Chapter Fifteen

2. McGraw-Hill/Irwin Introduction to Business © 2007 The McGraw-Hill Companies, Inc., All Rights Reserved. Chapter Fifteen Finance: Balancing Risk and Return to Increase Profitability

3. Learning Objectives • Appreciate the crucial relationship between risk and return and the way it affects all business finance decisions. • Understand short-term capital management and the tools managers use to increase the rate of return on capital. • Understand long-term capital management and the tools used to manage it, like net present value and breakeven analysis.

4. Learning Objectives • Describe four different methods companies can use to finance capital investments. • Differentiate between the roles debt and equity securities play in financial decision making.

5. What is Finance? • Finance • the set of activities people and companies engage in to decide how to invest their capital so that it generates more cash, profit, and wealth

6. The Relationship Between Risk and Return Value of the Asset Now – Value at Time of Purchase X 100 Value of the Asset at Time of Purchase

7. Question? What is the extra reward investors demand for bearing the additional risks associated with a speculative investment? • Speculation • Bond portfolio • Risk premium • Risk leverage

8. The Relationship Between Risk and Return • Risk premium • the extra reward investors demand for bearing the additional risks associated with a speculative investment

9. Business Finance • The role of business finance is to ensure that the methods a company uses to borrow, invest, spend, and even lend capital lead to a rate of return that maximizes the present market value of its stock

10. The Cycle of Profit Figure 15.1

11. Four Ways to Use Capital Figure 15.2

12. Capital Investment and Budgeting • Capital investment and budgeting • the development of a financial plan and budget to manage and invest capital so that it leads to the highest return on invested capital that can be obtained

13. Short-Term Capital Management Decisions • Short-term capital management • the financial decisions involved when a company purchases resources to make products that will be sold within a one-year period

14. Managing the Short-Term Operating Cycle Figure 15.3

15. Long-Term Capital Budgeting Decisions • Long-term capital budgeting • the financial decisions involved when a company chooses how to invest capital for extended periods of time

16. Long-Term Capital Budgeting Decisions • Net present value analysis • the financial analysis needed to determine the true rate of return of a proposed capital investment • tells a manager how much a long-term project would earn in today’s dollars

17. Long-Term Capital Budgeting Decisions • Breakeven point • the sales level that just covers all of a project’s costs but where no profit is earned • Variable costs • costs that are only incurred when the firm makes and sells products

18. Breakeven Analysis Figure 15.4

19. Long-Term Capital Budgeting Decisions • Capital budget • a set of rules for allocating funds to the different functions of a firm to achieve a predetermined rate of return on its investment

20. Breakeven Analysis and Inventory Turnover Figure 15.4

21. A Company as a Portfolio of Investments • Brand manager • a manager responsible for managing a brand-name product

22. Capital Financing • Capital financing • the development of a financial plan to allow a company to obtain the money it needs to fund its activities at the lowest possible cost

23. Short-Term Financing Methods • Cash reserves • Unsecured and secured loans • Accounts receivable financing • Commercial paper

24. Question? What is a loan not backed by valuable assets pledged to guarantee the loan will be paid back? • Secured loan • Unsecured loan • Line of credit • Commercial paper

25. Short-Term Financing Methods • Unsecured loan • a loan not backed by valuable assets pledged to guarantee the loan will be paid back • Line of credit • a short-term unsecured loan a company can draw against as its accounts payable become due

26. Short-Term Financing Methods • Secured loan • a loan backed by valuable fixed or current assets • Commercial paper • short-term, unsecured debts or notes issued at a certain rate of interest for up to nine months

27. Long-Term Financing Methods • Leverage • the ability to use borrowed capital in ways that have the potential to lead to high rates of return

28. Methods of Obtaining New Capital Figure 15.6

29. Long-Term Financing Methods • Hedge funds • mutual funds that use highly leveraged investments to try to rapidly increase investors’ capital returns

30. Long-Term Financing Methods • Principal • the amount of money originally borrowed • Capital structure • the balance between the amount of capital a company raises through debt and the amount it raises through equity

31. Debt Securities: Bonds • Debt securities • investment documents that provide evidence of a company’s legal obligation to repay within a certain period of time the money it borrows and make regular interest payments on that money in the meantime

32. Debt Securities: Bonds • Bonds • common types of debt securities issued by a company for a period of more than one year Find out how to buy bonds at eHow.com

33. Debt Securities: Bonds • Call provision • a company’s legal right to buy its bonds back early from bondholders to avoid high interest-rate payments

34. Debt Securities: Bonds • Current yield • a financial measure of a bond’s current rate of return • obtained by dividing the bond’s original interest rate by its current closing price

35. How to Read a Corporate Bond Table Figure 15.7

36. Equity Securities: Stocks • Equity securities • the capital stock certificates a company issues giving shareholders the legal right to its assets and dividends from its profits

37. Equity Securities: Stocks • Initial public offering • the first time the owners of a company’s stock offer it for sale to the general public

38. Types of Stock • Blue-chip • Growth • Income • Speculative

39. Equity Securities: Stocks • Price-to-earnings ratio • a way of valuing a stock by dividing its closing price by its annual earnings per share

40. Non-Operations Investing and Financing • Treasury stock • stock a company buys back from the public and becomes part of stockholders’ equity on the firm’s balance sheet

41. Video: Jack Welch • Several questions are asked of Jack Welch who at the time of this interview had recently authored his book, “Winning.” • What is the best thing about being a manager, according to Welch?