CORPORATE FINANCE FOUNDATIONS

I. What is finance?
1. The board of directors discusses finance
- Board strategic focus:
 Inventory management:
o The company was a consumer products company, and the inventory can lose value
rapidly as consumer tastes change
 Acquisition:
o The company frequently expanded by buying other companies
o What new products, what new markets to add  strategically evaluiate new resources
 Borrowing policy
 Share buybacks:
o Whether we should buy back some of outstanding shares (cổ phiếu đang lưu hành)?
 Large institutional investor
o Pension funds (quỹ hưu trí), insurance companies, mutual funds

2. Finance inside of companies

- Finance: what to buy, where to get the money to buy it, and how to manage it once you have it
 What you need to buy?
o Long term (infrastructure)
o Short term (inventory, staffing, marketing, etc.)
 How to get the money?
o Borrow
o Shareholders
o Internal profits
 Manage the assets
o Scheduling
o Budgets
o Controls/ process

3. Finance outside of companies

Entrepreneurs --------- Faciliators --------- Investors
* Faciliators: banks, mutual funds, private equity, insurrance, investment banks

II. Risk and return

1. What is risk and why don’t we like it?
- Risk:
 Uncertainty about what will happen in the future
- People need to be paid to accept risk (ex: inssurance)
2. Reducing risk through diversification
- Diversification reduces risks: “Don’t put all eggs in one basket”

3. Beta: The concept

- Beta risks:
 Risk that you can do nothing
  Measures the market-wide risk that cannot be eliminated through diversification bacause it
happens to everyone
 To measure this kind of risks  we use CAPM:
Cov ( Ri ; R M )
βR=
Var ( R M )
 Cash has Beta ( β ) of 0

- Summarize: a company’s Beta tells us how a company’s stock price moves as the overall stock market
moves
 β >1: if the market goes down  the company goes more down
 β <1: if the market goes down  it is not affected much on that company
 β=1 : If the makret goes down/ up by X%  The company’s investment portfolio will go down/
up by X%

5. Risk-free rate
- Risk-free rate:
 The return an investor would expect from an absolutely risk-free investment over a specific of
time
 Compute how much return to expect for s given level of risk (đồng lợi nhuận thu được trên một
đơn vị rủi ro)
 For a given level of risk, how much return, over and above the risk-free rate, would an investor
require?
- The fomular:
Risk-free rate = Expected inflation + The time value of money

6. Equity risk premium (phần bù rủi ro vốn cổ phần)

- Equity investment:
 An investment in the shares of a company
- Equity risk premium:
 The extra amount you expect to earn on your investment because you are investing in risk of
assets
 Ex:
Stock investment = 11%
- Risk-free premium = 5% (coi lai)
= Equity risk premium = 6%

7. Capital asset pricing model (CAPM)

- More anticipated risk means more expected return
- Formular of CAPM:
Risk-free rate
+ (Equity risk premium × Beta)
= Expected return
 The risk-free rate: the minimum return that we have to earn on any investment
- Return on investment should be greater than the risk-free rate plus equity risk premium

III. Obtainin long-term financing

1. Introducing long-term financing
- A small mortgage reduces the risk of losing your house be cause of financial distress, but a large
mortgage reduces the amount of income taxes you pay to the government.
2. Does capital structure matter?
- Does it matter how I structure my long-term financing?
- Short-term financing will come from suppliers anf local banks
- Does capital structure impact the value of the company?  Yes
Investment method Payments to lenders considered Tax reductions?
Loans Interest Yes
Ownerships invests Dividends No
 Conclusion:
 So if the providers of capital are called lenders, then the payments to them are interest, and
they’re tax reduction
 If the providers of capital are called investors, then the payments for tem are dividends, and
they’re not tax reduction
 The solution is choosing loans not investment

3. Factors influencing optimal capital structure

- If income tax rates are high, should a company have more borrowing in its capital structure or less?
 Higher tax rates  larger tax reduction on interest
 Larger tax reduction  cheap loans
 Cheap loans  more borrowing
- Optimal capital structure:
 Higher tax rates = more borrowing
 Collateral quality (tài sản thế chấp) = more borrowing

4. Cost of capital: All debt or all equity financing

- Cost of capital:
 Is the cost of obtaining external financing, which is a combination of the cost of borrowing and
the cost of investment
 Determines which projects are going to be profitable and which projects are not; which projects
are gonna be started and which projects are not
- Cost of capital increases  Risk increases  Required return increases
- Cost of borrowing:
 Interest rate for loans
- Cost of equity investment:
 Necessary expected return
- Debt financing is legally supported >< Owners accept the risk of a business  equity investment return
of investors > which of lenders

5. Cost of capital: Split debt-equity financing

- Lenders benefits from an equity cushion

6. Weighted-average cost of capital (WACC)

- The formular:
⌊ X 1 × Lender rate ⌋ + ⌊ X 2 × Investment rate ⌋
 X 1 , X 2: trọng số; X 1 + X 2=1
- Compare WACC with Expected operating return:
 If WACC > EOR  X
 If WACC < EOR  
- WACC is used to answer the question: “What does it cost us to get money?”
IV. Understanding securities markets
1. The difference between a stock and a bond
- Stock:
 Evidence that a stockholder is the owner of a part of the company that issued (phát hành) the
stock
 Ownership, equity
- Bond
 Evidence that the bondholder is owned money by the company that issued the bond
 Loan, debt
- So sánh sự khác nhau:
Pure Debt Pure Equity
Interest payments mandatory Dividend payments optional
Payment amount fixed Payment amount flexible
Loan needs to be repaid No obligation to repay
When bankruptcy: collect money first When bankruptcy: last to collect money

2. Stock markets
- Physical or virtual place for people to trade stocks
- The largest stock market in the world  The New York stock exchange
- The second largest stock market in the world  NASDAQ
- Ex for having an overview of stock market: buyers are willing to buy new cars knowing used market
exists to sell car later  Stock market = Used share market

3. Bond Markets
- Sovereign bonds:
 Government bonds issued by countries
- Municipal bonds (sub-sovereign bonds):
 Government bonds issed by cities, provinces, states, or government agencies
- Corporate bonds:
 Bonds issed by companies
- Assets – backed bonds:
 Bonds backed by a set of assets (account receiveable, mortgages on home, etc.)  2003 crisis
- Public debt:
 Company bond publicly traded
- Private debt:
 Borrowed directly from bank or group of banks

4. Publicly traded shares: What impacts the share price?

5. Initial public offering (IPO): Microsoft

- Initial public offering (IPO):
 Means first time company sells shares in the market
V. Capital budgeting
1. Capital budgeting overview
2. The importance of the time value of money
3. Example: Buying light switches