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Published byJeremy Terry Modified over 9 years ago
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Corporate Finance Everything….. R Srinivasan
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Corporate Finance Valuation and Cost of capital Capital budgeting Capital structure, financing and dividend policy Working capital
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Valuation Generalised valuation Arbitrage and value additivity Patterns Level perpetuity Growing perpetuity Level annuity Growing finite cash flow
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Valuation Growing finite [t years] cash flow C 1 /(r-g){1-(1+g) t /(1+r) t }
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Valuation Compounding intervals (1+r/m) m -1 Continuous compounding Stated and effective rates Nominal and real rates 1+r nominal =(1+r real )(1+inflation rate)
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Valuation: Straight Bonds YTM Duration Sensitivity of value to changes in interest rates [1*PV(C1)/V]+[2*PV(C2)/V]+[3*PV(C3)/V] V/V = (1+r)/(1+r)*D
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Valuation: Common Stock Perpetual growth models Sustainable growth P 0 =No-Growth +PVGO No-growth =EPS 1 /r PVGO=NPV 1 /(r-g) where NPV 1 =-INV 1 +INV 1 *ROE/r g=Ploughback*ROE EPS 1 /P 0 interpretation
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Valuation Multiple stages Supernormal stage plus PV of normal growth Free cash flow NOI approach
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Cost of Capital Security return and standard deviation Portfolio return and standard deviation Diversification Portfolio variance= 1/N Average Var+(N-1)/N Average covariance Systematic and unsystematic risk CAPM Opportunity cost of capital r [r A ]and Adjusted cost of capital r*
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Cost of Capital 1. V L = V U +T c *D 2. WACC = D/V * (1-T c ) * r D +E/V * r E [Definition of WACC] 3. r E = r A + (r A - r D ) * (1- T c ) * D/E [MM Proposition II] 4. E = {1+ (1- T c ) * D/E} * A [If debt is risk free] 5. r E = r f + (r M - r f ) * E [CAPM] 6. WACC= r A *(1- T c * D/V) MM
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Valuation Contingent cash flow Call/Put American/European Binomial Black-Scholes Underlying asset price, Exercise Price, Risk- free rate, Volatility, Time
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Capital Budgeting NPV and IRR not payback and accounting rate of return Accept/reject single project use NPV or IRR, unless no/multiple IRR Mutually exclusive projects: Same life and risk Use NPV [or IRR of difference between projects]
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Capital Budgeting Mutually exclusive projects: Different lives same risk Use NPV-assumes replacement projects have zero NPV. OK for projects with long lives Use NPV-with specific replacements that make project with comparable lives Use replacement chain or EAC Care: Use only real cash flows for EAC
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Capital Budgeting Incremental nominal cash flows with empirically measured discount rate Components of cash flow Investment in fixed assets, salvage value Investment in working capital, release Operating revenues/expenses NO INTEREST
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Capital Budgeting NPV assumes “now or never” Real Option framework Abandonment Follow-up Wait and learn Flexibility
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Capital structure Market Efficiency MM-1 No taxes MM-2 Corporate taxes Miller Both corporate and personal taxes G L = {1-(1-T C )*(1-T pE )/(1-T p )} Bankruptcy costs Agency costs
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Dividends MM Does not matter Lintner behavioural model DIV 1 -DIV 0 =Adjustment rate*(target ratio*EPS 1 -DIV 0 ) Agency costs/signalling
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Working Capital Management Operating cycle, cash conversion cycle, weighted cycles and supply chain management Investment in receivables Cash management EOQ and Miller-Orr models
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