Corporate Finance A2

1. Corporate Finance A2 Vysokáškolafinanční a správní Winter Semester 2012 Jaromír R. Stemberg jaromir@mail.vsfs.cz

2. Course Layout • Twelve two-hour lessons • The course is to introducegeneralfinancial management problems, realtions, terminology, and solutions • EndswithanExam (zkouška)

3. Literature • Block, Stanley: FoundationsofFinancial ManagementMcGraw-Hill, 2009ISBN 978-0-07-128525-4

4. Grading • Written test, oral exam

5. 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

6. History of Money and Accounting

7. Money • Barter trade • Cowry shells form 1200 B.C. in China till mid 20th century in Africa • Precious metal coins, banknotes • Development of banking • “Plastic money” of today

8. Development of Accounting • Babylon, 18th century B.C.- first organized records kept to account for assets and loans • Italy, 13th century A.D. - double-entry bookkeeping • 20th century A.D.- international accounting standards US GAAP and IAS/IFRS

9. Financial Reports and Analysis

10. Balance Sheet AssetsLiabilities Current Assets Current Liabilities Cash and Equivalents Short-Term Accounts Payable Short-Term ReceivablesCurrent Tax Payable Inventory Short-Term Loans and Borrowings Accruals and Other S/T Assets Accruals and Other S/T Liabilities Long-Term AssetsLong-Term Liabilities Intangible Fixed Assets Long-Term Payables • Tangible Fixed AssetsProvisions • Long-Term Receivables • Owners’ Equity Share Capital Share Premium and Capital Funds Retained Earnings Y-T-D Profit (Loss)

12. Cash FlowStatement

13. Ratios and Analyses • Profitability Ratios- profitmargin- return on assets (investments), return on equity • Asset Utilization Ratios- receivable, inventory, fixed, total assetsturnover- averagecollection period, days of sales outstanding • Liquidity Ratios- current ratio- quick ratio • Analyses- DuPont analysis- horizontal, vertical, trend

14. Du Pont Analysis

15. Forecast and Budget

16. 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

17. 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

18. Operational and Financial Leverage

19. Fixed and variableexpenses totalexpenses $ fixnedexpenses 0 No. ofunitsproduced

20. Fixed and variableexpenses totalexpenses $ fixnedexpenses No. ofunitsproduced

21. Break-Even Point revenue $ totalexpenses fixedexpenses No. ofunitsproduced

22. Break-Even Point revenue profit $ totalexpenses fixedexpenses No. ofunitsproduced

23. Break-Even Point revenue $ totalexpenses fixedexpenses No. ofunitsproduced

24. Operationalleverage • Usesfixed/variablecost • Canincreaseprofits but increases risk • _Fixedcosts _Price – Variablecost per unit

25. Operationalleverage • _ Fixedcosts _Price – Variablecost per unit • Fixedcost 60.000 Fixedcost 12.000Variablecost 0,80 / unitVariablecost1,60 / unitUnitprice 2,00Unit price 2,00 60.000/(2,00-0,80) = 50.00012.000/(2,00-1,60)= 30.000break-even point isbreak-evenpoint is50.000 units30.000 units

26. FinancialLeverage 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

27. FinancialLeverage

28. FinancialLeverage 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?

29. FinancialLeverage

30. FinancialLeverage 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?

31. FinancialLeverage 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.

32. Time Value of Money

38. Valuation and Rateof Return

39. Objectives Thevaluationof a financialassetisbased on thepresentvalueofthefuture cash flows Therequiredrateof return in valuinganassetisbased on the risk involved

40. Bonds Coupon / zero coupon bonds Valuation of bonds: present value of future cash inflows P = P .. bond price Y .. Yield Pn .principalpaymentat maturity • i .. interest (orexpected return) t .. numbercorresponding to a period n ..numberofperiods

41. Stock • Infinitestreamoflevel dividend payments • Constantgrowth in dividends • D .. dividend payment • r .. requiredrateof return • g ..dividend growth

42. CostofCapital

43. CostofCapital Weightedaverageof: • costofdebt (loans, bonds) • costofequity (commonstock, preferredstock)

44. CostofDebt Interestpayment minus tax Kd = i (1 – t) Kd.... Costofdebt i .... Interestpaid t .... corporate tax rate

45. CostofEquity Dividend devided by market price Ke = D / P0 Ke .... costofequity D .... current dividend P0 .... market priceofthestock • Ifdividendsconstantlygrow, then • Ke= (D / P0) + g g .... constantgrowthrate in dividends Sellingcosts are to bedeductedfrompricefornewlyissuedstock