corporate finance in a nutshell 2010
TRANSCRIPT
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Corporate Finance in a NutshellCorporate Finance in a Nutshell
Corporate Finance
in a Nutshell
Daniel Smith – June 7th, 2010
in a Nutshell
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Corporate Finance in a NutshellCorporate Finance in a Nutshell
1
How to get
money
Firm
Investor
Financial
MarketsBonds
Stocks
How to
spend
Goods
Markets
4
5
910
11
12
Daniel Smith – June 7th, 2010
Toolkit
NPV Risk
Definition
Shortcuts
Extensions
<-> other methods
IRR, Payback, etc
Variance
Covariance
Beta
1
Owner Manager
2
36
7
8
13
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Corporate Finance in a NutshellCorporate Finance in a Nutshell
How to get
money
Firm
Investor
Financial
MarketsBonds
Stocks
How to
spend
Goods
Markets
Daniel Smith – June 7th, 2010
Toolkit
NPV Risk
Definition
Shortcuts
Extensions
<-> other methods
IRR, Payback, etc
Variance
Covariance
Beta
Owner Manager
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Corporate Finance in a NutshellCorporate Finance in a Nutshell
The Need for a Firm
Money Talent
The Firm
1
Daniel Smith – June 7th, 2010
• Legally distinct – pays its own taxes
• Limited Liability
4
Principal-Agent-Conflict
Investors Managers
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Corporate Finance in a NutshellCorporate Finance in a Nutshell
The Managers Decisions
How to pay
for it
Investment
Decision
1
Daniel Smith – June 7th, 20105
What to
buy
for it
The Firm
Financing
Decision
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Corporate Finance in a NutshellCorporate Finance in a Nutshell
How to get
money
Firm
Investor
Financial
MarketsBonds
Stocks
How to
spend
Goods
Markets
Daniel Smith – June 7th, 2010
Toolkit
NPV Risk
Definition
Shortcuts
Extensions
<-> other methods
IRR, Payback, etc
Variance
Covariance
Beta
Owner Manager
![Page 7: Corporate Finance in a Nutshell 2010](https://reader034.vdocuments.mx/reader034/viewer/2022051820/5527d36755034622368b4936/html5/thumbnails/7.jpg)
Corporate Finance in a NutshellCorporate Finance in a Nutshell
The Concept of Present Value
Assume we can lend or borrow at 10%
100 € 110 € 121 € 133,10 €
x 1,1x 1,1 x 1,1x 1,1 x 1,1x 1,1
2
Daniel Smith – June 7th, 20107
t=0 t=1 t=2 t=3
100 € 110 € 121 € 133,10 €
/ 1,1/ 1,1 / 1,1/ 1,1 / 1,1/ 1,1
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Corporate Finance in a NutshellCorporate Finance in a Nutshell
The Concept of Present Value
Assume we can lend or borrow at 10%
100 € 110 € 121 € 133,10 €
/ 1,10/ 1,10 / 1,11/ 1,11 / 1,12/ 1,12 / 1,13/ 1,13
2
Daniel Smith – June 7th, 20108
t=0 t=1 t=2 t=3
100 € 100 € 100 € 100 €= = = =
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Corporate Finance in a NutshellCorporate Finance in a Nutshell
The Concept of Present Value
Assume we can lend or borrow at 10%
97,67€ 107,44 € 118,18 €
/ 1,1/ 1,1
2
Daniel Smith – June 7th, 20109
t=0 t=1 t=2 t=3
-100 €
/ 1,1/ 1,1 / 1,1/ 1,1
130 €
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Corporate Finance in a NutshellCorporate Finance in a Nutshell
• Net Present Value Rule:
The Concept of Present Value
Cash Flow at time i
2
Daniel Smith – June 7th, 201010
• NPV > 0: accept
• NPV < 0: reject
Opportunity rate of return
from 0 to i
Depends on:
Risk and time of alternative
investments
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Corporate Finance in a NutshellCorporate Finance in a Nutshell
Why is NPV ideal for everyone?
Assume we can lend or borrow at 10%
109,09€ / 1,1/ 1,1
2
Daniel Smith – June 7th, 201011
t=0t=1
-100 € 120 €
NPV =
9,09€
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Corporate Finance in a NutshellCorporate Finance in a Nutshell
consume
Why is NPV ideal for everyone?
Assume we can lend or borrow at 10%
Want to consume now:
Pay Back
120€
x 1,1x 1,1Borrow
109,09€
2
Daniel Smith – June 7th, 2010
consume
12
t=0 t=1
-100 € 120 €NPV =
9,09€
9,09 €
invest
120€109,09€
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Corporate Finance in a NutshellCorporate Finance in a Nutshell
Why is NPV ideal for everyone?
Assume we can lend or borrow at 10%
Want to consume later:
Pay Back
110€
x 1,1x 1,1Borrow
100€
2
Daniel Smith – June 7th, 2010
consume
13
t=0 t=1
-100 €NPV =
9,09€
10 €invest
110€100€
120 €
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Corporate Finance in a NutshellCorporate Finance in a Nutshell
How to get
money
Firm
Investor
Financial
MarketsBonds
Stocks
How to
spend
Goods
Markets
Daniel Smith – June 7th, 2010
Toolkit
NPV Risk
Definition
Shortcuts
Extensions
<-> other methods
IRR, Payback, etc
Variance
Covariance
Beta
Owner Manager
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Corporate Finance in a NutshellCorporate Finance in a Nutshell
Shortcuts for calculating NPV
C C C C C C ...C
3
Daniel Smith – June 7th, 201015
t=0 t=1 t=2 t=3 t=4 t=5 t=6 ...
C C C C C C ...
Perpetuity
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Corporate Finance in a NutshellCorporate Finance in a Nutshell
Shortcuts for calculating NPV
C C C C C C ...
C C ...
3
Daniel Smith – June 7th, 201016
t=0 t=1 t=2 t=3 t=4 t=5 t=6 ...
C C C C
C C C C C C ...
Annuity
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Corporate Finance in a NutshellCorporate Finance in a Nutshell
Shortcuts for calculating NPV
C C(1+g) C(1+g)2 C(1+g)3
3
Daniel Smith – June 7th, 201017
t=0 t=1 t=2 t=3 t=4 t=5 t=6 ...
C C(1+g) ...
Growing
Perpetuity
C(1+g)2 C(1+g)3 C(1+g)4 C(1+g)5
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Corporate Finance in a NutshellCorporate Finance in a Nutshell
How to get
money
Firm
Investor
Financial
MarketsBonds
Stocks
How to
spend
Goods
Markets
Daniel Smith – June 7th, 2010
Toolkit
NPV Risk
Definition
Shortcuts
Extensions
<-> other methods
IRR, Payback, etc
Variance
Covariance
Beta
Owner Manager
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Corporate Finance in a NutshellCorporate Finance in a Nutshell
The Managers Decisions
Investment
DecisionBonds
Stocks
How to pay
for it
4
Daniel Smith – June 7th, 201019
What to
buy
The Firm
Financing
Decision
for it
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Corporate Finance in a NutshellCorporate Finance in a Nutshell
Ways of Financing
Bonds Stocks
• Fixed payout• No fixed payout
Debt Equity
4
Daniel Smith – June 7th, 201020
• Fixed payout
• Fixed running time
• Payout guaranteed (save for bankruptcy)
• No control involved
• No residual claim
• No fixed payout
• Runs indefinitely
• No guarantees
• Shared control
• Residual claim
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Corporate Finance in a NutshellCorporate Finance in a Nutshell
Ways of Financing
The Firm
Debt
4
Daniel Smith – June 7th, 201021
Equity
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Corporate Finance in a NutshellCorporate Finance in a Nutshell
Valuing Bonds
5 year
4% couponReturn on equivalent
investment: 5%
3,80 3,63 3,46 81,493,29
4
Daniel Smith – June 7th, 201022
2011 2012 2013 2014 2015
4 4 4 44
100Bond Price = 95,67
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Corporate Finance in a NutshellCorporate Finance in a Nutshell
Valuing Bonds
Bond Characteristics
• Coupons
Return on equivalent investment
4
Daniel Smith – June 7th, 201023
• Coupons
•Maturity Bond Price
Yield to maturity
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Corporate Finance in a NutshellCorporate Finance in a Nutshell
Valuing Bonds – The Term Structure
2011 2012 2013 2014 2015
1/
1+r1
1/
(1+r2)2
1/
(1+r3)3
1/
(1+r4)4
1/
(1+r5)5
2010
4
Daniel Smith – June 7th, 201024
2011 2012 2013 2014 20152010
r1
r2
r3
r4
r5
Spot
Rates
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Corporate Finance in a NutshellCorporate Finance in a Nutshell
Valuing Bonds – The Term Structure
2011 2012 2013 2014 20152010
Forward
Rates(1+r4)4/(1+r1)
(1+r5)5/(1+r3)3
4
Daniel Smith – June 7th, 201025
2011 2012 2013 2014 20152010
r1
r2
r3
r4
r5
Spot
Rates
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Corporate Finance in a NutshellCorporate Finance in a Nutshell
Valuing Stocks
Return on equivalent
investment: 10%
2,85 3,17 3,43 3,923,70 31,05
5
Daniel Smith – June 7th, 201026
2011 2012 2013 2014 2015
3 3,50 4 54,50
Stock Price = 48,15
...
5
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Corporate Finance in a NutshellCorporate Finance in a Nutshell
Valuing Stocks - alternatively
Return on equivalent
investment: 10%
2,85
45,30
5
Daniel Smith – June 7th, 201027
2011
3
2,85
Dividend
Stock Price49,82Stock Price = 48,15
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Corporate Finance in a NutshellCorporate Finance in a Nutshell
Valuing Stocks
Return on equivalent
investment: 10%
2,85 3,17 3,43 3,923,70 31,05
5
Daniel Smith – June 7th, 201028
2011 2012 2013 2014 2015
3 3,50 4 54,50
Next Years Stock Price = 49,82
...
5
45,30
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Corporate Finance in a NutshellCorporate Finance in a Nutshell
Valuing Stocks – Constant Dividend Growth
5
Daniel Smith – June 7th, 201029
2011 2012 2013 2014 2015
D D(1+g) D(1+g)2
...
...D(1+g)3 D(1+g)4
constant dividend growth
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Corporate Finance in a NutshellCorporate Finance in a Nutshell
Valuing Stocks - Growth
Assume we know the next dividend and the current price
For the growth rate g, we
can either guess or assume:
The company retains a fraction
5
Daniel Smith – June 7th, 201030
The company retains a fraction
of earnings
Plowback ratio =
1 – payout ratio
This is invested, earning the
return on equity
ROE = EPS/Book equity per
share
So we have
g = plowback ratio x ROE
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Corporate Finance in a NutshellCorporate Finance in a Nutshell
Valuing Stocks - PVGO
If the company always paid out
all its earnings without
growing, we would have
However, the firm reinvests a
part to grow, so it is actually
5
Daniel Smith – June 7th, 201031
Knowing r and EPS, we can easily calculate PVGO
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Corporate Finance in a NutshellCorporate Finance in a Nutshell
How to get
money
Firm
Investor
Financial
MarketsBonds
Stocks
How to
spend
Goods
Markets
Daniel Smith – June 7th, 2010
Toolkit
NPV Risk
Definition
Shortcuts
Extensions
<-> other methods
IRR, Payback, etc
Variance
Covariance
Beta
Owner Manager
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Corporate Finance in a NutshellCorporate Finance in a Nutshell
Other valuation techniques - Payback
-10 5 5 11 A
Payback is simply the time until we‘ve recouped our initial investment
6
Daniel Smith – June 7th, 201033
2011 2012 2013 2014 2015
-10 3 4 32
-10 2 5 14 B
C
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Corporate Finance in a NutshellCorporate Finance in a Nutshell
Other valuation techniques - Payback
-10 5 5 11 A
What if we had:
6
Daniel Smith – June 7th, 201034
2011 2012 2013 2014 2015
-10 3 4 32
-10 2 5 14 B
C1000
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Corporate Finance in a NutshellCorporate Finance in a Nutshell
Other valuation techniques - IRR
6
Daniel Smith – June 7th, 201035
0 1 2 3 4
-10 3 4 32
IRR is the rate r that sets the NPV = 0
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Corporate Finance in a NutshellCorporate Finance in a Nutshell
Other valuation techniques - IRR
1.0
1.5
2.0
2.5
IRR = 8%
6
Daniel Smith – June 7th, 201036
-1.5
-1.0
-0.5
0.0
0.5
0% 1% 2% 3% 4% 5% 6% 7% 8% 9% 10% 11% 12% 13%
NPV
r
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Corporate Finance in a NutshellCorporate Finance in a Nutshell
Other valuation techniques - IRR
-8.0
-6.0
-4.0
-2.0
0.0
2.0
4.0
-50% -45% -40% -35% -30% -25% -20% -15% -10% -5% 0% 5% 10% 15%
IRR = ?
6
Daniel Smith – June 7th, 201037
0 1 2 3 4
-14 2 2 -510
Assume we had had:
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Corporate Finance in a NutshellCorporate Finance in a Nutshell
How to get
money
Firm
Investor
Financial
MarketsBonds
Stocks
How to
spend
Goods
Markets
Daniel Smith – June 7th, 2010
Toolkit
NPV Risk
Definition
Shortcuts
Extensions
<-> other methods
IRR, Payback, etc
Variance
Covariance
Beta
Owner Manager
![Page 39: Corporate Finance in a Nutshell 2010](https://reader034.vdocuments.mx/reader034/viewer/2022051820/5527d36755034622368b4936/html5/thumbnails/39.jpg)
Corporate Finance in a NutshellCorporate Finance in a Nutshell
Other valuation techniques – Profitability Index
-10 30 5 A
Assume we can only invest 10
NPV = 21
Examine the NPV per dollar invested
PI = 2.1 3
7
Daniel Smith – June 7th, 201039
2010 2011 2012
-5 5 15
-5 5 20 B
C
NPV = 16
NPV = 12
PI = 3.2
PI = 2.4
1
2
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Corporate Finance in a NutshellCorporate Finance in a Nutshell
Other valuation techniques – EAC
-4 4 4Machine A
NPV = 2.94
-4 4 4
NPV = 5.15
NPV = 5.93
7
Daniel Smith – June 7th, 201040
2011 2012 2013
-4 7Machine B
2010 2014 2015
NPV = 2.36
-4 7 -4 7
NPV = 5.93
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Corporate Finance in a NutshellCorporate Finance in a Nutshell
Other valuation techniques – EAC
-4 4 4Machine A
NPV = 2.94
1.24 1.24
1.08 1.08 1.08EAC is the cash flow
that, constant over the
investment
7
Daniel Smith – June 7th, 201041
2010 2011 2012
-4 7Machine B
2009 2011 2012
NPV = 2.36
1.24 1.24 investment
period, yields the same
NPV
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Corporate Finance in a NutshellCorporate Finance in a Nutshell
How to get
money
Firm
Investor
Financial
MarketsBonds
Stocks
How to
spend
Goods
Markets
Daniel Smith – June 7th, 2010
Toolkit
NPV Risk
Definition
Shortcuts
Extensions
<-> other methods
IRR, Payback, etc
Variance
Covariance
Beta
Owner Manager
![Page 43: Corporate Finance in a Nutshell 2010](https://reader034.vdocuments.mx/reader034/viewer/2022051820/5527d36755034622368b4936/html5/thumbnails/43.jpg)
Corporate Finance in a NutshellCorporate Finance in a Nutshell
Risk – Expectation and standard deviation
0
2
4
6
8
10
2002 2003 2004 2005 2006 2007 2008
Stock
8
Daniel Smith – June 7th, 201043
2004 2005 2006
0,10 0,08 0,12
2003 2007 2008
0,09 0,13 0,11Returns
5,00 5,50 5,94 6,65 7,25 8,19 9,10
2002 2003 2004 2005 2006 2007 2008
2002
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Corporate Finance in a NutshellCorporate Finance in a Nutshell
Risk – Expectation and standard deviation
2004 2005 2006
0,10 0,08 0,12
2003 2007 2008
0,09 0,13 0,11
Expectation EX = 0,105
8
Daniel Smith – June 7th, 201044
Expectation EX = 0,105
Variance
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Corporate Finance in a NutshellCorporate Finance in a Nutshell
Risk – Expectation and standard deviation
0,10 0,08 0,12 0,09 0,13 0,11
x - EX -0,005 -0,025 0,015 -0,015 0,025 0,005
(x – EX)2 0,000025 0,000625 0,000225 0,000225 0,000625 0,000025
x
8
Daniel Smith – June 7th, 201045
σ2
(x – EX)2 0,000025 0,000625 0,000225 0,000225 0,000625 0,000025
0,0035
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Corporate Finance in a NutshellCorporate Finance in a Nutshell
Risk – Expectation and standard deviation
The covariance formula is
8
Daniel Smith – June 7th, 201046
(1) Calculate the mean for X and Y
(2) Calculate the sum of the products
(3) Divide by (N-1)
Correlation coefficient:
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Corporate Finance in a NutshellCorporate Finance in a Nutshell
Risk – Expectation and standard deviation
8
X
Cov(X,Y)
Correlation
coefficient
Y
Daniel Smith – June 7th, 201047
EX EY
Var(X) Var(Y)
Standard
deviation of X
Standard
deviation of Y
coefficient
of X and Y
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Corporate Finance in a NutshellCorporate Finance in a Nutshell
Risk – Expectation and standard deviation
1
2
3
4
5
1
2
3
4
5
1
2
3
4
5
1
2
3
4
5EX = 0
σ2 = 1
8
Daniel Smith – June 7th, 201048
-5
-4
-3
-2
-1
0
1
-5
-4
-3
-2
-1
0
1
-5
-4
-3
-2
-1
0
1
-5
-4
-3
-2
-1
0
1
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Corporate Finance in a NutshellCorporate Finance in a Nutshell
Risk – Expectation and standard deviation
EX = 0
σ2 = 0,25
1
2
3
4
5
1
2
3
4
5
1
2
3
4
5
1
2
3
4
5
8
Daniel Smith – June 7th, 201049
-5
-4
-3
-2
-1
0
1
-5
-4
-3
-2
-1
0
1
-5
-4
-3
-2
-1
0
1
-5
-4
-3
-2
-1
0
1
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Corporate Finance in a NutshellCorporate Finance in a Nutshell
Risk – Expectation and standard deviation
For a portfolio of X and Y, we have
aX
8
Daniel Smith – June 7th, 201050
bY
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Corporate Finance in a NutshellCorporate Finance in a Nutshell
Risk – Expectation and standard deviation
Assume we keep adding stocks to our portfolio
0.8
1
1.2
Variance
Unique risk
8
Daniel Smith – June 7th, 201051
0
0.2
0.4
0.6
0.8
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15
Number of stocks
Market risk
Unique risk
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Corporate Finance in a NutshellCorporate Finance in a Nutshell
Risk – Expectation and standard deviation
What if securities are uncorrelated?
Variance
0.8
1
1.2
8
Daniel Smith – June 7th, 201052
Number of stocks
0
0.2
0.4
0.6
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15
No market risk
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Corporate Finance in a NutshellCorporate Finance in a Nutshell
However, we can‘t
measure every stock‘s
correlation with every
other stockIdea: Measure the
correlation of every stock
with all of the other
Risk – Expectation and standard deviation
8
Daniel Smith – June 7th, 201053
with all of the other
stocks, i.e. the market
β tells us how much a stock moves up
(on average) if the market moves up
by 1%
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Corporate Finance in a NutshellCorporate Finance in a Nutshell
How to get
money
Firm
Investor
Financial
MarketsBonds
Stocks
How to
spend
Goods
Markets
Daniel Smith – June 7th, 2010
Toolkit
NPV Risk
Definition
Shortcuts
Extensions
<-> other methods
IRR, Payback, etc
Variance
Covariance
Beta
Owner Manager
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Corporate Finance in a NutshellCorporate Finance in a Nutshell
Risk – Combining Portfolios
11
12
13
14
Expected
Return B
9
Daniel Smith – June 7th, 201055
8
9
10
11
0 5 10 15 20 25 30 35
Standard deviation
A
Corr = 0
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Corporate Finance in a NutshellCorporate Finance in a Nutshell
11
12
13
14
11
12
13
14
Risk – Combining Portfolios
11
12
13
14
11
12
13
14
BExpected
Return
Corr = 0
9
Daniel Smith – June 7th, 2010
8
9
10
11
0 5 10 15 20 25 30 35
56
8
9
10
11
0 5 10 15 20 25 30 35
8
9
10
11
0 5 10 15 20 25 30 35
8
9
10
11
0 5 10 15 20 25 30 35
A
Standard deviation
Corr = 0
Corr = -0,3
Corr = -0,7
Corr = -1
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Corporate Finance in a NutshellCorporate Finance in a Nutshell
11
12
13
14
Risk – Combining Portfolios
11
12
13
14
11
12
13
14
11
12
13
14
BExpected
Return
Corr = 0
Corr = 0,3
Corr = 0,7
Corr = 1
9
Daniel Smith – June 7th, 2010
8
9
10
11
0 5 10 15 20 25 30 35
57
8
9
10
11
0 5 10 15 20 25 30 35
8
9
10
11
0 5 10 15 20 25 30 35
8
9
10
11
0 5 10 15 20 25 30 35
A
Standard deviation
Corr = 0
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Corporate Finance in a NutshellCorporate Finance in a Nutshell
11
12
13
14
Risk – Combining Portfolios
Expected
Return
C
BCapital Market Line
M
9
Daniel Smith – June 7th, 2010
8
9
10
11
0 5 10 15 20 25 30 35
58
Standard deviation
Arf
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Corporate Finance in a NutshellCorporate Finance in a Nutshell
Risk – CAPM
11
12
13
14
Expected
Return
M
Security Market Line
9
Daniel Smith – June 7th, 201059
8
9
10
11
0 0,5 1 1,5 2
Beta
rf
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Corporate Finance in a NutshellCorporate Finance in a Nutshell
Risk – APT
By APT, we have
expected risk-free factor x premium
9
Daniel Smith – June 7th, 201060
expected
return
risk-free
returnfactor x premium
Specialization: Fama-French-Three Factor Model
market correlation size factor book-to-market
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Corporate Finance in a NutshellCorporate Finance in a Nutshell
How to get
money
Firm
Investor
Financial
MarketsBonds
Stocks
How to
spend
Goods
Markets
Daniel Smith – June 7th, 2010
Toolkit
NPV Risk
Definition
Shortcuts
Extensions
<-> other methods
IRR, Payback, etc
Variance
Covariance
Beta
Owner Manager
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Corporate Finance in a NutshellCorporate Finance in a Nutshell
The cost of capital
For financing, the company has both equity and debt available
10
Bonds Stocks
Daniel Smith – June 7th, 201062
Fixed at rd
Interest
Payments
Dividend
PaymentsCAPM
Variable
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Corporate Finance in a NutshellCorporate Finance in a Nutshell
The cost of capital
10
Debt D
WACC
Daniel Smith – June 7th, 201063
Equity ECAPM
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Corporate Finance in a NutshellCorporate Finance in a Nutshell
The cost of capital
10
Other important points:
Don‘t use fudge factors
If beta isn‘t available, it can be approximated
Daniel Smith – June 7th, 201064
If beta isn‘t available, it can be approximated
Certainty equivalents are an alternative
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Corporate Finance in a NutshellCorporate Finance in a Nutshell
How to get
money
Firm
Investor
Financial
MarketsBonds
Stocks
How to
spend
Goods
Markets
Daniel Smith – June 7th, 2010
Toolkit
NPV Risk
Definition
Shortcuts
Extensions
<-> other methods
IRR, Payback, etc
Variance
Covariance
Beta
Owner Manager
![Page 66: Corporate Finance in a Nutshell 2010](https://reader034.vdocuments.mx/reader034/viewer/2022051820/5527d36755034622368b4936/html5/thumbnails/66.jpg)
Corporate Finance in a NutshellCorporate Finance in a Nutshell
Insert: Accounting crash course
11
Balance sheet:
Assets Liabilities and Equity
Current Assets Current Liabilities
Daniel Smith – June 7th, 201066
Fixed Assets Long-Term Liabilities
Equity
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Corporate Finance in a NutshellCorporate Finance in a Nutshell
Insert: Accounting crash course
11
Profit and Loss Statement
Revenues
- Operating Expenses
Operating Profit
Daniel Smith – June 7th, 201067
- Other Expenses
- Interest Expenses
- Taxes
Net Income
Income Before Taxes
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Corporate Finance in a NutshellCorporate Finance in a Nutshell
Insert: Accounting crash course
11
Profit and Loss Statement
Revenues
- Operating Expenses Operating Expenses:
Cost of Sales
General & Administrative
Daniel Smith – June 7th, 201068
- Other Expenses
- Interest Expenses
- Taxes
Net Income
General & Administrative
Depreciation
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Corporate Finance in a NutshellCorporate Finance in a Nutshell
Insert: Accounting crash course
11
Cash Flow Statement
Revenues
- Operating Expenses
Net Cash Flow
Daniel Smith – June 7th, 201069
- Other Expenses
- Interest Expenses
- Taxes
Net Income Net Income
+ Depreciation
- Capital Expenditure
- Change in Working Capital
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Corporate Finance in a NutshellCorporate Finance in a Nutshell
Insert: Accounting crash course
11
Cash Flows – Top Down
Sales
- Cost of Sales
- Other Costs
Depreciation
Daniel Smith – June 7th, 201070
- Other Costs
- Taxes
- Change in Working Capital
Net Cash Flow
- Capital Expenditure
Revenues
- Operating Expenses
- Other Expenses
- Interest Expenses
= Income Before Taxes X Tax Rate
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Corporate Finance in a NutshellCorporate Finance in a Nutshell
Project Analysis
11
Basically, NPV analysis can be used to determine the
advantageousness of a certain project
However, the future cash flows are often uncertain and
the company needs to examine a wide variety of
Daniel Smith – June 7th, 201071
the company needs to examine a wide variety of
scenarios to determine potential threats
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Corporate Finance in a NutshellCorporate Finance in a Nutshell
Project Analysis
11
Sensitivity Analysis
0
2
4
6
x
NPVBreak even
Daniel Smith – June 7th, 201072
0 1 2 3 4
-10 3 4 x2
-4
-2
0
1 2 3 4 5 6 7 8 9 10 11x
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Corporate Finance in a NutshellCorporate Finance in a Nutshell
Project Analysis
11
Monte Carlo Analysis
Model the
projectSpecify probabilities
for forecast errors
Daniel Smith – June 7th, 201073
projectfor forecast errors
Run simulation
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Corporate Finance in a NutshellCorporate Finance in a Nutshell
Project Analysis
11
Options
2
5
3,5
Daniel Smith – June 7th, 201074
0 1 2 3
-10 3 4
3
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Corporate Finance in a NutshellCorporate Finance in a Nutshell
How to get
money
Firm
Investor
Financial
MarketsBonds
Stocks
How to
spend
Goods
Markets
Daniel Smith – June 7th, 2010
Toolkit
NPV Risk
Definition
Shortcuts
Extensions
<-> other methods
IRR, Payback, etc
Variance
Covariance
Beta
Owner Manager
![Page 76: Corporate Finance in a Nutshell 2010](https://reader034.vdocuments.mx/reader034/viewer/2022051820/5527d36755034622368b4936/html5/thumbnails/76.jpg)
Corporate Finance in a NutshellCorporate Finance in a Nutshell
Investment, Strategy and Economic Rents
12
Machine leads to cash flows of
Assuming a
discount rate
of zero, what
When should I buy the
machine?
Daniel Smith – June 7th, 201076
1 2 3
3 3 3of zero, what
will the price
of the
machine be?
9
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Corporate Finance in a NutshellCorporate Finance in a Nutshell
If a project has positive NPV for me, I must have some
competitive advantage or others would have already
undertaken the project
Investment, Strategy and Economic Rents
12
If I know the market value of an asset, I should use that
Daniel Smith – June 7th, 201077
If I know the market value of an asset, I should use that
as a starting point for my analysis
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Corporate Finance in a NutshellCorporate Finance in a Nutshell
How to get
money
Firm
Investor
Financial
MarketsBonds
Stocks
How to
spend
Goods
Markets
Daniel Smith – June 7th, 2010
Toolkit
NPV Risk
Definition
Shortcuts
Extensions
<-> other methods
IRR, Payback, etc
Variance
Covariance
Beta
Owner Manager
![Page 79: Corporate Finance in a Nutshell 2010](https://reader034.vdocuments.mx/reader034/viewer/2022051820/5527d36755034622368b4936/html5/thumbnails/79.jpg)
Corporate Finance in a NutshellCorporate Finance in a Nutshell
Agency problems and performance measurement
13
Money Talent
The Firm
Daniel Smith – June 7th, 201079
Principal-Agent-Conflict
Investors Managers
Want
maximum
return
Want an
easy lifeNeed to measure
performance
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Corporate Finance in a NutshellCorporate Finance in a Nutshell
Agency problems and performance measurement
13
Incentive alignment make managers want high returns, through
compensation in stock and options
bonus scheme based on performance
Daniel Smith – June 7th, 201080
Net Return on
InvestmentEconomic Value Added
ROI – cost of capital
ROI = Operating Income /
Asset Book Value
Income earned – cost of capital x investment
Depend on accounting data!
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Corporate Finance in a NutshellCorporate Finance in a Nutshell
How to get
money
Firm
Investor
Financial
MarketsBonds
Stocks
How to
spend
Goods
Markets
Daniel Smith – June 7th, 2010
Toolkit
NPV Risk
Definition
Shortcuts
Extensions
<-> other methods
IRR, Payback, etc
Variance
Covariance
Beta
Owner Manager
![Page 82: Corporate Finance in a Nutshell 2010](https://reader034.vdocuments.mx/reader034/viewer/2022051820/5527d36755034622368b4936/html5/thumbnails/82.jpg)
Corporate Finance in a NutshellCorporate Finance in a Nutshell
Efficient Markets and Behavioral Finance
14
1,04Pt
Pt
probability 0,5
Random Walk:
Daniel Smith – June 7th, 201082
0,97Pt probability 0,5
The stock either moves up by 4% or down by 3% every
day, independent of the previous history
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Corporate Finance in a NutshellCorporate Finance in a Nutshell
Efficient Markets and Behavioral Finance
14
Daniel Smith – June 7th, 201083
Random walk simulations seem very similar to real
stock prices
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Corporate Finance in a NutshellCorporate Finance in a Nutshell
Efficient Markets and Behavioral Finance
14
Efficient Market Hypothesis
Weak: All previous
price information
incorporated Strong: All
Daniel Smith – June 7th, 2010
Semi-Strong: All public
information incorporated
84
incorporated Strong: All
information
incorporated
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Corporate Finance in a NutshellCorporate Finance in a Nutshell
The End
Daniel Smith – June 7th, 201085
The End