## Topic outline

- General
- Course Introduction
In BUS103: Financial Accounting, we learned that firms are required to keep detailed financial records so that organized reports can be distributed to managers, shareholders, and government regulators. Principles of Finance will focus on what these managers, investors, and government agencies do with this information. It is an introductory course to various fields of finance and is comparable in content to courses that other institutions label as "corporate finance" or "financial management".

Finance is a broad term; you will find that both managers that compile the financial reports we discussed in financial accounting and stockbrokers working on Wall Street will claim that they work in finance. So what exactly is finance? Finance is the science of fund management. It is distinct from accounting in that, whereas accounting aims at organizing and compiling past information, finance is geared towards deciding what to do with that information.

In this course, you will be exposed to a number of different sub-fields within finance. You will learn how to determine which projects have the best potential payoff, to manage investments, and even to value stocks. In the end, you will discover that all finance boils down to one concept: return. In essence, finance asks: "If I give you money today, how much money will I get back in the future?" Though the answer to this question will vary widely from case to case, by the time you finish this course, you will know how to find the answer.

You will learn how to use financial concepts such as the time value of money, pro forma financial statements, financial ratio analysis, capital budgeting analysis, capital structure, and the cost of capital. This course will also provide an introduction to bonds and stocks. Upon completion of this course, you will understand financial statements, cash flow, time value of money, stocks and bonds, capital budgeting, ratio analysis, and long term financing, and apply these concepts and skills in business decisions.

- Unit 1: Introduction To Finance, Financial Statements, And Financial Analysis
As noted in the course introduction, finance is a broad subject and financial decisions are all around us. Whether you work on Wall Street or in a small company, finance is vital to every business. Therefore, understanding the fundamentals of finance is vital to your business education. This introductory unit addresses fundamental concepts of finance, stocks, and bonds. Also, Unit 1 exposes the importance of understanding ratios for financial statement analysis and analysis of cash flows. The main ratios explained are: solvency (or liquidity ratios), financial ratios, profitability ratios, and market value ratios. In addition, you will learn about financial growth, what financial factors determine growth, the importance of maintaining a sustainable growth rate, and how to use financial statement information to manage growth. Consider this situation: You are the manager of a small retail chain and your boss has given you the task of deciding whether to invest in a second store. You know that adding a second store means greater potential for growth. However, you also know that adding a new store will require spending cash. Facing this tough decision, how could you determine whether the company can "handle" such an investment? The answer might lie in ratio analysis. This section will explain how to use financial ratios to help you make these types of business decisions.

**Completing this unit should take you approximately 30 hours.** - 1.1: Introduction to Concepts in Finance
- 1.1.1: Ethics
We begin this course with an examination of the ethical considerations involved in finance. You will want to read carefully so that you can differentiate between ethics and morals. Be sure you can explain why it is important for individuals working in the financial sector to keep organizational, professional, and personal ethical behavior front-and-center.

- 1.1.2: Financial Decisions: Investment and Financing
As you read, ask yourself, "What criteria do corporations use to make financial decisions?" Investments and financing decisions boil down to how to spend money and how to borrow money. Two fundamental types of financial decisions are discussed in this section. First, investment involves capital assets that will provide the highest return over a specified time period. Second, financing refers to using own money or raising capital from external funding sources. By the end of this reading, you will be able to identify the criteria a corporation must use when making a financial decision.

- 1.1.3: BondsThis section discusses bonds. As you read, pay particular attention to how bonds work, the types of bonds that are used, and the function of the bond market. The application of bonds is particularly useful in the public sector when financing schools, municipal buildings, and real estate owned by non-profit organizations. Key takeaways in the discussion of bonds include: (1) the components of interest rates, (2) an understanding of the cost of money, (3) interest rate levels, and (4) term structure.
- The cost of money is the opportunity cost of holding money instead of investing it, depending on the interest rate. An interest rate is the rate at which interest is paid by a borrower for the use of money that they borrow from a lender. Market interest rates are mostly driven by inflationary expectations, alternative investments, risk of investment, and liquidity preference. Term structure of interest rates describes how interest rates change over time.
- A yield curve shows the relation between interest rate levels (or cost of borrowing) and the time to maturity. It also tells what investors' expectations for interest rates are and whether they believe the economy is going to be expanding or contracting. Three variables determine interest rates: inflation rate, GDP growth, and the real interest rate.
Par value is the amount of money a holder will get back once a bond matures; a bond can be sold at par, at premium, or discount. The coupon rate is the amount of interest that the bondholder will receive per payment, expressed as a percentage of the par value. Maturity date refers to the final payment date of a loan or other financial instrument. A callable bond allows the issuer to redeem the bond before the maturity date; this is likely to happen when interest rates go down. A sinking fund is a method by which an organization sets aside money to retire debts. Other important features of bonds include the yield, market price, and putability of a bond.

Bonds have some advantages over stocks, including relatively low volatility, high liquidity, legal protection, and a variety of term structures. However, bonds are subject to risks such as the interest rate risk, prepayment risk, credit risk, reinvestment risk, and liquidity risk.

- A bond is an instrument of indebtedness of the bond issuer to the holders. Duration is the weighted average of the times until fixed cash flows of a financial asset are received. A bond indenture is a legal contract issued to lenders that defines commitments and responsibilities of the seller and buyer. Bond credit rating agencies assess and report the credit worthiness of a corporation's or government's debt issues.
- A government bond is a bond issued by a national government denominated in the country's domestic currency. A zero-coupon bond is a bond with no coupon payments, bought at a price lower than its face value, with the face value repaid at the time of maturity. Floating rate bonds are bonds that have a variable coupon equal to a money market reference rate (e.g., LIBOR), plus a quoted spread. Other bonds include register vs. bearer bonds, convertible bonds, exchangeable bonds, asset-backed securities, and foreign currency bonds.
- Most individuals purchase bonds via a broker or through bond funds. By the end of this reading, you will be able to describe the process for purchasing a bond and explain why bond markets may not have price transparency.
- The value of a bond is obtained by discounting the bond's expected cash flows to the present using an appropriate discount rate. Yield to maturity is the discount rate at which the sum of all future cash flows from the bond are equal to the price of the bond. "Time to maturity" refers to the length of time before the par value of a bond must be returned to the bondholder. This reading will show you how to calculate a bond's yield to maturity and calculate the price of a bond.
Bondholders face several types of risk, including price risk, reinvestment risk, and default risk, among others. A bond's credit rating is a financial indicator assigned by credit rating agencies; bond ratings below BBB-/Baa are considered junk bonds.

- 1.1.4: Stock Valuation
Pay particular attention in this subunit to how stocks work, the types of stock, and how the stock market works.

- The stock of a company represents the original capital paid into the business by its founders and can be purchased in the form of shares. Shareholders have the right of preemption, meaning they have the first chance at buying newly issued shares of stock before the general public. By the end of this reading, you will be able to explain what it means to own stock and describe some of the rights of shareholders.
- By the end of this reading you will be able to define common stock and preferred stock and differentiate between these two types of stock.
This reading explains the rights of shareholders, depending on what kind of stock they own, including the right to claim income in the case of bankruptcy, voting rights, right to buy newly created shares, etc. This reading further differentiates preferred stock and common stock.

The actors in the stock market include individual retail investors, mutual funds, banks, insurance companies, hedge funds, and corporations. The world's largest stock exchange market is the New York Stock Exchange (NYSE), and the NASDAQ is an Ameriacn dealer-based stock market in which dealers sell electronically to investors or firms. By the end of this reading you will be able to differentiate among these stock markets and explain the purpose and function of a market index.

- Valuations rely heavily on the expected growth rate of a company; past growth rate of sales and income provide insight into future growth. A no-growth company would be expected to return high dividends under traditional finance theory. The portion of the earnings not paid to investors is, ideally, left for investment in order to provide for future earnings growth. By the end of this reading you will be able to explain how a stock is valued and describe the limitations of valuing a company with dividends that have a non-constant growth rate.
- Three approaches are commonly used in corporation valuation: the income approach, the asset-based approach, and the market approach. This reading will help you be able to differentiate between these three models.

- 1.1.5: Institutions, Markets, and Intermediaries
This section discusses the financial intermediary as an institution that facilitates the flow of funds between individuals or other economic entities. By the end of this reading, you will be able to discuss the purpose and types of financial institutions and identify the role that financial intermediaries play in the economy.

- 1.1.6: Securities
As you read this section, consider the question "How the Wall Street security markets actually work and why they need to be regulated?" Attention is given to how the security markets work and why they need to be regulated. Pay particular attention to the discussion about returns, market efficiency and how market regulation puts needed controls on the market.

This reading will introduce the types of stock market transactions, including IPOs, secondary market offerings, private placement, and stock repurchase. By the end of this reading, you will be able to differentiate between the different types of market organizations which facilitate trading securities: auction market, brokered market, and dealer market.

This reading will help you define and distinguish realized returns from unrealized returns. By the end of this reading, you will be able to calculate an investment's dollar return and percentage return. You will also be able to describe how historical and average returns can be used to predict future performance.

Behavior of an Efficient Market

The Efficient Market Hypothesis

Implications and Limitations of the Efficient Market Hypothesis

- This section discusses some of the most important legislation meant to regulate finance and protect stakeholders.

- 1.2: Corporate Finance and Corporate Structures
This video explains the definition of a stock and what individual investors obtain when they buy a share of a company's stock.

This video explains the definition of a bond and what individual investors obtain when they buy a corporate bond.

This video explains the difference between a stock and a bond.

- 1.2.1: Corporate Finance
This section discusses options and corporate finance. As you read, consider the question about "What are options? and, How is corporate finance used to grow businesses? " Pay particular attention to convertable securities, options, warrents, derivatives and managing risk with derivatives. Because these topics can be challenging to understand and master, if at any point in this course you need to refresh your understanding of the basics of various financial statements, come back to this section after you have reviewed the basics of financial statements. You might also consider testing your understanding of these concepts by taking the optional quiz included within this section.

This section discusses how a corporate bond is issued by a corporation to rise money in order to expand its business. Key takeaways from this discussion include the definition of a corporate bond, secured loan/debt, unsecured loan/debt, senior debt, and subordinated debt. By the end of this reading, you will be able to explain how an organization can finance their operations through bonds.

Convertible securities are convertible bonds or preferred stocks that pay regular interest and can be converted into shares of common stock. By the end of this reading, you will be able to identify the different features of convertible bonds and discuss the advantages and disadvantages of convertible bonds.

- Options give the owner the right, but not the obligation, to buy or sell an underlying asset or instrument. By the end of this reading, you will be able to describe the different factors that influence the value of an option and differentiate between the types of options.
- A warrant is a security that entitles the holder to buy the underlying stock of the issuing company at a fixed exercise price until the expiration date.
- A derivative is a financial instrument whose value is based on one or more underlying assets. By the end of this reading, you will be able to identify the uses of derivatives and differentiate between the different types of derivatives.
Derivatives allow risk related to the price of underlying assets, such as commodities, to be transferred from one party to another.

- 1.2.2: Liability of Principal and Agent
As you read this chapter, consider why contracts are important and how they work. Pay close attention to the following topics: liability in contract, principal criminal liability, and how agency relationships are terminated. By the end of this reading, you will be able to name the principal's liability in contracts, torts, and criminal law and the agent's personal liability in tort and contract, and how agency relationships are terminated. The relevance of legal issues presented in this section is integrally connected with business finance and how relationships are conducted in the business world.

- 1.2.3: Equity Finance
This section discusses how companies can use equity financing to raise capital, and/or increase shareholder liquidity (through an Initial Public Offering-IPO). By the end of this reading you will be able to explain the process of financing a firm through equity capital. For the aspiring business executive or student, it is critical to understand and be able to apply how businesses raise equity capital to expand their operations.

- 1.3: Financial Statements
This video introduces balance sheets. A balance sheet statement is an account of the value of assets, liabilities, and net worth of a company. It is always considered during a point in time, such as December 31, 2011. Assets are things that a company owns; whereas liabilities are things that a company owes. Assets minus liabilities results in the net worth of a company.

This video introduces balance sheets and equity.

This video introduces income statements. An income statement is an account of the revenues (net sales), costs, expenses, and taxes of a company during a period of time, say from December 31, 2011 to December 31, 2012. The goal of an income statement is to compute the net profits of a company and all the different items involved.

This video introduces cash accounting. An accountant, who is responsible for preparing financial statements, is concerned with accrual basis accounting; whereas, the financial analyst or manager is concerned with cash-basis accounting by keeping track of the real uses and sources of cash. Make sure you understand this difference.

This video introduces the accrual basis of accounting.

This video compares accrual and cash accounting.

This video discusses the relationship between balance sheets and income statements.

This video introduces cash flow statements.

- 1.3.1: Financial Statements, Taxes, and Cash Flow
The focus of this section is on financial statements, taxes and cash flow. Six key takeaways are presented that deal with (1) An introduction to financial statements, (2) Income statements, (3) The Balance sheet, (4) Tax considerations, (5) Statement of cash flows, and (6) Other statements. Please pay very close attention to this entire section because it lays the groundwork for the more practical applications of these concepts in adjoining sections of this course.

Defining the Financial Statement

Uses of the Financial Statement

Limitations of the Financial Statements

Elements of the Income Statement

Limitations of the Income Statement

Effects of GAAP on the Income Statement

Noncash Items

Assets

Liabilities and equity

Working Capital

Liquidity

Debt to Equity

Market Value vs. book Value

Limitations of the Balance sheet

Corporate Taxes

Tax Deductions

Depreciation

Individual Taxes

Cash Flow from Operations

Cash Flow from Investing

Cash Flow from Financing

Interpreting Overall Cash Flow

The Statement of Equity

Depreciation

Free Cash Flow

MVA and EVA

- 1.3.2: Analyzing Financial Statements
This section deals with analyzing financial statements, standardizing financial statements, overview of ratio analysis, profitability analysis, asset management ratios, liquidity ratios, debt management ratios, market value ratios, and the DuPont Equation. This section is presents key concepts that are vital to understanding the broader topic of coprorate finance and its applications in the real business world. If at any point in this section you need to refresh your understanding of the basics of various financial statements, come back to this section for a review. You might consider testing your understanding of these concepts by taking the optional quiz included within this section.

- Balance Sheets
Income Statements

Classification

Operating Margin

Profit Margin

Return on Total Assets

Basic Earning Power (BEP) Ratio

Return on Common Equity

Inventory Turnover Ratio

Day Sales Outstanding

Fixed Assets Turnover Ratio

Total Assets Turnover Ratio

Current Ratio

Quick Ratio (Acid-Test Ratio)

Total Debt to Total Assets

Times-Interest-Earned Ratio

Price/Earnings Ratio

Market/Book Ratio

The DuPont Equation

ROE and Potential Limitations

Assessing Internal Growth and Sustainability

Dividend Payments and Earnings Retention

Relationships between ROA, ROE, and Growth

Evaluating Financial Statements

Industry Comparisons

Benchmarking

Trend Analysis

Limitations of Financial Statement Analysis

Impact of Inflation on Financial Statement Analysis

Disinflation

Deflation

Discrepancies

Extraordinary Gains and Losses

- 1.3.3: Forecasting Financial Statements
Read this section and pay close attention to how forecasting is used in financial statements-particularly the income statement, balance sheet and the cash flow statements. What is the role of the three financial statements in a business? The answer is contained in this section. A major role of the financial manager is to forecast, plan, and assess possible future investment and financial decisions. This section also introduces what is involved in the managerial forecasting and decision making role. Topics in this section include the role of financial forecasting in planning, overview of forecasting, forecasting the income statement, forecasting the balance sheet, cash budgeting and analyzing forecasts. Managers and executives in the for-profit world and non-profit sectors use these financial forecasting tools on a regular basis to make decisions that affect their futures.

Strategic Planning

Additional Funds Needed (AFN)

Adjusting Capacity

Inputs

Steps Required to Forecast

Sales Forecast Input

Inputs to the Production Schedule

Inputs to COGS

Other Expenses

Pro Forma Income Statement

Pro Forma Balance Sheet

Balance Sheet Analysis

Receipts

Payments

The Forecast Budget

Ratio Analysis and EPS

Impacts of Forecasting on a Business

Regression Analysis for Forecast Improvement

Impact of Modifying Inputs on Business Operations

- 1.3.4: The Statement of Cash Flows
This section discusses four key concepts as follows: (1) Cash flows from operations, (2) Cash flows from investing, (3) Cash flows from financing,and (4) Interpreting overall cash flows. This section complements the Khan Academy videos that follow. Try to read this section and watch the videos during the same study session if possible. The managerial understanding of, and application of, these four cash flow concepts are vital to leading a successful organization.

Cash Flow from Operation

Cash Flow from Investing

Cash Flow from Financing

Interpreting Overall Cash Flow

- 1.4: Financial Ratios
This video discusses how to compute the P/E ratio and its significance.

This video discusses how to compute the P/E ratio and its significance.

This video discusses how to compute the P/E ratio and its significance.

An overview of the financial ratios is presented in this section. The manager or student may well ask the question "Why are financial ratios important to understanding the activities of the business?" This question is addressed in this section. Pay particular attention to the following topics: (1) Sources of financial ratios, (2) Purpose and types of ratios, (3) Accounting methods and principles, (4) Abbreviations and terminology, and (5) A summary of all ratios used to analyze financial statements. Try to commit to memory some of the basic formulas presented in this section.

This section presents financial ratios and their analysis. Why are financial ratios and their analysis important? To answer this question, you should pay particular attention to the firm's profitability, and allow comparisons between the firm and its industry. By the end of this reading, you will be able to summarize how an interested party would use financial ratios to analyze a company's financial statement.

Five key concepts are presented in this section. They are: (1) evaluating financial statements , (2) Industry comparisons, (3) Benchmarking, (4) Trend Analysis, and (5) Limitations of financial statements. Read this entire section because explanation is given how financial ratios are evaluated, compared, and benchmarked. These financial tools are used widely in the banking and credit industry to evaluate businesses that apply for credit. The banking decision to grant credit to a business is based on whether or not the analysis of the ratios demonstrates that the organization can repay the loan that they are requesting from the bank.

- 1.5: Pro Forma Financial Statements
Read this section that discusses the Pro Forma income statement. Pay close attention to the definition of Pro Forma statement because it is planned and prepared in advance of a transaction to project the future status of the company. By the end of this reading, you will be able to draft a pro forma income statement. Businesses in all industries use Pro Forma income statements to make managerial decisions that affect their sustainability.

This section discusses the Pro Forma balance sheet. The question concerning "Why should the Pro Forma Balance Sheet be used in a business?" is relevant as the economy changes. Possible uses of the Pro Forma balance sheet include mergers and acquisitions, warranties and negotiating a commercial lending relationship to support growth. A pro forma balance sheet summarizes the projected future status of a company after a planned transaction, based on the current financial statements. By the end of this reading, you will be able to prepare a pro forma balance sheet.

Read this section and pay close attention to the summary of pro- forma financial statements as follows: (1) the pro-forma income statement, (2) the pro-forma balance sheet,(3) assessment of pro-forma statements, (4) the bigger picture, and (5) end of chapter problems. Please attempt the practical exercises, at the end of this section, to check your understanding about the uses of pro-forma financial statements. Note: The images in this resource are broken. Per the publisher's website, the resource is in draft mode.

This section discusses financial modeling and proforma analysis. The five key takeaways include: (1) Introduction - financial goals and long-term planning, (2) Percent of sales method, (3) Forecasting a planned expansion, (4) The planned expansions value, and (5) Growth and firm value. Managers and executives use these financial tools regularly to make internal decisions and to present to external partners such as banks and investors.

- Topic 21
- Unit 2: Time Value Of Money: Future Value, Present Value, And Interest Rates
Suppose you have the option of receiving $100 dollars today vs. $200 in five years. Which option would you choose? How would you determine which is the better deal? Some of us would rather have less money today vs. wait for more money tomorrow. However, sometimes it pays to wait. Unit 2 introduces the concept of time value of money and explains how to determine the value of money today vs. tomorrow by using finance tools to determine present and future values. Also, Unit 2 exposes the concept of interest rates and how to apply them when multiple periods are considered.

**Completing this unit should take you approximately 24 hours.** - 2.1: The Time Value of Money
This video discusses the difference between present value and future value. The concept called the "time value of money" assumes that individuals face either an increase in prices in the economy as time passes in the form of an inflation rate, such as a 4% annual inflation rate, or an opportunity to put their savings in an investment account offering an interest rate, such as 5% per year. Therefore, under the "time value of money" concept, you can see that $1,000 that you can receive in two years from today does not have the same value as $1,000 today. In fact, it will have a lesser value today. Likewise, if you receive $1,000 today and have the opportunity to put this money in an investment account earning 5% per year, in two years you will have more than $1,000.

This video discusses how interest rates are applied. Note that a rate of return is usually expressed as a percentage (e.g., 4%) but when you need to apply it in a calculation, use it in decimal-form (e.g., 0.04 is the decimal-form of 4%, 0.10 is the decimal-form of 10%, etc). The same applies to the numerical expressions of interest rates.

This video discusses how interest rates are applied. When you need to calculate the future value of an amount using a simple interest rate, you apply the interest rate only to the initial amount. On the contrary, when you calculate the future value of an amount using the compound interest rate, you apply the interest rate not only to the initial amount but also to amounts of interest earned. The compound interest rate is commonly used by banks, credit card companies, and any other financial institution. The simple interest rate is usually applied to loans made in informal business deals, and even to loans involving family members!

- Read this section that discusses the time value of money. "Why is the time value of money important?". The answer to this question lies in the concepts presented in this section. In the finance world, a dollar is more valuable today than it is 1 year or 10 years from now. To explain why this is the case, formulas and examples are presented that demonstrate how money is used . As part of this discussion, the topic of why a dollar is worth more today than in the future is presented. Pay particular attention to the definitions and problems presented that relate to interest rate, future value, and present value.
The Relationship Between Future and Present Value

Calculating Perpetuities

Calculating Values for Different Durations of Compound Periods

Comparing Interest Rates

Calculating Values for Fractional Time Periods

Loans and Loan Amortization

Calculating the Yield of a Single-Period Investment

Calculating the Yield of an Annutity

- 2.2: Future Value and Compounding
Read this section that discusses four separate but related concepts. They include: (1) multi period investment, (2) approaches to calculating future value, and (3) single period investment. How are these topics used in the business world? The application of these concepts is useful when comparing alternative investments and scarce capital resources are available. Often in a business setting, limited capital resurces are available. Therefore, the decision concerning which investment is best depends on comparing which investments will bring the highest returns to the business.

Read this section that discusses Future Value and Multiple Flows. Students will learn how to calculate the future value of multiple annuities.

Read about ordinary annuities in this section. The business executive may ask how annuities are used in the real world of business? Pay close attention to how the present value of an ordinary annuity is calculated. Then, the future value of an ordinary annuity is discussed. This is followed by a discussion about when annuities are due. Examples of how and when annuities are used include investments, retirement planning for a future regular payment.

- 2.3: Present Value and Discounting
This video discusses the basic use of the Present Value (PV) formula when only one period is considered.

This video applies the PV formula when different cash flows are considered in different periods.

This video discusses how to re-calculate the PV amounts when the interest rate changes.

- 2.3.1: Present Value, Single Amount
Single Period Investment

Multi-Period Investment

The Discount Rate

Number of Periods

Calculating Present Value

- 2.3.2: Present Value, Multiple Flows
Read this section that discusses Present Value, Multiple Flows. Students will be able to use present value to determine the best financing option and calculate the present value of an investment portfolio that has multiple cash flows.

- 2.3.3: How is Capital Budgeting Used to Make Decisions?
Read this section that discusses capital budgeting and decision making along with the topics of net present values, annuity tables, internal rate of return. Examples about how large coporations use these topics are presented in this section. Large corporations use capital budgeting techniques when they invest in real estate projects or large equipment projects.

- 2.3.4: Present Value Interest Factor
Read this section that presents four scenarios that each pertain to the time value of money. First, the time period to reach a single amount target sum. Second, the time period to reach an annuities maturity. Third, Growth rate of a single amount. And fourth, the growth rate of an annuity. The application of these topics can be helpful on an individual level when considering investments and comparing which investments are going to give the highest projected return.

- 2.4: Variable Rates of Return
This video shows you how to use the future value formula when you are considering an interest rate that applies every six months but it is quoted on an annual basis.

This video shows you how to use the future value formula when you are considering the annual interest rate on a daily basis.

This video gives a review of what you learned from the first two videos.

This video shows you about what it means to use an annual interest rate continuously.

- 2.4.1: Time-Varying Rates of Return and the Yield Curve
Please read this section that discusses the time-varying rates of return and the yield curve, and bonds and the yield curve. In addition, sensitivity to changes in interest rates are also discussed. Application of these concepts is also presented so that the manager or executive will know how to use them. Note: There is some class specific information from the professor who created this document. Please ignore it.

- 2.4.2: Time Varying Interest Rates and Yield Curves
This section explains five topics that are important to businesses: (1) The fixed income market, (2) The varying interest rates and yield curves, (3) A model for stochastic interest rates, (4) The risk of rolling over, and (5) Implications of the yield curve. Why are these topics important to the business owner or executive? These topics are used when the returns on investments are sought by investors. Note: There is some class specific information from the professor who created this document. Please ignore it.

- 2.5: Special Applications: Perpetuities and Annuities
Annuities

Future Value of Annuity

Present Value of Annuity

Calculating Annuities

Read this section that discusses calculating perpetuities.

Read this section about calculating the yield of an annuity.

This section discusses how to value a series of annuities. Key take aways are summarized for the manager or students benefit. In addition, exercises and problems ralating to mortgage loans that illustrate how annuities pertain to everyday situations are presented. Summary exercises are also given to enhance subject learning.

- 2.6: Using Excel in Applications of the Time Value of Money
Do you know how to use a financial calculator? This section discusses how to use learning tools such as the financial calculator tutorial, excell financial calculator. Two case studies are also presented that demonstrate the application of present and future cash flows.

Do you know how to use an excel spreadsheet as a calculator? This section demonstrates how to use an excel spreadsheet as a personal calculator. A problem is also included that shows how to use the spreadsheet to solve a problem. The application of an excel spreadsheet is helpful when calculating personal or business interest rate problems.

Note: This document must be downloaded to open. Save this document to your computer before doing the sample problem and then do the sample problem. Do not save this document after you complete the practice problem. You must click "Enable Editing" in the yellow bar at the top of the document to complete the practice problem.

- Topic 35
- Unit 3: Capital Budgeting Techniques
Unit 3 shows how a financial manager makes capital investment decisions using financial tools. It is especially the case that this unit addresses the concept of capital budgeting and how to evaluate investment projects using the net present value calculations, internal rate of return criteria, profitability index, and the payback period method. In particular, this unit will teach you how to determine which cash flows are relevant (should be considered) when making an investment decision. Say for instance, you have been asked to give your recommendation about buying or not buying a new building. As the financial manager, it is your task to identify cash flows that, in some way or another, affect the value of the investment (in this case the building). Also, this unit explains how to calculate "incremental" cash flows when evaluating a new project, which can also be considered as the difference in future cash flows under two scenarios: when a new investment project is being considered and when it is not. Make sure to complete Unit 2 first before engaging in Unit 3 as this unit is considered the advanced portion using the financial techniques that are explained in Unit 2, such as the present and future value formulas.

**Completing this unit should take you approximately 24 hours.** - 3.1: Capital Budgeting and Net Present Value
- 3.1.1: Net Present Value
Read this section that discusses the following net present value concepts: (1) Net Present Values (NPV): (2) Calculating NPV; (3) Interpreting NPV; (4) Advantages of Using NPV; (5) Disadvantages of Using NPV; and (6) NPV Profiles. Examples of these concepts are shared about how to implement these concepts in practical applications.

- 3.1.2: Net Present Value Practice Quiz
Read this section that presents the application of Net Present Value (NPV) concepts. Ten Net Present Value quiz questions are presented to test your knowledge. When taking the quiz, the student should be familiar with how to calculate and apply Net Present Value concepts to a variety of projects and situations.

Note: You cannot click on the answers for this practice quiz. Clicking on the practice question will display the answer for that question.

- 3.2: Internal Rate of Return
- 3.2.1: Internal Rate of Return
Read this section about Internal Rate of Return (IRR). Particular attention should be given to the following topics: (1) Internal Rate of Return; (2) Definition of Internal Rate of Return; (3)Calculating Internal Rate of Return ; (4) Advantages of Using Internal Rate of Return: (5) Disadvantages of Using Internal Rate of Return ; (6) Calculating Multiple Internal Rates of Return and ; (7) Understanding and claculating Modified Internal Rates of Return. Problems and solutions are also provided in this section.

- 3.3: Profitability Index
- 3.3.1: Ranking Investment Proposal
Read this section that discusses capital budgeting and ranking investment proposals. The importance of this subject arises when businesses are comparing similar real estates investments with the intent of picking the investment that yields the highest return. Several methods are presented in this section and are commonly used to rank investment proposals, including net present value (NPV), internal rate of return (IRR), profitability index (PI), and accounting rate of return (ARR). The formulas and examples are given to demonstrate how to apply these formulas in the real world.

- 3.3.2: Other Methods
Read this section that discusses methods of evaluating capital budgeting, calculating the profitability index and discuss the modified internal rate of return (MIRR). Two separate investment proposals are compared and contrasted using multiple methods of comparison. This method of comparison gives the student or manager a broad view about how to evaluate the best decision for investing limited or scarce financial resources. Corporations use these capital budgeting methods when comparing and contrasting competing real estate investments that will yield variable returns.

- 3.4: Payback Period Method
Read section 4.4, which highlights a simple capital budgeting concept in finance that is used for making investment decisions. The payback period method is often used by small-business owners. Make sure to answer the questions given at the end of the section and compare your answers to the answers given at the end of the chapter.

The payback period (PP) method is a simple way for comparing the feasibility between projects. It is a measure that tells you how long a project takes to recover its initial investment. When choosing between projects, the PP rule is to accept that project with the shortest PP. For example, if project A takes 5 years to recover its initial investment but project B takes 1 year, then under this method it is best to choose project B. The PP method, as you can see, is very simple and may lead to erroneous decisions because it does not tell you anything about the size of the returns. Will you change your mind knowing that project A is a 7-year project that will give you a $50 million profit compared to project B that is a 2-year project that will only give you a $1 million profit?

The payback period (PP) method is computed by counting the time (in years, months, or days) that it takes for a project to recoup its initial investment. For example, suppose that a 3-year project that costs $100,000 will give you benefits of $50,000 in the first year, $100,000 in the second year, and $150,000 in the third year. The PP for this project is 1.5 years as it will take 1 year and 6 months to recover the entire $100,000. Notice that the net profit of this project is $200,000!

- 3.4.1: The Payback Method
Read this section that presents the Payback Method of investing. Specific emphasis is given to (1) Defining the payback method, (2) Calculating the payback method, (3) Discounted payback, (4) Advantages of the payback emthod, and (5) Disadvantages of the payback method. Examples that demonstrate application are presented in this section.

- 3.5: Evaluating Projects Incrementally
This video shows you how to work with a depreciating asset in an income statement.

This video shows you how to work with a depreciating asset in an income statement.

This video shows you how to work with a depreciating asset in an income statement.

When a replacement project is being considered, the initial investment is composed of the cost of the new project plus any installation or cleaning costs minus the after-tax cash flow from selling the current project. The MACRS depreciation schedule is used to estimate the current value of a physical asset, such as a computer, at any moment of time of this asset's life. That value is called the "book value." When a replacement project is being considered, the incremental operating cash flows need to be computed every period starting with period 1 as follows:

incremental \( C_1 \) = \( C_1 \) from the new project - \( C_1 \) from the current project

When a replacement project is being considered, the terminal cash flow is the cash flow that will be generated in the last period of the project. This is an important concept when machines with a long life are intended to be used for short periods until the end of a project. After the project is over, a long-lasting machine could either be sold to a buyer in the market at the given market price or sold as scrap for a lower amount than its remaining book value.

- 3.5.1: Introduction to Capital Budgeting
Read this section about making capital budgeting decisions. The discussion includes the following: (1) Goals of Capital Budgeting, (2) Ranking of Invesment Proposals, (3) Reinvestment Assumptions, (4) Long term and short term financing , (5) Payback Method (PM), (6) Internal Rate of Return(IRR), (7) Net Present Value (NPV), and (8) Cash Flow Analysis. Who uses these capital budgeting decisions? The answers to these questions are contained in this section. When managers and executives make financial decisions to invest limited resources, they use the information presented in this section because they are more likely to invest wisely.

- 3.5.2: Depreciation and Depreciation Methods
Read this section that presents the concept of depreciation and depreciation methods. Why are depreciation methods used in financial decision making? Real estate and long-term equipment is depreciated when making financial calculations using generally accepted accounting principles so that more accurate decisions are made. Examples are used to illustrate how long term assets are depreciated to arrive at more accurate financial calculations and the decisions that are result.

- 3.6: Using Excel in Applications of Capital Budgeting Decisions
- 3.6.1: How is Capital Budgeting Used to Make Decisions?
You have already read this chapter. Please now complete the problem sets pertaining to how capital budgeting is used to make decisions. Do corporations actually use capital budgeting concepts and formulas to make decisions? Concepts and examples are presented using Net Present Value (NPV), Present Value (PV) tables, summaries and problems are presented. Internal Rate of Return (IRR), Net Present Value (NPV) and the payback method are presented along with examples that demonstrate application. Examples are presented and discussed with respect to Kohls and J.C. Penny's using capital budgeting decisions.

- 3.6.2: Capital Budgeting Practice Quiz
You have read this material previously, so now please complete this quiz. Are you ready to test your understanding of capital budgeting? The student or manager should be prepared to demonstrate understanding about the definition of capital budgeting, functions pertaining to capital budgeting, and steps in a basic accounting flow.

Note: You cannot click on the answers for this practice quiz. Clicking on the practice question will display the answer for that question.

- Topic 53
- Unit 4: Risk and Return
Unit 4 provides an explanation of the relationship between risk and return. Every investment decision carries a certain amount of risk. Therefore, the role of the financial manager is to understand how to calculate the "riskiness" of an investment so that he or she can make sound financial and business decisions. For example, you are the financial manager for a large corporation and your boss has asked you to choose between two investment proposals. Investment A is a textile plant in a remote part of a third world country. This plant has the capacity to generate $50 million dollars in yearly profits. Investment B is a textile plant located in the United States, near a small Virginia Town with a rich textile industry tradition. However, investment B's capacity for profits is only $30 million (due to higher start-up and operating costs). You are the financial manager. Which option do you chose? While investment A has the capacity to yield significantly higher profits, there is a great deal of risk that must be taken into consideration. Investment B has a much lower profit capacity, but the risk is also much lower. This relationship between risk and return is explained in this unit. Specifically, you will learn how to compute the level of risk by calculating expected values and the standard deviation. Also, you will learn about handling risk in a portfolio with different investments and how to measure the expected performance of a stock investment when it is being affected by the overall performance of a stock market.

**Completing this unit should take you approximately 20 hours.** - 4.1: Statistical Concepts in Finance: Probabilities, Expected Value, Standard Deviation, and Risk-Return Tradeoff
This video gives an example of the relationship between risk and reward.

The expected value is simply an average but with probabilities attached. For example, suppose that you have these three possible investment outcomes with their respective probabilities of occurring:

*Investment Outcome**Probability**Profit $100,000**0.30**Profit$50,000**0.40**No profit and no loss**0.30*Notice that the sum of these probabilities needs to add up to 1.00 (or 100%). To compute your "average" profits, you need to consider their probabilities. This average is normally called the "expected value" in statistics. Using this example, the expected value is computed as follows: (100,000x0.30) + (50,000x0.40) + (0x0.30) = 30,000 + 20,000 + 0 = 50,000. Therefore, you expect to receive $50,000 from this investment project. In general, the expected value formula is:

Expected Value = (outcome A x probability of A) + (outcome B x probability of B) + ... + (outcome of Z x probability of Z)

where the sum of the probabilities add up to 1.00.

The standard deviation does not have an intuitive meaning, but it is a measure of risk in finance. When you are facing an investment project with several possible outcomes and you know their respective probabilities, you can compute the expected value of an investment project. But when you also need to know the level of risk, you can compute the standard deviation as follows:

Standard Deviation = square root of

(outcome A - expected value)2 x probability of A

+ (outcome B - expected value)2 x probability of B

+ ...

+ (outcome Z - expected value)2 x probability of Z

where the sum of the probabilities add up to 1.00.

In finance, an investor will take on more risk only if the return is higher, or vice versa. This is what we call in finance the "risk-return tradeoff."

- 4.1.1: Uncertainty, Expected Value, and Fair Games
Read this section that includes discussion and examples about Uncertainty, Expected Value and Fair Games, and Mathematical preliminaries because it forms the basis for analysis of individual decision making in uncertain situations. Examples of application are presented for students to learn the application of concepts.

- 4.1.2: Introduction to Risk and Return
This section presents an introduction to risk and return; understanding return; portfolio concerns such as diversificantion and weighting and expectations for expected returns; implications across portfolios; diversification and understanding security lines. Risk considerarions include the types of risk and measuring risk. Why are these topics of risk and return important to consider? The key takeaways of this section discuss how risk and return, risk diversificantion, and measuring risk affect how scare financial resources are used and the benefits that are received from scarce financial resources.

- 4.2: Uncertainty in Capital Budgeting
- 4.2.1: Risks Involved in Capital Budgeting
Read this section and pay particular attention to the risks associated with capital budgeting. Why is risk in capital budgeting important to understand and be able to apply? The answer to this question is contained in this section. Risks include operational risks, financial risks and market risks. The process of capital budgeting must take into account the different risks faced by corporations and their managers. The discussion of capital budgeting and a definition of risk topics are also presented in this section.

- 4.3: Risk and Reward in a Portfolio
- 4.3.1: Risks
Read this chapter and learn more about risk and return. Please do not skip over sections 4 and 5, as these are particularly important. When and how is risk and return used in a business setting? In this section, answers begin with understanding return. Portfolio considerations are then presented that include diversification and weighting and implications for expected returns, and implications for variance.

- 4.4: Risk Diversification in a Portfolio
- 4.4.1: Portfolio Considerations
Read this section that discusses portfolio diversification and weighting, implications for expected returns, and implications for variance.

- 4.4.2: Diversification
This section discusses diversification and the impact of diversification on risk and return. Two concepts of diversification are presented in this section. First, unsystematic risk addresses the impact of diversification on risk and return. Second, systematic risk evaluates the impact of diversification on risk and return. These concepts are used as corporations manage their investment portfolos and they seek to achieve the best returns possible, given existing market conditions.

- 4.5: Risk of Stock Investments and Market Betas
- 4.5.1: Announcements, News, and Returns Source
This section discusses capital structure, optimal capital structure, debt and equity, and cost of capital considerations. Why are these concepts important when managing a business? Application and examples are presented in this section so the student and manager will understand how to effectively utilize the concepts of optimal capital structure.

- 4.5.2: Implications Across Portfolios
Read this section and learn more about risk and return, implications across portfolios and the beta coefficient for portfolios. Why are these topics important to businesses? The answer is contained in this section. This section discusses how with individual stocks, a beta coefficient compares how much a particular stock fluctuates in value on a day-to-day basis.

- 4.5.3: Boundless Finance: "Chapter 8, Section 7: Understanding the Security Market Line"
Read this section that discusses expected risk and risk premium, defining the security market line, and the impact of the SML on the cost of capital.

- 4.6: Using Excel in Applications of Risk
After you have read and mastered the concepts covered in sections 4.2 thru 4.5, take the quiz in this section that covers risk and return. Twenty questions ask the student or manager about diversifying a portfolio, Capital Asset Pricing Model (CAPM), unsystemic risks and systemic risks, and weighting of an investment portfolio.

Note: You cannot click on the answers for this practice quiz. Clicking on the practice question will display the answer for that question.

- Topic 70
- Unit 5: Corporate Capital Structure, Cost Of Capital, And Taxes
Does it matter whether a company's assets are being financed with 50% from a bank loan and 50% from investors' money? Does that form of capital structure, where 50% of assets comes from debt and 50% from equity, influence how a company succeeds in business? This unit addresses these questions by focusing on the theory of capital structure. Specifically, Unit 5 explains the concept of capital structure and introduces you to the most common formula used when comparing a company's return to the cost of capital: The weighted average cost of capital (WACC). Also, Unit 5 exposes the concept of how tax policy affects a company's true cost of capital.

**Completing this unit should take you approximately 18 hours.** - 5.1: Capital Structure Finance Theory: Modigliani-Miller
This video gives you an example of two similar businesses that have different capital structures.

This video explains the difference between market value and book value for defining firm value.

This video explains how to calculate the market value of a firm by concentrating on the firm's assets.

- 5.1.1: Capital Structure Overview and Theory
This section discusses capital structure, optimal capital structure, debt and equity, and cost of capital considerations. Why are these concepts important when managing a business? Application and examples are presented in this section so the student and manager will understand how to effectively utilize the concepts of optimal capital structure.

- 5.2: Cost of Capital and Capital Structure: WACC
This video explains the relationship between choosing a particular cost of debt and the return on capital.

- 5.2.1: Capital Structure Considerations
This section covers discussions about capital structure, optimal capital structure,debt and equity and return on investment. How do businesses benefit from using these concepts? Businesses have the opportunity to earn more return from their investments and their blend of debt and equity capital strucure. Examples are presented that demonstrate how these concepts are used.

- 5.3: WACC Exercises
- 5.4.1: Weighted Average Cost of Capital (WACC)
This section presents the Weighted Average Cost of Capital (WACC) discussion. Why is the Weighted Average Cost of Capital (WACC) concept important? The answer to this question is presented with the WACC equation that is compiled and solved.

- 5.4.2: The Weighted Average Cost of Capital Practice Quiz
Once you have mastered the Weighted Average Cost of Capital concepts, take the 8 question quiz in this section that addresses what WACC is and is not.

- Topic 80
- Unit 6: Application: The CAPM Model
This unit puts what you have learned from the previous units about cost of capital, net present value, and risk into one widely used model: The CAPM model. The CAPM model is used to compute a company's costs of capital that can be used in net present value calculations. It has been used in court cases for estimating a company's stock value as with the case of the breakup of AT&T in 1984 that resulted in seven companies. Also, the CAPM model is used in computing stock valuation. This unit will show how the financial manager uses this financial tool to value stock and to determine which stocks are the better options for investors, based on their rates of returns and how they compare to the overall stock market return.

**Completing this unit should take you approximately 18 hours.** - 6.1: Calculating the Cost of Capital using CAPM
- 6.1.1: The Capital Asset Pricing Model
This section discusses how to price risky securities in order to determine if an investment should be undertaken. Why is this important? The answer is contained in the discussion that describes how to determine the expected rate of return of an asset. When you finish with this section, you should understand the terms systematic risk, systematic risk and beta. Most importantly, by understanding the Capital Asset Pricing Model (CAPM), you will be able to determine if an investment should be undertaken.

- 6.1.2: Cost of Capital
This section provides an overview of the cost of capital. In addition to the Weighted Average Cost of Capital (WACC), topics discussed in this section include flotation costs, cost of debt, cost of preferred stock, cost of common stock. Examples and problems are presented to show why this WACC is important.

- 6.1.3: Approaches to Calculating the Cost of Capital Quiz
Once you have mastered the concepts that pertain to cost of capital, take this 6 question quiz that will help you apply the concepts contained in the cost of capital.