FINC 5880 Subject Overview & Guidance

“if you don’t know where you are going,

it does not matter how you get there”

(Alice in Wonderland)Paul Bon- Shanghai 2014

Course Contents

Week 1: Framework – Dividend Policy and Share Buy Back Week 2: Capital Structure – Disney DemoWeek 3: Bottom Up Beta’s and Investment BankingWeek 4: Financial Options and Option Valuation - Leasing

Week 5: Mid Exam Week 6: Future Contracts and Future Valuation - SWAPS Week 7: WC Management – Short Term Financing – Hybrid FinancingWeek 8: Reorganizations/Bankruptcy Q&A and Guidance Final Exam

Fundamental Principal of Finance

Investment Decision Financing

Decision

Pay Out Decision

Invest in Assets with Return> Hurdle Rate

Find the right kind of debt and the right relation Debt/equity

If you don’t have enough Investments that have a return>hurdle rate; return the cash to the owners

®

Facebook (estimates)

ASSETS (debit) LIABILITIES (credit)CORP. BALANCE SHEET date:………..

Total Assets in Place: <1 B USD (2%)

Total Debt 0 B USD (0%)

Total Equity 50 B USD(100%)

Total Growth Assets: >49 B USD (98%)

1) Dividends are sticky…

2) Dividends follow earnings…

3) Are effected by tax laws

4) More and more firms buy back shares instead of paying out dividends

Peer Group analysis Disney…

Pay out ratio’s

(in M USD) first year4 years

ago3 Years

Ago2 Years

AgoLast Year

Net Income -20 0 100 130 175

Capital Expenditure 120 50 90 120 150

Depreciation 20 40 60 70 70

Non Cash Work.Cap. -10 20 -20 0 10

Total Debt 10 20 0 40 20

FINC 5880FINC 5880

““Capital Structure ” Capital Structure ” Shanghai 2012Shanghai 2012

Week 2 FINC 5880 Week 2 FINC 5880

邦保罗邦保罗

Only for Pro’sOnly for Pro’s

You found best Debt ratio around 40%

Ks% at different debt ratio’s

Like this…

Regression Beta’s

Regression Output…

Illustrated…

Weighting with each business…

So each business it’s own WACC%

Financial Options & Financial Options & Option Valuation Option Valuation

FINC 5880 week 6 Black Scholes pp 690-698 bookFINC 5880 week 6 Black Scholes pp 690-698 book

Spring 2012 ShanghaiSpring 2012 Shanghai

What if the option is overpriced? Say $30 instead of $ 26.85

• Then you can make arbitrage profits:

• Risk free $6.80…no matter what happens to share price!

Cash flow

At S=$50

At S=$200

Write 2 options

$60 $ 0 -$150

Buy 1 share

-$100 $50 $200

Borrow

$40 at 8%

$40 -$43.20 -$43.20

Pay off $ 0 $ 6.80 $ 6.80

IPO ouch?

Facebook “I PO”

S1 SEC.gov Feb 2012

FINC5880 2012

LeasingLease Financing

Corporate Finance

FINC5880

Shanghai Spring 2012

Class Assignment: Leasing• Consider a $10 M investment (10 year life) to be discontinued after 5 year

• Borrow at 10% interest per year (before tax) if you Buy the Equipment

• After 5 years residual value $2 M

• A 5 year lease would trigger annual lease payments of $ 2,6M starting immediately in t=0

• Under the lease the lessor maintains the equipment

• If the company buy/borrow this equipment the maintenance cost will need to be paid additionally at $0.5M per year at the beginning of each year starting immediately (t=0)

• Tax rate of the Lessee is 35%

• Modified Accelerated Cost Recovery System (MACRS) depreciation: over the 5 years is resp. 20%, 32%, 19%, 12% and 11%

• Compare the PV of the cost of owning (buy/borrow) with the PV of the cost of leasing….which one is lower?

Class assignment: From the Lessor’s point of view

• Assuming:• Lessor’s tax rate is 40%• Lessor’s alternative investment is a 5 year bond with an after tax

yield of 9%(1-40%)=5.4%• Asset will be depreciated to book value of $600,000 after 5 years

and the before tax residual value is $ 2M• This implies that Lessor can expect to receive $2M –

40%*$1.4M=$1,440,000 after the lease expires selling the asset directly…

• Develop the cash flows and determine the IRR% of this investment• Is 5.4%>,< or= IRR%? So what would the lessor invest his money in

in the Lease or the Bonds…?

Other Derivatives and Risk Other Derivatives and Risk ManagementManagement

Spring 1- 2011- Addendum- week 6

Shanghai

Financial Options & Financial Options & Option Valuation Option Valuation

FINC 5880 week 6 Black Scholes pp 690-698 bookFINC 5880 week 6 Black Scholes pp 690-698 book

Spring 2012 ShanghaiSpring 2012 Shanghai

In Excel…

The put-call parity…

• Relates prices of put and call options according to:

• P=C-So + PV(X) + PV(dividends)

• X= strike price of both call and put option• PV(X)= present value of the claim to X dollars to be paid

at expiration of the options

• Buy a call and write a put with same strike price…then set the Present Value of the pay off equal to C-P…

Futures & SWAPSFinancial Derivatives

Shanghai Spring 1- 2012 (pp765-775 and 784-789 book)

Week 6 FINC 5880

Pay off Futures…

Daily Mark to Market….(example)

Day (price today $17.10) delivery Day 5

Profit/Loss per ounce of Silver of long position

Daily Proceeds for 5000 ounces standard contract Silver

1 Future Price: $ 17.20 $0.10 $ 500

2 Future Price: $ 17.25 $0.05 $ 250

3 Future Price: $ 17.18 -$0.07 -$ 350

4 Future Price: $ 17.18 $0 $ 0

5 Future Price: $ 17.21 $0.03 $ 150

Total $ 550

Answer…no matter the price of oil at maturity the

proceeds are the same …

P=$50.67 P=$52.67 P=54.67

Costs from oil purchase

100,000*P=

$5,067,000

100,000*P=

$5,267,000

100,000*P=

$5,467,000

Profit on Futures contract

$2*100,000=

(Pt-Fo)*100,000

-$200,000

$ 0

(Pt-Fo)*100,000

(no difference with buy price)

-$2*100,000=

(Pt-Fo)*100,000

$200,000

Total costs $5,267,000 $5,267,000 $5,267,000

Class Assignment 6:Future Pricing…

• We follow the same reasoning of replication as what we did when we were looking at the valuation of options…

• We create 2 strategies that have the same pay off…and thus their investments should be equal:

• Strategy A: buy gold (price= -So)» sell gold at T (price ST)

• Strategy B: enter long position (no investment today) » Sell at T: (ST-Fo)

• At same time invest : -Fo/(1+Rf)^T» Growing in T to: Fo

• Required: show that strategy A and B have the same pay off as a Futures contract and then derive from this Fo=Function(So)

Answer…action Initial cash flow Cash flow at T

Borrow $400 and repay with interest at T

+$400 -$400(1+0.5%)^6=$412,15

Buy gold for $400 (buy under priced side)

-$400 ST

Enter in short future position $413 (sell over priced side)

$ 0 (no cash out) $413-ST

TOTAL $ 0 (no investment) $ 0.85 riskless

SWAP DEAL…

Pay outside bank -7%

Receive from SWAP dealer

+7%

Pay SWAP dealer -(LIBOR-0.1%)

Total Pay LIBOR-0.1%

Company A Company BSWAP

Dealer

7% LIBOR+0.25%

7% 7%+0.05%

LIBOR-0.1% LIBOR-0.1%

Pay outside bank -(LIBOR+0.25%)

Receive from SWAP dealer

LIBOR-0.1%

Pay SWAP dealer -7.05%

Total Pay -(7.05%+0.35%)

Working Capital Management

Advanced Corporate Finance

Spring 2012 Shanghai- week 7

FINC 5880 Webster University

HAPP¥ N€W ¥€AR !

Cash conversion cycle• Cash

• Purchase inventory

• Process goods

• Sell goods on credit

• Collect AR

• Cash

Assignment: Working Capital• Analyze the WC of your company

• Determine the cash cycle time and compare it to it’s main competitors

• If you were in charge in this company what would you do to better manage WC

• What is the implied value impact of your actions on the company’s value?

Alternative Current Asset Financing• Self liquidating approach: the useful

life time of the asset is matched with its financing

• Aggressive approach: the company finances part of its LT assets with short financing (taking the risk of changing r %)

• Conservative approach: the company finances LT also ST needs like part of the ST working capital requirements (avoiding any risk of changing r % on short capital) Making the fit…

Bankruptcy, Liquidation andReorganization

FINC 5880 SUFE Webster University- week 8-

Managing Reorganizations

Example Assignment:Altman’s Z-score model

• Z= 1.2X1+1.4X2+3.3X3+0.6X4+0.99X5

• Where:

• X1= working capital/total assets

• X2=retained earnings/total assets

• X3= Ebit/total assets

• X4=market value of all shares/book value of liabilities

• X5=sales/total assets

• The lower the Z score the higher the probability of bankruptcy• Altman’s model is a reasonable predictor for bankruptcy within a period of 2

years… • Z score of 1.8 or less (Bankruptcy likely); between 1.8 and 3.0 (Bankruptcy

uncertain); above 3.0 (Bankruptcy unlikely)• Calculate Z-scores for attached companies and analyse how well z-scores

match with bond/credit ratings…

Thank you…“Progress is of priceless value!”

“if you know where you are going,

it does matter how you get there”

(FINC5880 in Wonderland)