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Principles of Corporate Finance tenth edition

2011/3/21

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What do you want to learn from "Principles of Corporate Finance"

•  To understand what financial managers do and why.

•  How to make financial decisions.

•  To understand of how finance theory translates into practice.

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Brief Contents

•  Part One: Value •  Part Two: Risk •  Part Three: Best Practice in Capital Budgeting •  Part Four: Financing Decisions and Market Efficiency •  Part Five: Payout Policy and Capital Structure •  Part Six: Options •  Part Seven: Debt Financing •  Part Eight: Risk Management •  Part Nine: Financial Planning and Working Capital

Management •  Part Ten: Mergers, Corporate Control, and Governance •  Part Eleven: Conclusion

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Part One Index

Chapter1 Goals and Governance of the Firm

Chapter2 How to Calculate Present Values

Chapter3 Valuing Bonds

Chapter4The Value of Common Stocks

Chapter5 Net Present Value and Other Investment Criteria

Chapter6 Making Investment Decisions with the Net Present Value Rule

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Chapter 1Goals and Governance of the Firm

1-1 Corporate Investment and Financing Decisions

1-2 The role of the financial manager and the opportunity cost of capital

1-3 Goals of the corporation

1-4 Agency problems and corporate governance

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Two principle financial decisions

•  What investmensts should the corporation make?

•  How should it pay for the investments?

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There themes

1. Maximizing value

2. The opportunity cost of capital

3. The crucial importance of incentive and governance

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1-1 Corporate Investment and Financing Decisions

Company(revenue in billions for 2008)

Reccent Investment Decision

Recent Financeing Decision

Toyota(￥26,289billion) In 2008 opened new engineering and safety testing facilities in Michigan.

Returned ￥431 billion to shareholders in the from of dividends.

Wal-Mart(＄406 billion) In 2008 announced plans to investt over a billion dollars in 90 new stores in Brazil.

In 2008 raised ＄2.5　billion by an issue of 5years and 30 years bond.

Wells Fargo(＄52 billion) Acquired Wachovia Bank in 2008 for ＄15.1　billion.

Financed the aquisition by and exchange of shares.

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1-1 Related topic of corporate investment and financing decisions

•  project analysis(Chap10)

•  how to issue securities(Chap15)

•  payout decision(Chap16)

•  debt finance(Chap23)

•  hedge and insurance(Chapter26,27)

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1-2 The role of the financial manager and

the opportunity cost of capital •  financial maneger

：anyone responsible for an investment or financing decisions.

•  opportunity cost of capital ：investment opportunies available to investers in financial markets

Financial manager

Firm's operations(a

bundle of real assets)

Financial markets

(investors holding financial assets)

1

4a

4b 3

2

1 cash raised by selling financial assets to investors 2 cash invested in the firm's operations and used to purchase real assets 3 cash generated by the firm's operations 4 a cash reinvested 4 b cash returned to investors

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Fundamental trade-off for corporate investment decisions

Cash

Investment opportunity (real asset)

Financial manager

Shareholders Investment opportunity

(financial asset)

investment alternative pay dividend to shareholders

Shareholders invest for themselves

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1-3 Goals of the corporation

•  The goal of maximizing shareholders value is widely accepted in both theory and practice.

•  "Anglo-Saxon "economies,the idea of maximizing shareholder value is widely accepted as the chief financial goal of firms.

•  In other countries,workers' interests are put forward much more strongly.

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Should firms be managed for share holders or all Stakeholders?

Whose company is it?

Which is more important? -job security for employees or shareholder dividends?

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1-4 Agency problems and corporate governance

Separation of owership and control →conflicts between shareholders' and managers' objectives →agency problems!! 1)managers do not attempt to maximize firm value 2)shareholders incur costs to monitor the managers and

constrain their actions →to design to help align managers' and shareholders' interest →necessity for corporate governance

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Good system of corporate governance

•  legal and regulatory requirements

•  compensation plans

•  board of directors

•  monitoring

•  takeovers(Chap32)

•  shareholder pressure(Chap33)

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Chpter2 How to calculate present value

2-1 Future values and present values

2-2 Looking for shortcuts perpetuities and annuities

2-3 More shortcuts-growing perpetuities and annuities

2-4 How interest rate is paid and quoted

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2-1 Future values and present values

•  money has a time value

•  a doller today is worth more than a doller tomorrow

•  Present Value<Future Value

tt

rC

)1(PVValuePresent

+=＝

today 100

year2 114.49 ×1.07^2

÷1.07^2

discount rate hurdle rate opportunity cost of capital

・・・（1）

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Net Present Value

0) at time flowcash (the 0

)1(

investment-PVNPV

0

10

<

++=

=

CrCC

・・・（2）

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Discounted cash flow(DCF)

∑ = +=

+++

++

++

+=

T

t tt

TT

rC

rC

rC

rC

rC

1

33

221

)1(

)1()1()1()1(PV ・・・

∑ = ++=+=

T

tt

rCCC

1 t00 )1(PVNPV

・・・（3）

（2）に（3）を代入

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2-2 Looking for shortcuts

perpetuities and annuities

•  Consols:bonds that goverment is under no obiligation to repay but that offer a fixed income for each year to perpetuity.

•  Annuity:an asset that pays a fixed sum each year

for a specified number of years.

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Perpetuities and Annuities

rCPV

PVC

luepresent vaflowcash Return(r)

=

==

⇔

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2-3 More shortcuts-growing perpetuities and annuities

grC

rgC

rgC

rC

rC

rC

rCPV

−=

++

++

+

++

+=

++

++

++

=

1

3

21

211

33

221

)1()1(

)1()1(

1

)1()1(1

・・・

・・・

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Some useful shortcut formulas

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2-4 How interest rate is paid and quoted

rrm

emr

==⎥⎦

⎤⎢⎣

⎡ +∞→

)718.2(1limm

•  We need to distinguish between the quoted annual interest rate and the effective annual rate.

•  Effective interest rate is higher than the quated rate.

•  The figure 2.718 or e is the base for natural logarithms.

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Chapter3 Valuing Bonds

3-1 Using the present value formula to value bonds

3-2 How bond prices vary with interest rates

3-3 The term structure of interest rates

3-4 Explaining term structure

3-5 Real and nominal rates of interest

3-6 Corporate bonds and the risk of default

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3-1 Using the present value formula to value bonds

opportunity cost of capital 3%

year 1 2 3 4

1 principal 0 0 0 100

2 coupon 8.5 8.5 8.5 8.5

3 Cash Flow(=1+2) 8.5 8.5 8.5 108.5

4 Present Value 8.25 8.01 7.78 96.4

5 Total PV 120.44

PV(bond)

=PV(annuity of coupon payments)+PV(final payment of principal)

=(coupon×x year annuity factor)+(final payment×discount factor)

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3-2 How bond prices vary with interest rates

•  The price of long term bonds is affected more by changing interest rate than the price of short term bonds.

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Duration and Modified duration

•  Duration is measured the exposure of the bond's price to fluctations in interest rates.

PV)PV(CT・・・

PV)PC(C

PV)PC(C

PV)PC(C T×

++×

+×

+×

= 321 321Duration

yield1duration(%)volatilityduration Modified+

==

•  Modified duration measured how bond prices change when interest rates change.

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3-3 The term structure of interest rates

•  The relationship between short and long term interest rate is called the term structure of interest rates.

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The law of one price applied government bonds

Year(t)

1 2 3 4

Bond Price

(PV)

Yield to maturity

(y,%)

Spot rate 0.035% 0.04% 0.042% 0.044%

Discount facotors 0.966 0.925 0.884 0.842

Bond A(8% coupon)

Payment(Ct) 80 1,080 1160

PV(Ct) 77.29 998.52 1,075.82 3.98%

Bond A(11% coupon)

Payment(Ct) 110 110 1,110 1330

PV(Ct) 106.28 101.70 981.11 1,189.10 4.16%

Bond A(6% coupon)

Payment(Ct) 60 60 60 1,060 1240

PV(Ct) 57.97 55.47 53.03 892.29 1,058.76 4.37%

Bond D(Strip)

Payment(Ct) 1,000 1000

PV(Ct) 841.78 841.78 4.40%

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3-4 Explaining term structure Why didn't everyone rush to buy long term bonds?

1.  You believe that short term interest rate will be higher in the future.

2.  You worry about the greater exposure of long term bonds to change in interest rates

3.  You worry about the risk of higher inflation

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3-5 Real and nominal rates of interest

•  Does the relation between inflation and interest rates affect our decisions?

•  How does the inflation outlook affect the nominal rate of interest?

•  A strategy of rolling over short term investments affords some protection against uncertain inflation.

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3-6 Corporate bonds and the risk of default

•  States and local governments and corporations also borrow by selling bonds as well as federal government.

•  The firm will never pay more than the promised cash flows,but in hard times it may pay less.

•  The safety of most corporate bond can be judged from bond ratings provided by rating companies.

Moody's Standard & Poor's

Fitch

Aaa AAA

Aa AA

A A

Baa BBB

Ba BB

B B

Caa CCC

Ca CC

C C

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Chapter4 The value of common stocks

4-1 How common stocks are traded

4-2 How common stocks are valued

4-3 Estimating the cost of equity capital

4-4 The link between stock prices and earnings per share

4-5 Valuing a business by discounted cash flow

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4-1 How common stocks are traded

•  Primary markets:

sales of shares to raise new capital

•  Secondary market:

the place where investors buy and sell

ex)NYSE,Nasdaq,Euronext,Tokyo stock exchange,

London stock exchange etc

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4-2 How common stocks are valued

•  market value VS book value Market to Book Value Ratio Price Eanings Ratio

Company Competitiors Company Competitors

Johnson&Johnson 3.4 3 11.3 10.9

Pepsico 6.4 3 15.6 12.9

Cambell soup 9 4.6 8.8 11.3

Wal-Mart 3 2.1 14.6 13.4

Exxon Mobil 2.9 1.2 7.6 5.3

Dow Chemical 0.5 3 12.5 10.6

Dell Computer 4.5 3.7 7.9 5.3

Amazon 11.2 2.7 46.9 22.2

GE 1 1.7 4.6 8.8

PBR=株価÷1株あたり株主資本 PER=株価÷1株あたりの利益

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The determinants of stock prices

∑

∑∞

=

=

+=

++

+=

+

+++

++

+=

+

+==

−+==

1

1

H2

21

110

0

01

)1(

)1()1(

)1()1(1

1Price

rreturn Expected

t tt

HHH

t tt

HH

rDIV

rP

rDIV

rPDIV

rDIV

rDIV

rPDIVP

PPPDIV

・・・

•  PV(stock)=PV(expected future dividends)

income gain

capital gain

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Applying the stock valuation formula to Fledgling Electronics

Expected Future Values Present Values

Horizon Period(H)

Dividende

(DIVt) Price(Pt)

Cumulative

Dividends Future Price Total

0 - 100 - - 100

1 5 110 4.35 95.65 100

2 6 121 8.51 91.49 100

3 6 133 12.48 87.52 100

4 7 146 16.29 83.71 100

10 12 259 35.89 64.11 100

20 31 673 58.89 41.11 100

50 534 11,739 89.17 10.83 100

100 62,639 1,378,061 98.83 1.17 100

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4-3 Estimating the cost of equity capital

gPDIVr

rgr

DIVP

+=⇔

>−

=

0

1

10 g)(

dividend yield

expected rate of growth in dividends

※this formula rests on a very strict assumuption: constant divident growth in perpetuity

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4-4 The link between stock prices and earnings per share

Expected return=dividend return=earnings-price ratio

0

1

PEPS

=0

1

PDIV

=

rEPS

rDIVP 11

0 ==

• Stock price of the case of a company that does not grow at all

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Net present value of growth opportunities

⎟⎟⎠

⎞⎜⎜⎝

⎛−=⇔

00

1P

PVGOrPEPS

earnings-price ratio

PVGO10 +=

rEPSP

Net present value of growth opportunities

earning power of the firm's current and future asset

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4-5 Valuing a business by discounted cash flow

HH

HH

rPV

rFCF

rFCF

rFCFPV

)1()1()1(1 221

++

+++

++

+= ･･･

PV(free cash flow) PV(horizon value)

•  The value of business computed as the discounted value of free cash flow out to a valuation horizon(H),plus the forecasted value of the business at the horizon.

•  Free cash flow is the amount of cash that a firm can pay out to investers after paying for all investment necessary for growth.

•  Forecasting reasonable horizon values is particularly difficult.

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Chapter5 Net present value and other investment criteria

5-1 A review of the basics

5-2 Payback

5-3 Internal(or DCF) rate of return

5-4 Choosing capital investments when resources are limited

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5-1 A review of the basics

NPV rules

•  A dollar today is worth more than a dollar than a dollar tomorrow.

•  Net present value solely on the forecasted cash flows from the project and the opportunity cost of capital.

•  Because presnt value are all measured in today's dollars,you can add them up.

AssetsBook incomeBook return of rateBook =

cash flows and book income are often very diferent

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The theory and practice of finance

Figure5.2：Survey evidence on the percentage of CFO's who always, or almost always, use a particular technique for evaluating investment projects.

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5-2 Payback

•  The payback rule states that a project should be accepted if its pay back period is less than some specified cutoff period.

【reason for misleading of payback rule】

1.  The payback rule ignores all cash flows after the cutoff date

2.  The payback rule gives equal weight to all cash flows before the cutoff date

Cash Flows(＄）

Project C0 C1 C2 C3

Payback Period

(years)

NPV at 10%

A -2,000 500 500 5,000 3 ＋2,624

B -2,000 500 1,800 - 2 -58

C -2,000 1,800 500 - 2 ＋50

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5-3 Internal(or DCF) rate of return

Internal Rate of Return(IRR):

the project rate of return is the discount rate that gives a zero NPV

0

)1()1(1 221

0 =+

+++

++

+= TT

IRRC

IRRC

IRRCCNPV ・・・

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IRR and the opportunity cost

•  The internal rate of return is a profitability measure that depends solely on the amount and timing of the project cash flows.

•  The opportunity cost of capital is a standard of profitability that we use to calculate how much the project is worth.

•  The opportunity cost of capital is established in capital

markets.

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Misapplied IRR rule

•  If a project offers positive cash flows by negative flows,NPV can rise as the discount rate is increased.

•  If there is more than one change in the sign of the cashflows,the project may have several IRRs, or no IRR at all.

•  The IRR rule may give the wrong ranking of mutually exclusive projects that differ in economic life or in scale of required investment.

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5-4 Choosing capital investments when resources are limited

•  Capital rationing:

there are limitations on the investment program that prevent the company from undertaking all such projects.

investmentluepresent vanet Indexity Profitabil =

Project C0 C1 C2 NVP

at 10% Profitability index

A -10 30 5 21 2.1

B -5 5 20 16 3.2

C -5 5 15 12 2.4

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Capter6 Making investment decisions with the net present value

6-1 Applying the net present value rule

6-2 example IM&C's Fertilizer project

6-3 investment timing

6-4 Equivalent annual cash flows

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6-1 Applying the net present value rule

•  the problem of what to discount:

rule1:Only cash flow is relevant

・Depreciation is not a cash flow.

・Exclude debt interest or the cost of paying a loan from the project cash flow.

・Remenber the investment in working capital.

rule2:Always estimate cash flows on an incremental basis

・Include all indirect effects of the project.

　・Forget sunk cost.

　・Include opportunity cost.

rule3:Be consistent in your treatment of inflation

　・If cashs flow are forecasted in nominal terms,use a nominal discount rate.

　・Discount real cash flow at a real rate.

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6-2 example IM&C's Fertilizer project

Net cash flow

=cash flow from capital investment and disposal

+cash flow from changes in working capital

+operating cash flow

Perod0 1 2 3 4 5 6 7

1 Capital investment and disposal - 10,000 - - - - - - 1,442 2 Change in working capital - 550 - 739 - 1,972 - 1,629 1,307 1,581 2,002 3 Sales - 523 12,887 32,610 48,901 35,834 19,717 - 4 Cost of goods sold - 837 7,729 19,552 29,345 21,492 11,830 - 5 Other costs 4,000 2,200 1,210 1,331 1,464 1,611 1,772 - 6 Tax - 1,400 - 1,434 828 3,550 5,778 3,902 1,586 7 Operation cash flow(3-4-5-6) - 2,600 - 1,080 3,120 8,177 12,314 8,829 4,529 8 Net cash flow(1+2+7) - 12,600 - 1,630 2,381 6,205 10,685 10,136 6,110 3,444 9 Present value at 20% - 12,600 - 1,358 1,654 3,591 5,153 4,074 2,046 961 10 Net present value 3,520 (sum of 9)

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Project Analysis

•  to undertake a sensitivity analysis

•  to construct a diferent scenarios

•  break even analysis- to expolre how far sales could fall short of forecast before the project went into the red

※In Chapter10, we practice using each of these "what if" techniques.

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6-3 Investment timing

year of harvest 0 1 2 3 4 5

Net Future Value 50 64.4 77.5 89.4 100 109.4

Change value from previous year 28.8% 20.3% 15.4% 11.9% 9.4%

Net Present value 50 58.5 64 67.2 68.3 67.9

•  The optimal point to harvest the timber is year becauses this is the point that maximizes NPV.

•  Delaying the harvest further just reduces shareholder wealth.

•  We return to the problem of investment timing under uncertainty in Chapter 10 and 22.

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6-4 Equivalent annual cash flows

•  It's helpful to reverse the calculation,transforming an investment today into an equivalent stream of future cash flow.

•  Which machine shuould we take, A or B?

Machine C0 C1 C2 C3 FV PV at6％

A 15 5 5 5 30 28.37

B 10 6 6 22 21

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Choosing the lowest equivalent annual cost

•  Machine A is better because its equivalent annual cost is less(10.61 VS 11.45).

•  Our rule for choosing between plant and equipment with differnt economic lives to select the asset with the lowest fair change,that is, the lowest equivalent annual cost.

C0 C1 C2 C3 PV at6%

MachineA 15 5 5 5 28.37

Equivalent annual cost 10.61 10.61 10.61 28.37

C0 C1 C2 PV at6%

MachineB 10 6 6 21

Euqivalent annual cost 11.45 11.45 21

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Summary 1) Goals and Governance of the Firm maximizing value/the opportunity cost of capital/incentive and governance 2) How to Calculate Present Values future values/present values/net present value/DCF/perpetuities/annyuities 3) Valuing Bonds duration/modified duration/interest term structure 4) The Value of Commons Stocks EPS/PVGO/horizon value 5) Net Present Value and Other Investment Criteria book rate of return/pay back/IRR 6) Making Investment Decisions with the Net Present Value Rule Equivalent annual cash flows

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Reference

【コーポレートファイナンス関連】

•  マッキンゼーアンドカンパニー他（2006）「企業価値評価　第4版」ダイヤモンド社

•  鈴木一功（2004）「企業価値評価　実践偏」ダイヤモンド社

•  伊藤邦雄（2007）「ゼミナール企業価値評価」日本経済新聞社　

•  保田隆明（2008）「実況LIVE 企業ファイナンス入門講座―ビジネスの意思決定に役立つ財務戦略の基本」ダイヤモンド社

•  森生明（2001）「MBAバリュエーション」日経BP社

•  森生明（2006）「会社の値段」ちくま新書

•  石野雄一（2005）「道具としてのファイナンス」日本実業出版社

•  石野雄一（2007）「ざっくり分かるファイナンス 経営センスを磨くための財務 」光文社

•  砂川伸幸（2004）「コーポレートファイナンス入門」日経文庫

•  中沢恵・池田和明（1998）「キャッシュフロー経営入門」日経文庫

【その他応用編】

•  笹山 幸嗣 ・ 村岡 香奈子（2008） 「M&Aファイナンス 」金融財政事情研究会

•  齊藤誠「金融技術の考え方・使い方―リスクと流動性の経済分析」有斐閣

•  内藤伸浩(2003)「アセット・ファイナンス-資産金融の理論と実践」ダイヤモンド社

•  磯崎哲也（2010）「起業のファイナンス」日本実業出版社