Managerial Finance

Course Instructor:
Dr. Wasim Abbas Shaheen
 Lecture Outline
O Topic 11: Market Efficiency and Three Forms
O Topic 12: Capital Structure Theories,
O Topic 13: Long Term Sources of Finance –
Leasing
O Topic 14: Corporate Restructuring &
Takeovers

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Topic 11: Market Efficiency and its Three Forms

O What is Market Efficiency?

Eugene Fama described an efficient market as
one
“In which prices always fully reflect available
information”
O How Market efficient is measured?
O Ease of transactions
O Speed of transactions
O Cost of transaction
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 Three Forms
Eugene Fama divided the efficient market hypothesis into three
forms:
O The weak form:
O Past prices hold no information about future prices
O Can't beat buy/hold strategy
O Much evidence to support including correlation tests, filter test -
fail
O The semi-strong form:
O All publicly available information is immediately reflected in price.
O Subsumes weak form since price data is publicly available
O Assumes rational investors seek information impound quickly.
O Result - prices may rise or fall with few trades – few chances to
make money
O Quite a bit of information such as stock split and earnings
information are impounded quickly.

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 Three Forms

O The strong form:

O All relevant information reflected in stock
prices due to insiders, specialists
O Evidence shows announcements of
important information often anticipated
beforehand.
O Implies outside investors should buy and hold
market.

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Topic 12: Capital Structure and it Theories

O Capital structure can be defined as the mix of owned

capital and borrowed capital
O Maximization of shareholders’ wealth is prime objective
of a financial manager.
O The value of a firm is defined to be the sum of the value
of the firm’s debt and the firm’s equity.
V=D+E

DSE
O If the goal of the firm’s management is to make the firm
as valuable as possible, then the firm should pick the
debt-equity ratio that makes the pie as big as possible.

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 Stockholder Interests

There are two important questions:

1. Why should the stockholders care about maximizing
firm value?
Answer: Perhaps they should be interested in strategies
that maximize shareholder value.
1. What is the ratio of debt-to-equity that maximizes the
shareholder’s value?
Answer: There is no fix ratio suggested for any firm
which maximizes shareholders value as it turns out,
changes in capital structure benefit the stockholders if
and only if the value of the firm increases.

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 Capital Structure Theories

O The four major theories of approaches which

explain the relationship between capital
structure, cost of capital and valuation of firm
are:
1. Net Income (NI) Approach – Ke > Kd
2. Net Operating Income (NOI) Approach - Does
not focus on NI & Capital Structure
3. The Traditional Approach – mix of above two i.e
it focus on min WACC & max firm value
4. Modigliani-Miller (MM) Approach – Similar to
NOI and MODIGLIANI- MILLER explain the
relationship between capital structure, cost of
capital and value of the firm.
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Assumptions of Capital Structure Theories

O Firms use only two sources of funds

O Equity
O Debt.
O No change in investment decisions of the firm,
i.e. no change in total assets.
O 100% dividend payout ratio, i.e. no retained
earnings.
O Business risk of firm is not affected by the
financing mix.
O No corporate or personal taxation.
O Investors expect future profitability of the firm.

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Topic 13: Long Term Sources of
Finance – Leasing
O Lease is a contract between owner of an asset
(lessor) and the user of the asset (lessee) under
which the lessor gives the right to the lessee to use
the asset for agreed period of time and
consideration, called lease rental.
O Leasing helps start-ups, small businesses and
growing businesses to further capital investment.
O The cost of buying new equipment to meet the
changing and growing business needs can be difficult
for most small businesses.
O Leasing is infrastructure-friendly and can contribute
to a country’s infrastructure growth.
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Types of Lease Financing
O Operating Lease:
O Operating lease is a lease where the risk and
the return stay with the lessor i.e rent a car or
building.
O Financing Lease:
O A financial lease is a lease where the risk and
the return get transferred to the lessee.
car/house financing.

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Topic 14: Corporate Restructuring & Takeovers
(Mergers and other forms of business)

O Corporate restructuring is an action taken by

the corporate entity to modify its capital
structure or its operations significantly.
O Generally, corporate restructuring happens
when a corporate entity is experiencing
significant problems and is in financial
jeopardy.

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 Corporate Restructuring Types

1. Sell – offs
2. Spin – offs
3. Liquidation
4. Going Private
O Leverage Buyouts

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