Corporate Finance

Inhaltsverzeichnis

SESSION 1: CORPORATE GOVERNANCE............................................................................................ 1

SESSION 2: IN-CLASS CASE STUDY.................................................................................................... 1

SESSION 3: APPRAISAL & FINANCIAL STATEMENTS...........................................................................1

SESSION 4: STOCK VALUATION......................................................................................................... 1

SESSION 5: STOCK VALUATION II...................................................................................................... 2

SESSION 6: PAPER PRESENTATIONS I................................................................................................ 2

SESSION 7: CAPITAL STRUCTURE I.................................................................................................... 2

SESSION 8: PAPER PRESENTATIONS II............................................................................................... 2

SESSION 9: CAPITAL STRUCTURE II................................................................................................... 2

SESSION 10: VALUATION WITH LEVERAGE........................................................................................2

SESSION 11: CASE STUDY PRESENTATION & RECAP.......................................................................... 2

Session 1: Corporate Governance
Introduction to Corporate Finance

Investment Financing Liquidity

 Choose best projects
 Capital Budgeting
 What long-term
investments or
projects should the
business take on?
 Choose source of  Ensure you have
financing for enough cash and
investment inventory
 Capital Structure  Short-Term Financing
Planning
 How should we pay  How do we manage
for our assets? the day-to-day
 Should we use debt finances of the firm?
or equity?

Balance Sheet Model of the Firm

Cash Flows

Cash Flow Accounting Cash Flow

 Tracking money coming in and going  Focuses only on cash from the main
out of a business business activities
 Includes every cash transaction like  Helps understand how well a
sales, expenses, investments and company´s core operations are
loans bringing in cash
 Helps see if a company can pay bills,
debts and invest in things
 Cash flow looks at all money movements, while accounting cash flow just focuses
on money from the main business
 Cash flow helps with decisions and checking how much cash a company has
 Accounting cash flow tells how well the main business is doing in terms of cash
 cash flow tracks all money moving in and out
 accounting cash flow focuses on cash from the main business
Corporate Governance

 Corporate governance refers to the system of rules (customs, policies, laws and
institutions) to direct, administer and control a company
 It ensures that a company is managed effectively, ethically, and transparently
 It includes all stakeholders and is crucial for building trust, attracting investment, and
sustaining long-term success

Aspects
 protection of shareholder rights
 transparency in reporting
 adherence to ethical standards
 accountability of management
 risk management
 consideration of social and environmental impacts

Stakeholders
 Principal Stakeholder: Shareholders, management, the board of directors
 Other: employees, customers, creditors, suppliers, regulators, community at large
Agency Problems

= conflict of interest between principals (e.g. shareholders) and agents (e.g. managers), who
are hired to act on behalf of the principals

Agency Relationship
Principal hires an agent to represent his/her interests
Example: Stockholders (principals) hire managers (agents) to run the company

Problem:
Conflict of interests between principal and agent
Example: managers may prioritize personal gain, job security, or short-term goals over
maximizing shareholder wealth

Costs:
The costs associated with agency problems

Indirect agency cost Direct agency cost

Lost opportunity Corporate expenditures that benefit
Example: Management does not take an management but cost shareholders
investment even though owners wish to do Consequence: Need to monitor
so management actions

Monitoring and enforcement costs: Principals incur expenses to oversee and control agents'
actions to ensure they align with the principals' interests.
 Agency costs: These arise from conflicts of interest between principals and agents
and include expenses such as excessive executive compensation, perks, and empire
building.
 Opportunistic behavior costs: Agents may engage in opportunistic behavior, such as
shirking responsibilities or pursuing self-serving strategies, which can lead to financial
losses or damage to the company's reputation.
 Overall, agency problems can undermine corporate governance, reduce shareholder
value, and hinder the efficient allocation of resources within organizations.
Boards of Directors

 Boards (non-executives) are supposed to monitor management (executives) on behalf

of shareholders
- Advice of monitoring
- Define and approve major business decisions
- In charge of CEO selection, executive compensation, risk management, audits
 Common criticism of boards: A “rubber-stamp assembly”
- Executives have superior information
- Executives have considerable influence over the choice of board members
- (non-executive) Directors often have very small financial stakes
- Could just quickly approve decisions without really discussing

Ownership structure

 Concentrated ownership in the hands of a few investors is the preferred corporate

governance mechanisms in many countries
- Helps to overcome the collective action problem: small shareholders have no
incentives to monitor managers
 Ownership concentration has benefits and costs

Benefits
 Large blockholders have greater
incentives to collect information and
to monitor management
Costs
 Collusion of large shareholders with
management against smaller
investors (tunneling)
 Reduced liquidity in the secondary
markets
 “Overmonitoring”: Boards may
intervene too much and thereby
reduce management initiative

Widely-Held Firms Closely-Held Firms

 Separation between ownership and  Manager and shareholder incentives
control aligned
 Agency issues between managers  Agency issues between controlling
and shareholders and non-controlling shareholders
 Exit investment strategies  Voice investment strategies
 main distinction is the number and distribution of shareholders
Executive Compensation

 Financial rewards and benefits provided to top-level executives (salary, bonuses, …)

 Structure of managerial compensation:

o Packages that consist of a base salary, a bonus (often related to short run
accounting performance), a stock participation plan and stock options
 Economic function:
o Align management and stockholder interests
o Needs to be structured carefully to make sure that they achieve their goal
 Also implicit incentives:
o Reputation and future career concerns of managers

Market for Corporate Control

Hostile Takeover:
 Radical and spectacular mechanism for disciplining and replacing managers
 Occurs when the management of the target company does not recommend the deal
 Successful takeovers can result in the installation of new managers with fresh ideas,
leading to a change of control
 disruptive and costly, can lead to management changes

Incentive effects:
 Takeover threats can incentivize managers to perform better
 They mac also induce managers to prioritize short-term gains over long-term value to
avoid being taken over
 takeover threats can influence managerial behavior

Takeover Defenses:
 Managers may adopt various takeover defenses to prevent potential hostile takeovers
and strengthen their position
 Managers often implement takeover defenses to protect their position
Investor Protection

 Investor protection is ensured through a combination of laws, regulations and legal

enforcement

Legal Framework:
 Investors are safeguarded by laws, regulations, court decisions and legal enforcement
mechanisms
 There are variations in investor protection between civil law and civil law

Common Law Civil Law

 Law is developed through court
ruling
 Flexible and can adjust quickly to
events
 Strong investor protection
 Law is developed through
regulation and code of laws
 Based on code of principles,
does not change
 Weaker investor protection

Impact on Markets:
 Countries with stronger legal investor protection, such as the right to call
extraordinary shareholder meetings tend to have:
- Larger stock markets
- More initial public offerings (IPOs)
- Greater influx of external capital, particularly equity
- Less concentrated ownership structures
 stronger legal investor protection correlates with the growth and
development of capital markets

Corporate Debt

Disciplinary Tool:
 Debt is often seen as a disciplinary mechanism as it compels management to allocate
cash flow responsibly
 It limits managers’ ability to misuse free cash flow for personal benefits or
unprofitable projects
 Debt creates incentives for managers as they are obligated to repay it in the future
 Corporate debt serves as a disciplinary tool by constraining managerial discretion
over cash flow

Investor Protection:
 Creditor rights are typically more clearly defined than shareholder rights, providing
potentially stronger to investors
 Debt holders have recourse to bankruptcy or illiquidity threats if obligations are not
met
 In times of financial distress, creditors may gain control over the company

Costs of Debt:
 Debt comes with costs, particularly in the form of bankruptcy costs
Other Mechanisms

Investment Banks and Credit Rating Agencies:

 These entities are well-positioned to monitor firms and alert shareholders to
potential issues due to their access to superior information
 Conflicts of interest may arise
o Investment banks’ financial analysts may hesitate to be critical to avoid losing the
firms they cover as clients
o Rating agencies have been criticized for conflicts of interest, such as offering
consulting services alongside rating assignments
 Play crucial roles in monitoring firms but may face conflicts of interest

Proxy Voting Advisors (e.g. ISS, Glass Lewis):

 These firms provide guidance to investors on how to vote at annual shareholders
meetings
 Significant influence, particularly as many investors rely on their recommendations
 Also engage in consulting services, which may arise concerns about conflicts od
interest
 Provide recommendations to investors but also engage in consulting, potentially raing
questions about their impartiality

Financial Systems

 can be categorized into bank-based and market-based systems

Bank based systems Market based systems

 Central to the process of moving
funds between demanders and
suppliers of capital
 More active monitoring
 E.g. Germany and Japan
 Securities markets are as important
and can be significantly more
important
 External market discipline
 E.g. US and UK
Session 2: In-class Case Study
Genzyme Presentation
Session 3: Appraisal & Financial Statements
 Appraisal methods such as Payback Period, NPV, Profitability Index and EVA provide
insights into the financial viability and profitability of investment decisions
 each method offers unique perspectives and considerations for evaluating projects

Payback Period

 the time required for an investment to generate cash flows sufficient to recover its
initial cost
 a shorter payback period indicates a quicker return on investment, but it doesn’t
consider the time value of money
calculation:
Payback Period = year before recovery + (remainder / cash flow during year)
steps:
1. identify cash flows
2. calculate cumulative cash flows
3. determine payback period
4. interpolation (if cash flows not evenly distributed)

Strengths Weaknesses
 easy to use and understand  doesn’t account for the “time value
 can be used as a measure of liquidity of money”
 easier to forecast short term than  doesn’t consider cash flows beyond
long term flows the PBP
 cutoff period is subjective
Net Present Value (NPV)

 calculates the present value of all cash inflows and outflows associated with an
investment by discounting them to their present value using a specified discount rate
 measures the difference between the present value of cash inflows and the present
value of cash outflows over a given time period, discounted at a specific rate of return
or discount rate
 future cash flows must be discounted to get their present value

Discounting
 NPV involves discounting future cash flows back to their present value using a
discount rate
 PV = CF / (1+r)^t

Present Value (PV)

 represents the current value of a future sum of money, discounted at the appropriate
rate of return

Opportunity cost of capital

 the discount rate used in NPV calculations reflect the opportunity cost of capital
 represent the return that could be earned on an alternative investment of similar risk

Calculation NPV
 calculated by summing the present values of all cash flows (inflows and outflows)
associated with an investment or project and subtracting the initial investment

Internal Rate of Return (IRR)

 another investment appraisal method closely related to NPV
 represents the discount rate at which the NPV of an investment equals zero

Rules for Investment Decisions

 If NPV > 0: accept the investment (positive returns)
 If NPV = 0: marginally acceptable
 If NPV < 0: reject investment (no positive returns)

Perpetuities and Growing Perpetuities

 Perpetuities are investments with cash flows that continue indefinitely
 growing perpetuities are perpetuities with cash flows that grow at a constant rate
over time

Basic company valuation

 NPV is commonly used in company valuation to estimate the value of future cash
flows generated by the company

Rules of Time Travel

1: A dollar today is worth more than a dollar in the future due to opportunity cost
2: Cash flows occurring sooner are preferable to those occurring later
3: Cash flows should be compared on a consistent basis, considering timing and risk

Discounted = CF * (1+r)^t
Profitability Index

 measures the ratio of present value of future cash flows to the initial investment
 Profitability Index > 1 indicates that the project´s present value of future cash flows
exceeds its initial investment, making it economically attractive

Strengths Weaknesses
 same as NPV  same as NPV
 allows comparison of different scale  provides only relative profitability
projects

Economic Value Added (EVA)

 measures a company´s economic profit by deducting its cost of capital from its net
operating profit after taxes (NOPAT)
 helps assess whether a company is generating returns above its cost of capital,
indicating wealth creation for shareholders
EVA = (Rate of Return – Cost of Capital) * Capital

NPV & EVA

Session 4: Financial Statements Analysis
The Balance Sheet

 Presents a snapshot of a company´s financial condition at a specific point of time,

usually the end of the fiscal year
 Consists of assts and liabilities

Assets:
 Represent everything a company owns or controls that has economic value and can
be used to generate future benefits
Assets = Liabilities + Stockholder´s Equity

Current Assets Non-current Assets

 Short-term assets
 Assets expected to be covered into cash
or consumed within one year or the
normal operating cycle of the business
 (cash, accounts receivable, inventory,
prepaid expenses, …)
 long-term assets
 Expected to provide benefits over more
than one year
 (property, plant, equipment, intangible
assets, investments, and long-term
receivable)

Represent what the company owns

Liabilities:
 Represent a company´s obligations or debts that it owns to external parties

Current Liabilities Non-current Liabilities

 Short-term liabilities  long-term liabilities
 Obligations that are due and payable  not due within a year
within one year or the normal operating  (long-term-loans, bonds payable,
cycle of the business deferred tax liabilities, pension
 (accounts payable, short-term-loans, obligations)
accrued expenses, current portion of
long-term-debt)
Represent what a company owes

 By comparing assets to liabilities, stakeholders can assess a company´s solvency, liquidity

and overall financial situation

Working Capital
Net Working Capital = Current Assets – Current Liabilities
Stockholders Equity
 Key component of the balance sheet
 Represents the residual interest in the company´s assets after deducting liabilities
 Reflects the company´s financial health and its ability to generate value for shareholders
Book Value of the Equity

Market value Book value

 Refers to curremt price at which an 
Represents the value of an asset or
asset or liability can be bought or sold in liability as recorded on a company´s
the market balance sheet
 Determined by market forces  Based on historical accounting records
 Dynamic, can change over the time  Remains fixed until adjusted for
 Often used by investors to assess the accounting purposes
current value of investments  Provides a baseline for financial
reporting and accounting purposes
Market-to-Book Ratio = Market Value of Equity / Book Value of Equity

Enterprise Value
 Measure of a company´s total value, representing the market value of its equity plus its
debt and minus its cash and cash equivalents
 Provides a comprehensive assessment of a company´s worth, including both equity and
debt holders´ interests
 Commonly used in financial analysis to evaluate potential takeover targets or compare
companies regardless of their capital structures
 Enterprise Value = Market Value of Equity + Debt – Cash
The Income Statement

Income = Revenue - Expenses

 provides information on the company´s profitability and operating performance
 key calculations include gross profit, operating income, EBIT, pretax income and net
income, providing insights into different aspects of the company´s financial situation

Revenue:
 represents total amount of money earned from the sale of goods or services during
the period

Cost of Goods Sold (COGS):

 refers to the direct costs associated with producing the goods sold by the company
 gross profit is calculated by subtracting COGS from revenue

Gross profit:
 represents the difference between revenue and COGS, reflecting the profitability of
the company´s core business operations

Operating Expenses:
 include all costs incurred in the regular operations of the business, such as salaries,
rent, utilities and marketing expenses
 is calculated by subtracting operating expenses from gross profit

EBIT (Earnings before interest and taxes):

 represents the company´s earnings before deducting interest expenses and income
taxes
 provides a measure of the company´s operating profitability, excluding the effects of
financing and taxes

Pretax income:
 before taxes, is the company´s earnings before accounting for income taxes
 reflects the company´s profitability before tax obligations

Net income:
 also referred as the bottom line or the company´s profit after deducting all expenses,
including taxes
 represents the amount of money the company has earned or lost during the period

EPS (Earnings per share):

 measures the portion of a company´s profit allocated to each outstanding share of
common stock
 important indicator of a company´s profitability on a per-share basis, making it easier
to compare companies of different sizes or in different industries
 EPS = Net Income / Shares Outstanding
The Statement of Cash Flow

 Provides a summary of a company´s cash inflows and outflows

 Categorized in 3 main sections: operating activities, investing activities and financing
activities

Operating Activities:
 Involve cash flows related to the primary business operations of the company,
including revenues and expenses
 Typically include cash received from customers, interest received and dividends
received
 Cash inflows typically include cash received from customers, interests and dividends
received
 Cash outflows typically include payments to suppliers, employees and other operating
expenses
 Net cash flow from operating activities is calculated by adjusting net income for non-
cash items and changes in working capitals
 Reflect the cash generated or used

Investing Activities:
 Involve cash flows related to the acquisition or sale of long-term assets, such as
property, plant and equipment, and investments in securities
 Cash inflows typically include proceeds from the sale of assets or investments
 Cash outflows typically include payments for the purchase of assets or investments
 Net cash flow from investing activities represents the net change in cash resulting
from investment activities

Financing Activities:
 Involve cash flows related to the company´s capital structure, including debt and
equity financing
 Cash inflows typically include proceeds from issuing debt or equity securities
 Cash outflows typically include payments for debt principal repayment, dividends and
share repurchases
 Net cash flow from financing activities represents the net change in cash resulting
from financing activities
 Represent cash flows related to the company´s capital structure
Financial Statements Analysis

Ratio Analysis

Short-term
solvency (or
liquidity) ratios

 Firms’ ability to pay its bills over the short run with undue stress
 When <0, current ratio indicates negative net working capital
Long-term
solvency (or
financial
leverage) ratios

 Firms’ long-run ability to meet its obligations

 Times Interest Earned measures how well a company has its

interest obligations covered, but to measure the cash available
to pay interest, the EBITDA is used:

Asset
management
(or turnover)  Measures how efficiently a firm uses its assets to generate sales
ratios  The higher the ratio, the more efficient

 Measures for every euro in assets, how many euros in sales

were generated
Profitability Measures

ROA ROE

measures the profit per dollar of assets measures how well shareholders fared
during the year, the higher the more
profitable

Market Value Measures

Earnings per Share

Market-to-Book
Value

Or

Enterprise Value

Choose a Benchmark for your analysis

Time Trend Analysis  Look at the same ratio over a number of years

Peer Group Analysis  Compare ratio with similar firms

 Companies in same industry (Check SIC Code)

Inappropriate Peers  Some companies operate in several industries

 Different Accounting Standards

Aspirant Analysis  You may want to compare your firm with the best in the
industry

 Choose similar firms at the top of the industry

Source of  Financial Websites: Yahoo! Finance, Reuters,

 Information FT.Com, ADVFN.com, Motley Fool

 Company Accounts: Download from website

Stock Valuation

Dividend Yields, Capital Gains and Total Return

Total Return = Dividend Yield + Capital Gain Rate

 The expected total return of the stock should equal the expected return of other
investments available in the market with equivalent risk

Investment Horizon

One-Year Investor Multi-Year Investor

 If the current stock price was less than
this amount, expect investors to rush in
and buy it, driving up the stock price
 If the stock price exceeded this amount,
selling it would cause the stock price to
quickly fall
Dividend Discount Model
 horizon N
 The price of any stock is equal to the
present value of the expected future
dividends it will pay

Constant Dividend Growth Model

  Forecast for the firm’s future dividends states that they will grow at a constant rate g
forever
 The value of the firm depends on the current dividend level, the cost of equity and the
growth rate

Dividends vs. Investment & Growth

A firm can do two things with its earnings: pay them out to the investors or retain and
reinvest them.

Growth Investment

 The Dividends are calculated by

distributing the total earnings by all  To increase future earnings and dividends,
shares outstanding and multiplying the earnings can also be reinvested
it with the dividend payout rate, that
sets the amount of payout of the
earnings
 Dividend Payout Rate = 1 –
Retention Rate (What the company
wants to keep)

Increasing dividends / growth rate

 To increase dividends, firms can

increase the earnings or the payout  To increase its growth rate, firms can retain
rate (because the shares outstanding more of its earnings by reducing current
are constant) dividend
 This will former increase the share price,
the latter will decrease as well as the
present value

Maximizing firms value

 Do determine the optimal policy to maximize firms value, the profitability of the firm’s
investments play an important role
 Cutting the dividend to increase investment will raise the stock price only if the new
 investments have a positive NPV
 To value the stock, we cannot use the constant dividend growth model since the
growth rate is not constant

Changing Growth Rates

 Small changes in the assumed dividend growth rate can lead to large changes in the
estimated stock
 While the Dividend-Growth-Model use the dividend paid in N=1, with changing growing
rates we use the dividend paid in N+1 to determine the Long-Term-Growth

 Dividend-Discount Model with Constant Long-Term Growth

Total Payout Model

 Dividend-discount model implicitly assumes that any cash paid out to shareholders takes
the form of a dividend; but share repurchases may also be used to buy back its own stock

 The Total Payout Model also considers Repurchases

Dividend-discount model Total payout model

Only values a single share Values all the firm’s equity

Discounting dividends and use the Discounting total dividends and share
earnings per share when forecasting the repurchases and use the growth rate of
growth of the firms total payouts earnings when forecasting the growth of the
firms total payouts

Implications
  The more cash the firm uses to repurchase shares, the less it has available to pay
dividends
 By repurchasing, the firm decreases the number of shares outstanding, which
increases its earnings and dividends per share

Discounted Free Cash Flow Model

 Determines the value of the firm to all investors, including both equity and debt holders

PAGE 128
Session 5: Stock Valuation
Session 6: Paper Presentations I

Session 7: Capital Structure I

Session 8: Paper Presentations II

Session 9: Capital Structure II

Session 10: Valuation with Leverage

Session 11: Case Study Presentation & Recap

Session 1: Corporate Governance