FIN2601 Video conference 2019 S2 PDF

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2019/09/19

OVERVIEW OUTLINE OF THE PRESENTATION Part 1 Focuses on important generic information. Part 2: Focuses on the subject matter. Par

Focuse on assessmen matter .

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Part 1 Important generic information

ACADEMIC SUPPORT LECTURERS & ACADEMIC SUPPORT Ms K.D Sindane [email protected] Dr A.B Sibindi [email protected] Mr L.E Mosimanyane : [email protected] Tutors MODULE EMAIL Channel all your electronic enquiries via the email address FIN260 1 [email protected]

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myUnisa FIN2601 site: Additional resources

ADDITIONAL RESOURCES LEARNING UNITS OVERVIEW [CHAPTER

7

)

• DISCUSSION CLASS PRACTICE QUESTION _RISK AND RETURN & SHARE VALUATION • DuPon ANALYSIS EXAMPLE @ myUnisa • SEL ASSESSMENT ACTIVITIES MAY/ JUNE 2019

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Part 2 Subject matter

CHAPTERS COVERED IN FIN2601 CHAPTER 1 CHAPTER 2 CHAPTER 3 CHAPTER 5 CHAPTER 8 CHAPTER 6 CHAPTER 7

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PRESCRIBED FINANCIAL CALCULATOR: HP 10BII+

CHAPTER 1 THE ROLE OF MANAGERIAL FINANCE

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LEARNING OUTCOMES Describe the lega form o busines organisation Describe the goa o the firm Discus the agency problem

Legal forms of business organisation: characteristics A sole proprietorship is owned and operated by one individual. The profits from the sole proprietorship are taxed as the owner’s personal income, and the sole proprietor has unlimited liability. Partnerships are formed when two or more individuals enter into a business relationship for the purpose of profits. Like the sole proprietorship, partnerships are taxed as the personal income of each partner, according to that partner’s percentage of ownership. Partnerships also have unlimited liability to the creditors of the business.

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Strengths and Weaknesses of the Common Legal Forms of Business Organization

Goal of the firm Financial managers need goals to guide and motivate them when making decisions on behalf of the organisation.

Primary goal: shareholder wealth maximisation - Translates to maximising share price

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Profit maximisation vs maximising shareholder wealth Profit maximisation fails to account for differences in the level of cash flows (as opposed to profits), the timing of these cash flows, and the risk of these cash flows. Maximising shareholder wealth represents a forwardlooking goal centred on increasing the wealth of the owners or shareholders, of the firm. Shareholder wealth is influenced by cash flow, the timing of these cash flow and the risk of these cash flow This can be illustrated using the following simple share valuation equatio :

The goals of financial management Wealth maximisation objectiv : Share Price = Future dividends Required Return Financial mangers should accept only those action tha are expected to increase share price

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Agency Relationship An agency relationship exists whenever a principal hires an agent to act on his or her beha . An agency problem result when the agen makes decisions that are not in the best interest of principa .

Shareholders versus Managers Managers are naturally inclined to act in their own best interests. Mechanisms to motivate managers to act in shareholder’s best interest – Managerial compensation (incentives) – Shareholder intervention – Threat of takeover

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CHAPTER 2 THE FINANCIAL MARKET ENVIRONMENT

LEARNING OUTCOMES Understand the functions of financial markets, describe the differences between capital market and money market

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Financial markets A financial market can be defined as a meeting place where economic units with excess funds can transact with economic units in need of funds. Financial markets bring together the suppliers of funds and those seeking funds. There are two types of financial markets: the money market and capital market.

Money and capital markets The money market – a financial relationship created suppliers and demanders of shor term funds The capital market – a market that enables suppliers and demanders of lon term funds to make transaction

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CHAPTER 3 FINANCIAL STATEMENTS AND ANALYSIS

LEARNING OUTCOMES Identify the different types of ratios Define, calculate and interpret liquidity, activity, debt, profitability and market ratios Apply the DuPont analysis system to evaluate return ratios Formula’ will not provided in the exam

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Categories of financial ratios Financia ratio can be divided into five basi categories: 1. Liquidit : measure firm’s ability to meet short-term obligations 2. Activit : measure the speed at which various accounts are converted into sales or cash 3. Deb : measure the firm’s degree of indebtedness 4. Profitabilit : in totality, measure a firm’s profits vis-a-vis sales, assets or owners’ investments 5. Marke : relate the firm’s market value using current share price to accounting values

Financial ratios

NB!!! Formulas in the exam will not be provided

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Financial rati Example Debt ratio ABC Plumbing Ltd reports the following data for the past year: • Total asset turnover ratio 0,85 • Annual sales R3 074 000 • Total liabilities R1 643 000 Wha i the company’ debt rati ? Step Find the tota asset 3 074 000 ÷ 85 = 3 616 47 59 Step Find the deb ratio 1 643 000 ÷ 3 615 29 12 = 4 %

Financial rati Example Earnings per share (EPS)

Bridge Ltd had a profit after tax of 79 950 and preference share dividends of 15 00 . If the company had generated 10 000 in ordinary shares issue wha i it earning pe share (EPS)? Profi afte taxes 79 950 Preference share dividend ( 15 00 ) Ne profit 64 950 R64 950 50 Earning pe share = 10 000 =

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Summary of Ratio Analysis: The DuPont Analysis

Financial rati Example DuPont Analysis

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Financial rati Example DuPont Analysis myUnisa additional resource DuPont Analysis Example Construct the D Pont system of analysis by using the following financia data for Johnson Industries and determine which area o the firm need further analysis

Formula will not be provided in the exam

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CHAPTER 8 RISK AND RETURN

LEARNING OUTCOMES Calculate the expected return and standard deviation o single security Calculate the coefficient of variation of a single security Calculate the beta coefficient of single security and portfolio Calculate the required return o a single security and portfolio Formulas will not be provided in the exam

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DEFINING AND MEASURING RISK Risk

is the chance that an unexpected outcome will occur.

A

probability distribution is a listing of all possible outcomes with a probability assigned to each.

PROBABILITY DISTRIBUTIONS  It either will rain,

or it will not.

Only two possible outcomes.

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Return Measurement for a Single Asset Expected Return

Measuring Risk Standard Deviation

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Measuring risk Coefficient of Variation

PRACTICE QUESTION You have identified the Crave Simply and PureCrisp companies as possible investment Both companies are an ice cream and bubble tea business and are sensitive to the state o the econom You have presented the estimates o the expected performance unde three states o the economy in the table below:

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Required: What are the expected return standard deviations and coefficient o variation for these two companies?

THE CONCEPT OF BETA  Beta

Coefficient

:

 A measure o the extent to which the returns on a given share move with the share marke .  = : Shares are only half as volatile, or risky a the average shar . : Shares has the same risk as the  = average ris .  = : Shares are twice as risky as the average shar .

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Portfolio beta coefficients  The

beta o any set o securities is the weighted average o the individua securities betas

Portfolio beta: Example An investment banker has recommended a 100 000 portfolio containing assets G and . 30 000 will be invested in asse G with a beta o 60 and 70 000 wil be invested in asse H with a beta o Wha is the beta of the portfolio?

G H

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Capital Asset Pricing Model (CAPM) A

mode used to determine the required return on an asse which i based on the proposition tha any asset’s return should be equa to the ris free return plu a risk premium tha reflect the asset’ no diversifiable ris .

Risk premium for a share

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CAPM: Example The expected return on a share with a beta o 5 is 1 % I the expected ris free rate o return is %, wha should the marke risk premium b ? r =RF +β r −RF) = 15%= 3% + 1,5 rm 3%) r −RF = 11% 3% = 8%

CHAPTER 5 TIME VALUE OF MONEY

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LEARNING OUTCOMES Calculate, interpret and explain the future value and present value of single amount and annuities Calculate, interpret and explain the present value of a perpetuity Calculate the present of a mixed stream Calculate instalments to amortise a loan and calculate an interest rate or growth rate and time period also using discounting and compounding principles

TIME VALUE OF MONEY Time value o money we mean that an amount of money today is worth more than it will at some poin in time in the futur . A rand that is available today can be invested A

cash outflow (−) to earn a return A cash inflow (+ in form o dividends interest renta income .

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Time value of money is a matter of interest which may be earned i money i available today and invested o opportunity cos i an amoun wil be received a some futur . In thi chapte we learn to accoun fo difference in the timing o inflows or outflows o cash by mastering the basic interest and discounting calculatio .

An interest calculation involves calculating the end value, called the future value o an amount which is invested in the present (OUTFLOW) Discounting calculations involve the calculation o the present value o amounts which wil only be received a some poin in the future INFLOW)

Types of cash flow patterns Lump Sum Amount – A single payment

(received o made tha occurs eithe today o a some date in the futur . Annuity – Multiple payments of the same amoun ove equa time periods. Uneven Cash Flows – Multiple payment of differen amount ove a period o tim .

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Cash flow time lines

Future valu - the value to which an amount invested today will grow at the end of n periods. Present valu - the beginning amount that can be invested. PV also represents the current value of some future amount

Computational tools: Financial calculator

NB you will not find the “CPT” key on your HP10BII calculator

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Set the number of periods per year

Set the calculator at 4 decimal places Press the Shif key

(the key with the yellow

square on it) followed by the DISP key (the = key)

,

followed by the 4 ke .

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Computing the time value of money

Future value of single amount Example Home Ltd will invest 200 000 toda . The investmen wil earn % for 5 year with no funds withdraw . In 5 years, the amount in the investmen fund is Financia calculator

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Present value of single amount Example Blue Ltd will receive 8 000 in 6 year . If the interest rate is 1 % compounded annuall , How much wil be invested toda ? Financia calculator

Annuities Annuity – A series of equal payments (cash outflows o receipts (cash inflow occurring ove a specified time period Type o annuitie ; Ordinary annuity – The payments or receipts occu a the end o each period Annuity due – The payments o receipts occu at the beginnin star o each period switch calculator to BEG MODE

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Future value of an ordinary annuity Example Apple would like to invest 5 000 at the end of each 4 yea a an annua compound interes rate of 1 % How much wil the value o the investmen be afte fou years? Financia calculator

Future value of annuity due Example Wha amoun wil accumulate i you deposi 5 000 a the beginning of each year for the next 5 years in a savings account? Assume an interest rate of % compounded annuall . Financia calculator *switch calculato on BEG mode

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Perpetuity Streams o equa payment tha are expected to go on forever

Example What is the present value o a perpetuity o pe yea i the discoun rate i %? = 280 × 1 ÷ 0 = 4 000

280

Mixed stream A stream of cash flow that is not an annuit ; a stream of unequa periodic cash flows that reflect no particula patter .

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Present value of a mixed stream (cont.) Wha i the value o the following se o cash flows today? The interes rate i % fo al cash flow . Year

1

2

Cash flow

300

500

3

4

700

1000

Inpu in “CF registe : C 0=0 C 1 = 300 C 2 = 500 C 3 = 700 C 4 = 1000

Enter I =

, then press NPV button to

1 99 16

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Compounding interest more frequently than annually Interest is often computed more frequently than once a yea ; Saving institutions may compound interest half yearly (sem annually), quarter , month , week , daily o even continuous .

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Compounding interest more frequently than annually Let’s suppose that interest rate of 1 % is compounded sem annuall Since the interes i compounded twice a year now, we must divide the annual interest rate by two 1 % ÷ to obtain a rate o % pe perio . Since there are two compounding periods per year we must multiply the number of years by two 2 x ) to obtain the tota numbe o 4 period .

Nominal and effective annual rates of interest

The nominal interest rate, is the stated or contractua rate of interest charged by a lender o promised by a borrowe . The effective interes rate i the rate actually paid o earne . In general, the effective rate is greater than nominal rate whenever compounding occurs more than once pe year

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Deposits to accumulate a future sum One may wish to determine the annual deposit necessary to accumulate a certain amount of money many period henc Ted want to inves a monthly sum tha accumulate to 100 000 after 10 year . How much must he deposit each month if his bank offers him an interest rate of % per annum, compounded monthl ? Financia calculator

Loan amortisation Amortised loa - A loan that is repaid in equa payments ove it life Steven received a loan of 1 200 000 from the bank in order to buy a new hous . The terms of the loan is 25 years and the interest is 1 % per annum, compounded monthl Calculate the followin : 1. Hi monthl instalmen . 2. The interes and the principa componen o instalment numbe 1 . 3. The outstandin balance o instalmen numbe 10

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Loan amortisation Financia calculator

Monthly instalmen 18 20 16 10 INPUT 2n function AMORT = = = Interes 17 97 01 Principa 23 15 Outstandin balanc 1 197 76 44

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More on present value and future value Finding interest rate or growth rate

Finding an unknown number of periods

Suppose that you invest 1 080 no In return you will receive 1 517 after 3 year Calculate the interest rate on you investmen .

Ethan has 2 000 to invest today at an annua interest rate o % how many years will it take before the investment grows to 4 50 ?

Interes rate & numbe of periods Finding interest rate

Finding number of periods

The financial calculators require either the PV or the FV (eithe PV o PMT value to be inpu a a negative numbe to calculate an unknown interes o growth rate The financial calculators require either the PV or the FV (eithe PV o PMT value to be inpu a a negative numbe to calculate an unknown number

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Bring both calculators to the exam !

CHAPTER 6 INTEREST RATES AND BOND VALUATION

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LEARNING OUTCOMES Describe interest rate fundamentals, the term structure of interest rates, and risk premiums Apply the basic valuation mode to bonds calculate the value o a bond  Explain the yield to maturity (YTM), its calculation, and the procedure used to value bonds

Interest Rates & Required Returns: The real rate of Interest The rea interest rate r* is the rate that creates an equilibrium between the supply o saving and the demand for investment funds in a perfect worl .

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Interest Rates & Required Returns: Nominal or Actual Rate of Interest (Return) The nomina rate o interes is the actua rate of interest charged by the supplier of funds and paid by the demande . The nominal rate differs from the real rate of interest r* a a resul o two factor : – Inflationary expectations reflected in an inflation premium (IP), and – Issuer and issue characteristics such as default risks and contractual provisions as reflected in a risk premium (RP).

Interest Rates & Required Returns: Nominal or Actual Rate of Interest (Return) (cont.) the nominal rate of interest for security 1, r is.

Exampl : Wha is the rea rate o interes on you investmen i the current inflation rate is % and you have an investment opportunit tha pay 1 % with a risk premium o %? 𝐫 =1 %

%

%= %

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Theories of term structure: Expectations theory This theory suggest that the shape of the yield curve reflects investors expectations about the future direction o inflation and interes rate . Therefore an upwar sloping yield curve reflects expectations of higher future inflation and interes rate . In general the very strong relationship between inflation and interes rate support thi theor .

Theories of term structure: Liquidity preference theory Thi theory contend tha long term interes rates tend to be higher than short term rates for two reason : - lon term securities are perceived to be riskier than shor term securities - borrowers are generally willing to pay more for lon term funds because they can lock in at a rate for a longer period of time and avoid the need to rol ove the deb .

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Theories of term structure: Market segmentation theory This theory suggests that the market for debt at any point in time is segmented on the basis of maturit . As a result, the shape of the yield curve will depend on the supply and demand for a ...