Corporate Finance For Dummies

Get a handle on one of the most powerful forces in the world today with this straightforward, no-jargon guide to corporate finance

A firm grasp of the fundamentals of corporate finance can help explain and predict the behavior of businesses and businesspeople. And, with the right help from us, it’s not that hard to learn!

In Corporate Finance For Dummies, an expert finance professor with experience in everything from small business to large, public corporations walks you through the basics of the subject. You’ll find out how to read corporate financial statements, manage risks and investments, understand mergers and acquisitions, and value corporate assets.

In this book, you will also:

• Get a plain-English introduction to the financial concepts, instruments, definitions, and strategies that govern corporate finance
• Learn how to value a wide variety of instruments, from physical assets to intangible property, bonds, equities, and derivatives
• Explore the intricacies of financial statements, including the balance sheet, income statement, and statement of cash flows

Perfect for students in introductory corporate finance classes looking for an easy-to-follow supplementary resource, Corporate Finance For Dummies, delivers intuitive instruction combined with real-world examples that will give you the head start you need to get a grip on everything from the cost of capital to debt analytics, corporate bonds, derivatives, and more.

Michael Taillard, PhD, MBA, is an economic consultant and professor of finance. His financial experience ranges from nonprofits to large corporations and even to small business owners. He is an often-published author, and he wrote the previous edition of Corporate Finance For Dummies. In his free time, Michael enjoys kayaking!

Introduction 1

About This Book 1

Foolish Assumptions 2

Icons Used in This Book 3

New to this Edition 4

Beyond the Book 4

Where to Go from Here 4

Part 1: What’s Unique about Corporate Finance 5

Chapter 1: The Tale of Corporate Finance 7

Telling a Story with Numbers 7

Characterizing Motivations 10

The role of financial institutions 11

Defining investing 11

Setting the Stage 12

Chapter 2: Introducing Finance Land 15

Visiting the Main Attractions in Finance Land 15

Corporations 16

Depository institutions 17

Insurance companies 18

Securities firms 20

Underwriters 21

Funds 22

Financing institutions 23

Exchanges 25

Regulatory bodies 25

Federal Reserve and U.S Treasury 26

Getting a Job in Finance Land 28

Accounts payable and/or receivable 28

HR and payroll 29

Analysts 29

Auditors 29

Adjusters 29

Bookkeepers and accountants 29

Modelers and scientists 30

Economists and consultants 30

Traders 30

Treasurers 30

Bankers and more 31

Visiting the Finance Land Information Center 31

Internet sources 31

Print sources 32

Human sources 33

Chapter 3: Pitching Your Story for Money 35

Raising Capital 35

Diving into Debt 36

Asking the right people for money 37

Making sure the loan pays off in the long run 38

Looking at loan terms 39

Schmoozing Investors 40

Selling stock to the public 40

Looking at the different types of stock 42

Having Your Wish Granted 43

Part 2: Making a Statement 45

Chapter 4: Staying Balanced 47

Introducing the Balance Sheet 47

Evaluating the Weights on the Balance Scale 48

Understanding Assets 49

Current assets 49

Long-term assets 51

Intangible assets 53

Other assets 54

Learning about Liabilities 54

Current liabilities 54

Long-term liabilities 56

Eyeing Owners’ Equity 56

Preferred shares 56

Common shares 57

Treasury shares 57

Additional paid-in capital 57

Retained earnings 58

Finding Financial Zen 58

Chapter 5: Incoming Income 59

Adding It Up 59

Gross profit 60

Operating income 62

Earnings before interest and taxes (EBIT). 63

Net income 64

Earnings per share 65

Supplemental notes 66

Putting the Income Statement to Good Use 66

Chapter 6: Going with the (Cash) Flow 67

Moving Along Three Smooth Flows 67

Operating cash flows 68

Investing cash flows 69

Financing cash flows 70

Combining the three types of operations to get the net change in cash 71

Reaching Your Destination 72

Chapter 7: Mastering Metrics 75

Paying the Bills 75

Days sales in receivables 76

Accounts receivables turnover 77

Accounts receivables turnover in days 78

Days sales in inventory 78

Inventory turnover 79

Inventory turnover in days 80

Operating cycle 80

Working capital 81

Current ratio 82

Acid test ratio (aka Quick Ratio). 82

Cash ratio 83

Sales to working capital 83

Operating cash flows to current maturities 84

Working Your Assets 85

Net profit margin 85

Total asset turnover 86

Return on assets 86

Operating income margin 87

Operating asset turnover 88

Return on operating assets 88

Return on total equity 89

Return on common equity 89

DuPont equation 90

Fixed asset turnover 91

Return on investment 91

Gross profit margin 92

Operating ratio 93

Percent earned on operating property 93

Operating revenue to operating property ratio 94

Long-term debt to operating property ratio 95

Chapter 8: Calculating Capital 97

Sizing Up Shareholders 97

Financial leverage 98

Earnings per common share 98

Operating cash flows per share 99

Price to earnings ratio 100

Percentage of earnings retained 101

Dividend payout 102

Dividend yield 102

Book value per share 103

Cash dividend coverage ratio 104

Banking on Metrics 104

Earning assets to total assets ratio 105

Net interest margin 105

Loan loss coverage ratio 106

Equity to total assets ratio 107

Deposits times capital 107

Loans to deposits ratio 108

Keeping Debt Healthy 109

Times interest earned 109

Fixed charge coverage 110

Debt ratio 110

Debt to equity ratio 111

Debt to tangible net worth 111

Operating cash flows to total debt 112

Equity multiplier 113

Part 3: Valuations on the Price Tags of Business 115

Chapter 9: Determining Present and Future Values: Time Is Money 117

Losing Value over Time 118

Inflation 118

Interest rates 119

Predicting Future Value 120

Simple interest 120

Compound interest 121

Calculating the Present Value 121

A closer look at earnings 122

Discounted cash flows 123

Chapter 10: Calling in the Cavalry 125

Budgeting Capital 126

Rating Your Returns 127

Looking at costs 128

Calculating revenue 128

Calculating the accounting rate of return 128

Making the most of the internal rate of return through modification 130

Netting Present Values 132

Calculating NPV over time 132

Managing the project’s value 133

Paying It Back 134

Allocating Capital 134

Calculating the equivalent annual cost 135

Considering liquid assets 136

Managing Projects 137

Value schedule metrics 137

Budget metrics 139

Chapter 11: Bonding Over Business 143

Exploring the Different Types of Bonds 143

Considering corporate bonds 144

Gauging government bonds 144

Clipping coupon bonds 147

Backing up with assets 147

Converting bonds 148

Calling it in with callable bonds 149

Putting in the effort: puttable bonds 149

Registering the bearer 150

Counting on forgiveness with catastrophe bonds 150

Junking bad bonds 150

Reviewing Bond Rates 151

Reading Bond Information 153

Understanding Bond Valuation 156

Chapter 12: Savvy Stock Sales 159

Exchanging Stocks 159

Looking at the Different Types of Orders 160

Market order 161

Stop and limit orders 161

Pegged order 162

Time-contingent order 163

Comparing Long and Short Stocks 163

Buying long 163

Buying on margin 164

Selling short 164

Defining Caps and Sectors 165

Caps 165

Sectors 166

Raging Bulls and Grizzly Bears 167

Beating Stock Indices?. .168

Imagining the Value of Stocks 168

Surveying equity valuation models 169

Checking out corporate analysis 170

Evaluating industry performance 170

Factoring in stock market fluctuations 171

Considering macroeconomics 171

Chapter 13: Pricing Probability from Derived Value 173

Deriving Value 173

Keeping Your Options Open 174

Choosing between put and call 175

Valuing an option 176

Paying It Forward 177

Agreeing to forward 177

Valuing a forward 178

Standardizing the Future 179

Predicting futures 179

Valuing futures 180

Swapping Numbers 180

Managing risk with swaps 181

Generating revenue with swaps 182

Valuing a swap 182

Part 4: A Wonderland of Risk Management 183

Chapter 14: Managing Uncertainty 185

Understanding that Risk Is Unavoidable 185

Risking Your Interest with Inflation 186

Minimizing Market Risk 187

Giving Credit Where It’s Due 188

Getting Shady with Off-Balance-Sheet Risk 190

Factoring in Foreign Exchange Risk 190

Transaction risk 191

Translation risk 191

Other foreign exchange risk 192

Identifying Operating Risk 193

Looking at Liquidity Risk 194

Sorting Your Customer’s Laundry 195

Chapter 15: Through the Looking Glass of Modern Portfolio Theory 197

Delving into Portfolio Basics 198

Surveying portfolio management strategies 198

Looking at modern portfolio theory 199

Understanding passive versus active management 200

Joking about Market Efficiency 200

Risking Returns 202

Looking at the trade-off between risk and return 202

Diversifying to maximize returns and minimize risk 203

Considering risk aversion 205

Measuring risk 208

Optimizing Portfolio Risk 212

Reaching the efficient frontier 213

Innovating risk management 214

Chapter 16: Financially Engineering Yourself Deeper Down the Rabbit Hole 217

Making Securities Out of Anything 218

You can securitize everything 218

Slicing securities into tranches 219

Splicing Hybrids 220

The mixed-interest class of hybrids 220

Single asset class hybrids 221

Indexed-back CDs 222

Bundling Assets 222

Pass-through certificates 223

Multi-asset bundles 223

Unbundling 224

Exploring Exotics 224

Options 225

Swaps contracts 225

Loans 226

Engineering Finances 226

Moving into Computational Finance 228

Changing the face of trading 229

Banking from beyond 230

Building quantitative algorithms 230

Chapter 17: Weighing Capital 233

Calculating the Cost of Capital 233

Measuring cost of capital, the WACC way 235

Factoring in the cost of debt 235

Looking at the cost of equity 236

Dividend policy 237

Choosing the Proper Capital Structure 240

Part 5: Financial Management 243

Chapter 18: Assessing Financial Performance 245

Analyzing Financial Success 245

Using Common-Size Comparisons 246

Vertical common-size comparisons 247

Horizontal common-size comparisons 248

Cross comparisons 250

Performing Comparatives 252

Comparison over time 252

Comparison against the industry 254

Determining the Quality of Earnings 256

Accounting concerns 256

Sources of cash flows 258

Assessing Investment Performance 260

Conventional evaluations 260

Chapter 19: Forecasting Finances 263

Seeing with Analytical Eyes 264

Collecting data 264

Finding an average 266

Measuring distribution 267

Calculating probability 269

Viewing the Past as New 270

Finding trends and patterns 271

Looking at regression 272

Seeing the Future Unclouded: Forecasting 274

Using statistics and probability 274

Using reference class forecasting 276

Evaluating forecast performance 276

Chapter 20: Getting the Deets on M&A 277

Dissecting M&A 277

Diversification 279

Geographic expansion 280

Economies of scale 280

Economies of scope 281

Vertical integration 281

Horizontal integration 282

Conglomerate integration 282

Elimination of competitors 282

Manager compensation 283

Synergistic operations 283

Moving Beyond the M and the A 284

Mergers 284

Acquisitions 285

Buyouts 287

Factoring 287

Joint ventures 288

Partnerships 288

Licensing agreements 288

Hostile takeovers 288

Divesting Is Investing 289

Measuring What a Business Is Worth to You 290

Future cash flows 291

Control premiums 291

Company worth by comparison 292

Cash-flow evaluation 292

Measures of market share 293

Financing M&A 293

Part 6: The Part of Tens 295

Chapter 21: Ten Things You Need to Know about International Finance 297

There’s No Such Thing as a Trade Imbalance 298

Purchasing Power and Exchange Rates Are Different Things 300

Interest Rates and Exchange Rates Have a Muddled Relationship 300

Spot Rate Isn’t the Only Type of Currency Transaction 302

Diversification Can’t Completely Eliminate Risk Exposure 303

Cross-Listing Allows Companies to Tap the World’s Resources 304

Outsourcing Is a Taxing Issue 306

Politics Complicate Your Life 307

Cultural Understanding Is Vital 309

Cryptocurrencies Come with Risk 310

Chapter 22: Ten Things You Need to Understand about Behavioral Finance 313

Making Financial Decisions Is Never Rational 314

Being Irrational Can Be Entirely Rational 315

Framing Affects Your Decision-Making Prowess 316

Making Sound Financial Decisions Involves Identifying Logical Fallacies 317

Getting Emotional about Financial Decisions Can Leave You Crying 318

Financial Stampeding Can Get You Trampled 319

Letting Relationships Influence Finances Can Be Ruinous 320

Satisficing Is Good Enough 321

Prospect Theory Explains the Improbable 322

Being Biased Is Human Nature 323

Index 325

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