- 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
- 1.1.2: Financial Decisions: Investment and Financing
- 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.
- 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.
- 1.1.5: Institutions, Markets, and Intermediaries
- 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.
- 1.2: Corporate Finance and Corporate Structures
- 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.
- 1.2.2: Liability of Principal and Agent
- 1.2.3: Equity Finance
- 1.3: Financial 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.
- 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.
- 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.
- 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.
- 1.4: Financial Ratios
- 1.5: Pro Forma Financial Statements
- 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
- 2.2: Future Value and Compounding
- 2.3: Present Value and Discounting
- 2.3.1: Present Value, Single Amount
- 2.3.2: Present Value, Multiple Flows
- 2.3.3: How is Capital Budgeting Used to Make Decisions?
- 2.3.4: Present Value Interest Factor
- 2.4: Variable Rates of Return
- 2.4.1: Time-Varying Rates of Return and the Yield Curve
- 2.4.2: Time Varying Interest Rates and Yield Curves
- 2.5: Special Applications: Perpetuities and Annuities
- 2.6: Using Excel in Applications of the Time Value of Money
- 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
- 3.1.2: Net Present Value Practice Quiz
- 3.2: Internal Rate of Return
- 3.2.1: Internal Rate of Return
- 3.3: Profitability Index
- 3.3.1: Ranking Investment Proposal
- 3.3.2: Other Methods
- 3.4: Payback Period Method
- 3.4.1: The Payback Method
- 3.5: Evaluating Projects Incrementally
- 3.5.1: Introduction to Capital Budgeting
- 3.5.2: Depreciation and Depreciation Methods
- 3.6: Using Excel in Applications of Capital Budgeting Decisions
- 3.6.1: How is Capital Budgeting Used to Make Decisions?
- 3.6.2: Capital Budgeting Practice Quiz
- 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
- 4.1.1: Uncertainty, Expected Value, and Fair Games
- 4.1.2: Introduction to Risk and Return
- 4.2: Uncertainty in Capital Budgeting
- 4.2.1: Risks Involved in Capital Budgeting
- 4.3: Risk and Reward in a Portfolio
- 4.3.1: Risks
- 4.4: Risk Diversification in a Portfolio
- 4.4.1: Portfolio Considerations
- 4.4.2: Diversification
- 4.5: Risk of Stock Investments and Market Betas
- 4.5.1: Announcements, News, and Returns Source
- 4.5.2: Implications Across Portfolios
- 4.5.3: Boundless Finance: "Chapter 8, Section 7: Understanding the Security Market Line"
- 4.6: Using Excel in Applications of Risk
- 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
- 5.1.1: Capital Structure Overview and Theory
- 5.2: Cost of Capital and Capital Structure: WACC
- 5.2.1: Capital Structure Considerations
- 5.3: WACC Exercises
- 5.4.1: Weighted Average Cost of Capital (WACC)
- 5.4.2: The Weighted Average Cost of Capital Practice Quiz
- 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
- 6.1.2: Cost of Capital
- 6.1.3: Approaches to Calculating the Cost of Capital Quiz