Click to edit Master title style Corporate Financial Management 1 Jan Vlachý Jan Vlachý Brigham, E.F., Ehrhardt, M.C. Financial Management: Theory and

Click to edit Master title style

Corporate Financial Management 1

Jan VlachýJan Vlachý <[email protected]>Brigham, E.F., Ehrhardt, M.C. Financial Management: Theory and Practice, 13th Edition

Corporate Financial Management 1 2

Basic ConceptsCorporate Financial Management

Is the Art/Science of Creating and Maintaining the Value of a Company.

Gives a Firm its Common Language.It Consists of

Investment DecisionsFinancing DecisionsManagerial Decisions

Chapters 1-3


Investment Vehicle Model

The Set of Contracts Model recognises imperfections and includes the assumption of both explicit and implicit contracts, incl. Corporate Organization.

The World

FinancialMarkets

The Firm InvestorsFinancialIntermed.

Money × Real Assets Money × Financial Assets

Corporate Financial Management

InvestmentsFinancial Markets

F I N A N C E

Invest-ments

Financ-ing


Competitive Economic EnvironmentTwo-Sided Transactions (Buyer×Seller Equil.)Risk-Return TradeoffSignalling/ Behavioral Principle

<= Market Efficiency (Information, Transactions)Value (How can some people become rich?)

New Ideas, ExpertiseOptionsTime Value of Money

The Financial Environment

Financial transactions create an equilibrium; Real investments create value


Accounting, Cash Flows & TaxesPurposes of an Accounting System

Reporting the Firm’s Financial Activities to Stakeholders

Providing Information to Firm’s Decision Makers

Financial Management strives to use and interpret the informationAccounting - historical viewFinance - current and future


Limitations of AccountingWhy don’t shares trade at Book Val.? Market×Book Value of Assets/Liabs

Historical Accounting (depreciation)Inflation (value benchmarks have changed)Liquidity (can it readily be sold?)Time Value of Money (relates to Maturity

and Terms)

Note: Finance prefers to deal with cash flows in a time perspective.


TaxesIncome Tax

Make analyses on after-tax basisFor financial decisions, use marginal

tax rate (relavant if tax is progressive or unsymmetrical on negative base)

Capital Gains TaxDividend/Interest Income TreatmentSystem Biases (Loss Carry-forwards,

Exemptions, Deductions)


Time Value of Money Chapter 4

Future goods are not valued so highly as the same goods available at an immediate moment of time, nor do they allow their owners to achieve the same utility. For this reason, it must be considered that they have a more reduced value in accordance with justice. (Giles Lessines, 1285)

... i.e. People generally prefer having any amount of

money at their disposal earlier rather than later.... i.e. Investors require positive returns as

compensation for the inconvenience.


On Present and Future ValuesYou deposit $1,000 today with a bank

that pays 5% interest per year.FV1= PV+r×PV= PV(1+r)=

$1,000×1,05= $1,050 (Simple Interest)

FV2= FV1(1+r)= PV(1+r)×(1+r)= PV(1+r)2= $1,102.50 (Compound Interest)

FVt= PV(1+r)t PV= FVt / (1+r)t

Discounted Cash Flow Framework


Return of an Investment (Rate of Return, Yield):

Return, Net Present Value

( )Return

CashFlow EndValue BegValue

BegValue

C0

C1 C2 C3 C4 t

NPV = Present Value of expected cash flows (+positive-negative)


Practical IssuesDistinguish:

Realized ReturnExpected Return (<= Risk)Required Return (<= Unperfect Mkts)

Financial securities are usually priced “fairly” (Market Equilibrium).

Investment projects (and other entrepreneurial decisions) should bring value, i.e. have positive NPV.


Valuing Single Cash Flows (Ex.)What is the Future Value of $2,000

invested at 3% per year for five years?What is the Present Value of CZK 10m

to be received two years from now if the required return is 4% per year?

What is the Expected Return for an investment costing €10,000 today and offering €12,000 in three years?


Valuing Multiple Cash FlowsYou can invest $10,000. As a result, you

expect to get $2,000, $8,000, and $5,000 over the next three years, respectively. If the required return is 10%, what is the NPV of your investment?

t Ct PV(Ct)0 $ -10,000 -10,000.001 $ 2,000 1,818.182 $ 8,000 6,611.573 $ 5,000 3,756.57

Total PV: $ 2,186.33What is the return if you know the NPV?


AnnuitiesTypes of Annuity

Ordinary Annuity (Payments at end of period)

Annuity Due (Payments at beginning of period)

Deferred Annuity (First repayment more than one period after drawing)

1

1 11

1 1

nn

n t nt

rPVA PMT PMT

r r r

FVAn = PVAn(1+r)n; PVAn[due] = PVAn(1+r);PVAn[defd] = PVAn/(1+r)d


Amortization SchedulesA $1,000 loan yielding 8% requires equal

payments at the end of the next three yrs. How much principal will be rpd. in Year 2?

PMT = $1,000×[.08(1.08)3/(1.083-1)] = $388.03t 1 2 3Vt-1 $1,000.00 $691.97 $359.30It 80.00 55.36 28.74Vt-1 + It 1,080.00 747.33 388.04PMTt -388.03 -388.03 -388.03Vt 691.97 359.30 0.01

P2 = V1 - V2 = |PMT2| - I2 = $332.67


Perpetuities

PV = $100 / 7% = $1,428.57Growth Perpetuities:

PMTt = PMT0(1+g)t

PVgrowth = PMT1/(r-g) (... r > g)

1 1lim lim

1

lim1

n

perp n nn n

nn

rPV PVA PMT

r r

PMT PMT PMT

r rr r

Problem 4-27


Compounding Frequency (1)Compare annual return on deposit

with 6% interest paid annually and monthly.

FVA = PV×(1 + 6%) = PV×1.06

rA = (FVA-PV) / PV = .06×PV/PV = 6%

FVM = PV×(1 + 6%/12)12 = PV×1.00512 = PV×1.0617

rM = (FVM-PV) / PV = 6.17%


Compounding Frequency (2)Compare the cost of a 6% (nominal

rate) loan with monthly and quarterly interest.

Nominal Rate×Effective Annual RateNR = m×rm

EAR = (1 + rm)m - 1

EAR M = 1.00512 - 1 = 6.17%

EAR Q = 1.0154 - 1 = 6.14%


Bond and Stock ValuationMain sources of capital for Company

Bond: Debt CapitalStock: Equity Capital

Claim on fut. cash flows for InvestorBond: Contractual interest and princi-

pal payments (or proceeds of sale)Stock: Dividends (theoretically forever)

or proceeds of sale

Chapters 5,7


Valuation ProcedureBased on discounted cash flow

concept:Estimate expected future cash flowsDetermine required return (depending

on the riskiness of the expected cash flows)

Compute the present valueOther possibilities: Market price of

same or comparable asset


Features of Bonds/ Stocks Par (Face, Princ.) Value Coupon (Interest) Rate Coupon Payment

Frequency Maturity: Original (Issue),

Remaining (Residual) Terms of Repayment:

Bullet, Sinking Fund, Zero-Coupon (Pure Discount)

Call Provision (Option); other Rights; Junior/Senior

??? Dividends Dividend Payment

Frequency N/A

N/A

Common/Preferred Rights (Warrants,

Convertibles)... See Chapt. 19, Hybrid Financing


Bond Valuation Problem 5-1

t 1234

...89

101112

Ct

$ 80$ 80$ 80$ 80

...$ 80$ 80$ 80$ 80$1,080r= 9%

PV

$ 73.39$ 67.33$ 61.77$ 56.67

...$ 40.15$ 36.83$ 33.79$ 31.00$ 383.98$ 928.39

0 1

nt

tt

CV

r

For bond w/semi-annual coupons n=24, Ct=$40.To put required return on same basis as annual bond, one should assume EAR = 9% = (1+rS)2 - 1, i.e. rS = \/1.09 - 1 = 4.4%.


Yield to Maturity/ Yield to Call (1)Assume Johnson Co. has a bond with a

face value of $1,000 that matures in 12 years, has a coupon rate of 8%, and is currently selling for $928.39. What is the required return to buy the bond (YTM = 9.00%)?

Assume it can be called in 10 years at a call price of $1,100. What would be the required return to buy the bond if we knew the option would be excercised (YTC = 9.79%)?


Yield to Maturity/ Yield to Call (2)Yield to Maturity= Promised ReturnYield to Call= Return if CalledN=12; PV=-928.39; PMT=80; FV=1,000 => I

(YTM) = 9.00%N=10; FV=1,100 => I (YTC) = 9.79%Expected Return= YTM minus Risk

Credit (Default) Risk <= Rating

Interest Rate Risk/ Reinvestment RiskFX Risk, Liquidity Risk...


Market Interest Rates/Yield Curve

0

0,5

1

1,5

2

2,5

3

3,5

4

0 2 4 6 8 10 12

t

r


Stock Valuation Value a share which is expected to pay dividends

of $2.72 and $3.10, respectively, over the next two years, and sold thereafter for $48, if the required return is 10%?

V=$2.72/(1.1)+$3.10/(1.1)2+$48/(1.1)2= $44.70 But... How did I estimate the market price in 2

years? Let us assume constant dividends of $4.80 after

Year 2. Using perpetuity valuation: V2=$4.80/10%= $48

Problem


Constant Growth ModelDt = D0(1+g)t

V = D1/(r-g) (... r > g)

e.g. V = $36(1.05)/(13%-5%) = $31.5e.g. r = $1.30/$21.25 + 6% = 12.12%CG formula can also be used for

determining a horizon (terminal) value or for valuing declining growth stock.

For erratic or supernormal growth stock, split cash flows into two parts.


Risk and ReturnRisk refers to the chance that some

unexpected event would occur.In business, that would mean the decrease

of value of the firm, in financial markets any change in the value of financial instruments etc.

In other words, actual returns will differ from expected returns.

The expected return should therefore compensate an investor for the perceived risk.

Chapters 6, 7


Investments with Risk

1.00

2.0-10.0 30.0 50.0 5.0 0.10Boom

5.0 -2.0 20.0 25.0 5.0 0.20Above avg.

6.0 0.0 10.0 15.0 5.0 0.40Average

7.0 7.0 -5.0 -5.0 5.0 0.20Below avg.

10.0% 20.0%-15.0%-25.0% 5.0% 0.10Recession

BondGoldEq 2Eq 1T-BillProb.Economy

Problem


Expected ReturnE(r) = Σwiri

E(rEQ1) = .10(-25%) + .20(-5%) + .40(15%) + .20(25%) + .10(50%) = 12.5%

Eq 1 Eq 2 Bond T-bill GoldE(r) 12.5% 8.5% 6% 5% 2%

Eq 1 has the highest expected return.Is it the best investment?


Stand-Alone Riskσ = \/Σ(wi(ri-E(r))2

σEQ1 = \/[.10(-25-12.5)2 + .20(-5-12.5)2 + .40(15-12.5)2 + .20(25-12.5)2 + .10(50-12.5)2] = 19.4%

T-bill Bond Gold Eq 2 Eq 1σ 0% 1.9% 7.5% 12.9% 19.4%E(r) 5% 6% 2% 8.5% 12.5%

Volatility


Probability DistributionsProb.

Actual Return (%)

T-bill

Eq 2

HT

0 5 8.5 12.5

Eq 1


Portfolio Risk (1)Assume portfolio with 50% invested in

Eq 1, and 50% in Gold.

20.0 -10.0 50.0 0.10Boom 11.5 -2.0 25.0 0.20Above avg. 7.5 0.0 15.0 0.40Average 1.0 7.0 -5.0 0.20Below avg. -2.5% 20.0%-25.0% 0.10Recession

Port.GoldEq 1Prob.Economy

E(rP) = 7.25%

σP = 6.1%


Portfolio Risk (2)p (=6.1%) is much lower than:

either Eq 1 (19.4%) or Gold (7.5%).average of Eq 1 and Gold (13.5%).

The portfolio offers a decent return (average of Eq 1 and Gold returns) with low risk.

The key is low (actually negative) correlation between Eq 1 and Gold returns, facilitating diversification.


Managing Portfolio RiskSystematic and Specific Risk [Law of

Large Numbers] (Insurance, Consumer Credit)

Equilibrium Theories, e.g. Capital Asset Pricing Model [Sharpe, Lintner] (Equity Markets, Capital Investments)

Portfolio Theory [Markowitz] (Market Portfolios), based on function σP=ƒ(w1,w2,w3,..,σ1,σ2,σ3,..,ρ12, ρ13, ρ23,..)


Effect of Diversification

N10 20 30 40

Specific (Diversifiable) Risk

Systematic Risk

20

0

Total Risk

(%)

35


Capital Asset Pricing ModelIn an efficient market, the required return

will equal the expected return.efficient market => equilibrium pricetransactional, informational efficiencyefficient market arbitrage

An asset’s required return is the sum of the riskless return and an asset-specific risk premium.

Beta (β) is a measure of the asset’s market (systematic, undiversifiable) risk.

SML: ri = rF + β(rM - rF)


Beta as a Sensitivity Measureri = rF + β (rM - rF)

rM

riβ = 1

45°

0 < β < 1

β = 0rF


CAPM UtilizationTwo shares (in the same market) with

known rF, βA, βB, rA, looking for rB.rA = rF + βA (rM - rF)rB = rF + βB (rM - rF)14% = 6% + 1.4(rM-6%) => rM = 11.7% rB = 6% + 1.1(11.7%-6%) = 12.3%

Note: The beta of a portfolio equals the weighted average of its component betas (VP P = VA A + VB B + ...)

Problem


OptionsOption = Right (Financial and Embedded

Options, i.e. Contracts) or Opportunity (Real Options)

Financial options are traded contracts, derivatives of Underlying Assets (Equities, FX, Bonds, Commodities, Indices...)

Financial Derivatives include Options, Warrants, Forwards, Futures, Swaps, Repos...

Financial Derivatives are used primarily for Risk Management (Hedging, Speculation) ... See Chapt. 23

Chapter 8


ApplicationsFinancial Options

American vs. European OptionsCall vs. Put OptionsExotic Options (various terms of exercise,

caps, floors; exchange options, compound options,...)

Embedded Options... Constitute ContractsReal Options... In Business Decisions ...

See Chapts. 11,25


The Value of Options Intrinsic Value (would the option be executed if

nothing changed till excercise date?) = ƒ(p; r; t) ...usually easy to assess; can be used for designing option strategies

Time Value = ƒ(t; ) ...calculated by means of models (using market equilibrium assumption and replication)

Total Value (Call Option)

p

V

Time Value

Intrinsic Value (Call Option)

p

V

S

in-the-moneyout-of-the-money

at-the-money


Using the Replication PrincipleCall Option: S = $40, p = $32, d = $16 or u = $64 at

time t; rt = 2%.

d: Option out of the money, i.e. Vd = 0

u: Uption in the money, i.e. Vu = 64 - 40 = $24 Income structure can be replicated with N forward

transactions. These must have zero value if underlying asset costs $16, and must therefored be issued with forward price F = $16. Their present value is VF = p - F/(1+rt) = $16.31.

Value of N forward transactions at settlement if underlying asset costs u is Vu = N(u - F). To replicate u = 64 Vu = 24, N = 24/(64-16) = 0.5.

The option value is thus VC = 0.5×16.31 = $8,16.


Numerical Model (Binomial, CRR) Call Option S = 1 100; p = 1 000; r = 5%; 4 periods

1 215,51115,51

1 157,6371,29

1 102,50 1 102,5043,99 2,50

1 050,00 1 050,0027,14 1,52

1 000,00 1 000,00 1 000,0016,74 0,93 0,00

952,38 952,380,56 0,00

907,03 907,030,00 0,00

863,840,00

822,700,00

F = 1 100; N = 1VF = 1157,63 - 1100e-0,25×5% = 71,29VC = N VF = 71,29

F = 1 000N = (u - S)/(u - d) = 2,50/102,5 = 0,0244VF = 1050 - 1000e-0,25×5% = 62,42VC = N VF = 1,52

N = 0 => VC = 0


Analytical Model (Black-Scholes)VC = p N(d1) - S e-rt N(d2)

d1 = [ln(p/S) + (2/2) t] / ( t)

d2 = d1 - tp= $500; S= $510; r= 3%; t= 3months (=0,25); =20%

d1 = [ln(500/510)+(0,04/2)×0,25]/(0,2×0,5) = -0,0730

d2 = -0,0730 - 0,2×0,5 = -0,1730

N(d1) = N(-0,0730) = 0,4709; N(d2) = N(-0,1730) = 0,4313 (cummulative distribution function for a standardised normal random variable)

VC = 500×0,4709 - 510×e-20%×0,25×0,4313 = $17,12

VP = VC - p + Se-rt = 17,12-500+510×e-3%×0,25 = $23,31 (using put-call parity)


Cost of CapitalCost of Capital = Required Return for

Capital Budgeting Project2 possible approaches

Use CAPMFirm Value = Equity Value + Debt

Value.In a perfect market, a company cannot affect

its value by changing the way it is financed - it just influences the distribution of risks and returns between different classes of investors.

Chapter 9


Risk/Return of Real AssetsCAPM can be extended to include

real assets (i.e. capital budgeting projects)Pure Play Method (Finding single-

product companies in the same line of business as project being evaluated)

Accounting Beta Method (Regression of return of assets against average return on assets in the whole market)


Weighted Average Cost of CapitalWACC = (1-L)re + L(1-T)rd

L = D/(D+E) ... LeverageT ... Marginal Income tax Rate

Always based on opportunity, not historical costs and values!

After-tax cost must be used for all components!

Correct risk assumptions have to be made for individual projects!


WACCr = $3.6 / $70 = 5.14%c = $3.6 / ($70×(1-5%)) = 5.41%

WACC = 30%×6%×(1-40%)+ 5%×5.8%+ 65%×12% = 9.17%

Problems 9-4, 9-7


Component Cost of EquityWays to estimate required return:

DCF MethodCAPM Approach ( of equity, not project!)Bond Yield + Risk Premium Method

Equity for new projects may come from retained earnings or new issue.

New issues incur flotation costs. In this case, the component cost of capital is higher than required return.


Application of DCF MethodQST stock is trading at $30 a share. QST

will pay a $3 dividend at the end of the year and expects 5% annual growth. Costs of flotation amount to 10%. What is the required return and cost for new equity?

r = D1/V + g = $3/$30 + 5% = 15%

Vnet = V(1-F) = $30(1-10%) = $30×90% = $27

re = D1/[V(1-F)] + g = $3/[$30(1-10%)] + 5% = 16.1%


Risk, Leverage, Beta and WACCOperating Leverage: influences rA, i.e. both rE

and rD <=> an increase in operating risk increases A and WACC.

Financial Leverage: in efficient markets, an increase should increase d, but leave A and WACC unchanged.

(1-TL)A = L(1-T)D + (1-L)E (= portfolio)

Assuming low risk of debt, it is possible to approximate A = E (1-L)/(1-TL)

... on Leverage more in Chapt. 15


Distinguish RisksOperating (Business) Risk (depends on

structure of firm’s assets, not structure of financing) <= Operating Leverage

Financial Risk (based on firm’s capital structure) <= Fin. Leverage

Units Sold

Profit

Co. Return

Shldr. Return L = 0

L = 50%


Basics of Capital BudgetingGenerate ideasEstimate the expected future cash flows

from the project.Assess the risk and determine a required

return (cost of capital, hurdle rate, discount rate).

Compute present value of cash flows; if project has a positive NPV, it creates value => should be accepted.

Alt.: Find market price or compare with similar asset

Chapter 10


Types of ProjectsCapital budgeting projects include:

New products and new businessesMaintenance projectsCost saving/ revenue enhancementCapacity expansionProjects required by regulation/ policy

Independent/Exclusive ProjectsConventional/Nonnormal Cash Flows


Alternative Budgeting MeasuresNet Present ValueInternal Rate of Return (=Expected Rtrn)

Profitability IndexModified IRR (includes cost of capital)Payback ... ignores time value of

money and cash flows beyond paybackDiscounted Payback


Investment Criteria

PB = 2 + (10,000/30,000) = 2.3 yearsDPB = 2 + (17,934/22,539) = 2.8 yearsNPV = ΣDCF = $18.266PI = ΣDCF[1-4] / |CF0| = 1.26

IRR = 22.24%MIRR = (129,230/70,000)1/4 - 1 = 16.56%

Problem

Year 0 1 2 3 4CF -70,000 30,000 30,000 30,000 20,000DCF -70,000 27,273 24,793 22,539 13,660


IssuesIRR brings same results as NPV with

independent and conventional projects only

Unequal lives of exclusive projects, e.g. replacement projects ... use common horizon calculation or Equivalent Annual Annuities (EAA = NPV[r(1+r)n/(1+r)n-1])

It is realistic to assume some kind of capital budget constraint ... use artificially high discount rate or capital rationing (e.g. ranking by Profitability Index)


Estimating Cash FlowsCash flow income (includes e.g.

depreciation, ignores time value)Measure on incremental (marginal)

basisOnly future expenditures/revenues

are relevant (avoid sunk costs)Include taxes; not financing costs

(they are reflected in cost of capital)

Chapter 11


Types of Budgeting Cash FlowsNet Initial Investment Outlay

new assets purchase, old assets sale, increase in net working capital

Net Operating Cash FlowNonoperating Cash Flows

overhauls, changes in working capitalNet Salvage (Termination) ValueTax Adjustment (Capitalizing×Expensing)


Est. Cash Flows Problems 11-1,2,3


Budgeting Cash Flows Problem 11-9

NPV= - 7,160 + 2,000/1.15 + 2,384/1.152 + 1,968/1.13 + 1,744/1.154 + 1,712/1.155 + 3,232/1.156 = $921.36

Note: Different remaining lives, working capital investment


Analyzing RiskMarket Risk

Measured by (see CAPM) impacts discount rate

Stand-Alone RiskBreak-even AnalysisSensitivity AnalysisScenario AnalysisMonte Carlo Simulation


Simple ExampleProject costs $100,000, expected sales 1,000

units, price $80/unit, cash op. exp. $40/unit, 5-year life, fully amortized, terminal value $10,000. Cap. cost 12%, tax rate 25%. What is its NPV?

V = -I + [N×(P-U)×(1-T)+D×T][((1+r)n-1) /r(1+r)n] + [F×(1-T)]/(1+r)5 = -100,000 + [30,000+5,000]×3.60 + 7,500/1.76 = $ 30,423


Break-even Analysis (Sales)V = -I + [N×(P-U)×(1-T)+D×T]×3.60 + [F×(1-

T)]/(1+r)5

What N* would result in V = 0?

-I + [N*×(P-U)×(1-T)+D×T]×3.60 + [F×(1-T)]/(1+r)5 = 0

N* = [(100,000-7,500/1,76)/3.60-5,000]/30 = 720 pcs.

i.e. the project breaks even at 720 units sold.

Usually easier to use numerical iteration.


Sensitivity Analysis (Price)V = -I + [N×(P-U)×(1-T)+D×T]×3.60 +

[F×(1-T)]/(1+r)5

V/P = [N×(1-T)]×3.60 = 750×3.60 = $ 2,700

i.e. a price cut of $1 will result in a project

value decrease by $ 2,700.Almost always easier to use numerical

simulation.


Scenario Analysis (Sales, U.Cost)Scenario Worst

CaseMostLikely

BestCase

UnitSales

850 1,000 1,100

UnitCost

45 40 38

NPV 2,711 30,423 47,185


Real OptionsFlexibility to adjust plans based on newly

acquired information may increase NPV.Growth/development optionsContraction/abandonment optionsInvestment timing optionsExchange options

Valuation methods:Closed-form (analogy w/B-S)... rareDecision treesMonte Carlo

... further reading in Chapt. 25


Financial PlanningPro-Forma Financial Statements

Forecast the amount of external financing that will be required

Evaluate the impact that changes in the operating plan have on the value of the firm

Set appropriate targets for compensation plans

Chapter 12


Steps in Financial ForecastingForecast salesProject the assets needed to support

salesProject internally generated fundsProject outside funds neededDecide how to raise fundsSee effects of plan on ratios and

stock price


Additional Funds Needed Problem

$7,560 Tot. liab.&eq.$7,560 Total assets3,960Equity3,000Net FA1,000L-T debt$4,560 Total CA

$2,600 Total CL1,800Inventory800S.-Term Loan2,400Accounts rec.600Accruals

$1,200Accts. pay.$360Cash

Sales = $12,000; M = NI/Sales = 6%; P = D/NI = 25%.


Key AssumptionsOperating at full capacity last year.Each type of asset grows proportionally

with sales.Payables and accruals (i.e. current

liabilities) grow proportionally with sales.

Existing profit margin (6%) and payout (25%) will be maintained.

Sales are expected to increase by $3 million. (%S = 25%)


Graphical IllustrationAssets

Sales0

7,560

12,000

9,450

15,000

Assets =(A/S)×Sales= 0.63($3,000)= $1,890

Assets = 0.63 × Sales

A/S = $7,560/$12,000 = 0.63 = $9,450/$15,000(i.e. Capital Intensity Ratio remains unchanged)


Calculating AFNAFN = Required Increase in Assets -

Spontaneous Increase in Liabilities - Increase in Retained Earnings

AFN= A×(ΔS/S0)- L*×(ΔS/S0)- M×S1(1-P) = $7,560×25% - $1,800×25% - 6%×$15,000×75% = $1,890-$450-$675 = $765,000


Projected Balance Sheet

$9,450 Tot. liab.&eq.$9,450 Total assets4,635Equity3,750Net FA1,000L-T debt$5,700 Total CA

$3,815 Total CL2,250Inventory1,565S.-Term Loan3,000Accounts rec.

750Accruals$1,500Accts. pay.$450Cash

DR0=3,600/7,560=48%; DR1=4,815/9,450=51%CR0=4,560/2,600=1.75; CR1=5,700/3,815=1.49


Corp. Valuation & Governance Corporate Valuation Model (×Dividend

Growth Model) Based on Free Cash Flow Estimation

(instead of dividends) Can be used when dividends are not paid

(e.g. startups, subunits of firm)1. Estimate the Value of Operations

(discount FCF = NOPAT – Required Net Operating Working Capital)

2. Add Value of Nonoperating Assets and Growth Options

Chapter 13


Value Based ManagementValue-based Management involves the

systematic use of the corporate valuation model to evaluate a company‘s decisions.

Value drivers:Growth rate of salesOperating profitability (NOPAT/Sales)Capital requirements (Operating

Capital/Sales)WACC

Company creates value when EROIC (i.e. NOPAT/Capital) > WACC


Corporate Governance Shareholder wealth may be adversely influenced

by management behavior (agency problem) Corporate governance is a set of laws, rules and

procedures influencing managers in a way that maximizes the firm‘s intrinsic value. Monitoring Litigation Threat of removal Compensation plans Hostile takeovers (avoid managerial

entrenchment)

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Click to edit Master title style Corporate Financial Management 1 Jan Vlachý Jan Vlachý Brigham, E.F., Ehrhardt, M.C. Financial Management: Theory and