Financial Markets and Net Present Value.ppt

1、,Corporate Finance Ross Westerfield Jaffe,Sixth Edition,Chapter Outline,3.1 The Financial Market Economy 3.2 Making Consumption Choices Over Time 3.3 The Competitive Market 3.4 The Basic Principle 3.5 Practicing the Principle 3.6 Illustrating the Investment Decision 3.7 Corporate Investment Decision

2、Making 3.8 Summary and Conclusions,3.1 The Financial Market Economy,Individuals and institutions have different income streams and different intertemporal consumption preferences. Because of this, a market has arisen for money. The price of money is the interest rate.,The Financial Market Economy: E

3、xample,Consider a dentist who earns $200,000 per year and chooses to consume $80,000 per year. He has $120,000 in surplus money to invest. He could loan $30,000 to each of 4 college seniors. They each promise to pay him back with interest after they graduate in one year.,Dentist,Student #1,Student #

4、2,Student #3,Student #4,$30,000,$30,000,$30,000,$30,000,$30,000(1+r),$30,000(1+r),$30,000(1+r),$30,000(1+r),The Financial Market Economy: Example,Rather than performing the credit analysis 4 times, he could loan the whole $120,000 to a financial intermediary in return for a promise to repay the $120

5、,000 in one year with interest. The intermediary in turn loans $30,000 to each of the 4 college seniors.,Student #1,Student #2,Student #3,Student #4,$30,000,$30,000,$30,000,Bank,$120,000,Dentist,$30,000,$30,000(1+r),$30,000(1+r),$30,000(1+r),$30,000(1+r),$120,000(1+r),The Financial Market Economy: E

6、xample,Financial intermediation can take three forms: Size intermediation In the example above, the bank took a large loan from the dentist and made small loans to the students. Term intermediation Commercial banks finance long-term mortgages with short-term deposits. Risk intermediation Financial i

7、ntermediaries can tailor the risk characteristics of securities for borrowers and lenders with different degrees of risk tolerance.,Market Clearing,The job of balancing the supply of and demand for loanable funds is taken by the money market. When the quantity supplied equals the quantity demanded,

8、the market is in equilibrium at the equilibrium price. The price of money is the interest rate.,3.2 Making Consumption Choices over Time,An individual can alter his consumption across time periods through borrowing and lending. We can illustrate this by graphing consumption today versus consumption

9、in the future. This graph will show intertemporal consumption opportunities.,Intertemporal Consumption Opportunity Set,A person with $95,000 who faces a 10% interest rate has the following opportunity set.,One choice available is to consume $40,000 now; invest the remaining $55,000; consume $60,000

10、next year.,Intertemporal Consumption Opportunity Set,$0,$20,000,$40,000,$60,000,$80,000,$100,000,$120,000,$0,$20,000,$40,000,$60,000,$80,000,$100,000,$120,000,Consumption today,Consumption at t+1,Another choice available is to consume $60,000 now; invest the remaining $35,000; consume $38,500 next y

11、ear.,Taking Advantage of Our Opportunities,$0,$20,000,$40,000,$60,000,$80,000,$100,000,$120,000,$0,$20,000,$40,000,$60,000,$80,000,$100,000,$120,000,Consumption today,Consumption at t+1,A persons preferences will tend to decide where on the opportunity set they will choose to be.,Changing Our Opport

12、unities,$0,$20,000,$40,000,$60,000,$80,000,$100,000,$120,000,$0,$20,000,$40,000,$60,000,$80,000,$100,000,$120,000,Consumption today,Consumption at t+1,A rise in interest rates will make saving more attractive ,and borrowing less attractive.,Consider an investor who has chosen to consume $40,000 now

13、and to consume $60,000 next year.,3.3 The Competitive Market,In a competitive market: Trading is costless. Information about borrowing and lending is available There are many traders; no individual can move market prices. There can be only one equilibrium interest rate in a competitive marketotherwi

14、se arbitrage opportunities would arise.,3.4 The Basic Principle,The basic financial principle of investment decision making is this: An investment must be at least as desirable as the opportunities available in the financial markets.,3.5 Practicing the Principle: A Lending Example,Consider an invest

15、ment opportunity that costs $50,000 this year an provides a certain cash flow of $54,000 next year.,Is this a good deal? It depends on the interest rate available in the financial markets. The investment has an 8% return, if the interest rate available elsewhere is less than this, invest here.,3.6 I

16、llustrating the Investment Decision,Consider an investor who has an initial endowment of income of $40,000 this year and $55,000 next year. Suppose that he faces a 10-percent interest rate and is offered the following investment.,3.6 Illustrating the Investment Decision,$0,Consumption today,Our inve

17、stor begins with the following opportunity set: endowment of $40,000 today, $55,000 next year and a 10% interest rate.,One choice available is to consume $15,000 now; invest the remaining $25,000 in the financial markets at 10%; consume $82,500 next year.,$0,$99,000,Consumption at t+1,$90,000,3.6 Il

18、lustrating the Investment Decision,$0,Consumption today,A better alternative would be to invest in the project instead of the financial markets.,He could consume $15,000 now; invest the remaining $25,000 in the project at 20%; consume $85,000 next year.,$0,$99,000,Consumption at t+1,$90,000,3.6 Illu

19、strating the Investment Decision,$0,Consumption today,Note that we are better off in that we can command more consumption today or next year.,$0,$99,000,Consumption at t+1,$101,500,$101,500 = $15,000(1.10) + $85,000,$92,273 = $15,000 + $85,000(1.10),$90,000,$92,273,Net Present Value,We can calculate

20、 how much better off in todays dollar the investment makes us by calculating the Net Present Value:.,3.7 Corporate Investment DecisionMaking,Shareholders will be united in their preference for the firm to undertake positive net present value decisions, regardless of their personal intertemporal cons

21、umption preferences.,Corporate Investment DecisionMaking,Consumption today,Consumption at t+1,Positive NPV projects shift the shareholders opportunity set out, which is unambiguously good.,All shareholders agree on their preference for positive NPV projects, whether they are borrowers or lenders.,3.

22、7 Corporate Investment DecisionMaking,In reality, shareholders do not vote on every investment decision faced by a firm and the managers of firms need decision rules to operate by. All shareholders of a firm will be made better off if managers follow the NPV ruleundertake positive NPV projects and r

23、eject negative NPV projects.,The Separation Theorem,The separation theorem in financial markets says that all investors will want to accept or reject the same investment projects by using the NPV rule, regardless of their personal preferences. Logistically, separating investment decision making from

24、 the shareholders is a basic requirement of the modern corporation.,3.8 Summary and Conclusions,Financial markets exist because people want to adjust their consumption over time. They do this by borrowing or lending. An investment should be rejected if a superior alternative exists in the financial

25、markets. If no superior alternative exists in the financial markets, an investment has a positive net present value.,Corporate Finance Ross Westerfield Jaffe,Sixth Edition,Chapter Outline,4.1 The One-Period Case 4.2 The Multiperiod Case 4.3 Compounding Periods 4.4 Simplifications 4.5 What Is a Firm

26、Worth? 4.6 Summary and Conclusions,4.1 The One-Period Case: Future Value,If you were to invest $10,000 at 5-percent interest for one year, your investment would grow to $10,500 $500 would be interest ($10,000 .05) $10,000 is the principal repayment ($10,000 1) $10,500 is the total due. It can be cal

27、culated as: $10,500 = $10,000(1.05). The total amount due at the end of the investment is call the Future Value (FV).,Corporate Finance Ross Westerfield Jaffe,Sixth Edition,Executive Summary,This chapter discusses financial distress, private workouts, and bankruptcy. A firm that defaults on a requir

28、ed payment may be forced to liquidate its assets. More often, a defaulting firm will reorganize. Financial restructuring involves replacing old financial claims with new ones and takes place with private workouts or legal bankruptcy.,Chapter Outline,31.1 What is Financial Distress? 31.2 What Happens

29、 in Financial Distress? 31.3 Bankruptcy Liquidation and Reorganization 31.4 Private Workout or Bankruptcy: Which is Best? 31.5 Prepackaged Bankruptcy 31.6 Summary and Conclusions,31.1 What is Financial Distress?,A situation where a firms operating cash flows are not sufficient to satisfy current obl

30、igations and the firm is forced to take corrective action. Financial distress may lead a firm to default on a contract, and it may involve financial restructuring between the firm, its creditors, and its equity investors.,Insolvency,Stock-base insolvency; the value of the firms assets is less than t

31、he value of the debt.,Debt,Insolvency,Flow-base insolvency occurs when the firms cash flows are insufficient to cover contractually required payments.,Firm cash flow,The Largest U.S. Bankruptcies,31.2 What Happens in Financial Distress?,Financial distress does not usually result in the firms death.

32、Firms deal with distress by Selling major assets. Merging with another firm. Reducing capital spending and research and development. Issuing new securities. Negotiating with banks and other creditors. Exchanging debt for equity. Filing for bankruptcy.,What Happens in Financial Distress,Financialdist

33、ress,Source: Karen H. Wruck, “Financial Distress: Reorganization and Organizational Efficiency,” Journal of Financial Economics27 (1990), Figure 2. See also Stuart C. Gilson; Kose John, and Larry N.P. Lang, “Troubled Debt Restructurings: An EmpiricalStudy of Private Reorganization in Firms in Defaul

34、ts,” Journal of Financial Economics 27 (1990); and Lawrence A. Weiss,“Bankruptcy Resolution: Direct Costs and Violation of Priority Claims,” Journal of Financial Economics 27 (1990).,Responses to Financial Distress,Think of the two sides of the balance sheet. Asset Restructuring: Selling major asset

35、s. Merging with another firm. Reducing capital spending and R&D spending. Financial Restructuring: Issuing new securities. Negotiating with banks and other creditors. Exchanging debt for equity. Filing for bankruptcy.,31.3 Bankruptcy Liquidation and Reorganization,Firms that cannot meet their obliga

36、tions have two choices: liquidation or reorganization. Liquidation (Chapter 7) means termination of the firm as a going concern. It involves selling the assets of the firm for salvage value. The proceeds, net of transactions costs, are distributed to creditors in order of priority. Reorganization (C

37、hapter 11) is the option of keeping the firm a going concern. Reorganization sometimes involves issuing new securities to replace old ones.,Bankruptcy Liquidation,Straight liquidation under Chapter 7 usually involves: A petition is filed in a federal court. The debtor firm could file a voluntary pet

38、ition or the creditors could file an involuntary petition against the firm. A trustee-in-bankruptcy is elected by the creditors to take over the assets of the debtor firm. The trustee will attempt to liquidate the firms assets. After the assets are sold, after payment of the costs of administration,

39、 money is distributed to the creditors. If any money is left over, the shareholders get it.,Bankruptcy Liquidation: Priority of Claims,The distribution of the proceeds of liquidation occurs according to the following priority: Administration expenses associated with liquidation. Unsecured claims ari

40、sing after the filing of an involuntary bankruptcy petition. Wages earned within 90 days before the filing date, not to exceed $2,000 per claimant. Contributions to employee benefit plans arising with 180 days before the filing date. Consumer claims, not exceeding $900. Tax claims. Secured and unsecured creditors claims. Preferred stockholders claims. Common stockholders claims.,APR Example,Suppose the B.O. Drug Co. decides to liquidate under Chapter 7. Assume that the liquidation value is $2.7 million. Bonds worth $1.5 million are secured by a mortgage on the corporate