Corporate Finance

Everything.. R Srinivasan

Corporate Finance
Valuation and Cost of capital Capital budgeting Capital structure, financing and dividend policy Working capital

Valuation
Generalised valuation Arbitrage and value additivity Patterns Level perpetuity Growing perpetuity Level annuity Growing finite cash flow

Valuation
Growing finite [t years] cash flow
C1/(r-g){1-(1+g)t/(1+r)t}

Valuation
Compounding intervals (1+r/m)m-1 Continuous compounding Stated and effective rates Nominal and real rates 1+rnominal=(1+rreal)(1+inflation rate)

Valuation: Straight Bonds

YTM Duration Sensitivity of value to changes in interest rates [1*PV(C1)/V]+[2*PV(C2)/V]+[3*PV(C3)/V] V/V = (1+r)/(1+r)*D

Valuation: Common Stock

Perpetual growth models Sustainable growth P0=No-Growth +PVGO No-growth =EPS1/r PVGO=NPV1/(r-g) where NPV1 =-INV1 +INV1*ROE/r g=Ploughback*ROE EPS1/P0 interpretation

Valuation
Multiple stages Supernormal stage plus PV of normal growth Free cash flow NOI approach

Cost of Capital
Security return and standard deviation Portfolio return and standard deviation Diversification Portfolio variance=
1/N Average Var+(N-1)/N Average covariance

Systematic and unsystematic risk CAPM Opportunity cost of capital r [rA]and Adjusted cost of capital r*

Cost of Capital
1. VL = VU +Tc *D 2. WACC = D/V * (1-Tc) * rD+E/V * rE 3. rE = rA + (rA - rD ) * (1- Tc) * D/E 4. b E = {1+ (1- Tc) * D/E} *b A 5. rE = rf + (rM - rf) *b E 6. WACC= rA *(1- Tc * D/V)
[Definition of WACC] [MM Proposition II] [If debt is risk free] [CAPM] MM

Valuation
Contingent cash flow Call/Put American/European Binomial Black-Scholes Underlying asset price, Exercise Price, Riskfree rate, Volatility, Time

Capital Budgeting
NPV and IRR not payback and accounting rate of return Accept/reject single project use NPV or IRR, unless no/multiple IRR Mutually exclusive projects: Same life and risk Use NPV [or IRR of difference between projects]

Capital Budgeting
Mutually exclusive projects: Different lives same risk Use NPV-assumes replacement projects have zero NPV. OK for projects with long lives Use NPV-with specific replacements that make project with comparable lives Use replacement chain or EAC Care: Use only real cash flows for EAC

Capital Budgeting
Incremental nominal cash flows with empirically measured discount rate Components of cash flow Investment in fixed assets, salvage value Investment in working capital, release Operating revenues/expenses NO INTEREST

Capital Budgeting
NPV assumes now or never Real Option framework Abandonment Follow-up Wait and learn Flexibility

Capital structure
Market Efficiency MM-1 No taxes MM-2 Corporate taxes Miller Both corporate and personal taxes GL= {1-(1-TC)*(1-TpE)/(1-Tp)} Bankruptcy costs Agency costs

Dividends
MM Does not matter Lintner behavioural model
DIV1-DIV0=Adjustment rate*(target ratio*EPS1-DIV0)

Agency costs/signalling

Working Capital Management

Operating cycle, cash conversion cycle, weighted cycles and supply chain management Investment in receivables Cash management EOQ and Miller-Orr models