University of Guelph Humber
BADM 3000 – Finance
Summer 2024
BADM 3000 BADM 3160
Operations (Controller's Function) Capital (Treasury Function)
Finance Operations Capital Financing
(within 12 months) (within the operating cycle) (beyond the operating cycle) (beyond 12 months)
Debt (Fixed Income) > Inventory Long Term Assets Long Term Debt
> Bank Line of Credit > Payroll > Eligibility > Private - Bank/Equip. Suppliers
> Short Term Bank Loan > Accts. Payable > Purchase > Public - Bond Market
> Money Market Funding > Accts. Receivable > Financing Equity
> Taxes > Work-in-progress > Preferred Shares
> Fin. Statements > Common Shares
> Deprec. Expense
Learning Resources
Required Textbook(s):
Brealey Myers Marcus Mitra Maynes Lim
Fundamentals of Corporate Finance
Seventh Canadian Edition
Accompanied with the CONNECT Digital Learning Platform
Supplementary Text/ Other:
The case studies ($9.95 each) are from the Ivey Business School and can be accessed on-line at:
https://www.iveycases.com/ProductBrowse.aspx?f=1_3
The two cases that will be studies are:
1. Royal Manufacturing
2. London Ski Club
Courselink Content Material
Introductory Material
• Course Outline
• Course Schedule
• CONNECT Instructions
Lecture Notes
Topics in Finance
Required Reading and End-of Chapter Questions
Assignment – Financial Statement Analysis
Notes to Mid-Term and Final Exams
CONNECT Assign.
Session Date Material to be Covered Opening & Due
Dates (11:59 PM)
1 May 7 Chapter 1: Goals and Governance of the Firm Ch. 1&2
May 9 Chapter 2: Financial Markets and Institution May 6 – 13
2 May 14 & 16 Chapter 3: Accounting and Finance Ch. 3: May 7 - 13
3 May 21 Chapter 4: Measuring Corporate Performance Ch. 4: May 14 - 20
May 23 Chapter 19: Long-Term Financial Planning Ch 19 May 15 - 22
4 Mid Term Exam – Tuesday May 28th
4 May 30 Chapter 5: Time Value of Money Ch. 5: May 23 –
June 3
5 June 4 Chapter 20: Short-Term Financial Planning Ch. 20: May 23 -
June 6 Chapter 21: Cash and Inventory Management June 3
Chapter 22: Credit Management & Collection Ch.21&22 May 23
– June 5
6 June 11 Topics in Finance: Mortgages, Loans, RSP
June 13 IVEY Case Studies:
1. Royal Manufacturing
2. London Ski Club
Assignment Due: Fri. June 14 (11:59 PM)
Evaluation and Due Dates
Mid-Term Exam 25% May 28
Final Exam 40% June 20 – 26
CONNECT Assignments 10% Twice Weekly
Case Study Participation 10% June 13
Class Assignment 15% June 14
Final Exam Period
Thursday June 20 to Wednesday June 26
Chapter 1
Goals and Governance of the Firm
Chapter 2
Financial Markets and Institutions
Forms of Business Organization
Legal Owner/ Taxation Liabiity
Requir. Operator
Single Proprietorship N/A Yes Personal Unlimited
Partnership
General Low Yes Personal Unlimited
Limited Medium Yes* Personal Unlimited **
Hybrids High No Personal Limit/Unlim***
Corporation High No Corporate Limited
* General partners are operators; limited partner(s) is not
** General partner liability is unlimited; limited partner(s) is not
*** Unlimited for issues with personal involvement; limited for others
Limited Liability Partnership
The LLP legislation provides that a partner is not personally liable for any debts,
limit the liability of the firm. All of the firm's assets and insurance protection
remain at risk. In addition, all partners of an LLP remain personally liable for their
own actions and for the actions of those they directly supervise and control.
https://www.liveca.ca/blog/what-is-a-professional-corporation-and-is-it-right-for-my-practice
Personal Corporation - Medical Professional
Unincorporated Incorporated
Personal Corporation
Net Practice Incom e $ 300,000 Net Practice Incom e $ 300,000
RRSP Contribution (27,230) Adm in costs (4,000)
Personal Taxes Payable (108,000) Salary (213,000)
After Tax Incom e $ 164,770 Practice Incom e $ 83,000
Corporate Taxes (12%) (9,960)
Average Tax Rate Net Corp. Tax Incom e $ 73,040
Personal
Unincorporated 36.0% Salary $ 213,000
Incorporated RRSP Contribution (27,230)
Corporate 12.0% Taxes Payable (65,270)
Personal 30.6% After Tax Incom e $ 120,500
Total (Blended) 25.1%
Total After Tax Incom e $ 193,540
Increase In After Tax Incom e If Incorporated $ 28,770
Simplified Corporate Organization Chart
Financing: Sources and Uses
Use of Financing Financing Sources
Operations Short Term Debt Fixed
Long Term Assets Long- Term Debt Income
Tangible Equity (Shares & Ret. Earnings)
Intangible
Specific Use of Financing
Use of Financing Financing
Operations ← Short Term Debt Fixed
Long Term Assets ← Long- Term Debt Income
Tangible Equity (Shares & Ret. Earnings)
Intangible
Operations
Use of Financing Financing
Operations Short Term Debt Fixed
Long Term Assets Long- Term Debt Income
Tangible Equity (Shares & Ret. Earnings)
Intangible
↓
Operating Profit
Less: Interest Expense
Taxes
Net Income
Distribution of Proceeds from Operations
Use of Financing Financing
Operations ________ Short Term Debt Fixed
Long Term Assets → Long- Term Debt Income
Tangible Equity (Shares & Ret. Earnings)
Intangible ↑
↓ Government
Operating Profit ↑
Less: Interest Expense _________
Taxes ___________________________
Net Income __________________________________________________
↓
Dividends
Spectrum of National Economic Management
Left Centre
…....................................................................................... Right
…..............................................................................................
Wing Wing
Progressive Managed Capitalism Free Market
Socialism Selective Regulation Capitalism
Govt. Ownership/Control Little Government Involvement
Significant Regulation Deregulation
Denmark Canada United
Norway Britain States
Sweden France
Ethics and Management Objectives
Goals of the Firm Include:
• Maximizing net income for the firm’s owners (Shareholders)
• Ensure long-term profitability
• Act ethically and within all regulations set for performance
• Set internal operating guidelines that are ethical and adhere to
all external regulations imposed on the firm’s operations.
Ethics and Management Objectives
Agency Problem
• Conflict of interest between owner (Shareholders) and
Management/Board of Directors
• Can be misleading or falsified reporting by
Management to the Board of Directors
• Can be collusion between Management and the Board
to provide misleading or falsified information to
Shareholders
Ethics and Management Objectives
Goals of the Firm Include:
• “Insider Trading” by Management and/or Board members
• Management compensation structure – base salary, salary
tied to earnings, stock options
• Short-term earnings expectations tied to stock options
• Ability to move funds internationally hinders oversight
control
Normal Exercising of Stock Options
$ 16.00
$ 15.00
$ 14.00
$ 13.00
$ / Share $ 12.00
$ 11.00
$ 10.00
$ 9.00
$ 8.00
0 1 2 3 4 5 6 7 8 9
Year
Normal Exercising of Stock Options
$ 15.00
$ 16.00
$ 14.00
$ 13.00
$ / Share $ 12.00
$ 11.00
$ 10.00
$ 9.00
$ 8.00
0 1 2 3 4 5 6 7 8 9
Year
Enron/WorldCom Exercising of Stock Options
$ 15.00
$ 16.00
$ 14.00
$ 13.00
$ 12.00
$ / Share $ 11.00
$ 10.00
$ 9.00
$ 8.00
$ 7.00
$ 6.00
$ 5.00
$ 4.00
$ 3.00
0 1 2 3 4 5 6 7 8 9
Year
Enron History
• Enron was a broker in the purchase and sale of gas and, at the end of 2000,
it had become the seventh largest corporation in the United States in terms
of sales.
• The group suffered economic losses and its directors started misreporting financial
information to maintain its credit rating.
• Enron officials focused on increasing EPS, and manipulated accounting
data to favorably influence the stock price.
• Enron’s stock price, which hit a high of $91 per share in mid-2000, fell to
below $1 by year-end 2001.
Enron History
• On October 16, 2001, Enron reduced its net income after taxes by $544 million, and
adjusted its retained earnings by $1.2 billion, bringing the company’s stockholders’
equity down $1.7 billion.
• Around 15,000 employees held 62% of their savings in Enron stock, purchased at $83.13
in early 2001
• When it went bankrupt in October 2001, Enron’s stock plummeted to $0.10.
• When auditing Enron’s financial statements, Arthur Andersen failed to
meet GAAS guidelines. In March 2002, the U.S. Department of Justice
accused this firm of independent auditors of shredding documentation and
obstructing justice.
• After this accusation, Arthur Andersen disappeared as
an auditing firm.
Ethics and Management Objectives
• Sarbanes-Oxley Act (Bill 198 in Canada)
- Public Company Accounting Oversight Board
- Evaluation and disclosure of internal controls
- CEO and CFO must certify financial reports
- Improved auditor independence (Arthur Andersen)
- Enhanced criminal and civil penalties
- Protection for whistleblowers
The Sub-Prime Mortgage Crisis
Components of a Conventional (Canadian) Residential
Mortgage
1. Applicant subject to a financial “stress test”
2. Stress test will determine level of mortgage eligibility
3. Financial institution’s commitment (First Mortgage) is a
maximum of 80% of the market value of the property
4. Balance must come from applicant’s down-payment
5. Usually 20-25 year term (amortization)
6. Subject to periodic adjustment in the interest rate
7. Non-payment of monthly payments can lead to
repossession of the property by the financial institution.
Deregulated Sub-Prime Mortgages
Analysis of Canadian and U.S. Sub Prime Mortgages
Conventional US Sub-Prime Mortgage
Canadian Mortgage Partial Interest Only
Cost of Property $ 300,000 $ 300,000
Down Payment 20% 0%
Mortgage 240,000 300,000
5% 5 yr 25 yr Amort. 1,396 /month 1,745 /month
Actual Monthly Pay. 1,396 700 Rent
Payment Deficiency 1,045
Pay-Down in 5 yrs. (27,582) 29,679
Outstanding Mort. 212,418 71% 329,679 110%
Down Payment 20% 0%
Mortgage 240,000 300,000
5% 5 yr 25 yr Amort. 1,396 /month 1,745 /month
Actual Monthly Pay. 1,396 700 Rent
Payment Deficiency 1,045
Pay-Down in 5 yrs. (27,582) 29,679
Outstanding Mort. 212,418 71% 329,679 110%
Monthly Renewal Pay. 1,396 2,166
Renewal Increase - 1,466
Percent Increase - 310%
Initial Financing Required by Lender $300,000
based on 100% of Property Market Value
Required Repayment Obligation $329,679
In Five Years After Repossession
Percentage Increase 9.90%
Average Annual Increase Over Five Years 1.91%
Investment/Borrowing Cycle of a Toy Manufacturer
Prior Fiscal Yr. Current Fiscal Year
Sales Open Investment of January Surplus Invest. Maturity & Sales
Bal. Add'l. Borrowing
Nov. Dec. Jan. Feb. March April May June July Aug. Sept. Oct. Nov. Dec.
Ca sh or
Invest.
Borrowing
↑
Redemption of 6-month
Mortgage-Backed Security
Short Selling "The Big Short"
Investment Dealer
Investor Open Market
Temporary Financing
Initial Position
Step 1. Shares: 10,000
Investment Dealer Mkt. Price: $10.00
Transaction: $100,000
Investor Open Market
$100,000
↑
Temporary Financing
Step 1. Investor would borrow temporary funds equal to the open market
value of the shares the investor is shorting (eg: 10,000 shares @ $10 =
$100,000).
Step 2. Investment Dealer
$100,000 10,000 shares
↑↓
10,000 shares
Investor Open Market
Temporary Financing
Step. 2 The investor would then “borrow” shares from an investment dealer
who is holding the shares on behalf of other investors who own the shares.
As collateral, the investor would transfer the temporarily financing to the
investment dealer ($100,000).
Step 3. Investment Dealer
$100,000
10,000 shares → 10,000 shares
Investor Open Market
← $100,000
↓
$100,000
Temporary Financing
Step 3. The investor would then immediately sell the borrowed shares on
the open market, thereby securing the funds equivalent to the amount of the
temporary loan. The investor would then pay off the temporary loan
($100,000).
Closing Position
Step 4. Shares: 10,000
Investment Dealer Mkt. Price: $8.00
Transaction: $80,000
$100,000
Investor Open Market
$80,000
↑
Temporary Financing
Step 4. The investor would then anticipate that the market value of the
shares would fall (to $8.00 per share) and would again secure the temporary
financing needed to buy back the borrowed shares (now $8.00 per share @
$8.00 = $80,000)
Step 5. Investment Dealer
$100,000
10,000 shares ← 10,000 shares
Investor Open Market
→ $80,000
↑
$80,000
Temporary Financing
Step 5. The investor would buy the shares needed to return the borrowed
shares (at a cost of $80,000)
Step 6. Investment Dealer
$100,000 10,000 shares
↓↑
$100,000 10,000 shares
Investor Open Market
$80,000
Temporary Financing
Step 6. The investor would return the shares and be reimbursed the original
amount posted as collateral ($100,000)
Step 7. Investment Dealer
Investor Open Market
$100,000 $80,000
↓
$80,000
Temporary Financing
Step. 7. Finally, the investor would repay the temporary loan ($80,000) from
the collateral ($100,000) and net a profit ($20,000) without having
contributed any of their own money during the transaction.
Initial Position
Investment Dealer Shares: 10,000
$100,000 $20,000 Mkt. Price: $10.00
↑ Transaction: $100,000
Investor Rise in Market Price
Shares: 10,000
$100,000 $20,000 Mkt. Price: $12.00
↑ Transaction: $120,000
Temporary Financing
