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7330 Lecture01 Intro and Review-F10
7330 Lecture01 Intro and Review-F10
Ronald F. Singer
FINA 7330
Review of Financial
Management
Lecture 1
Fall 2010
Administration
• Instructor: Ronald F. Singer
• Phone: 713-743-4771
• Office Hours: Tuesday 4:45 to 6:00,
Thursday 4:00 to 4:45 or by appointment
• Room 210F Melcher Hall
• Webpage: www.bauer.uh.edu/singer
Class Administration
• Exams
• Late Entrants
• Reading, Eating, etc.
• Attendance
• Texts:
– Brealey, Myers and Allen, Principles of Corporate
Finance, 10th ed.
– Wall Street Journal
• Valuation Problem
– Groups, presentation, study
Outline
• Capital Budgeting Decision
– Financial Statement Analysis
– NPV Rule
– Arbitrage and Risk
– Time Value of Money
– Complicated Decisions
• Investments
– Risk versus Return
– Optimal Portfolio Selection (CML)
– Equilibrium Prices (SML and CAPM)
Review of Corporate Finance
• Three areas of inquiry
–Capital Budgeting
–Capital Structure
–Payout policy
Capital Budgeting
• What is to be discounted?
• How do we discount?
• What is the decision rule and why?
Macintosh Enterprises
Pro-Forma Income Statement
(Year ending December 31, 2008)
($ thousand)
Sales $5,000
Less: Operating Expenses (COGS) 2,000
Depreciation & Amortization 500
Allocated G & A Costs 300
Operating Income (EBIT) $2,200
Less: Interest Expense 800
Earnings Before Tax (taxable income) 1,400
Less Tax (@ 35%) 490
Net Income (Earnings after Tax) $910
Less: Cash Flow to Bondholders (Interest, principal, Bond Repurchase, Call) 1, 270
Less: Cash Flow to Preferred stockholders 100
Free Cash Flow to Common Stockholders 340
EBITDA $2,700
8
Firm Valuation
• What determines the value of the Firm?
– In a perfect capital market setting
– In an efficient market setting
– In the “Real World”
What determines the value of
securities
• Security Pricing Models
– Capital Asset Pricing Model (CAPM)
– Arbitrage Pricing Model (APT)
– Multifactor Model
– Option Pricing or Contingent Claims Pricing
Capital Budgeting
• The Net Present Value Rule
– What is it?
– Why does it work?
– Why would all investors regardless of their
personal preferences for current versus future
consumption agree on the NPV Rule?
– Present Value and the No-Arbitrage Price
• Why securities should sell at a price that is equal
to the PV of the Cash Flow to the holders.
First Separation Principle
• The firm can make a capital budgeting
decision independently of how the project
will be financed.
• Eventually, the firm will have to worry
about how to finance the project, but the
simple question right now is:
– Are the benefits from investing greater than
the cost?
• i.e. is the NPV of the project positive?
Risk
• Securities are priced as if the market in general is
“risk averse”. That is, the typical investor appears
to prefer a less risky alternative to a more risky
alternative.
return minimum
variance
portfolio
Individual Assets
P
Efficient Risky Portfolio
return
L
CM efficient frontier
rf
P
Relationship between Risk and
Return
• Efficient Portfolios (Capital Market Line)
Rp = Rf + Risk Premium
= Rf + (Rm - Rf) p
M
Relationship between Risk and
Return
• Individual Securities (Capital Asset
Pricing Model)
Ri = Rf + Risk Premium
= Rf + (Rm - Rf) i
Capital Structure
• What is the Capital Structure Decision?
• What are the determinants of a firms’
capital structure
• What do we have to consider?
Payout Policy
• What is payout policy?
• What are the Issues?
• What factors are important?
Generally
• We look to violations of Perfect Capital
markets: In particular:
– Costly Information
– Taxes
– Agency Problems
• Failure to align
managements’ with stockholders’
interest
• Market for corporate control