corporate financial theory 1 公司财务理论

Corporate Financial Theory,IntroductionClass ReviewTestsHomeworkSyllabusWeb sites & SupplementsGoal of Finance,Corporate Financial Theory,Goal of FinanceMaximize the value of the firm,Time Value of Money,Q: Which is greater? $100 today or $110 next year,Time Value of Money,Q: Which is greater? $100 today or $110 next yearA: It Depends on Inflation.,Time Value of Money,Q: Which is greater? $100 today or $110 next yearA: It Depends on Inflation.Ex.Bike Cost (today) = B0 = $100Bike Cost (next year) = B1 = $110,Time Value of Money,Q: Which is greater? $100 today or $110 next yearA: It Depends on Inflation.Ex.Bike Cost (today) = B0 = $100Bike Cost (next year) = B1 = $110 B0 = B1 $100 (today) = $110 (next year),Time Value of Money,Q: Which is greater? $100 today or $110 next yearA: It Depends on Inflation.Ex.Bike Cost (today) = B0 = $100Bike Cost (next year) = B1 = $110 B0 = B1 $100 (today) = $110 (next year) 100= 110/(1+.10),Time Value of Money,PV0 = C1 1 + rEx.Bike Cost (today) = B0 = $100Bike Cost (next year) = B1 = $110 B0 = B1 $100 (today) = $110 (next year) 100= 110/(1+.10),Time Value of Money,PV0 = C1 1 + rModified formula for unknown time frame: PV0 = Ct(1+r)t,Net Present Value,ExampleQ:Suppose we can invest $50 today & receive $60 later today. What is our profit?,Net Present Value,ExampleQ:Suppose we can invest $50 today & receive $60 later today. What is our profit?A: Profit = - $50 + $60 = $10,Net Present Value,ExampleQ: Suppose we can invest $50 today and receive $60 in one year. What is our profit? (assume 10% inflation),Net Present Value,ExampleQ: Suppose we can invest $50 today and receive $60 in one year. What is our profit? (assume 10% inflation)A: Profit = -50 + 60 = - 50 + 54.55 = $4.55 1 + .10This is the definition of NPV,Net Present Value,NPV = C0 + Ct (1 + r)t,Net Present Value,NPV = C0 + Ct (1 + r)tFor multiple periods we have the Discounted Cash Flow (DCF) formulaNPV0 = C0 + C1 + C2 + . (1+r) (1+r)2,Net Present Value,TerminologyC = Cash Flowt = time periodr = “discount rate” or “cost of capital”,Net Present Value,TerminologyC = Cash Flowt = time periodr = “discount rate” or “cost of capital”NotesC is not an accounting number r is not inflationr is the cost at which you can raise capital. The cost depends on the risk.,Risk and Present Value,ExampleQ:If you can invest $50 today and get $60 in return one year from now. What is your profit? (assume you can borrow money at 12%),Risk and Present Value,ExampleQ:If you can invest $50 today and get $60 in return one year from now. What is your profit? (assume you can borrow money at 12%)A: NPV = C0 + Ct (1 + r)t NPV = - 50 + 60 = 3.57 (1 + .12)1,Valuing an Office Building,Step 1: Forecast cash flowsCost of building = C0 = 350Sale price in Year 1 = C1 = 400Step 2: Estimate opportunity cost of capitalIf equally risky investments in the capital marketoffer a return of 7%, thenCost of capital = r = 7%,Valuing an Office Building,Step 3: Discount future cash flowsStep 4: Go ahead if PV of payoff exceeds investment,Risk and Present Value,Higher risk projects require a higher rate of returnHigher required rates of return cause lower PVs,Risk and Present Value,Decision Time,Rate of Return Rule,Accept investments that offer rates of return in excess of their opportunity cost of capital,Rate of Return Rule,Accept investments that offer rates of return in excess of their opportunity cost of capital,ExampleIn the project listed below, the foregone investment opportunity is 12%. Should we do the project?,Net Present Value Rule,Accept investments that have positive net present value,Net Present Value Rule,Accept investments that have positive net present value,ExampleSuppose we can invest $50 today and receive $60 in one year. Should we accept the project given a 10% expected return?,Short Cuts,Perpetuity PV = C r,Short Cuts,Perpetuity PV = C rConstant Growth Perpetuity PV = C r - g,Short Cuts,Perpetuity PV = C rConstant Growth Perpetuity PV = C r - gAnnuity PV = C ,1 1r r(1+r)t,_,Application of PV, NPV, DCF,Value bondsValue stocksValue projectsValue companies (M&A)Value Capital Structure (debt vs. equity),Opportunity Cost of Capital,How much “return” do you EXPECT to earn on your money?,Opportunity Cost of Capital,ExampleThe company may invest $100,000 today. Depending on the state of the economy, they may get one of three possible cash payoffs:,Opportunity Cost of Capital,Example - continuedThe stock is trading for $95.65. Depending on the state of the economy, the value of the stock at the end of the year is one of three possibilities:,Opportunity Cost of Capital,Example - continuedThe stocks expected payoff leads to an expected return.,Opportunity Cost of Capital,Example - continuedDiscounting the expected payoff at the expected return leads to the PV of the project,Internal Rate of Return,IRR is related to Opportunity Cost of CapitalPay Attention to Math,Internal Rate of Return,ExampleYou can purchase a turbo powered machine tool gadget for $4,000. The investment will generate $2,000 and $4,000 in cash flows for two years, respectively. What is the IRR on this investment?,Internal Rate of Return,Example You can purchase a turbo powered machine tool gadget for $4,000. The investment will generate $2,000 and $4,000 in cash flows for two years, respectively. What is the IRR on this investment?,Internal Rate of Return,Example You can purchase a turbo powered machine tool gadget for $4,000. The investment will generate $2,000 and $4,000 in cash flows for two years, respectively. What is the IRR on this investment?,Internal Rate of Return,IRR=28%,Internal Rate of Return,Pitfall 1 - Lending or Borrowing?With some cash flows (as noted below) the NPV of the project increases s the discount rate increases. This is contrary to the normal relationship between NPV and discount rates.,Internal Rate of Return,Pitfall 1 - Lending or Borrowing?With some cash flows (as noted below) the NPV of the project increases s the discount rate increases. This is contrary to the normal relationship between NPV and discount rates.,Discount Rate,NPV,Internal Rate of Return,Pitfall 2 - Multiple Rates of ReturnCertain cash flows can generate NPV=0 at two different discount rates.The following cash flow generates NPV=0 at both (-50%) and 15.2%.,Internal Rate of Return,Pitfall 2 - Multiple Rates of ReturnCertain cash flows can generate NPV=0 at two different discount rates.The following cash flow generates NPV=0 at both (-50%) and 15.2%.,1000,NPV,500,0,-500,-1000,Discount Rate,IRR=15.2%,IRR=-50%,Internal Rate of Return,Pitfall 3 - Mutually Exclusive ProjectsIRR sometimes ignores the magnitude of the project.The following two projects illustrate that problem.,Internal Rate of Return,Pitfall 4 - Term Structure AssumptionWe assume that discount rates are stable during the term of the project. This assumption implies that all funds are reinvested at the IRR. This is a false assumption.,Internal Rate of Return,Calculating the IRR can be a laborious task. Fortunately, financial calculators can perform this function easily. Note the previous example.,Application of PV, NPV, DCF,Value bondsValue stocksValue projects (Capital Budgeting)Value companies (M&A)Value Capital Structure (debt vs. equity),Valuing a Bond,ExampleIf today is October 2001, what is the value of the following bond?An IBM Bond pays $115 every Sept for 5 years. In Sept 2006 it pays an additional $1000 and retires the bond.The bond is rated AAA (WSJ AAA YTM is 7.5%)Cash FlowsSept 02030405061151151151151115,Valuing a Bond,Example continuedIf today is October 2001, what is the value of the following bond?An IBM Bond pays $115 every Sept for 5 years. In Sept 2006 it pays an additional $1000 and retires the bond.The bond is rated AAA (WSJ AAA YTM is 7.5%),Bond Prices and Yields,Yield,Price,Valuing Common Stock,Intrinsic Value Formula,Assume all earnings are distributed as div.PS = Div1 +Div2 + Div3 + Div4 / r-g 1+r(1+r)2(1+r)3 (1+r)3 If firms dont pay div, then we should replace Div with EPS (cash basis) in the formulaPS = *EPS1 r - g,Valuing Common Stocks,Dividend Discount Model - Computation of todays stock price which states that share value equals the present value of all expected future dividends.H - Time horizon for your investment.,Valuing Common Stocks,ExampleCurrent forecasts are for XYZ Company to pay dividends of $3, $3.24, and $3.50 over the next three years, respectively. At the end of three years you anticipate selling your stock at a market price of $94.48. What is the price of the stock given a 12% expected return?,Valuing Common Stocks,ExampleCurrent forecasts are for XYZ Company to pay dividends of $3, $3.24, and $3.50 over the next three years, respectively. At the end of three years you anticipate selling your stock at a market price of $94.48. What is the price of the stock given a 12% expected return?,Valuing Common Stocks,If we forecast no growth, and plan to hold out stock indefinitely, we will then value the stock as a PERPETUITY.,Valuing Common Stocks,If we forecast no growth, and plan to hold out stock indefinitely, we will then value the stock as a PERPETUITY.,Assumes all earnings are paid to shareholders.,Valuing Common Stocks,Constant Growth DDM - A version of the dividend growth model in which dividends grow at a constant rate (Gordon Growth Model).,Valuing Common Stocks,Example- continuedIf the same stock is selling for $100 in the stock market, what might the market be assuming about the growth in dividends?,AnswerThe market is assuming the dividend will grow at 9% per year, indefinitely.,Valuing Common Stocks,If a firm elects to pay a lower dividend, and reinvest the funds, the stock price may increase because future dividends may be higher.Payout Ratio - Fraction of earnings paid out as dividendsPlowback Ratio - Fraction of earnings retained by the firm.,Valuing Common Stocks,Growth can be derived from applying the return on equity to the percentage of earnings plowed back into operations.g = return on equity X plowback ratio,Valuing Common Stocks,ExampleOur company forecasts to pay a $5.00 dividend next year, which represents 100% of its earnings. This will provide investors with a 12% expected return. Instead, we decide to plow back 40% of the earnings at the firms current return on equity of 20%. What is the value of the stock before and after the plowback decision?,Valuing Common Stocks,ExampleOur company forecasts to pay a $5.00 dividend next year, which represents 100% of its earnings. This will provide investors with a 12% expected return. Instead, we decide to blow back 40% of the earnings at the firms current return on equity of 20%. What is the value of the stock before and after the plowback decision?,No Growth,With Growth,Valuing Common Stocks,ExampleOur company forecasts to pay a $5.00 dividend next year, which represents 100% of its earnings. This will provide investors with a 12% expected return. Instead, we decide to blow back 40% of the earnings at the firms current return on equity of 20%. What is the value of the stock before and after the plowback decision?,No Growth,With Growth,Valuing Common Stocks,Example - continuedIf the company did not plowback some earnings, the stock price would remain at $41.67. With the plowback, the price rose to $75.00. The difference between these two numbers (75.00-41.67=33.33) is called the Present Value of Growth Opportunities (PVGO).,Valuing Common Stocks,Present Value of Growth Opportunities (PVGO) - Net present value of a firms future investments.Sustainable Growth Rate - Steady rate at which a firm can grow: plowback ratio X return on equity.,* FCF and PV *,Free Cash Flows (FCF) should be the theoretical basis for all PV calculations.FCF is a more accurate measurement of PV than either Div or EPS.The market price does not always reflect the PV of FCF.When valuing a business for purchase, always use FCF.,Capital Budgeting,Valuing a Business or ProjectThe value of a business or Project is usually computed as the discounted value of FCF out to a valuation horizon (H).The valuation horizon is sometimes called the terminal value and is calculated like PVGO.,Capital Budgeting,Valuing a Business or Project,PV (free cash flows),PV (horizon value),Capital Budgeting,ExampleGiven the cash flows for Concatenator Manufacturing Division, calculate the PV of near term cash flows, PV (horizon value), and the total value of the firm. r=10% and g= 6%,Capital Budgeting,Example - continuedGiven the cash flows for Concatenator Manufacturing Division, calculate the PV of near term cash flows, PV (horizon value), and the total value of the firm. r=10% and g= 6%.,Capital Budgeting,Example - continuedGiven the cash flows for Concatenator Manufacturing Division, calculate the PV of near term cash flows, PV (horizon value), and the total value of the firm. r=10% and g= 6%.,Alternatives to NPV,Payback MethodAverage Return on Book ValueInternal Rate of Return,Capital Budgeting Rules,Valuing a project = capital budgeting4 Rules of Capital Budgeting1 - Consider all cash flows2 - Discount all CF at opportunity cost of capital3 - Select project that maximizes shareholder wealth4 - Must consider progects independent of each other = “Additivity Principle” NPV is used to evaluate projects because its satisfies all rules,Capital Budgeting Rules,Only Cash Flow is Relevant,Capital Budgeting Rules,Only Cash Flow is Relevant,Capital Budgeting Rules,Do not confuse average with incremental payoffInclude all incidental effectsDo not forget working capital requirementsForget sunk costsInclude opportunity costsBeware of allocated overhead costs,Points to “Watch Out For”,Be consistent in how you handle inflation!Use nominal interest rates to discount nominal cash flows.Use real interest rates to discount real cash flows.You will get the same results, whether you use nominal or real figures,Capital Budgeting Rules,INFLATION RULE,Problems with CB & NPV,1 Determine relevant cash flows2 - Cash flows not guaranteed3 - Projects with different livesTimingEquivalent annual annuity (cost)Profitability Index Linear Programming,Equivalent Annuities,Proj01234NPVEq. Ann.A-154.95.25.96.2 B-208.18.710.4 assume 9% discount rate,Equivalent Annuities,Proj01234NPVEq. Ann.A-154.95.25.96.2 2.82 B-208.18.710.4 2.78assume 9% discount rate,Equivalent Annuities,Proj01234NPVEq. Ann.A-154.95.25.96.22.82 .87B-208.18.710.42.781.10assume 9% discount rate,Profitability Index,When resources are limited, the profitability index (PI) provides a tool for selecting among various project combinations and alternativesA set of limited resources and projects can yield various combinations.The highest weighted average PI can indicate which projects to select.,Profitability Index,ExampleWe only have $300,000 to invest. Which do we select?ProjNPV InvestmentPIA230,000200,0001.15B141,250125,0001.13C194,250175,0001.11D162,000150,0001.08,Profitability Index,Example - continuedProjNPV InvestmentPIA230,000200,0001.15B141,250125,0001.13C194,250175,0001.11D162,000150,0001.08Select projects with highest Weighted Avg PIWAPI (BD) = 1.13(125) + 1.08(150) + 1.0 (25) (300) (300) (300) = 1.09,Profitability Index,Example - continuedProjNPV InvestmentPIA230,000200,0001.15B141,2501