1. Advanced Corporate Finance
Review
FINA 7330
Advanced Corporate Finance
Lecture 13
Ronald F. Singer
Fall, 2009

2. Making Investment Decisions
NPV Rule
Incremental Cash Flow
After Tax basis when paid
Opportunity Costs
Changes in Working Capital
Depreciation Not a Cash Flow
Treat Inflation Consistently
MAXIMIZE NPV

3. Practical Problems in Capital Budgeting
Basically: What happens when you cannot take all positive NPV projects.
Must Consider the package of projects which maximizes the NPV of all possible alternatives
Classes:
Two possibilities
Once and for all deals
Repetitive deals

4. Once and for all deals
Mutually Exclusive Projects: Basically dealing with mutually exclusive decisions
Mutually Exclusive Projects
Beware of the conflicts between IRR and NPV
Investment Timing: When is the optimal time to take on a project: (Want to max the Present value of the NPV)
Budget Constraints: What subset of all possible combinations give you the highest NPV

5. Repetitive Deals
Mutually Exclusive projects with different starting times, economic lives
Replacement Decision
In general, you “smooth” the cash flows by finding Equivalent Annual Cash Flow, so that projects can be compared.

6. Repetitive Deals
Mutually Exclusive projects with different starting times, economic lives
Equivalent Annual Cash Flow
Replacement Decision
Replace when
EACF replacement > EACF existing

7. Analysis of Projects Sensitivity Analysis Scenario Analysis
Break Even Analysis
Monte Carlo Simulations
Real Options and Decision Trees
React to ongoing information as it is revealed

8. Strategic Investment Decisions
Trust Market Values
Look for comparative advantage
Consider opportunity costs
How will introducing this project effect other products you produce
When will introduction of this project induce competition
What will happen to the price over time

9. Payout Policy Critical Dates Announcement Date Record Date
Payment Date
Ex-dividend Date

10. Payout Policy Dividends versus repurchase of shares
Signaling implications of announcements
Agency Costs
Free Cash Flow
Tax implications
Liquidity

11. DDiv(t) = a(Div(t)*-Div(t-1))
Lintner’s Model
DDiv(t) = a(Div(t)*-Div(t-1))
Where the dividend target (Div(t)*) is determined as a proportion of long run earnings

12. Payout Policy What investors do What firms do
What effect does dividend policy have on price

13. Empirical Payout Policy
Repurchases versus Dividends
Signals
Fixed price tenders versus open market purchases
High market/book versus low market/book
What does market/book tell you
What do you expect the reaction in these 2 cases to be
Repurchase versus Dividends

14. Long-Run Policy
Tax Effects
Free Cash Flow

15. Dividend Policy What should corp. do? What should individual do?
What is the impact on the total value of the firm

16. Agency Problems
How do you induce managers to act in stockholders’ interest

17. Message of EVA
+ Managers are motivated to only invest in projects that earn more than they cost.
+ EVA makes cost of capital visible to managers.
+ Leads to a reduction in assets employed.
- EVA does not measure present value
Rewards quick paybacks and ignores time value of money
+ Present Value of EVA does measure NPV and thus consistent rewarding via EVA leads to good decisions

18. Capital Structure Capital Structure Defined
The Modigliani Miller Theory
Static Tradeoff Theory
Taxes
Bankruptcy costs and costs of financial distress
Information costs
Pecking Order Theory

19. Capital Structure Agency Problems Underinvestment
Overinvestment (risk shifting)

20. Raising Capital Information and how capital is raised
Debt versus equity
Cash flow in versus cash flow out
Organizational changes
Transactions that increase ownership concentration increase stock prices
Underwritten versus Rights offering
Greater Commitment by underwriter has positive impact on stock price

21. Summary Leverage Increasing (+Price Reaction)
Cash Flow In (+Price Reaction)
Underwritten versus Rights Offering (less underpricing)
Firm Commitment versus Best Efforts
Negotiated versus Competitive Bid for underwriter
Traditional Registration versus Shelf Registration
Organizational Structure (Price reaction)
Increasing concentration of ownership
Voluntary Reorganization

22. Advent of “innovative securities”
Inefficient markets
Incomplete markets
Resolves conflicts of interest
Tax or regulatory arbitrage
Encourage efficient production