1 Instructor’s Manual – Chapter 16 | Ferrell / Hirt / Ferrell: Business © 2016 by McGraw-Hill Education.
Ferrell / Hirt / Ferrell:
Business
Instructor’s Manual – Chapter 16
Chapter 16: Financial Management and
Securities Markets
Use this Instructor’s Manual to facilitate class discussion and incorporate the unique features of the text’s
highlights. Follow-up via the Connect exercises is then encouraged to provide a holistic understanding of the
chapter.
C H A P T E R F O R E C A S T
In this chapter, we look at both short- and long-term financial management. First, we discuss the management
of short-term assets, which companies use to generate sales and conduct ordinary day–to-day business
operations. Next we turn our attention to the management of short-term liabilities, the sources of short-term
funds used to finance the business. Then, we discuss the management of long-term assets such as plants,
equipment, and the use of common stock (equity) and bonds (long-term liability) to finance these long-term
corporate assets. Finally, we look at the securities markets, where stocks and bonds are traded.
L E A R N I N G O B J E C T I V E S
LO 16-1 Describe some common methods of managing current assets.
LO 16-3 Summarize the importance of long-term assets and capital budgeting.
LO 16-5 Discuss how corporations can use equity financing by issuing stock through an investment banker.
LO 16-7 Critique the short-term assets and liabilities of a small manufacturer, and recommend corrective
action.
L E A R N T H E T E R M S
bonds (p. 497)
capital budgeting (p. 494)
line of credit (p. 492)
lockbox (p. 487)
secured bonds (p. 497)
secured loans (p. 492)
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Ferrell / Hirt / Ferrell:
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Instructor’s Manual – Chapter 16
K E Y T E R M S A N D D E F I N I T I O N S
bonds
Debt instruments that larger companies sell to raise long-term funds.
capital budgeting
The process of analyzing the needs of a business and selecting the assets
that will maximize its value.
commercial certificates of
deposit (CDs)
Certificates of deposit issued by commercial banks and brokerage
companies, available in minimum amounts of $100,000, which may be
traded prior to maturity.
commercial paper
A written promise from one company to another to pay a specific
amount of money.
dividend yield
The dividend per share divided by the stock price.
eurodollar market
A market centered in London for trading U.S. dollars in foreign countries.
factor
A finance company to which businesses sell their accounts receivable—
usually for a percentage of the total face value.
floating-rate bonds
Bonds with interest rates that change with current interest rates
otherwise available in the economy.
investment banking
The sale of stocks and bonds for corporations.
junk bonds
A special type of higher-interest-rate bond that carries higher inherent
risks.
line of credit
An arrangement by which a bank agrees to lend a specified amount of
money to the organization upon request.
lockbox
An address, usually a commercial bank, at which a company receives
payments in order to speed collections from customers.
long-term (fixed) assets
Production facilities (plants), offices, and equipment—all of which are
expected to last for many years.
long-term liabilities
Debts that will be repaid over a number of years, such as long-term
loans and bond issues.
marketable securities
Temporary investments of “extra” cash by organizations for up to one
year in U. S. Treasury bills, certificates of deposit, commercial paper, or
Eurodollar loans.
3 Instructor’s Manual – Chapter 16 | Ferrell / Hirt / Ferrell: Business © 2016 by McGraw-Hill Education.
Ferrell / Hirt / Ferrell:
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Instructor’s Manual – Chapter 16
over-the-counter (OTC)
market
A network of dealers all over the country linked by computers,
telephones, and teletype machines.
primary market
The market where firms raise financial capital.
prime rate
The interest rate that commercial banks charge their best customers
(usually large corporations) for short-term loans.
retained earnings
Earnings after expenses and taxes that are reinvested in the assets of the
firm and belong to the owners in the form of equity.
secondary markets
Stock exchanges and over-the-counter markets where investors can
trade their securities with others.
secured bonds
Bonds that are backed by specific collateral that must be forfeited in the
event that the issuing firm defaults.
secured loans
Loans backed by collateral that the bank can claim if borrowers do not
repay them.
securities markets
The mechanism for buying and selling securities.
serial bonds
A sequence of small bond issues of progressively longer maturity.
trade credit
Credit extended by suppliers for the purchase of their goods and
services.
transaction balances
Cash kept on hand by a firm to pay normal daily expenses, such as
employee wages and bills for supplies and utilities.
Treasury bills (T-bills)
Short-term debt obligations the U. S. government sells to raise money.
unsecured bonds
Debentures, or bonds that are not backed by specific collateral.
unsecured loans
Loans backed only by the borrower’s good reputation and previous
credit rating.
working capital management
The management of short-term assets and liabilities.
Ferrell / Hirt / Ferrell:
Business
Instructor’s Manual – Chapter 16
C O N T E N T O U T L I N E
The following section provides the flow of information using the LEARNING OBJECTIVES as a guide, KEY TERMS
learners will need to take away from the course and a notation of when to use POWERPOINT SLIDES with
LECTURE NOTES to drive home teaching points. There is also a reminder on when CONNECT activities can be
used. This is created so that you can facilitate in–class or online discussion effectively.
LO 16-1
Describe some common methods of managing current assets.
• Introduction
• Managing Current Assets and Liabilities
o Managing Current Assets
PowerPoint Slides
PPT 16.4
Lecture Outline and Notes:
I. Managing Current Assets and Liabilities
A. Current assets include cash, investments, accounts receivable, and
inventory.
B. Current liabilities are short-term debt obligations—accounts payable,
wages payable, taxes payable, and notes (loans) payable.
C. Current and short-term assets are often used interchangeably.
D. Short-term financial management is sometimes called working capital
management because current assets and liabilities continually flow
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Instructor’s Manual – Chapter 16
PPT 16.5
PPT 16.7
b. Transaction balances are cash kept on hand by a business to pay
normal daily business expenses.
1) The bank can then start clearing the checks and get the
money into the company’s checking account much more
e. Companies generally want to collect cash quickly but pay it out
a. When cash comes in faster than it is needed to pay bills,
for up to one year in U.S. Treasury bills, certificates of deposit,
commercial paper, or Eurodollar loans.
c. U.S. Treasury bills (T-bills) are short-term debt obligations of the
another to pay a specific amount of money.
1) Because commercial paper is backed only by the name and
reputation of the issuing company, sales of commercial
paper are restricted to only the largest and most financially
paper, requiring the Fed to take action.
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Instructor’s Manual – Chapter 16
PPT 16.11
PPT 16.12
f. The eurodollar market is a market for trading U.S. dollars in
foreign countries.
1) Investors have a chance to earn a slightly higher rate of
return with just a little more risk than U.S. Treasury bills.
4. Maximizing Accounts Receivable
a. Each credit sale represents an account receivable—a payment
owed to a business from credit customers.
b. Many firms offer discounts on purchases if they pay the invoice
industry trade groups.
5. Optimizing Inventory
a. The object is to minimize the firm’s investment in inventory
without experiencing production cutbacks as a result of critical
materials shortfalls or lost sales due to insufficient finished
goods inventories.
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PPT 16.14
PPT 16.15
F. Managing Current Liabilities
1. Accounts Payable
a. Accounts payable is money an organization owes to suppliers for
goods and services.
b. Trade credit, the most widely used and important source of
short-term financing, is credit extended by suppliers for the
purchase of their goods and services.
1) Most suppliers offer trade discounts to businesses that pay
2. Bank Loans
a. Banks provide both large and small businesses short-term funds
in the form of loans or lines of credit.
a specified amount of money to the organization upon request—
provided that the bank has the required funds to make the loan.
c. Secured loans are backed by collateral that the bank can claim if
the borrower does not repay the loan.
d. Unsecured loans are backed only by the borrower’s good
reputation and previous credit rating.
b. Some companies sell their accounts receivable to a finance
company called a factor, which gives the selling organizations
cash and assumes responsibility for collecting accounts.
c. Additional nonbank liabilities that must be efficiently managed
to ensure maximum profitability are taxes owed to the
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Instructor’s Manual – Chapter 16
LO 16-3
Summarize the importance of long-term assets and capital
budgeting.
o Pricing Long-term Money
PPT 16.17
PPT 16.18
PPT 16.20
II. Managing Fixed Assets
A. Long-term (fixed) assets are those assets expected to last for many
years, such as plants and equipment.
1. Leasing is one approach for companies who do not have the funds to
purchase expensive buildings or equipment.
a. A capital lease is a long-term contract and shows up on the
show up on the balance sheet.
B. Capital Budgeting and Project Selection
3. It does not end with the selection, purchase, and use of an asset; all
C. Assessing Risk (Figure 16.1)
1) Pharmaceutical companies face many risks with new
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Instructor’s Manual – Chapter 16
PPT 16.21
PPT 16.22
2. Long duration projects or assets are riskier.
a. The longer a project or asset is expected to last, the greater its
b. Buying rather than repairing new machinery is riskier.
D. Pricing Long-Term Money
1. There is a limited supply of funds available for investment.
a. The returns on any project must cover not only the costs of
operating the project but also the interest expenses for the debt
of their funds and increase profit.
2. New firms tend to enter industries with greatest rewards for success
a. Competition intensifies and drives down profit potential
LO 16-4
Specify how companies finance their operations and manage
fixed assets with long-term liabilities, particularly bonds.
• Financing with Long-Term Liabilities
PPT 16.23
III. Financing with Long-term Liabilities
A. Two ways of financing to acquire fixed assets include equity financing
and debt financing.
B. Long-term liabilities are debts that will be repaid over a number of
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PPT 16.24
PPT 16.25
C. Bonds: Corporate IOUs
1. A bond is a debt instrument that a company sells to raise long-term
funds.
2. Bonds are issued by corporations, public utilities, nonprofit
corporations, and federal, state, and local governments.
3. Most bonds can be transferred from one owner to another in a bond
market.
4. The bond contract, or indenture, sets forth all the terms of
agreement between the lender and the bond issuer, including:
a. The face value—the initial value of the bond.
b. The maturity date—the date the bond owner receives the face
D. Types of Bonds
1. Unsecured bonds are debentures, or bonds not backed up by
specific collateral.
2. Secured bonds are bonds in which the issuing company pledges
specific assets to bondholders as a guarantee should it be unable to
make the interest and principal payments.
3. Serial bonds are a sequence of small bond issues of progressively
stock through an investment banker.
• Financing with Owners’ Equity
• Investment Banking
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PPT 16.26
connect
Need help
understanding Equity
Financing and Debt
explanation.
PPT 16.29
IV. Financing with Owners’ Equity
A. Owners’ equity is the owners’ investment in an organization.
B. Sole proprietors and partners own all or a part of their businesses
outright.
1. Their equity includes the money and assets they have brought into
their ventures.
certificate.
2. The market value is the current market price of the common stock.
stock.
E. When a company has profits left over after paying expenses and taxes, it
can retain some or all of the earnings to invest in corporate expansion or
pay out some of the earnings to stockholders in the form of dividends.
2. When the board of directors distributes some of a company’s profits
to the owners, it issues them cash payments called dividends.
price. (Table 16.4)
4. Not all companies pay dividends.
A. A company that needs more money may be able to obtain financing by
issuing stock.
1. When a company issues stock for the first time, it is called a new
2. A company that offers its stock to the public for the very first time is
said to be going public, and the sale is called an initial public
offering.
B. New issues are sold directly to the public and to institutions through the
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Instructor’s Manual – Chapter 16
LO 16-6
Describe the various securities markets in the United States.
• The Securities Markets
o Stock Markets
o The Over-The-Counter Market
o Measuring Market Performance
PPT 16.32
PPT 16.33
PPT 16.34
PPT 16.35
VI. The Securities Markets
A. Securities markets provide:
1. The mechanism for buying and selling securities.
2. Liquidity—the ability to turn securities into cash.
3. Secondary markets permit the trading of previously issued securities.
4. Secondary market trades may take place on organized exchanges or
in what is known as over-the-counter markets.
B. Stock Markets
1. Formerly exchanges were divided into organized exchanges and
over-the-counter markets.
2. NYSE and NASDAQ are now publicly traded companies (previously
were not-for-profit organizations).
a. Both exchanges merged with electronic exchanges for cheaper
and faster trading than floor trading.
b. NASDAQ was traditionally an electronic market.
country linked by computers, telephones, and Teletype machines.
1. Mostly consists of penny stocks, other small stocks, and illiquid bank
D. Measuring Market Performance (Figure 16.2)
1. There are a variety of averages and indexes available for comparison
a. An index compares current stock prices with those in a specified
base period.
b. An average is the average of certain stock prices.
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PPT 16.36
PPT 16.37
2. Many investors follow the activity of the Dow Jones Industrial
Average to see whether the stock market has gone up or down. 30
companies currently make up the Dow. (Table 16.5)
3. Recognizing financial bubbles can be difficult in the enthusiastic
atmosphere of rising markets.
a. The most recent recession was partly precipitated by a crash of a
housing bubble.
1) The Dow Jones Industrial Average gained 10 times from
August 1982 to the beginning of 2000. This was the Internet
bubble, and they are difficult to see until they burst.
2) Before the housing bubble burst in October 2007, the Dow
Jones hit an all-time high.
b. The Federal Reserve and the Federal government acted quickly
to bail out failing institutions—staving off a potentially worse
recession.
c. Investors must be well-informed to make sound financial
decisions.
LO 16-7
Critique the short-term asset and liabilities of a small
manufacturer and recommend corrective action.
PPT 16.38
PPT 16.39
VII. Solve the Dilemma—Surviving Rapid Growth
A. Glasspray Corporation is a small firm that makes industrial fiberglass
spray equipment
B. Supplies a range of firms:
1. Mom-and-pop boatmakers
2. Major industrial giants (overseas and here at home)
C. Just about every molded fiberglass resin product is constructed with the
help of one or more of the company’s machines
increases in year-to–year sales
E. President and founder Stephen T. Rose:
1. Lamented the sad state of his firm’s working capital position
2. “Our current assets aren’t and our current liabilities are!”
3. To the top officers: “We can’t afford any more increases in sales!
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F. Discussion questions:
1. Normally, rapidly increasing sales is a good thing. What seems to be
the problem here?
A rule of thumb in finance is to always match short– and long-run
investments with short- and long-term financing, respectively.
Organizations experiencing a temporary surge in sales may use short-
term loans to finance the increased sales (added costs from overtime,
extra raw materials, and so forth). However, short-term funds come
at a premium, which is why they should be used only for short-run
investments (such as a temporary increase in sales). If sales are
expected to increase from year to year (and assuming the firm is
already operating at or near capacity), operation expansion is the
accrued salaries, accrued taxes, and short-term bank loans.
3. What are some management techniques applied to current
liabilities that Glasspray might use to improve its working capital
some of the short-term debt with long-term financing or equity (the
debt used to finance the increased sales), and it could take
advantage of any trade credit its suppliers offer.