Intermediate Corporate Finance Lecture Slides for Module A PDF

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Intermediate Corporate Finance Lecture Slides for Module A (Lecture 1) 

3 Aspects of Corporate Finance o Capital budgeting: planning and managing the firm’s long-term investments  E.g. should you open another branch? o Capital structure: how to finance these investments?  Optimal mix of debt and equity o Working capital management: managing short-term assets  E.g. how much cash & inventory to keep?

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In class exercise. What are Corporate and Non Corporate Decisions o issue more bonds/debt? – Corporate Finance o pay dividends – Corporate o More effective rate (tax). How? – Maybe Corporate  Lower tax rates abroad o Budget research and development spending - Corporate o Increase or decrease product prices – Non corporate o Bringing in more cash - Corporate o Supplier choice – Non Corporate o Technology (inside or outside) – Non corporate o Purchase another company ex: tech company to incorporate them into the firm - Corporate o Mergers and acquisitions - Corporate

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The Balance Sheet o Assets = Liabilities + Equity o Assets: either current (short-lived) or fixed (long-lived) o Liabilities: either current or long-term o Equity: residual value if firm were to sell all its assets and use money to pay off debt o  Balance sheet = snapshot of the firm on a particular date

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The Financial View of Firm o Assets in place + Growth Assets = Debt + Equity o Assets in place: existing investments that generate cash flows today o Growth assets: expected value that will be created in the future o  Forward looking feature o Different from the balance sheet o Assets you’ll grow in the future: growth assets o An example for a firm that has little assets but a lot of growth assets

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Ex: start up companies

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Ex: Tesla, Uber

 The stock price exceeds the value of the asset (because of growth assets) o Because a really, cool product is the leader in the industry, profits will increase so the stock they buy will as well o Ex: Tesla’s Value today  Accounting’s approach: Vo= Assets today – liabilities today = equity value  Financial view: (D1 + P1) / (1+r) = income (if sold at the end of the year T=1) o The growth potential is in P1. It is expected to increase over time  ….

If you keep the stock forever Vo= D1/(1+r) + (D2)/(1+r)^2

o Cash flows o You see the growth opportunity when you see cash flows come in o Price in one year should reflect the presence of the increase in cash flows

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3 Basic Themes o Corporate Finance is “Common Sense”  Taking investment that generates 9% return with funds that cost 10% to raise is not a smart investment decision

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 Firms should prefer a funding mix that costs 10% instead of 11%  Firms should return cash to owners if most investment opportunities generate returns below the cost of funding   Smart businesspeople have always recognized and used these basic principles  Underlying principles: if the funding costs are lower than the return on the investment, you should invest  firm value: the firm only invest if equity is positive o Corporate Finance is Focused  Standard objective is to maximize the value of the business  Choose the optimal investment decision rule  Choose the optimal debt to equity ratio  Choose the optimal amount of cash that should be returned to the owners  If you accept this objective function, everything in corporate finance makes complete sense;  If you don’t, nothing will.  Objective is to maximize the firms value  Other objectives are…  Ex: firm A acquiring firm B. objective could be to increase reputation of the firm  Ex: sustainability and impact on the environment o Corporate Finance is universe  Every business, small or large, public or private, advanced or emerging market, must make investment, financing, and payout decisions

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 Objective for all of these businesses: maximize the firm value  Constraints and challenges might differ a lot, first principles do not change:  Public firm might have much lower cost of debt and equity than private firm, but both should try to minimize their cost of capital  Emerging market firm may face greater uncertainty regarding future investments than developed market firm, but both should only invest if return sufficiently high  Underlying principles are the same, but constraints are different In the big picture of corporate finance, the first big piece is the investment decision; which of the following best characterizes that decision? o Firms should take investments that generate the highest profits o Firms should take investments that generate the most cash flows o Firms should take investments that earn the highest return o Firms should take investments that earn returns greater than the risk-free rate o Firms should take investments that earn returns greater than the risk-adjusted hurdle rate In the big picture of corporate finance, the dividend principle states that firms should return as much cash as they can to their owners. If firms followed this principle, which of the following would you expect to observe? o Firms will pay out all of their earnings as dividends/stock buybacks o Firms will not pay out any of their earnings to stockholders

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o Firms that have high earnings and low growth potential will return more cash to stockholders o Firms that have high earnings and high growth potential will return more cash to stockholders o None of the above 

If the firm never pays out any dividends, the stock value would be 0 (think of the Vo formula)

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You have cash, and either you want to re-invest or you return to shareholders

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If you don’t have any growth potential, you would return dividends to shareholders

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If you have a firm with high earnings and high growth potential, you would re-invest into projects

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