Study Guide Corporate Finance
Total Page:16
File Type:pdf, Size:1020Kb
Load more
Recommended publications
-
The Promise and Peril of Real Options
1 The Promise and Peril of Real Options Aswath Damodaran Stern School of Business 44 West Fourth Street New York, NY 10012 [email protected] 2 Abstract In recent years, practitioners and academics have made the argument that traditional discounted cash flow models do a poor job of capturing the value of the options embedded in many corporate actions. They have noted that these options need to be not only considered explicitly and valued, but also that the value of these options can be substantial. In fact, many investments and acquisitions that would not be justifiable otherwise will be value enhancing, if the options embedded in them are considered. In this paper, we examine the merits of this argument. While it is certainly true that there are options embedded in many actions, we consider the conditions that have to be met for these options to have value. We also develop a series of applied examples, where we attempt to value these options and consider the effect on investment, financing and valuation decisions. 3 In finance, the discounted cash flow model operates as the basic framework for most analysis. In investment analysis, for instance, the conventional view is that the net present value of a project is the measure of the value that it will add to the firm taking it. Thus, investing in a positive (negative) net present value project will increase (decrease) value. In capital structure decisions, a financing mix that minimizes the cost of capital, without impairing operating cash flows, increases firm value and is therefore viewed as the optimal mix. -
How Risky Is the Debt in Highly Leveraged Transactions?*
Journal of Financial Economics 27 (1990) 215-24.5. North-Holland How risky is the debt in highly leveraged transactions?* Steven N. Kaplan University of Chicago, Chicago, IL 60637, USA Jeremy C. Stein Massachusetts Institute of Technology Cambridge, MA 02139, USA Received December 1989, final version received June 1990 This paper estimates the systematic risk of the debt in public leveraged recapitalizations. We calculate this risk as a function of the difference in systematic equity risk before and after the recapitalization. The increase in equity risk is surprisingly small after a recapitalization, ranging from 37% to 57%, depending on the estimation method. If total company risk is unchanged, the implied systematic risk of the post-recapitalization debt in twelve transactions averages 0.65. Alternatively, if the entire market-adjusted premium in the leveraged recapitalization represents a reduction in fixed costs, the implied systematic risk of this debt averages 0.40. 1. Introduction Highly leveraged transactions such as leveraged buyouts (LBOs) and lever- aged recapitalizations have grown explosively in number and size over the last several years. These transactions are largely financed with a combination of senior bank debt and subordinated lower-grade or ‘junk’ debt. Recently, the debt in these transactions has come under increasing scrutiny from investors, politicians, and academics. All three groups have asked in one way or another how risky leveraged buyout debt is in relation to the return it *Cedric Antosiewicz provided excellent research assistance. Paul Asquith, Douglas Diamond, Eugene Fama, Wayne Person, William Fruhan (the referee), Kenneth French, Robert Korajczyk, Richard Leftwich, Jeffrey Mackie-Mason, Merton Miller, Stewart Myers, Krishna Palepu, Richard Ruback (the editor), Andrei Shleifer, Robert Vishny, and seminar participants at the Securities and Exchange Commission, the University of Chicago, and MIT’s Sloan School made helpful comments on earlier drafts. -
Net Present Value (NPV): the Basics & the Pitfalls
Presented at the 2013 ICEAA Professional Development & Training Workshop - www.iceaaonline.com Net Present Value (NPV): The Basics & The Pitfalls Cobec Consulting Kevin Schutt, Manager Nathan Honsowetz, Consultant ICEAA Conference, June 2013 Agenda Presented at the 2013 ICEAA Professional Development & Training Workshop - www.iceaaonline.com 2 Time Value of Money Presented at the 2013 ICEAA Professional Development & Training Workshop - www.iceaaonline.com Discount Factor “A nearby penny is worth a distant dollar” ‐ Anonymous 3 Time Value of Money Presented at the 2013 ICEAA Professional Development & Training Workshop - www.iceaaonline.com Year 1 2 3 4 FV1 FV2 FV3 FV4 PV1 PV2 PV3 PV4 4 Inputs to NPV Presented at the 2013 ICEAA Professional Development & Training Workshop - www.iceaaonline.com 5 NPV Example Presented at the 2013 ICEAA Professional Development & Training Workshop - www.iceaaonline.com 6 Investment Alternatives Presented at the 2013 ICEAA Professional Development & Training Workshop - www.iceaaonline.com If NPV > 0 No correlation IRR > Cost of Capital Benefit/Cost > 1 7 Economic Analysis Regulations Presented at the 2013 ICEAA Professional Development & Training Workshop - www.iceaaonline.com 8 NPV in the Private Sector Presented at the 2013 ICEAA Professional Development & Training Workshop - www.iceaaonline.com 9 Net Present Value: The Pitfalls Presented at the 2013 ICEAA Professional Development & Training Workshop - www.iceaaonline.com Pitfall! Activision, 1982 10 NPV Pitfall #1: Formula error Presented at the 2013 ICEAA -
Financial Market Analysis (Fmax) Module 2
Financial Market Analysis (FMAx) Module 2 Bond Pricing This training material is the property of the International Monetary Fund (IMF) and is intended for use in IMF Institute for Capacity Development (ICD) courses. Any reuse requires the permission of the ICD. The Relevance to You You might be… § An investor. § With an institution that is an investor. You may be managing a portfolio of foreign assets in a sovereign wealth fund or in a central bank. § With an institution that is in charge of issuing sovereign bonds. § With an institution that is a financial regulator. Defining a Bond – 1 A bond is a type of fixed income security. Its promise is to deliver known future cash flows. § Investor (bondholder) lends money (principal amount) to issuer for a defined period of time, at a variable or fixed interest rate § In return, bondholder is promised § Periodic coupon payments (most of the times paid semiannually); and/or § The bond’s principal (maturity value/par value/face value) at maturity. Defining a Bond – 2 Some bond have embedded options. § Callable Bond: The issuer can repurchase bond at a specific price before maturity. § Putable Bond: Bondholder can sell the issue back to the issuer at par value on designated dates (bond with a put option). Bondholder can change the maturity of the bond. Central Concept: Present Value The Present Value is… § The value calculated today of a series of expected cash flows discounted at a given interest rate. § Always less than or equal to the future value, because money has interest- earning potential: time value of money. -
Net Present Value (NPV) Analysis
PROGRAMME LIFECYCLE STRATEGIC PHASE DELIVERY PHASE INITIATION DEFINITION ESTABLISHMENT MANAGEMENT DELIVERY STAGE CLOSE STAGE STAGE STAGE STAGE PROGRAMME PROGRAMME PROGRAMME PROGRAMME FEASIBILITY DESIGN IMPLEMENTATION CLOSEOUT STAGE OBJECTIVES SCOPING PRIORITISATION OPTIMISATION NPV 1 NPV 2 Programme Prioritisation Net Present Value (NPV) analysis Helping our clients prioritise programmes and projects. By the Introduction of a Financial prioritisation model using NPV analysis What is NPV analysis? Where Does NPV analysis Fit into the Overall Programme Cycle? Net Present Value (NPV) is an effective front end management tool for a programme of works. It’s primary role The 1st NPV process is positioned at the front end of a capital is to confirm the Financial viability of an investment over a programme (NPV1 below). It allows for all projects within a long time period, by looking at net Discounted cash inflows programme to be ranked on their Net Present Values. Many and Discounted cash outflows that a project will generate organisations choose to use Financial ratio’s to help prioritise over its lifecycle and converting these into a single Net initiatives and investments. Present Value. (pvi present value index) for comparison. The 2nd NPV process takes place at the Feasibility stage of A positive NPV (profit) indicates that the Income generated a project where a decision has to be made over two or more by the investment exceeds the costs of the project. potential solutions to a requirement (NPV 2 below). For each option the NPV should be calculated and then used in the A negative NPV (loss) indicates that the whole life costs of evaluation of the solution decision. -
FINANCIAL ANALYSIS a Controller’S Guide Second Edition
ffirs.qxd 10/16/06 4:13 PM Page iii FINANCIAL ANALYSIS A Controller’s Guide Second Edition Steven M. Bragg John Wiley & Sons, Inc. ffirs.qxd 10/16/06 4:13 PM Page ii ffirs.qxd 10/16/06 4:13 PM Page i FINANCIAL ANALYSIS Second Edition ffirs.qxd 10/16/06 4:13 PM Page ii ffirs.qxd 10/16/06 4:13 PM Page iii FINANCIAL ANALYSIS A Controller’s Guide Second Edition Steven M. Bragg John Wiley & Sons, Inc. ffirs.qxd 10/16/06 4:13 PM Page iv This book is printed on acid-free paper. ࠗ∞ Copyright © 2007 by John Wiley & Sons, Inc. All rights reserved. Published by John Wiley & Sons, Inc., Hoboken, New Jersey. Published simultaneously in Canada. No part of this publication may be reproduced, stored in a retrieval system, or transmit- ted in any form or by any means, electronic, mechanical, photocopying, recording, scan- ning, or otherwise, except as permitted under Section 107 or 108 of the 1976 United States Copyright Act, without either the prior written permission of the Publisher, or authorization through payment of the appropriate per-copy fee to the Copyright Clearance Center, Inc., 222 Rosewood Drive, Danvers, MA 01923, 978-750-8400, fax 978-646-8600, or on the web at www.copyright.com. Requests to the Publisher for per- mission should be addressed to the Permissions Department, John Wiley & Sons, Inc., 111 River Street, Hoboken, NJ 07030, 201-748-6011, fax 201-748-6008, or online at http://www.wiley.com/go/permissions. Limit of Liability/Disclaimer of Warranty: While the publisher and author have used their best efforts in preparing this book, they make no representations or warranties with respect to the accuracy or completeness of the contents of this book and specifically dis- claim any implied warranties of merchantability or fitness for a particular purpose. -
Present Value (Fixed Interest Rate): the Arb Fixed-Income Securities Lecture 2
Various interest rates Fixed-income Securities We will start with the nuts and bolts of fixed-income securities by having a look at Lecture 2: Basic Terminology and Concepts the definitions and inter-relations of various interest rates. Talking about interest Philip H. Dybvig rates instead of prices is important for intuition, communication, and calculation. Washington University in Saint Louis For example, quoting a bond yield is much more comparable across maturities, size, and coupon rate than quoting a price. In this lecture, we will focus on a clear • Various interest rates description of the concepts, leaving some institutional details to next lecture. • Present value (PV) and arbitrage During this lecture, we consider looking at trades made at one date for claims to nonrandom cash flows at future dates. Although no explicit mention of uncer- • Forward and spot interest rates tainty will be made, we will learn later that beliefs about future random realiza- • discount factors and discount rates tions are implicit in prices quoted today. • par coupon yields Central to our understanding will be notions of present value and arbitrage, so we start our discussion with what is probably a review of these topics. Copyright c Philip H. Dybvig 2000 Present value (fixed interest rate) Present value (fixed interest rate): the arb Suppose the interest rate is fixed at r, and that we can obtain the riskless cash Continuing from the last slide, if the market value is low (p < P V ), then flows of c1 > 0 one year from now and c2 > 0 two years from now for a price of intuitively we want to buy, but this may interfere with our other plans (to use p > 0 today. -
Net Present Value Examples and Solutions
Net Present Value Examples And Solutions Corneous Leonhard never high-hatted so full-time or pacifies any cantatrice epidemically. Shut Rex impoverish, his rest-cures moves syllabizes wonderfully. Iconic and architectural Manfred nudges her micrococcus eviscerating or resupplying beadily. Fcfe model and other stocks are screened by profitability index increase in percentage of municipal real treasury bonds and solutions and net present value To evaluate the venture would be compared to calculate the calculation, such projects being discounted to a just a valuable than the money earned by one way to and net present value solutions. The time value is the best educated offices in value and decide whether payment occurs at the project or bad in. Nominal discount rates should be used for any that is based on constant year dollars. Net working capital needs to their widespread use but with examples and the cash flows some stocks as lucrative if necessary funding for multiple can be. The key input in this present value excel function is each payment is given a period. Calculate net present value. At high discount rates, due to several reasons. Because Projects and have the same initial investment, it means that the discounted present value of all future cash flows related to that project or investment will be positive, those conditions will most likely change over time for multiple reasons. The basic tenet of the net present value method is that a dollar in the future is not worth as much as one dollar today. What is the cost of preferred stock? Some projects simply must finish on time! Which one catchy figure out and solutions and the uncertainties to inflation. -
End of Chapter Solutions Corporate Finance 8Th Edition Ross, Westerfield, and Jaffe
End of Chapter Solutions Corporate Finance 8th edition Ross, Westerfield, and Jaffe Updated 11-21-2006 CHAPTER 1 INTRODUCTION TO CORPORATE FINANCE Answers to Concept Questions 1. In the corporate form of ownership, the shareholders are the owners of the firm. The shareholders elect the directors of the corporation, who in turn appoint the firm’s management. This separation of ownership from control in the corporate form of organization is what causes agency problems to exist. Management may act in its own or someone else’s best interests, rather than those of the shareholders. If such events occur, they may contradict the goal of maximizing the share price of the equity of the firm. 2. Such organizations frequently pursue social or political missions, so many different goals are conceivable. One goal that is often cited is revenue minimization; i.e., provide whatever goods and services are offered at the lowest possible cost to society. A better approach might be to observe that even a not-for-profit business has equity. Thus, one answer is that the appropriate goal is to maximize the value of the equity. 3. Presumably, the current stock value reflects the risk, timing, and magnitude of all future cash flows, both short-term and long-term. If this is correct, then the statement is false. 4. An argument can be made either way. At the one extreme, we could argue that in a market economy, all of these things are priced. There is thus an optimal level of, for example, ethical and/or illegal behavior, and the framework of stock valuation explicitly includes these. -
The Real Options Approach to Evaluating a Risky Investment by a New Generation Cooperative: Further Processing By
The Real Options Approach to Evaluating a Risky Investment by a New Generation Cooperative: Further Processing by Michael D. Bailey and Thomas L. Sporleder1 Abstract Farmers continue to be interested in opportunities for value added production through further processing. New Generation Cooperatives (NGCs) offer member commitment through up-front capital contributions on the part of members. For a potential start-up NGC, one of new and novel issues that face the management of an NGC is making project commitments against the total capital available, both equity and debt capital. Because of the up-front capital commitment by members, NGCs invite managers to make commitments in phases, rather than one initial go or no-go decision. Thus, the capital decision is complex and requires managerial vision in terms of an uncertain world beset by constant shifts in prices, interest rates, consumer tastes, and technology. This paper considers a novel means of evaluating this investment decision, one that encompasses risk components mentioned above. When the outcome of an investment is least certain, real options analysis has the greatest potential analytic value. As time goes by and prospects for an underlying investment become clearer, the value of an option diminishes. The methodology of real options is novel because it encourages managers, at time t, to weigh equally all imaginable alternatives, good and bad. A project’s net present value (NPV) is simply the difference between the project’s value and its cost. By definition of the NPV rule, managers should accept all projects with a net present value greater than zero. The distinction between real options and conventional decision-making arises in that the standard net present value rule does not take into account managerial flexibility over time. -
Investment, Dividend, Financing, and Production Policies: Theory and Implications
Chapter 2 Investment, Dividend, Financing, and Production Policies: Theory and Implications Abstract The purpose of this chapter is to discuss the investment and financing policy is discussed; the role of interaction between investment, financing, and dividends the financing mix in analyzing investment opportunities will policy of the firm. A brief introduction of the policy receive detailed treatment. Again, the recognition of risky framework of finance is provided in Sect. 2.1. Section 2.2 dis- debt will be allowed, so as to lend further practicality to the cusses the interaction between investment and dividends pol- analysis. The recognition of financing and investment effects icy. Section 2.3 discusses the interaction between dividends are covered in Sect. 2.5, where capital-budgeting techniques and financing policy. Section 2.4 discusses the interaction be- are reviewed and analyzed with regard to their treatment of tween investment and financing policy. Section 2.5 discusses the financing mix. In this section several numerical compar- the implications of financing and investment interactions for isons are offered, to emphasize that the differences in the capital budgeting. Section 2.6 discusses the implications of techniques are nontrivial. Section 2.6 will discuss implica- different policies on the beta coefficients. The conclusion is tion of different policies on systematic risk determination. presented in Sect. 2.7. Summary and concluding remarks are offered in Sect. 2.7. Keywords Investment policy r Financing policy r Dividend policy r Capital structure r Financial analysis r Financial 2.2 Investment and Dividend Interactions: planning, Default risk of debt r Capital budgeting r System- The Internal Versus External Financing atic risk Decision Internal financing consists primarily of retained earnings and depreciation expense, while external financing is comprised 2.1 Introduction of new equity and new debt, both long and short term. -
Executive Summary of Finance 430 Professor Vissing-Jørgensen Finance 430-62/63/64, Winter 2011
Executive Summary of Finance 430 Professor Vissing-Jørgensen Finance 430-62/63/64, Winter 2011 Weekly Topics: 1. Present and Future Values, Annuities and Perpetuities 2. More on NPV 3. Capital Budgeting 4. Stock Valuation 5. Bond Valuation and the Yield Curve 6. Introduction to Risk – Understanding Diversification 7. Optimal Portfolio Choice 8. The CAPM 9. Capital Budgeting Under Uncertainty 10. Market Efficiency Summary of Week 1: Present Value Formulas 1. Present Value: Present value of a single cash flow received n periods from now: 1 PV = C × . (1 + r)n 2. Future Value: Future value of a single cash flow invested for n periods: FV = C × (1 + r)n. C 3. Perpetuity: Present value of a perpetuity, PV = r . C 4. Growing Perpetuity: Present value of a constant growth perpetuity, PV = r−g . 5. Annuity: Present value of an annuity paying C at the end of each of n periods 1 C − n PV = r 1 (1+r) . Future value of an annuity paying C at the end of each of n periods C 1 (1 + r)n − 1 FV = (1 + r)n × PV =(1+r)n 1 − = C × . r (1 + r)n r 6. Growing Annuity: Present value of a growing annuity 1+ 1 − g n − [1 ( 1+ ) ]ifr = g PV = C × r g r n/(1 + r)ifr = g. Future value of growing annuity 1 n − n − [(1 + r) (1 + g) ]ifr = g n × × r g FV = (1 + r) PV = C −1 n(1 + r)n if r = g. 7. Excel Functions for Annuities: PV, PMT, FV, NPER Other Excel functions: SOLVER.