Corporate(Finance(Exam(Revision(

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CORPORATE(FINANCE!!

Exam!Revision!(Topic&1:&The&Role&of&Financial&Management&&&Role&of&the&Tax&Environment&(Financial"Management"

The(study(of(how(people(and(businesses(evaluate(investments(and(raise(funds(to(finance(them(• What(long(term(investments(should(the(firm(undertake?(

o Referred(to(as(capital(budgeting(• How(should(the(firm(raise(money(to(fund(these(investments?(

o Capital(structure(decisions(o Optimum(combination(of(debt(and(equity(

• How(can(firm(best(manage(its(cash(flows(as(they(arise(in(its(dayDtoDday(operations?(o Working(capital(management(o Working(capital(=(current(assets(–(current(liabilities(

(Goal"of"the"Financial"Manager"

• Main(objective(–(MAXIMISE(SHAREHOLDER(WEALTH(o Shareholder(wealth(=(share(price(X(number(of(shares(o Consistent(with(increasing(share(value(and(firm(value(

• Interactions(between(the(company(and(financial(markets(o Making(investment(decisions(o Making(decisions(on(how(to(finance(these(investments(

• Profit(maximisation(o Is(an(objective(but(not(main(one(o Problems(with(timings(and(uncertainty(of(returns(o Accrual(issues(

(Taxes"

Dividend(Imputation:(• A(tax(system(applying(to(companies(and(their(shareholders,(where(the(net(income(of(the(

company(is((imputed(to(the(shareholders(and(taxed(at(their(marginal(rate(• Although(company(income(is(taxed(twice(–(first(at(company(level(and(then(again(when(

dividends(are(received(by(shareholders(–(shareholders(receive(a(credit(for(the(income(tax(paid(by(the(company(

• Ensures(that(company(net(income(tax(paid(to(shareholders(as(dividends(is(taxed(only(once,(at(the(shareholders(personal(income(tax(rates(

• Dividends(can(be(fully(franked,(partially(franked(or(not(franked(at(all(o Franking(percentage(is(dependent(on(companies(available(franking(credits(

Imputation(Credits:(• Amount(of(Australian(income(tax(paid(by(a(company(which(is(associated(with(a(franked(

dividend(paid(by(a(company(to(its(shareholders.(Its(purpose(is(to(provide(the(shareholder(with(a(credit(for(the(income(tax(paid(by(the(company(which(can(be(used(to(offset(the(total(amount(of(personal(income(tax(levied(on(the(tax(payer(

((((

Corporate(Finance(Exam(Revision(

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Taxation"Categories"

Taxation(Category(1:(• Companies(with(shareholders(that(are(fully(or(substantially(integrated(by(the(dividend(

imputation(system(• Company(pays(fully(franked(shares,(therefore(tax(rate(isn’t(important(

Taxation(category(2:(• Shareholders,(sole(proprietors(and(companies(not(integrated(by(dividend(imputation(system(• 0%(franked(shares,(so(shareholders(have(to(pay(full(tax(D(∴(tax(rate(is(important(

Taxation(Category(3:(• Companies(with(shareholders(that(are(part(integrated(by(the(dividend(imputation(system(• Pay(partially(franked(dividends(• Therefore(amount(of(income(tax(paid(by(company(has(some(effect(on(afterDtax(wealth(

(Topic&2:&Time&Value&of&Money&(

• The(time(value(of(money(recognises(the(change(in(value(over(time(• A(dollar(received(today(is(worth(more(than(a(dollar(received(in(the(future(• Time(value(of(money(concept(is(important(as(it(forms(the(basis(of(financial(decision(making(• When(deciding(whether(an(investment(project(should(proceed,(the(present(future(of(cash(

inflows(would(need(to(exceed(initial(outflows(in(order(to(maximise(wealth((Interest(

• Difference(between(amount(invested/borrowed(and(future(amount(returned(• Nominal(annual(rate(of(interest(

o Nominal(annual(rate(j,(is(a(way(of(representing(how(interest(is(paid,(where(m(is(the(number(of(times(interest(is(compounded(each(year(

o ! = !!(

• Effective(annual(interest(rate(o The(rate(obtained(by(compounding(a(nominal(i,(m(times(per(year(o !"# = (1 + !

!)!(

• Simple(interest(o Used(for(short(term(financial(instruments(where(compounding(would(have(little(

effect(• Compound(Interest(

o Involves(earning(interest(on(interest((Future(Value(

• !"! = !" 1 + ! !(• Calculator:(±PV,(N,(I/Y,(COMP(FV(=(FV(• Future(Value(Compounding(Continuously(

o !"! = !"!!!"(Present(Value(

• !" = ! !"!(!!!)!(

• Calculator:(FV,(N,(I/Y,(COMP(PV(=(PV(Interest(Rate(

• ! = !"!"

!! − 1(

• Calculator:(±PV,(FV,(N,(COMP(I/Y(=(I/Y((

Corporate(Finance(Exam(Revision(

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Number(of(Periods(• Calculator:(±PV,(FV,(I/Y,(COMP(N,(=(N(

&Topic&3:&Annuities&(Annuity"

• A(series(of(equal(cash(flow(amounts(over(time,(usually(spread(at(equal(time(intervals(• Simple(annuities(–(cash(flows(with(the(same(frequency(as(the(interestDcompounding(

frequency(• General(annuities(–(Cash(flows(with(cash(flows(different(from(interestDcompounding(

frequency((Ordinary(Annuity(

• Cash(flows(occur(at(the(end(of(each(time(interval(• Accumulated(sum(of(an(ordinary(annuity(is(the(total(amount(invested/borrowed(plus(

compound(interest(• For(PV(of(an(annuity:(Calculator:(±PMT,(N,(I/Y,(COMP(PV(=(PV(• To(work(out(annuity(payments:(Calculator:(±PV,(N,(I/Y,(COMP(PMT(=(PMT(• To(work(out(interest(earned:(Calculator:(±PV,(N,(PMT,(COMP(I/Y(=(I/Y(

Annuity(Due(• Payments(occur(at(the(beginning(of(each(time(interval(• Need(to(change(calculator(to(BGN(mode(

(Perpetuity(

• An(annuity(with(an(infinite(life(• Present(Value(of(a(perpetuity(

o Regular(infinite(payments((R)(divided(by(interest(rate((i)(o ! = !

! ((Unequal(Cash(flows(

• Not(an(annuity(as(cash(flow(aren’t(equal(• Calculator:(0(DATA,(then(each(cash(flow(followed(by(data,(2ND(F(CASH,(enter(I/Y,(!(COMP(

((Topic&4:&Risk&&&Rates&of&Return&(Nominal"Rate"of"Return"

• The(interest(rate(paid(on(debt(securities(without(an(adjustment(for(loss(in(purchasing(power(• To(get(you(to(invest(money(for(a(period,(the(nominal(rate(of(return(has(to(compensate(for:(

o Forgoing(spending(your(money(now(o Increases(in(price(over(the(period(o Risk(of(default(and(losing(you(investment(

Real"Rate"of"Return"

• The(nominal(rate(of(interest(less(any(loss(in(purchasing(power(during(the(time(of(the(investment(

• Approximate(rate:(! = ! + !( where:(R(=(real(rate,(r(=(inflation(rate(• Accurate(rate:(1 + ! = (1 + !)(1 + !)(

! = ! + ! + !"((• Rearrange(for(R:(1 + ! = !!!

!!!(

Corporate(Finance(Exam(Revision(

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Expected"Return"

• Expected(rate(of(Return(o The(arithmetic(average(of(all(possible(outcomes(where(each(outcome(is(weighted(

against(its(probability(o This(is(because(returns(from(dividends(and(capital(gains(are(uncertain(o ! ! = ! !!!!(!!)!

!!! ((Risk"

• Financial(risk(is(the(uncertainty/variability(of(future(cash(flows(• Upside(–(future(cash(flows(may(be(higher(• Downside(–(future(cash(flows(could(be(lower(–(could(even(lose(all(• ! = ! (!! − ! ! )!!!(!!)!

!!! (• If(normally(distributed,(68%(of(returns(will(be(within(±(calculated(standard(deviations(

o Is(mean(is(20(and(SD(is(5,(then(68%(will(be(within(15(and(25((Risk/Return(Relationship(

• You(would(expect(a(higher(expected(return((E(R))(from(a(higher(risk(• Systematic(Risk(

o Effects(the(whole(market(o The(proportions(of(variations(in(treatment(that(cannot(be(eliminated(through(

investor(diversification((o e.g.(RBA(increasing(rates(–(all(shares(will(fall(

• Unsystematic(Risk(o Company(related(o The(portion(of(variation(in(investment(returns(that(can(be(eliminated(through(

investor(diversification(o e.g.(Myer(opening(a(new(store,(BHP(workers(going(on(strike(

Diversification(• Combine(investments(together(into(portfolios(• Now(view(total(risk(of(investments(return(as(coming(from(two(sources:(systematic(and(

unsystematic(• Adding(investments(into(a(portfolio(reduces(the(unsystematic(risk(component(so(ultimately(

market(risk(is(the(only(risk(remaining(• Best(to(spread(investments(over(multiple(industries(to(further(reduce(risk(

(HoldingDPeriod(Return(

• The(return(an(investor(would(receive(from(holding(a(security(for(a(designated(period(of(time(

• !"#!!"#$%& = ! !"#$%&!!"!!"#$!!!!!!!"#$%&!!"!!"#$!! = ! !!!

!!!! (

• !"#$%#&%!!"#$%&$'( = ! (!!!!(!))!!!!!!!! (

(Capital(Asset(Pricing(Model((CAPM)(

• Equation(stating(that(the(expected(rate(of(return(on(an(investment(is(a(function(of(the(riskDfree(rate(the(investors(systematic(risk,(and(the(expected(risk(premium(in(the(market(

• !! = !! + !!(!! − !!)(o Rj=(required(rate(of(return(for(jth(security(o Rf(=(risk(free(rate(of(return(o !j(=(the(investments(systematic(risk(o Rm(=(the(return(from(market(portfolio,(beta(=(1(

• If(!(<(1,(it(moves(less(than(market,(∴(less(risk(