1-0 semester 1 2008 corporate finance 2201 afe welcome students!!
TRANSCRIPT
1-1
Semester 1 2008
CORPORATE FINANCE
2201 AFE
WELCOME STUDENTS!!
1-2
About Your Convenor
Mirela Malin
B Bus (Acct) BIntFin (Hons) PhD Candidate
My research interests include:• Asset Pricing
• Multifactor Models• Behavioural Finance
• Behavioural Models• Continuation and Reversal Strategies• Combined Return Predictability
Strategies
1-3
Teaching Team
Course Convenor: Mirela MalinOffice: G06 Room 2.22Phone: 5552 7719Email: [email protected]: Thursday 2 - 4 pm
Tutors:Michael [email protected]
Eliot [email protected]
Office: AFE tutors room in G06 1.34 and 1.35 Telephone: TBA, Consultation Time: TBA
1-4
Course Comments
• Most important ingredients of success in Corporate Finance course is:
• Attend lectures
• Consistent tutorial effort
• NOTE: Tutorials start in Week 2!!!
• Each week there will be tutorial homework
• Be aware of the Homework rules in the course outline
• Mid Semester Exam – Saturday 26th April - Week 7
• Final Exam – End of Semester Exam Period
• Text: Ross, Westerfield and Jordan 7th Edition
1-5
Week 1
Lecture 1
Ross, Westerfield & Jordan 7e
Chapter 1
Chapter 2
1-6
Fundamental Concepts for Today’s Lecture
• What is Corporate Finance?
• The role of a financial manager
• Understand the goals of financial management
• Explain the Agency problem
• The role of financial markets
• Financial statements issues
1-7
What is Corporate Finance?
• Corporate Finance is the study of ways to
answer three important questions:
• What long-term investments should the firm
take on?
• Where will we get the long-term financing to
pay for the investment?
• How will we manage the everyday financial
activities of the firm?
1-8
Financial Management Decisions
• Capital budgeting• What long-term investments or projects should
the business take on?
• Capital structure• How should we pay for our assets?• Should we use debt or equity?
• Working capital management• How do we manage the day-to-day finances of
the firm?
1-9
Forms of Business Organization
• Three major forms:• Sole proprietorship• Partnership
• General• Limited
• Corporation• S-Corp• Limited liability company
1-10
Sole Proprietorship
• Advantages• Easiest to start• Least regulated• Single owner keeps all
the profits• Taxed once as
personal income
• Disadvantages• Limited to life of owner• Equity capital limited to
owner’s personal wealth
• Unlimited liability• Difficult to sell
ownership interest
1-11
Partnership
• Advantages• Two or more owners• More capital available• Relatively easy to start• Income taxed once as
personal income
• Disadvantages• Unlimited liability
• General partnership
• Limited partnership
• Partnership dissolves when one partner dies or wishes to sell
• Difficult to transfer ownership
1-12
Corporation
• Advantages• Limited liability• Unlimited life• Separation of
ownership and management
• Transfer of ownership is easy
• Easier to raise capital
• Disadvantages• Separation of
ownership and management
• Double taxation (income taxed at the corporate rate and then dividends taxed at the personal rate)
www.nolo.com
1-13
Goal Of Financial Management
• What should be the goal of a corporation?
• Maximize profit?
• Minimize costs?
• Maximize market share?
• Maximize the current value of the company’s
stock?
1-14
• The financial manager of a company makes
decisions on behalf of the shareholders.
• Thus the correct goal is to maximise shareholder’s
wealth.
• That is, to maximise the value of the existing
shares.
• Does this mean we should do anything and
everything to maximize owner wealth?
Goal Of Financial Management
1-15
The Agency Problem
• Agency relationship• Principal hires an agent to represent his/her
interest• Stockholders (principals) hire managers
(agents) to run the company
• Agency problem• Conflict of interest between principal and agent
• Agency costs• Direct• Indirect
1-16
Managing Managers
• Managerial compensation• Incentives can be used to align management
and stockholder interests• The incentives need to be structured carefully
to make sure that they achieve their goal
• Corporate control• The threat of a takeover may result in better
management
• Other stakeholders• Governments, suppliers, employees
1-17
Financial Markets
• What is a Market? A Market is the means through which the buyers and sellers are
brought together.
• Role of a Financial Market• To channel savings into investments• Enable sale and purchase of financial assets
• Cash flows to the firm – Fig. 1.2 page 15• Primary vs. secondary markets• Dealer vs. auction markets• Listed vs. over-the-counter securities
• NYSE
• NASDAQ
1-18
End of Chapter 1
1-19
Week 1
Lecture 1
Ross, Westerfield and Jordan 7e
Chapter 2
Financial Statements, Taxes and Cash Flows
1-20
Key Concepts and Skills
• Know the difference between book value and market value
• Know the difference between accounting income and cash flow
• Know the difference between average and marginal tax rates
• Know how to determine a firm’s cash flow from its financial statements
1-21
Balance Sheet
• The balance sheet is a snapshot of the firm’s assets and liabilities at a given point in time
• Balance Sheet Identity• Assets = Liabilities + Stockholders’ Equity• Assets – Liabilities = Stockholders’ Equity
• Net Working Capital• Current Assets – Current Liabilities• Positive when the cash that will be received over the next 12
months exceeds the cash that will be paid out• Usually positive in a healthy firm
1-22
The Balance Sheet - Figure 2.1
1-23
Liquidity, MV vs BV, D vs E• Liquidity
• Ability to convert to cash quickly without a significant loss in value
• Liquid firms are less likely to experience financial distress• But liquid assets earn a lower return• Trade-off to find balance between liquid and illiquid assets
• Market Vs. Book Value• The balance sheet provides the book value of the assets,
liabilities and equity.• Market value is the price at which the assets, liabilities or equity
can actually be bought or sold.• Which is more important to the decision-making process?
• Debt Vs. Equity• Financial Leverage
1-24
US Corporation Balance Sheet – Table 2.1
1-25
Income Statement
• The income statement measures the performance of a firm over a specified period of time.
• Revenues – Expenses = Income
• Matching principle – show revenue when it accrues and match the expenses required to generate the revenue
1-26
US Corporation Income Statement – Table 2.2
1-27
Taxes
• The one thing we can rely on with taxes is that they are always changing
• Marginal vs. average tax rates• Marginal – the percentage paid on the next
dollar earned• Average – the tax bill / taxable income
• For financial decision making purpose, the marginal tax is used
1-28
The Concept of Cash Flow
• Cash flow is one of the most important pieces of
information that a financial manager can derive
from financial statements
• Cash Flow Identity:• Cash Flow From Assets = Cash Flow to Creditors +
Cash Flow to Stockholders
Cash generated from utilizing assets =
Cash paid to those that finance the purchase of
those assets (Creditors + Stockholders)
1-29
Cash Flow From Assets
• CFFA = CFC + CFS
• CFFA = OCF – NCS – ΔNWC
• Cash Flow From Assets (CFFA) = Operating Cash
Flow (OCF) – Net Capital Spending (NCS) –
Changes in Net Working Capital (ΔNWC)
1-30
Cash Flow From Assets
• CFFA = OCF – NCS – ΔNWC
• OCF = EBIT + depreciation – taxes = $547
694 + 65 - 212 = 547
• NCS = end net fix. assets – begin net fix. assets + depr. = $130
1709 - 1644 + 65 = 130
• Changes in NWC = ending NWC – beginning NWC = $330
1014 - 684 =
330
‘05 1403(CA) - 389(CL) - ’04 1112(CA) - 428(CL)
• CFFA = 547 – 130 – 330 = $87
1-31
Cash Flow from Assets
• Operating cash flow:• EBIT 694.00• + Depreciation + 65.00• – Taxes – 212.00 $547
Less• Net capital spending:
• Ending net fixed assets 1,709.00• – Beginning net fixed assets – 1,644.00• + Depreciation + 65.00 $130
Less• Change in net working capital:
• Ending net working capital 1,014.00• – Beginning net working capital 684.00 $330.00
• Cash flow from assets: $87.00
1-32
• CFFA = CFC + CFS
• CFC = Interest Paid – Net New Borrowings
• CFFA = CFC + CFS
• CFS = Dividends Paid – Net New Equity
Cash Flow to Creditors and Shareholders
1-33
Cash Flow to Creditors and Shareholders
• CFC = interest paid – net new borrowing = $24
70 - 46 = 24
’05 LTdebt 454 – ’04 LTdebt 408
• CFS = dividends paid – net new equity = $63
103 - 40 = 63
’05 CS. 640 – ’04 CS 600
• CFC + CFS = 24 + 63 = $87
1-34
Cash Flow to Creditors and Shareholders
• Cash flow to creditors:• Interest paid 70.00• – Net new borrowing – 46.00
$24.00
Plus• Cash flow to shareholders:
• Dividends paid 103.00• – Net new equity raised 40.00 $63.00
• Cash flow to creditors and shareholders = $87
1-35
Cash Flow Identity
• CF Identity: CFFA = CFC + CFS
• CFFA = 547 – 130 – 330 = $87
• CFC + CFS = 24 + 63 = $87
1-36
Cash Flow Summary Table 2.5
1-37
Lecture 1 Key Points
• Three main areas in Corporate Finance• Capital Budgeting• Capital Structure• Working Capital Management
• Goal of financial management = maximise shareholders value
• Book value differs from Market value• It is the market value we want to maximise• Cash flows are important in valuation• Cash flow identity: CFFA = CFC + CFS
1-38
Basic Algebra Reminders..
Order of Operations: BODMAS• Brackets first then• Other grouping symbols (eg: LN(x), xa, x-1)• Division and• Multiplication next• Addition and• Subtraction last
1-39
Example
• 10+5[(3/10)7-1] = 5.001• First we have to remove the square bracket• But before that we remove the round bracket
by performing the division • Then the power and subtraction in the square
bracket• Multiplication by 5• Addition of 10
1-40
Basic Algebraic Identities and Laws (1)
• a(b + c) = ab + ac
• 3(2+5) = 3*2 + 3*5
• (a + b) / c = a/c + b/c
• (9+7)/5 = 9/5 + 7/5
• (a / b) / (d / c) = (a / b) * (c / d) = ac / bd
• (3/2)/(5/7) = (3/2)*(7/5) = (3*7)/(2*5)
1-41
• x-1 = 1/x , x-a = 1/xa , bx-1 = b/x , bx-a = b/xa • 5-1 = 1/5 , 5-2 = 1/52 3*5-1 = 3/5 , 3*5-2 = 3/52
• x1/2 = √x , x1/a = a√x , xb/a = a√(xb)• 91/2 = √9 , 91/3 = 3√9 , 93/2 = 2 √(93)
• am * an = am+n , (am)n = am*n , am * bm = (a*b)m • 23 * 24 = 23+4 = 27 , (23)4 = 23*4 , 24 * 34 = (2*3)4
• am/an = am-n , am/bm = (a/b)m
• 25/22 = 25-2 , 23/53 = (2/5)3
Basic Algebraic Identities and Laws (2)
1-42
Basic Algebraic Identities and Laws (3)
• LN means logarithm with the base of e
• e is a constant (2nd function on some calculators)
• There is a button on the calculator for LN and e
• LN(a*b) = LN(a) + LN(b)• LN(3*2) = LN(3) + LN(2)
• LN(a/b) = LN(a) – LN(b)• LN(3/2) = LN(3) – LN(2)
• LN(xa) = a*LN(x)• LN(32) = 2*LN(3)
• If ℮x = y then LN(y) = x• e2 = 7.389056099 then LN(7.389056099) = 2
1-43
End of Chapter 2