Citibank: basic of corporate finance
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UNIT 3: Time Value of Money
The time value of money is introduced in this unit. You will learn how and why the
value of money changes over time. You will also be introduced to the ideas of
present value and future value and how those computations are used to evaluate a
potential investment. The topics in this unit are quantitative, with several formulas
introduced and explained. All of the computations can be completed using a
financial calculator. You will learn how to identify the key variables necessary for
input into the calculator to find the proper solution. The concepts presented in this
unit are important because much of the remainder of the workbook builds upon
them.
UNIT 4: Valuing Financial Assets
An introduction to the process of valuing financial assets is provided in this unit.
These simple methods for valuation are based on the ideas presented in Unit Three.
The unit provides an explanation of some of the basic terms associated with
financial assets. Basic formulas used to place a value on simple financial assets
(bonds, preferred stock, and common stock) are also demonstrated. The unit
requires some mathematical calculations, but all are simple and straight-forward.
The ideas for valuing these securities serve as building blocks when more complex
securities are being considered.
UNIT 5: Introduction to Capital Budgeting
The basic ideas and methodologies surrounding capital budgeting are introduced in
Unit Five. You will see how the idea of present value can be used to evaluate
alternatives for capital investment when resources are scarce. The most important
points in this unit are the calculation of net present value and internal rate of
return. These two computations are important for the evaluation of many types of
projects and securities. Most financial calculators will perform the computations,
and we will demonstrate how to identify the key variables needed for input into
your calculator.
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UNIT 6: Corporate Valuation – Risk
In this unit, some real-world complications, including risk and uncertainty, are
applied to some of the simple ideas presented earlier. More specifically, you will
see how an analyst may make assumptions concerning the future operations of a
firm in order to estimate future cash flows. From these estimates, a value can be
placed upon the firm or project. Some key statistical terms are presented. These
ideas and terms are used to build the foundation for the capital asset pricing model
(CAPM). This model is the most widely-used method for calculating the value of a
firm. The unit has many calculations and you should feel comfortable identifying
the key variables needed to use the CAPM.
UNIT 7: Corporate Valuation – Cost of Capital
The main focus of this unit is a discussion of each component of capital and the
costs associated with the use of each component. You will see how these costs are
combined in the proper proportions to find the weighted-average cost of capital
(WACC). This is the appropriate rate to be used to discount a set of future cash
flows. This unit contains both key terms and important computations used later in
the course.
UNIT 8: Corporate Valuation – Estimating Corporate Value
The ideas presented in Units Six and Seven are brought together in this unit. An
estimate of corporate value can be found by forecasting a set of cash flows and
discounting them at the weighted average cost of capital. You will be introduced to
a relatively simple method for forecasting cash flows based on a set of
assumptions concerning the future operations and finances of a company. Other
methods for estimating corporate value are presented and the relative strengths and
weaknesses of each are discussed. The unit requires some simple calculations,
including applications of the WACC and present value.
UNIT 9: Fixed Income Securities
In this unit you will revisit the debt markets discussed briefly in Units Two and
Four through the introduction of the mathematics which surround fixed income
securities (bonds). The calculations of yield and rate of return concerning bonds
making fixed interest payments are introduced and the relationship between the
yield and the price of a bond are discussed. The unit also includes a discussion
of duration and its calculation. All of the computations are relatively
straightforward; many financial calculators can perform most of the calculations.
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UNIT 10: Derivative Securities
The final unit in the corporate finance workbook focuses on some derivative
securities that are used in managing exposure to risk. The unit includes brief
introductions to options and swaps and a simple explanation of how they are used.
This unit is included so that you can begin to understand some complex securities
that are encountered in future courses. For a more thorough discussion of risk
management and the use of swaps and options, refer to the workbooks designed to
cover these topics. This unit is included only to provide a brief introduction to the
topics.
COURSE OBJECTIVES
When you complete this workbook, you will be able to:
n Understand the basic concepts of the three main financial statements
n Recognize the significance of the time value of money in the financial
planning process
n Identify techniques used by financial planners to evaluate, compare, and
select investment alternatives
n Recognize the basic valuation concepts and calculations that apply to
corporate valuation
n Identify fixed income securities that may be included in an investment
portfolio and derivative securities that are used to manage risk
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THE WORKBOOK
This self-instruction workbook has been designed to give you complete control over
your own learning. The material is broken into workable sections, each containing
everything you need to master the content. You can move through the workbook at
your own pace, and go back to review ideas that you didn't completely understand the
first time. Each unit contains:
Unit Objectives – which point out important elements in the
unit that you are expected to learn.
Text – which is the "heart" of the workbook. This
section explains the content in detail.
Key Terms – which also appear in the Glossary. They
appear in bold face the first time they appear
in the text.
Instructional
Mapping –
terms or phrases in the left margin which
highlight significant points in the lesson.
þ
Practice Exercises
and Progress
Checks –
help you practice what you have learned and
check your progress. Appropriate questions
or problems are presented at
strategic places within the units and at the
end of each unit. You will not be graded
on these by anyone else; they are to help you
evaluate your progress. Each set of
questions is followed by an Answer Key.
If you have an incorrect answer, we
encourage you to review the corresponding
text and then try the question again.
In addition to these unit elements, the workbook includes the:
Glossary – which contains all of the key terms
used in the workbook.
Index – which helps you locate the glossary
item in the workbook.
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This workbook is designed to provide you with a background in the key points of
corporate finance. Upon completing the workbook, you should feel comfortable with
the ideas and calculations presented in the course. The practice problems in each unit
will help you assess your understanding of the material in that unit. Try to work each
problem before looking at the solutions. That will help you identify the sections that
may require more review on your part. Since this corporate finance workbook really
serves as the foundation for the other workbooks and courses in the series, it
is important that you understand the main ideas that you will study.
As we have mentioned, many sections in this workbook contain mathematical formulas
and calculations. It is important that you understand the formulas and feel comfortable
making these computations. It is not critical that you memorize every formula. The
goal of these sections is to help you recognize the relevant information contained in a
problem and be able to input that data into your calculator. Whenever possible, we will
also discuss the calculations that can be made on a business calculator. In those cases,
you will need to review your owner's manual for the specific instructions for your
calculator.
This is a self-instructional course; your progress will not be supervised. We expect
you to complete the course to the best of your ability and at your own speed. Now
that you know what to expect, you are ready to begin. Please turn to Unit One. Good
Luck!
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Unit 1
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UNIT I: FINANCIAL STATEMENT ANALYSIS
INTRODUCTION
Companies use financial statements to record their asset investments, report their
profitability, and describe their cash flow. Analysts evaluate financial statements (often
called a company's "books") for clues about a company's performance. There are three types
of financial statements:
• Balance Sheet
• Income Statement
• Cash Flow Statement
We include an overview of financial statement analysis in the Corporate Finance Workbook to
help you understand the terminology that is used by persons working in finance and to
introduce some calculations that will apply later in the course, particularly in the units that
discuss corporate valuation. For a more in-depth study, you can take the Citibank self-
instruction course on Financial Statement Analysis.
UNIT OBJECTIVES
When you complete this unit, you will be able to:
• Recognize the three main types of financial statements
• Identify the relationships between accounts on the Balance Sheet, line items on
the Income Statement, and the calculation of the Cash Flow Statement
• Calculate common ratios used in financial statement analysis and interpret the
results
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1-2 FINANCIAL STATEMENT ANALYSIS
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BALANCE SHEET
Conditions at a
point in time
The Balance Sheet is a record of assets held by a business and capital
used to pay for those assets. It is a snapshot of conditions at a specific
point in time, generally at the end of a quarter or year. A typical
Balance Sheet looks like the example for XYZ Corporation (Figure
1.1).
XYZ Corporation
December 31, 1993
(In Millions $)
ASSETS LIABILITIES AND EQUITY
Cash 5.7 Accounts Payable 22.7
Marketable Securities 6.3 Notes Payable 31.5
Accounts Receivable 50.9 Accrued Wages and Taxes 2.3
Inventories 88.7 Other Current Liabilities 4.9
Prepaid Expenses 1.1 Total Current Liabilities 61.4
Other Current Assets 0.3
Total Current Assets 153.0 Long-term Debt 107.4
Preferred Stock 12.3
Gross Fixed Assets 158.8 Total Long-term Liabilities 181.1
Less Depreciation 24.9
Net Fixed Assets 133.9 Common Stock (8 Mil. Outst.) 10.4
Retained Earnings 95.4
Total Common Equity 105.8
Total Assets 286.9 Total Liabilities and Equity 286.9
Figure 1.1: Balance Sheet
Let's look at a definition of each account in XYZ Corporation's Balance
Sheet.
Assets
Assets are used to produce the products or generate the services that are
sold by the company. Although all assets are stated in monetary terms,
only cash represents actual money.
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FINANCIAL STATEMENT ANALYSIS 1-3
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Short-term Assets
Current
Some asset accounts represent the current (short-term) assets of XYZ
Corporation. They include:
• CASH – amount of cash held by the company in liquid bank
accounts
• MARKETABLE SECURITIES – value of short-term investments held by
the company
• ACCOUNTS RECEIVABLE – amount owed to the company by its
customers who have purchased their products or services on
credit terms
• INVENTORIES – amount of money the company has invested in
raw materials, work-in-progress, and finished goods available for
sale
• PREPAID EXPENSES – amount of expenses paid by the company
before the expense is incurred. One example is rent on an office
building paid at the beginning of the year for the entire year.
• OTHER CURRENT ASSETS – any other item related to production
that does not fit into the above classifications
Long-term Assets
Investments for
operations
XYZ Corporation also has long-term investments for the operation
of its business. These asset accounts include:
• GROSS FIXED ASSETS – amount that the company paid for its
property, manufacturing plants, and equipment when it acquired
those assets at some time in the past
• DEPRECIATION – total amount of money that the company has
charged as an expense for using the plants and equipment. Since
this account is a deduction from an asset account, it is referred to
as a contra-asset account.
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