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Lecture 1 – Introduction to Corporate Finance Financial Management Duties
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Capital Budgeting – The process of planning and managing a firm’s long-term investments Capital !tructure – The specific mi"ture of long-term de#t and e$uit% the firm uses to finance it operations &or'ing Capital Management – Managing the firm’s short-term assets and lia#ilities
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Chief Financial (fficer – oversees the treasurer and controller and sets overall financial strateg% Treasurer – responsi#le for financing) cash management) and relationships *ith financial mar'ets and institutions Controller – responsi#le for #udgeting) accounting) and auditing
Forms of Business (*nership
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+roprietorship – ,n unincorporated #usiness o*ned #% a single individual ,dvantages -asil% and ine"pensivel% formed Fe* government regulations ,voids corporate income ta"es Disadvantages .nlimited lia#ilit% for the o*ner Limited to the life of the o*ner Illi$uid Difficult to o#tain large amounts of capital
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+artnership – Business o*ned #% to* or more persons *ho are personall% responsi#le for all its lia#ilities ,dvantages -asil% and ine"pensivel% formed Fe* government regulations ,voids corporate income ta"es
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Lecture 1 – Introduction to Corporate Finance
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Disadvantages .nlimited lia#ilit% for general partners Limited life for the organi/ation Difficult to transfer o*nership Difficult to o#tain large amounts of capital Corporation – , #usiness that is legall% distinct from its o*ners ,dvantages .nlimited life -as% to transfer o*nership Limited lia#ilit% Disadvantages Double taxation Comple" legal re$uirements 0%#rid Forms of (rgani/ation
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Limited partnership – Certain partners are designated general partners) *ho have unlimited lia#ilit% (ther o*ners are limited partners #ecause their lia#ilit% is limited +rofessional Corporation – , t%pe of corporation common among professionals ,n ! corporation has 12 or fe*er shareholders
The 3oal of Financial Management
Ma"imi/e !hareholder &ealth – Mangers *or' on #ehalf of shareholders and should pursue policies that enhance shareholder value !ocial 4esponsi#ilit% – The concept that #usinesses should #e activel% concerned *ith the *elfare of societ% at large ,genc% +ro#lems and Control of the Corporation
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,genc% +ro#lem – The conflict of interest #et*een the firm’s o*ners and managers
Management 3oals – Managers have a tendenc% to increase their o*n per's or to increase the si/e of the organi/ation in an attempt to increase their po*er Methods to -ntice Managers to ,ct in the Best Interests of !toc'holders The threat of firing The threat of ta'eovers Managerial compensation
Lecture 1 – Introduction to Corporate Finance
Direct Intervention #% !hareholders
(*nership !tructure outside the . ! – in some countries) o*nership is more concentrated) creating separate pro#lems
+ – 4evenues appear *hen the% accrue) not *hen the% are collected -"penses are matched *ith the revenues that appear ¤ ¤ 6oncash items – Depreciation Ta"es – The marginal ta" rate is the most relevant *hen evaluating pro7ects Balance !heet • ¤ Balance !heet – +resents a snapshot of the firm’s assets) lia#ilities) and o*ner’s e$uit% .ssets – life of less than one %ear Fi"ed .Lecture 2 – Financial Statements. Taxes.nal%sis • time ¤ Cash Flo*s ..ssets – life longer than one %ear ¤ Lia#ilities and (*ners’ -$uit% – The claims against assets Current Lia#ilities – life of less than one %ear Long-term Lia#ilities – de#t 8financial leverage9 that is not due in the ne"t %ear (*ners’ -$uit% – value of the capital supplied #% common stoc'holders Boo' :alues vs Mar'et :alues – assets must #e sho*n on the #alance sheet at their historical cost ad7usted for depreciation These are not mar'et values ¤ Cash Flo* .ssets – Listed in order of their li$uidit% on the left-hand side of the statement Current .nal%sis – sho*s the firm’s cash receipts and cash pa%ments over a period of Cash Flo* from (perations – #egins *ith net income and ad7usts for non-cash items . and Cash Flow Class notes Lecture 5 – Financial !tatements) Ta"es) and Cash Flo* • • 4evie* the income statement) #alance sheet) and cash flo* statement -mphasi/e cash flo*s and the difference #et*een accounting accruals Income !tatement • ¤ Income !tatement – !ho*s ho* profita#le a firm has #een over some period of time 3.
and Cash Flow Class notes Cash .ctivities Cash flo* to creditors – interest paid minus net ne* #orro*ing Cash flo* to stoc'holders – dividends paid minus net ne* e$uit% . Taxes.Lecture 2 – Financial Statements.sed for Investments – mone% spent on fi"ed assets and received from sales of fi"ed assets ¤ ¤ Cash Flo* from Financing .
nal%sis (#7ectives • • Introduce the anal%sis of financial statements through the use or ratios 4evie* the uses and limitations of ratios 4atio .nal%sis • ¤ ¤ ¤ ¤ ¤ • 4atio .Lecture 3 – atio !nal"sis Class notes Lecture .sset Management 4atios Long-Term !olvenc% 8De#t9 4atios +rofita#ilit% 4atios Mar'et :alue 4atios Li$uidit% 4atios – sho* the relationship of a firm’s cash and other current assets to its current lia#ilit% ¤ ¤ ¤ • Current 4atio – indicates the e"tent to *hich current lia#ilities are covered #% those assets e"pected to #e converted to cash in the near future <uic' 4atio – a measure of the firm’s a#ilit% to pa% off short-term o#ligations *ithout rel%ing on the sale of inventories Cash 4atio – a ver% short-term measure of li$uidit% .nal%sis – designed to help evaluate financial statements Li$uidit% 4atios . set of ratios *hich measure ho* effectivel% a firm is managing its assets ¤ ¤ ¤ Inventor% Turnover – the num#er of times per %ear that the firm fills up and completel% empties its inventor% Da%s’ !ales in Inventor% – the num#er of da%s it *ould ta'e to sell off the firm’s current level of inventor% 4eceiva#les Turnover – measures ho* fast sales are collected .sset Management – . – 4atio .
sset Turnover – measures ho* effectivel% the firm uses all of its assets 4atio .nal%sis • Long-Term !olvenc% 8De#t9 4atios – The e"tent to *hich a firm uses de#t financing It has three implications= ¤ ¤ ¤ ¤ ¤ • !toc'holders maintain control *hile limiting their investment 4is's of the firms is transferred to creditors 4eturn on the o*ner’s e$uit% is magnified Total De#t 4atio – measures the percentage of funds provided #% creditors Times-Interest--arned – measures the a#ilit% of the firm to meet its annual interest pa%ments +rofita#ilit% 4atios – sho* the com#ined effects of li$uidit%) asset management) and de#t on operating results ¤ ¤ ¤ • +rofit Margin – measures income per dollar of sales 4eturn on .Lecture 3 – atio !nal"sis Class notes ¤ ¤ ¤ Da%s !ales in 4eceiva#les – the average length of time the firm must *ait after ma'ing a credit sale #efore receiving cash Fi"ed .ssets 84(.9 – measure of profit per dollar of assets 4eturn on -$uit% 84(-9 – measures the rate of return on common stoc'holders’ investment Mar'et :alue 4atios – relates the firm’s stoc' price to its earnings and #oo' value per share ¤ ¤ +rice--arnings 8+>-9 4atio – sho*s ho* much investors are *illing to pa% per dollar of reported profits Mar'et-to-Boo' 4atio – the ratio of a stoc'’s mar'et price to its #oo' value and gives an indication of ho* investors regard the compan% .sset Turnover – measures ho* effectivel% the firm uses its plant and e$uipment Total .
nal%sis • • • • • • 6ot as useful for large) diverse companies Inflation distorts #alance sheets !easonal factors distort ratio anal%sis ?&indo* dressing’ techni$ues distort financial statements Different accounting practices can distort comparisons 6o o#7ective standard on *hat is good and #ad .ses • • • • Internal .nal%sis – Compare a particular compan% *ith a group of ?#enchmar'’ companies Limitations of 4atio .nal%sis – -"amine *hether there is a strengthening or *ea'ening position +eer 3roup .Lecture 3 – atio !nal"sis Class notes Financial !tatement .ses – evaluate management and planning for the future -"ternal .ses – Investor sand creditors find the information useful in their decision ma'ing Time-Trend .
ccomplishments .nal%/ing the investment and financing choices +ro7ecting the future conse$uences of current decisions Deciding *hich alternatives to underta'e Measuring su#se$uent performance against goals Dimensions of Financial +lanning – focus is on capital #udgeting for the ne"t t*o to five %ears ¤ ¤ ¤ • &orst case scenario – planning for lean economic times 6ormal gro*th – firm gro*s *ith its mar'ets .ggressive gro*th – rapid gro*th *ith mar'et or e"ceeding mar'et +lanning .Lecture # – Lon$%Term Financial &lannin$ and 'rowth Class notes Lecture @ – Long-Term Financial +lanning and 3ro*th (#7ectives • • • -"amine the reasons for financial planning (utline the process for developing a #udget +resent some common pro#lems Financial +lanning • ¤ ¤ ¤ ¤ Basic +olic% -lements 6eeded investment in ne* assets Degree of financial leverage the firm uses Firm’s dividend polic% &or'ing capital polic% Financial +lanning +rocess • • • • • .
sset re$uirements Financial re$uirements The plug – e"ternal financing needed ¤ Inputs and Considerations Dividend pa%out ratio 4etention ratio !pontaneous financing Fi"ed asset re$uirement » » • ¤ ¤ ¤ -"cess capacit% Lump% assets Determinants of 3ro*th +rofit margin – higher profits support higher gro*th Dividend polic% – lo*er dividend provide more internal funds for gro*th Financial polic% – de#t can #e used for gro*th .pproach – Most varia#les are proportional to sales Inputs and Considerations !ales forecast .Lecture # – Lon$%Term Financial &lannin$ and 'rowth Class notes ¤ ¤ ¤ ¤ -"amining interactions -"plore options .void surprises -nsure feasi#ilit% and internal consistenc% Financial +lanning Model • ¤ +ercent of !ales .
Lecture # – Lon$%Term Financial &lannin$ and 'rowth Class notes ¤ Total asset turnover – increases allo* for higher gro*th Current assets *ould support increased sales !ummar% • • • -sta#lishes goals and used to evaluate su#se$uent performance Forces the financial manager to prepare for adverse events and devise strategies +roceeds #% trial and error .
Lecture ( – Interest ates and )ond *aluation Class notes Lecture 1 Interest 4ates and Bond :aluation • • • Bonds To e"plain ho* #onds are valued -"amine different #ond features To e"plain the relationship #et*een interest rates and #ond valuations • • • • • Bond – simpl% a long-term loan Treasur% Bond – issued #% the federal government Corporate Bond – issued #% corporations Municipal Bonds – issued #% state and local governments Foreign Bonds – issued #% either foreign governments or foreign corporations Bonds Characteristics • • • • • • +ar :alue – the face value of the #ond Coupon – the specified num#er of dollars of interest paid each period Coupon 4ate – the annual coupon divided #% the face value of a #ond Maturit% – the date on *hich the principal amount of a #ond is paid Aield to Maturit% – the rate of return earned on a #ond if it is held to maturit% Current Aield – annual coupon pa%ments divided #% #ond price .lternative T%pes of Bonds • • Floating 4ate Bond – a #ond *hose interest rate fluctuates *ith shifts in the general level of interest rates Bero Coupon Bond – a #ond that pa%s no annual interest #ut is sold at a discount #elo* par .
#ond that pa%s interest onl% if the interest is earned Inde"ed Bond – . #ond that has interest pa%ments #ased on an inflation inde" so as to protect the holder from inflation Bond Features • Call +rovisions – gives the issuing corporation the right to call the #onds for redemption ¤ ¤ Call +remium – the additional sum the compan% must pa% the #ondholders to call the #onds Deferred Call – Bonds are often not calla#le until several %ears after the% *ere issued ¤ • 4efunding (peration – issuing lo*er-%ielding securities and using the proceeds to retire a previous higher-rate issue !in'ing Funds – a provision in a #ond contract that re$uires the issuer to retire a portion of the #ond issue each %ear ¤ %ear The compan% can call in for redemption a certain percentage of the #onds each ¤ The compan% ma% #u% the re$uired num#er of #onds on the open mar'et Bond :aluation • • Bond :aluation – the value of an% financial asset is simpl% the present value of the cash flo*s the asset is e"pected to produce Changing Bond :alues (ver Time – The value 8price9 of #onds drop *hen interest rates rise and vice-versa ¤ ¤ +ar #ond – &henever the going rate of interest is e$ual to the coupon rate) a fi"ed rate #ond *ill sell at its par value Discount #ond – &henever interest rates rise a#ove the coupon rate) a fi"ed-rate #ond’s price *ill fall #elo* its par value .Lecture ( – Interest ates and )ond *aluation Class notes • • • Converti#le Bond – . #ond that is e"changea#le) at the option of the holder) for common stoc' of the issuing firm Income Bond – .
d7ustment Divide the annual coupon interest pa%ment #% t*o to determine the amount of interest paid each si" months Multipl% the %ears to maturit% #% t*o to determine the num#er of semiannual periods ¤ Divide the nominal interest rate #% t*o to determine the periodic semiannual interest rate Bond 4is's • • • Interest 4ate 4is' – the ris' of a decline in a #ond’s price due to an increase in interest rates 4einvestment 4ate 4is' – the ris' that a decline in interest rates *ill lead to a decline in income from a #ond portfolio Default 4is' – the li'elihood that the issuers *ill not #e a#le to ma'e pa%ments Corporate Bonds • • • Mortgage Bonds – a #ond #ac'ed #% fi"ed assets De#entures – a #ond that is not secured #% a mortgage on specific propert% !u#ordinate De#entures – a #ond having a claim on assets onl% after the senior de#t has #een paid off in the event of li$uidation Bond 4atings • Bond 4atings – Bonds have #een assigned $ualit% ratings that reflect their pro#a#ilit% of going into default ¤ Investment 3rade Bonds – rated triple-B or higher .Lecture ( – Interest ates and )ond *aluation Class notes ¤ ¤ • ¤ ¤ +remium #ond – &henever interest rates fall #elo* the coupon rate) a fi"ed-rate #ond’s price *ill rise a#ove its par value The mar'et value of a #ond *ill al*a%s approach its par value as its maturit% date approaches !emiannual .
high-ris') high-%ield #ond Dou#le-B and lo*er #onds Importance 0as a direct) measura#le influence on the #ond’s interest rate and cost of capital Man% institutions are restricted to investment-grade securities Bond Mar'ets • • • Corporate #onds are traded primaril% in the over-the-counter mar'et Most #onds are o*ned #% and traded among large financial institutions (ver-the-counter #ond dealers arrange transfers of large #loc's of #onds among the relativel% fe* holders of the #onds Term !tructure of Interest 4ates • ¤ ¤ term Term !tructure – the relationship #et*een #ond %ields and maturities .p*ard !loping – rates are lo*er in the short-term and higher in the long-term Do*n*ard !loping – rates are higher in the short-term and lo*er in the long- Aield Curve -"planations • • • -"pectations Theor% – the shape of the %ield curve depends on investors’ e"pectations a#out future interest rates Li$uidit% +reference Theor% – the preference for more li$uid short-term securities places up*ard pressure on the slope of a %ield curve !egmented Mar'ets Theor% – investors and #orro*ers choose securities *ith maturities that satisf% their forecasted cash needs .Lecture ( – Interest ates and )ond *aluation Class notes ¤ ¤ Cun' Bonds – .
dd these t*o components to find the intrinsic value of the stoc' . *aluation Class notes Lecture D – !toc' :aluation • • • 4evie* characteristics of e$uities Introduce stoc' valuation methods -"amine capital mar'et efficienc% theories Common !toc' :aluation • Common !toc' – :alued the same as an% other asset – #% discounting all e"pected future cash flo*s The cash flo* comes in t*o forms= ¤ ¤ • Dividends Capital 3ains Cash Flo*s – the #asic stoc' valuation e$uation :alue of stoc' E +F E +: of future dividends • at all Bero 3ro*th – a common stoc' *hose future dividends are no e"pected to gro* +F E D>' • Constant 3ro*th – a common stoc' *hose gro*th is e"pected to continue into the foreseea#le future at a constant rate ¤ Constant 3ro*th Model – a model used to find the value of a constant gro*th stoc' Total return is comprised of a capital gains return and a dividend return +F E D1>8' – g9 • 6onconstant 8supernormal9 3ro*th – a compan% *hich gro*s much faster for a specified period of time ¤ ¤ ¤ Find the +: of the dividends during period of rapid gro*th Find the price of the stoc' at the end of the nonconstant gro*th period using the dividend gro*th model .Lecture + –Stoc.
ris' premium) *hich depends on #eta and the mar'et ris' premium -"pected return E ris'-free rate G ris' premium 's E '4F G Hs8'M – '4F9 Common !toc' Features • Control of the firm – the right to elect directors *ho appoint officers to manage the #usiness ¤ ¤ ¤ • • +ro"% – a document giving one person the authorit% to act for another) t%picall% the po*er to vote shares of common stoc' +ro"% Fight – .n attempt #% a person or group to gain control of a firm Ta'eover – an action *here#% a group succeeds in ousting a firm’s management and ta'ing control of the compan% +reemptive 4ight – a provision the gives common stoc'holders the right to purchase ne* issues of common stoc' Dividends – +a%ments #% a corporation to shareholders) made in either cash or stoc' +referred !toc' Features • +referred !toc' – stoc' *ith dividend priorit% over common stoc') normall% *ith a fi"ed dividend and *ithout voting rights ¤ ¤ !tated :alue – normall% I1FF per share Cumulative Dividends – +referred dividends must #e paid in full prior to the pa%ment of common dividends !toc' Mar'ets .Lecture + –Stoc. *aluation Class notes • Capital .+M9 – theor% *here the e"pected return of a securit% e$uals its #eta times the mar'et ris' premium -"pected rates of return depend on t*o things= 1 Compensation for the time value of mone% 5 .sset +ricing Model 8C.
mem#ers *ho e"ecute orders for commission #ro'ers on a fee #asis !uperD(T !%stem – an electronic 6A!.is to attract order flo* The% do this #% attracting #lue chip companies to list on their e"change Floor .< – 6ational .s%stem allo*ing orders to #e transmitted directl% to the specialist Floor Traders – 6A!.mem#ers *ho trade for their o*n accounts (perations – the #usiness of the 6A!. *aluation Class notes • • • • +rimar% Mar'et – the mar'et in *hich ne* securities are originall% sold to investors Initial +u#lic (fferings !econdar% Mar'et – the mar'et in *hich previousl% issued securities are traded among investors Dealer – maintains an inventor% and stands read% to #u% and sell at an% time Bro'er – an agent *ho arranges securit% transactions among investors 6e* Aor' !toc' -"change 86A!-9 • • • • • • • • Mem#er – the o*ner of a seat on the 6A!- Commission Bro'ers – mem#ers that ta'e orders that customers have placed *ith their respective #ro'erage firms and e"ecute them on the e"change !pecialist – acts as a dealer and maintains a limit order #oo' Floor Bro'ers – 6A!.Lecture + –Stoc.< • s%stem 6.ctivities – !pecialists normall% operate in front of their posts to monitor and manage trading in their assigned stoc's 6.!D.utomated <uotations ¤ ¤ .ssociation of !ecurities Dealers . computer net*or' of securities dealers 6o ph%sical location *here trading ta'es place .!D.
*aluation Class notes ¤ Multiple mar'et ma'er s%stem rather than a specialist s%stem Capital Mar'et -fficienc% • • • +rice Behavior in an -fficient Mar'et – prices instantaneousl% ad7ust to and full% reflect information -fficient Mar'ets 0%pothesis – securities are t%picall% in e$uili#rium Levels of Mar'et -fficienc% ¤ ¤ ¤ &ea'-Form -fficienc% – all information contained in past price movements is full% reflected in current mar'et prices !emistrong-Form -fficienc% – Mar'et prices reflect all pu#licl% availa#le information !trong-Form -fficienc% – Mar'et prices reflect all pertinent information) *hether pu#licl% availa#le or privatel% held .Lecture + –Stoc.
/et &resent *alue and 0ther In1estment Criteria Class notes Lecture J Capital Budgeting= 6et +resent :alue and (ther Investment Criteria • • Investigate different methods to evaluate pro7ectsK -"amine the #enefits and dra*#ac's of 6et +resent :alue) +a%#ac') and Internal 4ate of 4eturn +ro7ect Classifications 8Investments9 • • • • • • 4eplacement= maintenance of #usiness 4eplacement= cost reduction -"pansion of e"isting products or mar'ets -"pansion into ne* products or mar'ets !afet% and environmental pro7ects (ther Capital Budgeting -valuation Techni$ues • 6et +resent :alue 86+:9 – a measure of ho* much value is created or added toda% #% underta'ing an investment ¤ -stimating 6+: – Discounted Cash Flo* :aluation Find the present value of each cash flo* !um these discounted cash flo*s If the 6+: is positive) the pro7ect should #e accepted • ¤ +a%#ac' – time until cash flo*s recover the initial investment of the pro7ect Benefits <uic' and simple anal%sis Biased to*ards li$uidit% .– Capital )ud$etin$.Lecture .d7usts for illi$uidit% of distant cash flo*s .
/et &resent *alue and 0ther In1estment Criteria Class notes ¤ • Dra*#ac's Ignores the time value of mone% Ignores cash flo*s received after the pa%#ac' period Fails to consider ris' differences 6o o#vious criterion Discounted +a%#ac' – the length of time re$uired for an investment’s cash flo*s) discounted at the cost of capital) to cover its costs ¤ 4emaining issues -as% to understand anal%sis !till ignores cash flo*s after the pa%#ac' period 6o o#vious decision criterion • /ero Internal 4ate of 4eturn – the discount rate that ma'es the 6+: of an investment ¤ +ro#lems 6onconventional Cash Flo*s Mutuall% -"clusive Investments .– Capital )ud$etin$.Lecture .
Lecture 12 – Capital In1estment Decision Class notes Lecture 1F Capital Investment Decisions • • • Identif% relevant cash flo*s for pro7ect evaluationK Create pro forma financial statements *ith identified cash flo*sK -"amine alternate methods to derive operating cash flo* and special cases +ro7ect Cash Flo*s • 4elevant Cash Flo*s – the specific cash flo*s that should #e considered in a capital #udgeting decision ¤ ¤ • • ¤ ¤ ¤ Ta"es Based on cash flo*s) not accounting income (nl% incremental cash flo*s are relevant !tand-.lone +rincipal – assumption that the evaluation of a pro7ect ma% #e #ased on the pro7ect’s incremental cash flo*s .ctual Cash Flo*s Initial Investment – occurs at the #eginning &or'ing Capital – current assets minus current lia#ilities (ccurs at #eginning and end of pro7ect (perating Cash Flo*s – cash flo*s produced #% the pro7ect -BIT G Depr – ¤ !alvage :alue – occurs at the end !ale of the e$uipment or pro7ect Capital 3ain – ta"es must #e paid on gain Capital Loss – ta" shelter has #een created Calculation – .fter ta" cash E M: – 8M: – B:98t9 Incremental Cash Flo*s • • !un' Costs – a cash outla% that has alread% #een incurred and *hich cannot #e recovered regardless of *hether the pro7ect is accepted or re7ected (pportunit% Costs – the return on the #est alternative use of an asset .
L ¤ ¤ ¤ Bottom-.p .pproach – !ales minus relevant costs Ta"-!hield .L9 .ccelerated Cost 4ecover% !%stem 8M.Lecture 12 – Capital In1estment Decision Class notes • ¤ • • ¤ ¤ ¤ !ide -ffects – the effects of a pro7ect on cash flo*s in other parts of the firm -rosion – the cash flo*s of a ne* pro7ect that come at the e"pense of a firm’s e"isting pro7ects 6et &or'ing Capital – the increased current assets resulting from a ne* pro7ect) minus the increase in accounts pa%a#le and accruals (ther issues Interested onl% in pro7ect cash flo*s *hen it actuall% occurs) not *hen it accrues Interested in after-ta" cash flo* Be*are of allocated overhead costs +ro Forma !tatements and +ro7ect Cash Flo* • • • +ro Forma Financial !tatement – financial statements pro7ecting future %ears’ operations +ro7ect Cash Flo*s – operating cash flo*s minus change in net *or'ing capital and capital spending Depreciation – accounting depreciation is a noncash deduction Therefore) depreciation has cash flo* implications #ecause it influences ta"es ¤ ¤ Modified .pproach – 8sales – costs981 – T.pproach – 6I G D-+4 Top-Do*n .C4!9 Boo' :alue versus Mar'et :alue (perating Cash Flo* • (perating Cash Flo* – cash generated from the operation 3enerall% calculated as -BIT G D-+4 – T.L9 G 8D-+498T.
nal%sis • • • !ensitivit% .nal%sis – estimation of the pro#a#ilities of different possi#le outcomes from an investment pro7ect Brea'--ven .nal%sis – a techni$ue in *hich 'e% varia#les are changed one at a time !cenario .Lecture 11 –&ro3ect !nal"sis and 41aluation Class notes Lecture 11 +ro7ect .nal%sis • Brea'--ven .nal%sis – anal%sis of the level of sales *hich the compan% #rea's even on a pro7ect :aria#le Costs – costs that change *hen the $uantit% of output changes Fi"ed Costs – costs that do not change *hen $uantit% changes Total Costs – sum of the a#ove (perating Cash Flo* and Brea'--ven • • .nal%sis and -valuation • • • -valuate 6+: estimatesK -"amine sensitivit% and #rea'-even anal%sisK Loo' at the effects of operating leverage -valuating 6+: -stimates 0o* relia#le is the 6+: estimateM +ro7ected versus .nal%sis – a techni$ue in *hich ?#ad’ and ?good’ sets of financial circumstances are compared !imulation .ctual Cash Flo*s Forecasting 4is' – the possi#ilit% that errors in pro7ected cash flo*s *ill lead to incorrect decisions !ources of :alue – the a#ilit% to identif% *h% the compan% is going to ma'e mone% on a pro7ect • • • &hat-If .ccounting Brea'--ven – the sales level that results in /ero net income Cash Brea'--ven – the sales level that results in a /ero operating cash flo* .
dditional Considerations • Managerial (ptions – opportunities that managers can e"ploit if certain things happen in the future • Contingenc% +lanning – option to a#andon) *ait) e"pand) etc !trategic (ptions – options for future) related #usiness products or strategies Capital 4ationing – the situation that e"ists if a firm has positive 6+: pro7ects #ut cannot find financing !oft 4ationing – occurs *hen units in a #usiness are allocated a certain amount of financing for capital #udgeting 0ard 4ationing – occurs *hen a #usiness cannot raise financing for a pro7ect under an% circumstances .Lecture 11 –&ro3ect !nal"sis and 41aluation Class notes • Financial Brea'--ven – the sales level that results in a /ero 6+: Leverage • • • • • (perating Leverage – the e"tent to *hich fi"ed costs are used in a firm’s operations Implications – the higher the operating leverage) the greater the ris' Degree of (perating Leverage – the percent change in operating cash flo* relative to the percent change in $uantit% sold Financial Leverage – the e"tent to *hich a firm relies on de#t Total Leverage 8ris'9 – com#ines the effects of operating and financial leverage It sho*s ho* sensitive earnings are to changes in sales .
sing the dividend gro*th model) solve for N .lternativel%) it can #e estimated #% o#serving the re$uired return on similar securities Cost of De#t – the return that lenders re$uire on the firm’s de#t 3enerall%) *e *ill use the #ond valuation e$uation • &eighted .verage Cost of Capital 8&.pproach – .CC9 .CC9 • • 4evie* the capital components and their calculationsK Introduce the &eighted .+M .pproach – .verage Cost of Capital 8&.dvantages – ad7usts for ris') Cost of -$uit% – the return that e$uit% investors re$uire on their investment in the firm Discounted Cash Flo* .CC9 e$uationK Cost of Capital= !ome +reliminaries • • 4e$uired return versus cost of capital – the terms re$uired return) appropriate discount rate) and cost of capital are used interchangea#l% Financial +olic% and Cost of Capital – a firm attempts to minimi/e their cost of capital through a couple of different methods Cost of -$uit% • • o o • return o use on companies *ithout dividends o Disadvantages – varia#les must #e predicted) reliance of past information to predict future .verage Cost of Capital 8&.dvantages – simplicit% Disadvantages – needs sta#le dividends) doesn’t consider ris') sensitive to gro*th rate C.Lecture 12 –5ei$hted !1era$e Cost o6 Capital 75!CC8 Class notes Lecture 15 – &eighted .se #eta to calculate the Cost of +referred !toc' and De#t • Cost of +referred !toc' – simpl% the fi"ed dividend divided #% the price of the stoc' .
CC – the *eighted average of the costs of de#t) preferred stoc') and common e$uit% .Lecture 12 –5ei$hted !1era$e Cost o6 Capital 75!CC8 Class notes • &.
ngels – *ealth) individual investors inside a communit% that are *illing to invest in small companies :enture Capital – investment companies that speciali/e in investing in privatel% held companies *ith the intention of ta'ing them pu#lic Initial +u#lic (ffering 8I+(9 – *hen a privatel%-o*ned firm issues stoc' to the pu#lic for the first time Initial +u#lic (ffering +rocess • !election of an .dministration 8!B.nder*riting – .nder*riting !%ndicate – man% investment #an's assist the lead under*riter *ith placement Firm Commitment .nder*riter can return unsold shares to the compan% • • 4egistration !tatement .nder*riter – an investment that oversees the process .nder*riting – .Lecture 1# – Conclusion Class notes Lecture 1.a statement filed *ith the !-C that discloses all material information a#out the compan% 4oad !ho* – Compan% and lead under*riters meet *ith institutional investor to mar'et the compan% and gauge demand .nder*riter has full responsi#ilit% for selling the issue Best -fforts . – 4aising Capital and Initial +u#lic (fferings 8I+(s9 • • Introduce financing methodsK Follo* the initial pu#ic offering processK -arl%-!tage Financing • • • • • • • • +ersonal -$uit% Ban' Loans !mall Business .9 !uppliers>Customers Credit Cards .
greement – Insiders 8original o*ners and venture capitalists9 agree to not sell their shares for a specified length of time 8t%picall% si" months9 !ummar% of +rice Movements – 3enerall%) the price rises in the earl% aftermar'et and tails off over the long-term 4ights (fferings • • 4ights (ffering – an issue of common stoc' offered to e"isting stoc'holders Mechanics of a 4ights (ffering 6um#er of 6e* !hares – funds to #e raised divided #% the su#scription price 6um#er of rights needed to #u% a share of stoc' – (ld shares>6e* shares • :alue of a 4ight – the difference #et*een the value of the shares #efore and after the rights offering .nder*riter !upport – 3enerall%) the under*riter purchases shares in the open mar'et during the first month if the price approaches the offer price Loc'up .Lecture 1# – Conclusion Class notes Indications of Interest – non-#inding orders from institutional investors • • !etting the (ffer +rice and 6um#er of !hares – under*riter uses discounted cash flo* anal%sis) peer comparisons) and indications of interest Building the Boo' – the under*riting s%ndicate *ill #egin filling orders once the price has #een set The .ftermar'et • Initial 4eturn – closing price on the first da% of trading is usuall% su#stantiall% higher than the offer price Flipping 8!pinning9 – the practice of #u%ing at the offer price and selling on the first da% or the first *ee' (verallotment (ption – the under*riter has the option of purchasing an additional 12O of shares .greements – handsha'e agreements #% institutions to purchase additional shares in the earl% aftermar'et • • • .n*ritten .
Lecture 1# – Conclusion Class notes • • -"-4ights – the stoc' price *ill drop #% appro"imatel% the value of the right *hen the rights e"pire !etting the !u#scription +rice – the price does not matter It has to #e lo*er than the mar'et price and greater than /ero .
Chronolog% ¤ Declaration Date – the date on *hich the #oard of directors passes a resolution to pa% a dividend ¤ -"-Dividend Date – the date t*o #usiness da%s #efore the date of record ¤ Date of 4ecord – the date #% *hich a holder must #e on record in order to #e designated to receive a dividend ¤ Date of +a%ment – the date the chec's are mailed Does Dividend +olic% MatterM .Lecture 1# – Conclusion Class notes Lecture 1@ – Dividends • • • • -"amine dividend polic% and its relevanceK Loo' at the implications of a dividend polic%K Consider alternatives to dividendsK Introduce stoc' dividends and stoc' splits Cash Dividends and Dividend +a%ments • • Dividend – a pa%ment made out of a firm’s earnings to its o*ners) in the form of either cash or stoc' Distri#ution – a pa%ment made #% a firm to its o*ners from sources other than current or accumulated retained earnings Cash Dividends and Dividend +a%ments • • • 4egular Cash Dividends – a cash pa%ment made in the normal course of #usiness) usuall% four times per %ear Target +a%out 4atio – the percentage of net income paid out as cash dividends (ptimal Dividend +olic% – the dividend polic% that stri'es a #alance #et*een current dividends and future gro*th and ma"imi/es the firm’s stoc' price Cash Dividends and Dividend +a%ments • Dividend +a%ment= .
void the need to sell e$uit% ¤ Maintain a target de#t-e$uit% ratio ¤ Maintain a target dividend ratio !toc' 4epurchases • 4epurchases – another method used to pa% out a firm’s earnings to its o*ners .Lecture 1# – Conclusion Class notes • • • Dividend Irrelevance Theor% – a firm’s dividend polic% has no effect on either its value or its cost of capital Bird-in-the-0and Theor% – a firm’s value *ill #e ma"imi/ed #% setting a high dividend pa%out ratio Ta" +reference Theor% – investors prefer lo* dividends #ecause capital gains are ta"ed at a lo*er rate Does Dividend +olic% MatterM • 4eal &orld Factors ¤ Information Content of Dividends – investors regard dividend changes as signals of management’s earnings forecasts ¤ Clientele -ffect – the tendenc% of a firm to attract a set of investors *ho li'e its dividend polic% Dividend +olic% • • 4esidual Dividend .void dividend cuts ¤ .void cutting #ac' on positive 6+: pro7ects to pa% dividends ¤ .pproach – firm pa%s dividends onl% after meeting its investment needs *hile maintaining a desired de#t-e$uit% ratio Dividend !ta#ilit% – Firm maintains its dividends *henever possi#le Dividend +olic% • Compromise Dividend +olic% ¤ .
Lecture 1# – Conclusion Class notes !toc' Dividends • • • • !toc' Dividends – a pa%ment made #% a firm to its o*ners in the form of stoc' !toc' !plit – an increase in a firm’s shares outstanding *ithout an% change in o*ners’ e$uit% Trading 4ange – the price range #et*een the highest and lo*est prices at *hich a stoc' is traded 4everse !plit – a stoc' split in *hich a firm’s num#er of shares outstanding is reduced .
genc% Theor% – the conflicts of interest that arise among management) emplo%ees) shareholders) and #ondholders These conflicts and ho* companies tr% to overcome such conflicts What We Do Not Know • 0o* are Ma7or Financial Decisions MadeM (ur ignorance is largest *hen it comes to ma7or strategic decisions • &hat Determines +ro7ect 4is' and +resent :alueM 0o* do %ou find positive 6+: pro7ectsM • 4is' and 4eturn – 0ave &e Missed !omethingM C.+M is hard to prove or disprove conclusivel% 0ave *e missed a 'e% varia#leM • 0o* Can &e -"plain Capital !tructureM .Lecture 1# – Conclusion Class notes Lecture 1@ – Conclusion • • • 4evie* *hat *e have covered in this course and some things *e should have covered &hat *e 'no* &hat is un'no*n Conclusion What We Do Know • • 6et +resent :alue – is a pro7ect *orth more than it costsM 4is' and 4eturn Investors don’t li'e ris' and re$uire a higher return to compensate The ris' that matters is the ris' that investors cannot get rid of • • -fficient Capital Mar'ets – securit% prices accuratel% reflect availa#le information and respond rapidl% to ne* information as soon as it #ecomes availa#le .
Lecture 1# – Conclusion Class notes Theoreticall%) the amount of de#t should not affect the value of a firm In realit%) it does matter • • The Dividend Controvers% Continues – man% people #elieve dividends are good) others #elieve the% are #ad) and still others #elieve the% are irrelevant 0o* Can &e -"plain Merger &avesM Man% firms seemed to #e merging in 1JDJ and no#od% merging in 1JJ5 &h%M .
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