1. 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

2. Course Contents Week 1: Framework – Dividend Policy and Share Buy Back Week 2: Capital Structure – Disney Demo Week 3: Bottom Up Beta’s and Investment Banking Week 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 Financing Week 8: Reorganizations/Bankruptcy Q&A and Guidance Final Exam

3. Fundamental Principal of Finance Maximize Firm Value Hurdle Rate reflect Risk of Investment Return reflect size and timing of Cash Flows Optimal Mix of Debt/Equity Maximizes Value The right kind of debt matches the Assets © ℗ How much cash to return depend on Investment Opportunities Do your shareholders prefer Dividends or Buy Backs? Investmen t 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 ®

4. Facebook (estimates) Assets in Place Existing Investments Generate Cash Flow today (Fixed assets and Working Capital) Debt Fixed Claims on Cash flows (little/no role in Management Fixed Maturity Tax Deductible Growth Assets Expected Value that will be created by future Investments Equity Residual Claim on Cash flows Significant role in Management Perpetual Live 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%)

5. 1) Dividends are sticky…

6. 2) Dividends follow earnings…

7. 3) Are effected by tax laws

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

9. Peer Group analysis Disney…

10. Pay out ratio’s (in M USD)first year4 years ago3 Years Ago2 Years AgoLast Year Net Income-200100130175 Capital Expenditure1205090120150 Depreciation20406070 Non Cash Work.Cap.-1020-20010 Total Debt102004020

11. FINC 5880 “Capital Structure ” “Capital Structure ” Shanghai 2012 Week 2 FINC 5880 邦保罗 Only for Pro’s

12. You found best Debt ratio around 40%

14. Ks% at different debt ratio’s

15. Like this…

16. Regression Beta’s

17. Regression Output…

18. Illustrated…

19. Weighting with each business…

20. So each business it’s own WACC%

21. FINC 5880 week 6 Black Scholes pp 690-698 book Spring 2012 Shanghai

22. 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-$43.20 Pay off$ 0$ 6.80

23. IPO ouch?

24. Facebook “I PO” S1 SEC.gov Feb 2012 FINC5880 2012

25. Leasing Lease Financing Corporate Finance FINC5880 Shanghai Spring 2012

26. 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?

27. 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…?

28. Other Derivatives and Risk Management Spring 1- 2011- Addendum- week 6 Shanghai

29. FINC 5880 week 6 Black Scholes pp 690-698 book Spring 2012 Shanghai

30. In Excel…

31. 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…

32. Futures & SWAPS Financial Derivatives Shanghai Spring 1- 2012 (pp765-775 and 784-789 book) Week 6 FINC 5880

33. Pay off Futures…

34. 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 5 Future Price: $ 17.21$0.03$ 150 Total$ 550

35. Answer…no matter the price of oil at maturity the proceeds are the same … P=$50.67P=$52.67P=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

36. 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)

37. Answer… actionInitial cash flowCash 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) -$400ST Enter in short future position $413 (sell over priced side) $ 0 (no cash out)$413-ST TOTAL $ 0 (no investment)$ 0.85 riskless

38. SWAP DEAL… Pay outside bank-7% Receive from SWAP dealer +7% Pay SWAP dealer-(LIBOR-0.1%) Total PayLIBOR-0.1% Company A Company B SWAP Dealer 7% LIBOR+ 0.25% 7%7%+0.05% 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%)

39. Working Capital Management Advanced Corporate Finance Spring 2012 Shanghai- week 7 FINC 5880 Webster University HAPP¥ N€W ¥€AR !

40. Cash conversion cycle Cash Purchase inventory Process goods Sell goods on credit Collect AR Cash

41. 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?

42. 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…

43. Bankruptcy, Liquidation and Reorganization FINC 5880 SUFE Webster University- week 8- Managing Reorganizations

44. Example Assignment: Altman’s Z-score model Z= 1.2X 1 +1.4X 2 +3.3X 3 +0.6X 4 +0.99X 5 Where: X 1 = working capital/total assets X 2 =retained earnings/total assets X 3 = Ebit/total assets X 4 =market value of all shares/book value of liabilities X 5 =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…

45. Thank you… “Progress is of priceless value!” “if you know where you are going, it does matter how you get there” (FINC5880 in Wonderland)