In the document the slides, the notes of the lesson and the book are processed. At the end of the document you will also find an overview of all formulas per topic.
NO BETAS WILL BE ASKED ON THE EXAM!!! So no question of what is the beta of Volkswagen
We are going to talk about investments. This is an important part of the work of CFO. E.g. the building of a new
energy island in the North Sea.
It is not only investing in physical assets, but also in e.g. companies, acquiring a company in its whole.
Funding is extremely important and looking for it is one of the most important tasks of a CFO.
It is not only about raising money from the
stock market, but also about raising debt.
Recently ArcelorMittal said they would get a
loan from the European Investment Bank to
reduce carbon emissions. -> green investments
are high on the agenda of EU.
1
,Once you have raised all the money and you cannot invest it properly in a certain attribute or element that is
tangible, you can invest in something else.
Shell has had hard times, since the oil business it not doing well. They saw a decrease in the profits and the cash,
so they paid no dividends.
You don’t want to go bankrupt.
Course overview
We will focus on investment decisions for the first pillar of
the course. How can we assess whether an investment
opportunity is a good decision. We look at the return and
risk. Once we know in what to invest, we should see how to
finance this decision. We have to look at debt versus equity
and where we get the money from. This all should lead to
company valuation, to understand the value of an
organization, what drives it.
IPO = initial public offer = first time the shares of an
organization is on the stock market
2
, TOPIC 1 : BASICS OF VALUATION
Goals and financial governance of the firm
Role of finance director
Investment decisions : in what assets will the company invest?
Financing decisions : best financial mix or optimal ratio between different forms of equity and loan capital?
=> liabilities
Dividend decisions
Special decisions : merger / acquisition / financing unlisted companies / international operations / bankruptcy
Risk management (defined by the above roles)
Financial goal of the corporization?
Profit maximization?
Proposed investment would be €100, so you have to add €100 in the company. It would not be good to invest.
You would maximize profit, but this would ignore the other elements, such as equity. We would have a return of
10% in the starting position, but we would go to only 6% return after the investment.
Assume the new goal is not profit-maximization, but only on return -> what is the problem? It ignores the cost of
capital. If you maximize return, if you only focus on return, you ignore that if you invest, the investment has to be
financed in one way or another. As well it ignores the risk of the investment, this implies that you would induce
management to take a lot of risk to optimize the return, in the long run this is negative for the survival for the
company. Taking more risk also implies that you will have higher cost of capital -> we should maximize return
combined with cost of capital and risk => protect shareholder value.
This also focusses on current returns and next-year, then you have a very short-term view, while we should also
invest in the long-term, such as in innovation. You have to care for your stakeholders in the long term!
Other example : should they go for absolute profit, earnings per share or market price per share?
Capital Number of shares Profit Profitability EPS
(= profit / capital)
Originally €100 10 €20 20% = €2
Extra investment €100 + 10 €4 4%
TOTAL €200 20 €24 12% 24/20 = €1.2
Absolute profit is increased, but in relative terms the profitability for the shareholders has decreased. The overall
profitability after capital increase has fallen due to the lower return on the additional resources.
But profitability / EPS should not be the objective of a company due to the following reasons :
Timing is not taken into account. -> time value of money!
Risk / uncertainty is not taken into account
Financial goal
Maximize market value for shareholders = maximize market price per share
Value = f(probability including timing, risk)
Probability : return on investment
Risk : probability of the return
3
,Profitability includes also the return notion and the money invested, but also the risk!
Goal
Shareholders or stakeholders?
The goal of the firm is difficult to answer. You see in the graph a survey from 1995, 25 years ago there was a
worldwide survey asking CEO’s whether they focus on the shareholders or at the stakeholders. You see a lot of
differences worldwide.
In capitalistic societies (UK and US) there is focus on shareholders. In the European countries it is more mixed and
in Japan there is a bigger focus on all stakeholders.
ESG stands for environmental, social and governance -> a company should not only hare about its shareholders,
but also about externalities, such as environment, social elements, such as the shareholders. The ESG-goals
become more and more important as well in the corporate finance environment.
What do certain institutions important when they invest? Goal 1 immediately show the ESG-goals. 25 years ago
(the survey) they did not care about the stakeholders, but now 92% of the investors find it important that ESG-
goals are implemented. You deserve a premium valuation for the shares, from which the shareholders benefit, so
focusing on ESG is not against the shareholders, but better for the shareholders in the long term. So we should go
away from short-term vision, but look at the long-term and hereby look at the ESG-goals. If we focus on
stakeholders, shareholders will benefit from this in the long term.
4
,Social responsible investment (SRI) vs. business as usual
Socially responsible investments don’t do worse than
average investments. Last couple of years, SRI (social
responsible investments) do better than the average.
If you focus on ESG and you act socially responsible,
you enhance shareholder value. You don’t have to
sacrifice shareholder values for the stakeholder
values, it is the opposite.
Example : energy companies
The US energy stocks are currently at their lowest price since the attack on pearl harbour.
You see for the oil, that the stock prices are lowering, while for new energy (on the left) the stock prices went up
quick.
Goal
Dividends vs. job security?
5
, CSR improves shareholder value
Causal relationship :
Implementing CSR leads to higher ROE, ROI, value creation
When a firm performs well (above average for its industry), good stakeholder relations help sustain it for a
longer period of time
- Employees may work harder, or customers will buy more products or pay more for them
When a firm performs poorly, good stakeholder relations help it bounce back faster
Finance vs. Accounting
Accounting Finance
Reporting Decision making
Focus on the past Focus on the future
Rule-based (GAAP, IFRS...) Reality-based
PROFIT CASH FLOW
We are going to focus on finance from a shareholder perspective. Finance is about decision making : are you going
to invest or create debt? The past will guide our decision-making, but we are future oriented. We don’t care about
accounting rules, but we need financial reality. You need cash, this is important!
Economic value vs. book value
The focus will be on the economic value of assets and sources of value. It will not be about the accounting value,
so not reporting about the past.
We want to understand not the accounting value of the equity, or the earnings the company has retained in the
past. We want to look at equity value of a company. For a quoted company the equity is the market value, which
is the current share price x the number of shares -> this way we will see how the shareholders want to pay and
how much they want to value the company. You will see that the accounting value of equity will be a lot lower
than the market value of equity, this by growth options. On the accounting balance sheet we don’t see the
intangible values, such as growth options, we cannot see it from the past.
The PP&E, inventory... all tangible assets are all quite good shown on the balance sheet of a company.
E.g. the market value of the equity of a company is 11 billion and together with the debt, we get the enterprise
value, which is here 18 billion. However we only see 15 billion on the side of the assets, so 3 billion is the value of
the growth options. Investors say that the value of the company is 3 billion more valuable than the assets shown
in the books.
If you take a company like Amazon, Apple, Google... there is a huge difference between the accountant value of
equity and the market value of the equity. This is shown in the example of the young company. Here we have a
value of growth options of 9 million, so all the value is resight in the future. => we are looking at what the future
will hold for the company. If the future of the company is good, this will resemble in a high equity and high growth
options.
6
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