
• Eksamen vil bestå af 80-90% beregningsopgaver, 10-20%
forståelsesspørgsmål.
• I beregningsopgaverne gives der point primært efter rigtige/forkerte
svar.
CHAPTER OUTLINE
1.1 Why Study Finance?
1.2 The Four Types of Firms
1.3 The Financial Manager
1.4 The Financial Manager’s Place in the Corporation
1.5 The Stock Market
1.6 Financial Institutions
1.1 WHY STUDY FINANCE? (1 OF 2)
​Individuals are taking charge of their personal finances with decisions such
as:
• When to start saving and how much to save for retirement
• Whether a particular stock is a good investment
• How to evaluate the terms of a home mortgage
1.1 WHY STUDY FINANCE? (2 OF 2)
​In your business career, you may face such questions such as:
• Should your firm launch a new product?
• Should your firm produce a part or outsource production?
• How can you raise money for your start-up firm?
CHARACTERISTICS OF THE DIFFERENT TYPES OF
FIRMS (1 OF 2)
Table 1.1 Characteristics of the Different Types of Firms
Ownership
Owners
Number of Liability for Change
blank Manage the Taxation
Owners Firm’s Debts Dissolves
Firm
Firm
Sole One Yes Yes Yes Personal
Proprietorship
Partnership Unlimited Yes; each partner is Yes Yes Personal
liable for the entire
amount
Limited At least one GP-Yes GP-Yes GP-Yes Personal
Partnership general LP-No LP-No LP-No
partner (GP),
no limit on
limited partners
(LP)
CHARACTERISTICS OF THE DIFFERENT TYPES OF
FIRMS (2 OF 2)
Table 1.1 [Continued]

Ownership
Owners
Number of Liability for Change
blank Manage the Taxation
Owners Firm’s Debts Dissolves
Firm
Firm
Limited Unlimited No Yes No* Personal
Liability
Company
S Corporation At most 100 No No (but they No Personal
legally may)
C Corporation Unlimited No No (but they No Double
legally may)

*However, most LLCs require the approval of the other members to transfer your
ownership.
1.3 THE FINANCIAL MANAGER (1 OF 5)
​The financial manager has three main tasks:
• Make investment decisions
• Make financing decisions
• Manage short-term cash needs
1.3 THE FINANCIAL MANAGER (2 OF 5)
​Making Investment Decisions
• The financial manager must weigh the costs and benefits of each investment or
project
• They must decide which investments or projects qualify as good uses of the
money stockholders have invested in the firm
1.3 THE FINANCIAL MANAGER (3 OF 5)
​Making Financing Decisions
• The financial manager must decide whether to raise more money from new and
existing owners by selling more shares of stock (equity) or to borrow the
money instead (bonds and other debt)
1.3 THE FINANCIAL MANAGER (4 OF 5)
​Managing Short-Term Cash Needs
• The financial manager must ensure that the firm has enough cash on hand to
meet its obligations from day to day
• This job is also known as managing working capital
1.3 THE FINANCIAL MANAGER (5 OF 5)
​The Goal of the Financial Manager
• The overriding goal of financial management is to maximize the wealth of the
owners, the stockholders.
1.4 THE FINANCIAL MANAGER’S PLACE IN THE
CORPORATION (1 OF 3)
​Stockholders own the corporation but rely on financial managers to actively
manage the corporation
• The board of directors and the management team headed by the CEO possess
direct control of the corporation
1.4 THE FINANCIAL MANAGER’S PLACE IN THE
CORPORATION (2 OF 3)
​The Corporate Management Team
• Board of Directors
• A group of people elected by shareholders who have the ultimate decision-making
authority in the corporation
• Chief Executive Officer (CEO)
• The person charged with running the corporation by instituting the rules and
policies set by the board of directors
FIGURE 1.2 THE FINANCIAL FUNCTIONS WITHIN A
CORPORATION
​Board of Directors
​ hief Executive Officer
C
• Chief Financial Officer
• Controller
• Accounting
• Tax Department
• Treasurer
• Capital Budgeting
• Risk Management
• Credit Management
• Chief Operating Officer
1.4 THE FINANCIAL MANAGER’S PLACE IN THE
CORPORATION (3 OF 3)
​Ethics and Incentives in Corporations 
• Agency Problems
• When managers put their own self-interest ahead of the interests of the shareholders
• The CEO’s Performance
• When the stock performs poorly:
• The board of directors might react by replacing the CEO
• A corporate raider may initiate a hostile takeover
1.5 THE STOCK MARKET
​Corporations can be private or public
• A private corporation has a limited number of owners and there is no organized
market for its shares
• A public corporation has many owners and its shares trade on an organized
market, called a stock market
FIGURE 1.3 WORLDWIDE STOCK MARKETS
RANKED BY VOLUME OF TRADE
The bar graph shows the 10 biggest stock markets in the world ranked by total
value of shares traded on exchange in 2015.

Source : www.world-exchanges.org.
1.5 THE STOCK MARKET
​Primary Versus Secondary Markets
​ raditional Trading Venues
T
• NYSE and NASDAQ
• Market Makers
• Specialists
• Bid-Ask Spread
• Bid price
• Ask price
• Liquidity
• Transaction Cost
1.5 THE STOCK MARKET
​New Competition and Market Changes
• Limit Order
• Limit Order Book
• Market Orders
• High Frequency Traders (HFTs)
​Dark Pools
• Do not make their limit order books visible
1.5 THE STOCK MARKET
​Other Financial Markets
• Bond Market
• Foreign Exchange Market
• Commodities Market
• Derivative Securities
1.6 FINANCIAL INSTITUTIONS (1 OF 5)
​Financial Institutions
• Entities that provide financial services, such as taking deposits, managing
investments, brokering financial transactions, or making loans
1.6 FINANCIAL INSTITUTIONS (2 OF 5)
​The Financial Cycle
• In the financial cycle:
1. People invest and save their money
2. Through loans and stock, that money flows to companies who use it to fund
growth through new products, generating profits and wages
3. The money then flows back to the savers and investors
FIGURE 1.5 THE FINANCIAL CYCLE
1.6 FINANCIAL INSTITUTIONS (3 OF 5)
​Types of Financial Institutions
• Banks and Credit Unions
• Insurance Companies
• Mutual Funds
• Pension Funds
• Hedge Funds
• Venture Capital Funds
• Private Equity Funds
1.6 FINANCIAL INSTITUTIONS (4 OF 5)
​Types of Financial Institutions
• Financial conglomerates/financial services firms combine more than one type
of institution
FINANCIAL INSTITUTIONS AND THEIR ROLES IN
THE FINANCIAL CYCLE (1 OF 2)
Table 1.2 Financial Institutions and Their Roles in the Financial
Cycle
Institution Source of Money Use of Money
Banks and Credit Unions Deposits (savings) Loans to people and businesses
Examples: Wells Fargo,
SunTrust
Insurance Companies Premiums and investment Invests mostly in bonds and some
Examples: Liberty Mutual, earnings stocks, using the investment income
Allstate to pay claims
Mutual Funds People’s investments Buys stocks, bonds, and other
Examples: Vanguard, (savings) financial instruments on behalf of its
Fidelity investors
Pension Funds Retirement savings Similar to mutual funds, except with
Examples: CalPERS, REST contributed through the the purpose of providing retirement
workplace income
FINANCIAL INSTITUTIONS AND THEIR ROLES IN
THE FINANCIAL CYCLE (2 OF 2)
Table 1.2 [Continued]
Institution Source of Money Use of Money
Hedge Funds Investments by Invests in any kind of investment
Examples: Bridgewater, wealthy individuals and in an attempt to maximize returns
Citadel endowments
Venture Capital Funds Investments by Invests in start-up, entrepreneurial
Examples: Kleiner Perkins, wealthy individuals and firms
Sequoia Capital endowments
Private Equity Funds Investments by Purchases whole companies by
Examples: TPG Capital, wealthy individuals and using a small amount of equity
KKR endowments and borrowing the rest
1.6 FINANCIAL INSTITUTIONS (5 OF 5)
​Role of Financial Institutions
• Financial institutions:
• Move funds from savers to borrowers
• Move funds through time
• Help spread out risk-bearing
CHAPTER OUTLINE
2.1 Firms’ Disclosure of Financial Information
2.2 The Balance Sheet
2.3 The Income Statement
2.4 The Statement of Cash Flows
2.5 Other Financial Statement Information
2.6 Financial Statement Analysis
2.7 Financial Reporting in Practice
2.2 THE BALANCE SHEET (1 OF 11)
​Also called “Statement of Financial Position”
​Lists the firm’s assets and liabilities
​Provides a snapshot of the firm’s financial position at a given point in time
2.2 THE BALANCE SHEET (2 OF 11)
​The Balance Sheet Identity
• The two sides of the balance sheet must balance
The Balance Sheet Identity
Assets = Liabilities + Stockholders’ Equity
2.2 THE BALANCE SHEET (3 OF 11)
​Current Assets
• Cash and other marketable securities
• Short-term, low-risk investments
• Easily sold and converted to cash
• Accounts receivable
• Amounts owed to the firm by customers who have purchased on
credit
• Inventories
• Raw materials, work-in-progress and finished goods
• Other current assets
• Catch all category that includes items such as prepaid expenses
2.2 THE BALANCE SHEET (4 OF 11)
​Long-Term Assets
• Assets that produce tangible benefits for more than one year
• Recorded value reduced through a yearly deduction called depreciation
according to a schedule that depends on an asset’s life span
• Depreciation is not an actual cash expense, but a way of recognizing that fixed
assets wear out and become less valuable as they get older
2.2 THE BALANCE SHEET (5 OF 11)
​Long-Term Assets
• The book value of an asset is its acquisition cost less its accumulated
depreciation
• Other long-term assets can include such items as property not used in business
operations, start-up costs in connection with a new business, trademarks and
patents, and property held for sale
2.2 THE BALANCE SHEET (6 OF 11)
​Liabilities
• Current Liabilities
• Accounts payable
• The amounts owed to suppliers purchases made on credit
• Notes payable and short-term debt
• Loans that must be repaid in the next year
• Repayment of long-term debt that will occur within the next year
• Accrual items
• Items such as salary or taxes that are owed but have not yet been paid, and deferred or
unearned revenue
2.2 THE BALANCE SHEET (7 OF 11)
​Liabilities
• Net working capital
• The capital available in the short term to run the business:

Net Working Capital = Current Assets − Current Liabilities

2.2 THE BALANCE SHEET (8 OF 11)
​Liabilities
• Long-Term Liabilities
• Long-term debt
• A loan or debt obligation maturing in more than a year
2.2 THE BALANCE SHEET (9 OF 11)
​Stockholders’ Equity
• Market Value Versus Book Value
• Book value of equity
• Net worth from an accounting perspective
• Assets – Liabilities = Equity
• True value of assets may be different from book value
• Market capitalization
• Market price per share times number of shares
• Does not depend on historical cost of assets
2.2 THE BALANCE SHEET (10 OF 11)
​Market to Book Ratio
• The ratio of a firm’s market capitalization to the book value of
stockholders’ equity:

• Also called Price-to-Book (P/B) ratio

• Sometimes used to classify firms as value stocks (low M/B) or
growth stocks (high M/B)
FIGURE 2.1 MARKET-TO-BOOK RATIOS IN 2016
This figure presents market-to-book ratios of different firms and groups of firms
in 2016. Firms that might be classified as value stocks (low market-to-book
ratios) are in red and those that might be classified as growth stocks (high
market-to-book ratios) are in blue.
2.2 THE BALANCE SHEET (11 OF 11)
​Enterprise Value
• The value of the underlying business assets, unencumbered by
debt and separate from any cash and marketable securities
Enterprise Value = Market Value of Equity + Debt − Cash
2.3 THE INCOME STATEMENT (1 OF 4)
​The income statement lists the firm’s revenues and expenses over a period of
time
• Sometimes called the profit and loss or “P&L” statement
​The  last or “bottom” line of the income statement shows net income
• A measure of its profitability  during the period
• Also referred to as the firm’s earnings
2.3 THE INCOME STATEMENT (2 OF 4)
​Earnings Calculations
• Gross Profit
• Revenues (Net Sales) - Cost of Sales = Gross Profit
• Operating Expenses
• Gross Profit − Operating Expenses = Operating Income
• Earnings Before Interest and Taxes (EBIT)
• Operating Income +/ − Other Income = Earnings Before Interest and Taxes
• Pretax and Net Income
• EBIT +/ − Interest Income (Expense) = Pretax Income
• Pretax Income − Taxes = Net Income
2.3 THE INCOME STATEMENT (3 OF 4)
​Earnings Per Share
• Net income reported on a per-share basis
2.3 THE INCOME STATEMENT (4 OF 4)
​Earnings Per Share
• Fully diluted EPS increases number of shares by:
• Stock options issued to employees
• The right to buy a certain number of shares by a specific date at a specific price
• Shares issued due to conversion of convertible bonds
• Convertible bonds are corporate bonds with a provision that gives the bondholder an
option to convert each bond into a fixed number of shares of common stock
2.5 INCOME STATEMENT ANALYSIS
​EBITDA
• Financial analysts often compute a firm’s earnings before interest, taxes,
depreciation, and amortization, or EBITDA
• Because depreciation and amortization are not cash flows, this subtotal reflects
the cash a firm has earned from operations
2.6 THE STATEMENT OF CASH FLOWS (1 OF 9)
​The firm’s statement of cash flows uses the information from the income
statement and balance sheet to determine, during a set period:
• How much cash the firm has generated
• How that cash has been allocated
​Cash is important because it is needed to pay bills and maintain operations
and is the source of any return of investment for investors
2.6 THE STATEMENT OF CASH FLOWS (2 OF 9)
​The statement of cash flows is divided into three sections which roughly
correspond to the three major jobs of the financial manager:
1. Operating activities
2. Investment activities
3. Financing activities
2.6 THE STATEMENT OF CASH FLOWS (3 OF 9)
​Operating Activity
• Use the following guidelines to adjust for changes in working capital:
• Accounts receivable:
• Adjust the cash flows by deducting the increases in accounts receivable
• This increase represents additional lending by the firm to its customers and it reduces
the cash available to the firm
2.6 THE STATEMENT OF CASH FLOWS (4 OF 9)
​Operating Activity
• Accounts payable:
• Similarly, we add increases in accounts payable
• Accounts payable represents borrowing by the firm from its suppliers
• This borrowing increases the cash available to the firm
2.6 THE STATEMENT OF CASH FLOWS (5 OF 9)
​Operating Activity
• Inventory:
• Finally, we deduct increases to inventory
• Increases to inventory are not recorded as an expense and do not contribute to net
income
• However, the cost of increasing inventory is a cash expense for the firm and must be
deducted
• We also add depreciation to net income, since it is not a cash outflow
2.6 THE STATEMENT OF CASH FLOWS (6 OF 9)
​Investment Activity
• Subtract the actual capital expenditure that the firm made
• Also deduct other assets purchased or investments made by the firm, such as
acquisitions
2.6 THE STATEMENT OF CASH FLOWS (7 OF 9)
​Financing Activity
• The last section of the statement of cash flows shows the cash flows from
financing activities
• Dividends paid
• Cash received from sale of stock or spent repurchasing its own stock
• Changes to short-term and long-term borrowing
2.6 THE STATEMENT OF CASH FLOWS (8 OF 9)
​Financing Activity
• Payout Ratio and Retained Earnings
Retained Earnings = Net Income − Dividends
2.6 THE STATEMENT OF CASH FLOWS (9 OF 9)
​The last line of the Statement of Cash Flows combines the cash flows from
these three activities to calculate the overall change in the firm’s cash
balance over the time period of the statement
2.6 FINANCIAL STATEMENT ANALYSIS (1 OF 24)
​Investors often use accounting statements to:
• Compare the firm with itself by analyzing how the firm has changed over time
• Compare the firm to other similar firms using a common set of financial ratios
2.6 FINANCIAL STATEMENT ANALYSIS (2 OF 24)
​Profitability Ratios
• Gross Margin
• How much a company earns from each dollar of sales after paying
for the items sold
2.6 FINANCIAL STATEMENT ANALYSIS (3 OF 24)
​Profitability Ratios
• Operating Margin
• How much a company earns before interest and taxes from each
dollar of sales
2.6 FINANCIAL STATEMENT ANALYSIS (4 OF 24)
​Profitability Ratios
• Net Profit Margin
• The fraction of each dollar in revenues that is available to equity
holders after the firm pays its expenses, interest, and taxes
2.6 FINANCIAL STATEMENT ANALYSIS (5 OF 24)
​Liquidity Ratios
• Current Ratio
• The ratio of current assets to current liabilities
2.6 FINANCIAL STATEMENT ANALYSIS (6 OF 24)
​Liquidity Ratios
• Quick Ratio
• The ratio of only cash and “near cash” assets to current liabilities
2.6 FINANCIAL STATEMENT ANALYSIS (7 OF 24)
​Liquidity Ratios
• Cash Ratio
• The most stringent liquidity ratio:
2.6 FINANCIAL STATEMENT ANALYSIS (8 OF 24)
​Asset Efficiency
• Asset Turnover
• A first broad measure of efficiency
2.6 FINANCIAL STATEMENT ANALYSIS (9 OF 24)
​Asset Efficiency
• Fixed Asset Turnover
• Since total assets include assets that are not directly involved in
generating sales, a manager might also look at fixed asset turnover
2.6 FINANCIAL STATEMENT
ANALYSIS (10 OF 24)
​Working Capital Ratios
• Accounts Receivable Days
• The firm’s accounts receivable in terms of the number of days’
worth of sales that it represents
2.6 FINANCIAL STATEMENT
ANALYSIS (11 OF 24)
​Working Capital Ratios
• Inventory Days and Inventory Turnover
• Inventory Days is the number of days’ cost of goods sold
represented by inventory
• Inventory Turnover tells how efficiently a company turns its
inventory into sales
 2.6 FINANCIAL STATEMENT
ANALYSIS (12 OF 24)

​Interest Coverage Ratios

• Also known as times interest earned (TIE)
• TIE = Earnings divided by interest
• Can define earnings as operating income, EBIT, or EBITDA
• Assesses how easily a firm is able to cover its interest payments
2.6 FINANCIAL STATEMENT
ANALYSIS (13 OF 24)
​Leverage Ratios
• Debt-Equity Ratio
• The debt-equity ratio is a common ratio used to assess a firm’s
leverage

 This ratio can be calculated using book or market values

2.6 FINANCIAL STATEMENT
ANALYSIS (14 OF 24)
​Leverage Ratios
• Debt-to-Capital Ratio
• The debt-to-capital ratio calculates the fraction of the firm
financed by debt:

• This ratio can also be calculated using book or market values

2.6 FINANCIAL STATEMENT
ANALYSIS (15 OF 24)
​Leverage Ratios
• Net Debt
• While leverage increases risk to equity holders, firms may also
hold cash reserves in order to reduce risk
• Another useful measure is net debt
2.6 FINANCIAL STATEMENT
ANALYSIS (16 OF 24)
​Leverage Ratios
• Debt-to-Enterprise Value Ratio
 2.6 FINANCIAL STATEMENT
ANALYSIS (17 OF 24)

​Leverage Ratios
• Equity Multiplier
• Total Assets/Book Value of Equity
2.6 FINANCIAL STATEMENT
ANALYSIS (18 OF 24)
​Valuation Ratios
• Analysts and investors use a number of ratios to gauge the
market value of the firm
• The most important is the firm’s price-earnings ratio (P/E)
• The P/E ratio is often used to assess whether a stock is over- or
under-valued based on the idea that the value of a stock should be
proportional to the earnings it can generate
 2.6 FINANCIAL STATEMENT
ANALYSIS (19 OF 24)

​Valuation Ratios
• P/E ratios can vary widely across industries and tend to be higher for industries
with higher growth rates
• P/E to Growth (PEG) Ratio
• One way to capture the idea that a higher P/E ratio can be justified by higher
expected earnings growth
• It is the ratio of the firm’s P/E to its expected earnings growth rate
• The higher the PEG ratio, the higher the price relative to growth, so some investors
avoid companies with PEG ratios over 1
2.6 FINANCIAL STATEMENT
ANALYSIS (20 OF 24)
​Operating Returns
• Return on Equity
• Evaluating the firm’s return on investment by comparing its
income to its investment
2.6 FINANCIAL STATEMENT
ANALYSIS (21 OF 24)
​Operating Returns
• Return on Assets
• Evaluating the firm’s return on investment by comparing its
income to its assets
2.6 FINANCIAL STATEMENT
ANALYSIS (22 OF 24)
​Operating Returns
• Return on Invested Capital
• After-tax profit generated by the business, excluding interest,
compared to capital raised that has already been deployed
2.6 FINANCIAL STATEMENT
ANALYSIS (23 OF 24)
​The DuPont Identity
• This expression says that ROE can be thought of as net income
per dollar of sales (profit margin) times the amount of sales per
dollar of equity
2.6 FINANCIAL STATEMENT
ANALYSIS (24 OF 24)
​The DuPont Identity
• This final expression says that ROE is equal to
• Net income per dollar of sales (profit margin) times
• Sales per dollar of assets (asset turnover) times
• Assets per dollar of equity (equity multiplier)
EXAMPLE 2.8 DUPONT ANALYSIS (1 OF 4)
Problem
​The following table contains information about Walmart (WMT)
and Nordstrom (JWN). Compute their respective ROEs and then
determine how much Walmart would need to increase its profit
margin in order to match Nordstrom’s ROE.

blank Profit Margin Asset Turnover Equity Multiplier

Walmart 3.6% 2.3 2.7
Nordstrom 6.1% 1.5 4.2
EXAMPLE 2.8 DUPONT ANALYSIS (2 OF 4)
Solution
Plan and Organize
​The table contains all the relevant information to use the DuPont Identity to
compute the ROE. We can compute the ROE of each company by multiplying
together its profit margin, asset turnover, and equity multiplier. In order to
determine how much Walmart would need to increase its profit margin to match
Nordstrom’s ROE, we can set Walmart’s ROE equal to Nordstrom’s, keep its
turnover and equity multiplier fixed, and solve for the profit margin.
EXAMPLE 2.8 DUPONT ANALYSIS (3 OF 4)
Execute
Using the DuPont Identity, we have:
ROEWMT = 3.6% × 2.3 × 2.7 = 22.4%
ROEJWN = 6.1% × 1.5 × 4.2 = 38.4%
Now, using Nordstrom’s ROE, but Walmart’s asset turnover and
equity multiplier, we can solve for the profit margin that Walmart
needs to achieve Nordstrom’s ROE:
38.4% = Margin × 2.3 × 2.7
EXAMPLE 2.8 DUPONT ANALYSIS (4 OF 4)

Evaluate
​Walmart would have to increase its profit margin from 3.6% to 6.2% in order
to match Nordstrom’s ROE. It would be able to achieve Nordstrom’s ROE
with much lower leverage and around the same profit margin as Nordstrom
(6.2% vs. 6.1%) because of its higher turnover.
 INSTITUT FOR ØKONOMI
AARHUS UNIVERSITET

INSTITUT FOR CHRISTOFFER THIMSEN

ØKONOMIAARHUS UNIVERSITET 22. SEPTEMBER 2020 POST DOC