Corporate Finance A2 Vysok kola finann a sprvn Winter Semester
2012 Jaromr R. Stemberg [email protected]
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Course Layout Twelve two-hour lessons The course is to
introduce general financial management problems, realtions,
terminology, and solutions Ends with an Exam (zkouka)
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Literature Block, Stanley: Foundations of Financial Management
McGraw-Hill, 2009 ISBN 978-0-07-128525-4
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Grading Written test, oral exam
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Contents Review of the Last Semester Time Value of Money
Valuation and Rate of Return Cost of Capital and Capital Budgeting
Capital Markets Bonds, Stock and Security Financing
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History of Money and Accounting
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Money Barter trade Cowry shells form 1200 B.C. in China till
mid 20 th century in Africa Precious metal coins, banknotes
Development of banking Plastic money of today
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Development of Accounting Babylon, 18 th century B.C. - first
organized records kept to account for assets and loans Italy, 13 th
century A.D. - double-entry bookkeeping 20 th century A.D. -
international accounting standards US GAAP and IAS/IFRS
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Financial Reports and Analysis
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Balance Sheet Assets Liabilities Current AssetsCurrent
Liabilities Cash and EquivalentsShort-Term Accounts Payable
Short-Term ReceivablesCurrent Tax Payable InventoryShort-Term Loans
and Borrowings Accruals and Other S/T AssetsAccruals and Other S/T
Liabilities Long-Term AssetsLong-Term Liabilities Intangible Fixed
AssetsLong-Term Payables Tangible Fixed AssetsProvisions Long-Term
Receivables Owners Equity Share Capital Share Premium and Capital
Funds Retained Earnings Y-T-D Profit (Loss)
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Cash Flow Statement
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Ratios and Analyses Profitability Ratios - profit margin -
return on assets (investments), return on equity Asset Utilization
Ratios - receivable, inventory, fixed, total assets turnover -
average collection period, days of sales outstanding Liquidity
Ratios - current ratio - quick ratio Analyses - DuPont analysis -
horizontal, vertical, trend
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Du Pont Analysis
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Forecast and Budget
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Budgetting Systematic setting of future goals Bottom-up or
top-down Identification of external influence and risks (such as
customers, competition, macroeconomics) Identification of external
influence and risks (such as capacity of production and resources,
human factor) Setting of expected growth (reduction), pipeline,
percent-of-sales, investment planning
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Financial Forecasting Pro forma income statement Revenue
(pipeline, funnel, percentage) Expenses (variable, fixed) Pro forma
balance sheet A/R, A/P, inventory Fixed assets, liabilities, equity
Pro forma cash flow statement
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Operational and Financial Leverage
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Fixed and variable expenses 0 $ total expenses fixned expenses
No. of units produced
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Fixed and variable expenses No. of units produced $ fixned
expenses total expenses
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$ Break-Even Point No. of units produced revenue total expenses
fixed expenses
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Break-Even Point profit revenue total expenses fixed expenses $
No. of units produced
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$ Break-Even Point No. of units produced revenue total expenses
fixed expenses
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Operational leverage Uses fixed/variable cost Can increase
profits but increases risk _ Fixed costs _ Price Variable cost per
unit
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Operational leverage _ Fixed costs _ Price Variable cost per
unit Fixed cost 60.000Fixed cost 12.000 Variable cost 0,80 /
unitVariable cost 1,60 / unit Unit price 2,00Unit price 2,00
60.000/(2,00-0,80) = 50.00012.000/(2,00-1,60)= 30.000 break-even
point isbreak-even point is 50.000 units30.000 units
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Financial Leverage 2 firms: exactly the same Same sector Same
opportunities Same Management The only difference: the debt L
(leveraged firm) has 50% of debt U (unleveraged firm) has no
debt
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Financial Leverage Firm UFirm L Shares (Capital) Financial debt
Total 100 000 0 100 000 50 000 100 000 Number of shares (Price of a
share 100) 1 000 500 EBIT Financial interests (interest rate 5%)
Net income before tax EPS before tax 10 000 0 10 000 10 (10 000/1
000) 10 000 2 500 7 500 15 (7 500/500) Net income after tax (Tax
rate 33%) EPS after tax 6 700 6,70 5 000 10,00
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Financial Leverage The shareholder of L has a return of 15
(before tax) The shareholder of U has a return of 10 (before tax)
What do you prefer?
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Financial Leverage Firm UFirm L Shares Financial debt Total 100
000 0 100 000 50 000 100 000 Number of shares (Price of a share
100) 1 000 500 EBIT Financial interests (interest rate 5%) Net
income before tax EPS before tax 0 2 500 -2 500 -5 Net income after
tax EPS after tax 0 -2 500 -5
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Financial Leverage The shareholder of L has a return of -5
(before tax) The shareholder of U has a return of 0 (before tax)
What do you prefer?
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Financial Leverage For leverage to be profitable, the rate of
return on the investment must be higher than the cost of the
borrowed money Conclusion Leverage can create value or destroy it
To create value, the IRR must be higher than the cost of loan; if
not, leverage destroys value.
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Time Value of Money
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Money in Time 1624 the Native Americans sold Manhattan for $24.
Ridiculously low pice? If the amount was invested then at 7.5%
(compounded annually), what would be the price today?
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Money in Time almost $40 trillion (exactly $39 637 279 191
271.20) it would make them the richiest people in the world
Future Value of an Annuity TimeAnnuity Now100 1st year100 2nd
year100 3rd year100... nth year100
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Future Value of an Annuity Time Annuity Interest 7%Total Now100
7.00107.00 1st year10014.49221.49 2nd year10022.50343.99 3rd
year10031.08475.07 4th year10040.25615.32 5th
year10050.07765.39
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Future Value of an Annuity FV A = A * (1 + r) 0 + A * (1 + r) 1
+ A * (1 + r) 2 +.. + A * (1 + r) n FV A = A [(1 + r) n 1] / r
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Present Value FV n = PV * (1 + r) n PV = FV n * 1 / (1 + r)
n
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Present Value PV = FV n * 1 / (1 + r) n PV = FV 1 * 1 / (1 + r)
1 + FV 2 * 1 / (1 + r) 2 +.. + FV n * 1 / (1 + r) n
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Present Value of an Annuity PV A = A * [1 / (1 + r)] 1 + A * [1
/ (1 + r)] 2 +.. + A * [1 / (1 + r)] n PV A = A * {[1 1/(1 + r) n ]
/ r}
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Valuation and Rate of Return
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Objectives The valuation of a financial asset is based on the
present value of the future cash flows The required rate of return
in valuing an asset is based on the risk involved
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Bonds Coupon / zero coupon bonds Valuation of bonds: present
value of future cash inflows P = P.. bond price Y.. Yield P
n.principal payment at maturity i.. interest (or expected return)
t.. number corresponding to a period n..number of periods n YtYt +
PnPn (1+i) t (1+i) n t=1
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Stock Infinite stream of level dividend payments Constant
growth in dividends D.. dividend payment r.. required rate of
return g..dividend growth
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Cost of Capital
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Weighted average of: -cost of debt (loans, bonds) -cost of
equity (common stock, preferred stock)
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Cost of Debt Interest payment minus tax K d = i (1 t) K d....
Cost of debt i.... Interest paid t.... corporate tax rate
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Cost of Equity Dividend devided by market price K e = D / P 0 K
e.... cost of equity D.... current dividend P 0.... market price of
the stock If dividends constantly grow, then K e = (D / P 0 ) + g
g.... constant growth rate in dividends Selling costs are to be
deducted from price for newly issued stock
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Sources of Financing Hidden reserves within the company
Suppliers credit Bank loans Financial investors Strategic investors
Securities
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The Capital Budgeting Decision Long-term investment decision
Cash flow rather then earnings Payback method Dynamic methods
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Long-Term Investment Most significant financial decisions
Infuences the firms preformance in many future years Planning
involves future revenues and expenditures The farther in the future
the time horizon, the more uncertain outcome
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Capital Budgeting Proces Search for investment opportunities
Collection of data Analysis, evaluation and decision making
Reevaluation and adjustment
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INVESTMENT PROJECTS Investment project: investment in the phase
of planning or implementation Conventional cash flow: cash out at
the beginning followed by cash inflows Feasibility Study: document
describing strategic, financial, technical, marketing and sales
information needed for go / no-go decision
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Investment Projects Categories Accounting: financial tangible
intangible Development new development re-newing regulatory- safety
- environment - new regulations
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Investment Projects Categories Mutual influence substitution
(mutually excluding) independent complementary (mutually
supporting) Cash flow conventional period of expenses is replaced
by lasting period of revenue unconventional a few income / expense
periods switch during the project duration
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Investment Projects Categories Function new fixed asset new
product new organization structure new company new legislation new
markets History green field running business
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Phases of an Investment Project Pre-investment phase projects
identification feasibility study Investment phase establishement of
legal, financial and organizational base tender suppliers
acquisition of technology and documentation personnel trial run
Implementation phase implementation management
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Project Identification Monitoring of the business surroundings
market of products, supplies, services, capital, workforce
technology legislation, political and economical influence Short
list monitoring of possibilities evaluation of basic idea
attractiveness preliminary estimate of returns and
profitability
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Evaluation Techniques Static Average annual revenue (total
revenues/total duration) Average payback (investment/average annual
revenue) Average margin (average annual revenue/investment) Payback
period Dynamic Net Present Value (NPV) Internal Rate of Return
(IRR) Paybeck Period (PP) Profitability Index (PI)
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Cash Flow Over Accounting Projects evaluated by cash generation
rahter than accounting results Eliminate non-cash transactions and
add in cash expenditures Problem: publicly traded companies
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Payback Method Computes the time required to recoup the initial
investment Ignores the inflows after the cutoff period Doesnt
consider the time value of money
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Internal Rate of Return Project 1
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Internal Rate of Return Project 2
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Net Present Value
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Analysis
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Risk and Capital Budgeting
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The Concept of Risk Based on uncertainity of future outcomes
Most investors are risk-averse The greater risk is involved the
higher return is expected Risk decision making: simulation models
and decision trees Risk of a project inconnection with the total
risk of the firm
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Basic Business Statistics D (expected value) = DP DPDP 30020%60
60060%360 90020%180 DP =600 Doutcome Pprobability of occurance