Learning Objectives

Capital Structure 

When is Capital Structure relevant and when is it irrelevant?  It is relevant (in terms of affecting firm value), only if it changes payouts to parties other than the security holders of the firm, or if it changes the cashflows generated by the operations of the firm.

One is not a neutral debt-equity ratio!

Cost of capital is not the same as the cost of equity capital.  Cost of capital is the cost of obtaining capital to fund the operations of the entire company; one way to measure it is to compute the weighted average cost of capital

Market Value

Market Value is (almost) always more important than book value.  Book value is useful only as an approximation to market value.

The future versus the past

We are (almost) always interested in the future.  We may use the past, but usually only to estimate future values.  If the past is not useful in evaluating the future, it is useless.

What moves market prices?

Information that is public knowledge will not affect market prices.  In other words, the key is News!

If the answer provided by a formula or theory doesn't make sense, it's probably wrong!  Check reasonableness

A formula is worthless if you do not know what the symbols used in the formula refer to.  Garbage in, garbage out!

Always keep in mind the units of measurement.  A formula that multiples one quantity measured in dollars and another quantity measured in units cannot give you an answer measured in percent!  You can't add numbers that are measured in different units -- apples and oranges, in other words.

Learn how to read balance sheets and income statements.  If you don't know your accounting terms, you don't know the language of business, and certainly not the language of finance.

Don't confuse the goals of an accounting system with the goals of a financial analyst/economist.  But learn to use the products of an accounting system like a good financial analyst.


What do you need to know?