Fn2191 VLE - Study guide PDF

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Summary

Principles of corporate finance H. Zhong, P. Frantz, R. Payne, J. Favilukis FN2191 2018 Undergraduate study in Economics, Management, Finance and the Social Sciences This subject guide is for a 200 course offered as part of the University of London undergraduate study in Economics, Management, Finan...

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Principles of corporate finance H. Zhong, P. Frantz, R. Payne, J. Favilukis FN2191

2018

Undergraduate study in Economics, Management, Finance and the Social Sciences This subject guide is for a 200 course offered as part of the University of London undergraduate study in Economics, Management, Finance and the Social Sciences. This is equivalent to Level 5 within the Framework for Higher Education Qualifications in England, Wales and Northern Ireland (FHEQ). For more information, see: www.london.ac.uk

This guide was prepared for the University of London by: Dr Hongda Zhong, Assistant Professor of Finance, The London of Economics and Political Science and Dr. J. Favilukis, Lecturer, The London School of Economics and Political Science

This is one of a series of subject guides published by the University. We regret that due to pressure of work the authors are unable to enter into any correspondence relating to, or arising from, the guide. If you have any comments on this subject guide, favourable or unfavourable, please use the form at the back of this guide.

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Published by: University of London © University of London 2018

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Contents

Contents Introduction to the subject guide .......................................................................... 1 Aims of the course ......................................................................................................... 1 Learning outcomes ........................................................................................................ 1 Syllabus ......................................................................................................................... 2 Essential reading ........................................................................................................... 2 Further reading .............................................................................................................. 2 Online study resources ................................................................................................... 4 Subject guide structure and use ..................................................................................... 5 Examination advice........................................................................................................ 6 Glossary of abbreviations used in this subject guide ....................................................... 7

Chapter 1: Present value calculations and the valuation of physical investment projects ................................................................................................................... 9 Aim of this chapter

....................................................................................................... 9

Learning objectives ........................................................................................................ 9 Essential reading ........................................................................................................... 9 Further reading .............................................................................................................. 9 Overview ....................................................................................................................... 9 Introduction ................................................................................................................ 10 Fisher separation and optimal decision-making ............................................................ 10 Fisher separation and project evaluation ...................................................................... 13 The time value of money .............................................................................................. 14 The net present value rule ............................................................................................ 15 Other project appraisal techniques ............................................................................... 17 Using present value techniques to value stocks and bonds ........................................... 21 A reminder of your learning outcomes .......................................................................... 23 Key terms .................................................................................................................... 23 Sample examination questions ..................................................................................... 23

Chapter 2: Real options ........................................................................................ 25 Aim of the chapter....................................................................................................... 25 Learning objectives ...................................................................................................... 25 Essential reading ......................................................................................................... 25 Further reading ............................................................................................................ 25 Introduction ................................................................................................................ 25 Decision tree, source of option value and early exercise ................................................ 26 Three types of real options ........................................................................................... 30 A reminder of your learning outcomes .......................................................................... 36 Key terms .................................................................................................................... 36 Sample examination questions ..................................................................................... 37

Chapter 3: The choice of corporate capital structure ........................................... 39 Aim of the chapter....................................................................................................... 39 Learning objectives ...................................................................................................... 39 Essential reading ......................................................................................................... 39 Further reading ............................................................................................................ 39 Overview ..................................................................................................................... 39

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FN2191 Principles of corporate finance

Basic features of debt and equity ................................................................................. 40 The Modigliani–Miller theorem .................................................................................... 41 Modigliani–Miller and corporate taxation ..................................................................... 43 Modigliani–Miller with corporate and personal taxation ............................................... 46 Summary ..................................................................................................................... 48 A reminder of your learning outcomes .......................................................................... 48 Key terms .................................................................................................................... 48 Sample examination questions ..................................................................................... 49

Chapter 4: Leverage, WACC and the Modigliani-Miller 2nd proposition ............. 51 Aim of the chapter....................................................................................................... 51 Learning objectives ...................................................................................................... 51 Essential reading ......................................................................................................... 51 Further reading ............................................................................................................ 51 Overview ..................................................................................................................... 51 Weighted average cost of capital ................................................................................. 52 Modigliani and Miller’s 2nd proposition ....................................................................... 54 A CAPM perspective (optional) .................................................................................... 58 Summary ..................................................................................................................... 59 Key terms .................................................................................................................... 60 A reminder of your learning outcomes .......................................................................... 60 Sample examination questions ..................................................................................... 61

Chapter 5: Asymmetric information, agency costs and capital structure ............ 63 Aim of the chapter....................................................................................................... 63 Learning objectives ...................................................................................................... 63 Essential reading ......................................................................................................... 63 Further reading ............................................................................................................ 63 Overview ..................................................................................................................... 64 Capital structure, governance problems and agency costs ............................................. 64 Agency costs of outside equity and debt ...................................................................... 64 Agency costs of free cash flows.................................................................................... 70 Firm value and asymmetric information ........................................................................ 71 Summary ..................................................................................................................... 75 Key terms .................................................................................................................... 76 A reminder of your learning outcomes .......................................................................... 76 Sample examination questions ..................................................................................... 76

Chapter 6: Equity financing .................................................................................. 79 Aim of the chapter....................................................................................................... 79 Learning objectives ...................................................................................................... 79 Essential reading ......................................................................................................... 79 Further reading ............................................................................................................ 79 Introduction ................................................................................................................ 79 Private equity financing ............................................................................................... 80 Initial public offerings and seasoned equity offerings .................................................... 85 IPO underpricing and winner’s curse ............................................................................ 89 A reminder of your learning outcomes .......................................................................... 92 Key terms .................................................................................................................... 92 Sample examination questions ..................................................................................... 93

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Contents

Chapter 7: Dividend policy ................................................................................... 95 Aim of the chapter....................................................................................................... 95 Learning objectives ...................................................................................................... 95 Essential reading ......................................................................................................... 95 Further reading ............................................................................................................ 95 Overview ..................................................................................................................... 96 How to return capital to equity holders? ...................................................................... 96 Modigliani–Miller meets dividends ............................................................................... 97 Prices, dividends and share repurchases ....................................................................... 98 Dividend policy: stylised facts ....................................................................................... 99 Taxation and clientele theory ..................................................................................... 100 Asymmetric information and dividends ....................................................................... 102 Agency costs and dividends ....................................................................................... 103 Summary ................................................................................................................... 103 A reminder of your learning outcomes ........................................................................ 104 Key terms .................................................................................................................. 104 Sample examination questions ................................................................................... 104

Chapter 8: Mergers and takeovers ..................................................................... 105 Aim of the chapter..................................................................................................... 105 Learning objectives .................................................................................................... 105 Essential reading ....................................................................................................... 105 Further reading .......................................................................................................... 105 Overview ................................................................................................................... 106 Merger motivations ................................................................................................... 106 Payment method in takeover ...................................................................................... 107 The market for corporate control ................................................................................ 110 The impossibility of efficient takeovers ....................................................................... 110 Two ways to get efficient takeovers ............................................................................ 112 Empirical evidence ..................................................................................................... 113 Summary ................................................................................................................... 114 A reminder of your learning outcomes ........................................................................ 115 Key terms .................................................................................................................. 115 Sample examination questions ................................................................................... 116

Chapter 9: Risk management and hedging ........................................................ 117 Aim of the chapter..................................................................................................... 117 Learning objectives .................................................................................................... 117 Essential reading ....................................................................................................... 117 Further reading .......................................................................................................... 117 Introduction .............................................................................................................. 117 Why do firms hedge?

................................................................................................ 118

Typical financial instruments for hedging .................................................................... 123 Cost of risk management ........................................................................................... 126 Interest rate parity and carry trade ............................................................................. 127 A reminder of your learning outcomes ........................................................................ 129 Key terms .................................................................................................................. 129 Sample examination questions ................................................................................... 130

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FN2191 Principles of corporate finance

Notes

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Introduction to the subject guide

Introduction to the subject guide

This subject guide provides you with an introduction to the modern theory of corporate finance. As such, it covers a broad range of topics and aims to give a general background to any student who wishes to do further academic or practical work in finance or accounting after graduation. We begin with project valuation methods and then examine issues that come under the broad heading of corporate finance. We will study how key decisions made by firms affect firm value and empirical evidence on these issues. The areas involved include: •

the capital structure decision

•

dividend policy

•

mergers and acquisitions

•

raising equity

•

risk management.

By studying these areas, you should gain an appreciation of: •

optimal financial policy on a firm level

•

conditions under which an optimal policy actually exists

•

how the actual financial decisions of firms may be explained in theoretical terms.

Aims of the course This course provides a theoretical framework used to address issues in project appraisal and financing, payout policy, capital structure, mergers and acquisitions, equity offerings and risk management. It provides students with the tools required for further studies in financial intermediation and investments.

Learning outcomes At the end of this course, and having completed the Essential reading and activities, you should be able to: •

explain how to value projects, and use key capital...