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Summary Strategic Financial Decision Making (prof. Sekerci)
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Strategic Financial Decision MakingTable of Contents
1. Review of key concepts in corporate finance ......................................................................... 4
1.1. Financial markets ......................................................................................................... 4
1.2. Investment valuation ................................................................................................... 7
1.2.1 Decision tools ...................................................................................................................................7
1.2.2 Key ingredients of NPV...................................................................................................................18
1.3. Firm valuation............................................................................................................ 20
1.3.1 Dividend discount model (DDM) ....................................................................................................20
1.3.2 Total payout model ........................................................................................................................21
1.3.3 Discounted cashflow (DCF) ............................................................................................................21
1.3.4 Multiples ........................................................................................................................................22
1.3.5 Book value approach (BV) ..............................................................................................................23
2. Advanced valuation ........................................................................................................... 23
2.1 The Weighted Average Cost of Capital Method ........................................................... 23
2.2 The Adjusted Present Value Method .......................................................................... 28
2.3 The Flow-to-Equity Method........................................................................................ 31
2.4 Costs of Capital of a Project or Unlisted Firm .............................................................. 33
2.4.1 Hamada approach (risk-less debt) .................................................................................................34
2.4.2 Conine approach (risky debt) .........................................................................................................35
2.5 Valuation of International Firms ................................................................................. 35
3. Raising equity capital ......................................................................................................... 40
3.1. Equity financing for private companies ....................................................................... 40
3.1.1 Types of sourcing ...........................................................................................................................40
3.1.2 Valuation of a venture ...................................................................................................................41
3.1.3 Agency conflicts between entrepreneur and VC ...........................................................................42
3.1.4 Venture capital investing ...............................................................................................................44
3.1.5 Exiting an investment in a private company ..................................................................................46
3.2. The initial public offering (IPO) ................................................................................... 47
3.2.1 Timing .............................................................................................................................................47
3.2.2 Going public or staying private? ....................................................................................................48
3.2.3 Types of IPO’s .................................................................................................................................48
3.2.4 The mechanics of a traditional IPO ................................................................................................50
3.2.5 Alternative way of an IPO ..............................................................................................................53
3.3. IPO puzzles ................................................................................................................ 54
3.3.1 Underpricing...................................................................................................................................54
3.3.2 Cyclicality and recent trends ..........................................................................................................54
3.3.3 Cost of an IPO .................................................................................................................................54
3.3.4 Long term underperformance .......................................................................................................55
3.3.5 Unit IPO’s........................................................................................................................................55
3.4. The seasoned equity offering (SEO) ............................................................................ 55
, 3.4.1 The equity management model of a public firm ...........................................................................55
3.4.2 Internal capital market theory .......................................................................................................56
3.4.3 Obtaining board of directors’ approval .........................................................................................56
3.4.4 Mechanics of SEO ...........................................................................................................................56
3.4.5 Price reaction .................................................................................................................................56
3.4.6 Performance after SEO...................................................................................................................57
3.4.7 Cost of a SEO ..................................................................................................................................57
4. Agency problems in corporate finance ................................................................................ 58
4.1 Agency costs of leverage – Exploiting debt holders ..................................................... 58
4.1.1 Excessive risk taking and asset substitution ..................................................................................58
4.1.2 Debt overhang and under-investment ..........................................................................................59
4.1.3 Cashing out .....................................................................................................................................61
4.1.4 Reducing agency costs of leverage ................................................................................................61
4.2 Agency benefits of leverage – Motivating managers ................................................... 62
4.2.1 Concentration of ownership ..........................................................................................................62
4.2.2 Reduction of Wasteful Investments...............................................................................................63
4.2.3 Leverage and commitment ............................................................................................................63
4.3 Agency costs and tradeoff theory ............................................................................... 64
4.4 Asymmetric information and capital structure ............................................................ 65
4.4.1 Asymmetric information ................................................................................................................65
4.4.2 Leverage as a credible signal ..........................................................................................................65
4.4.3 Issuing equity and adverse selection .............................................................................................66
4.4.4 Implications for equity issuance ....................................................................................................67
4.4.5 Implications for capital structure ...................................................................................................67
5. Corporate governance........................................................................................................ 69
5.1 Internal Corporate Governance .................................................................................. 70
5.1.1 Management structures.................................................................................................................70
5.1.2 Ownership ......................................................................................................................................71
5.1.3 Board of directors ..........................................................................................................................76
5.1.4 Executive compensation ................................................................................................................78
5.2 External Governance through regulation .................................................................... 79
5.2.1 Emergence of regulation ................................................................................................................79
5.2.2 Acts .................................................................................................................................................79
5.3 Corporate Governance Around the World................................................................... 80
5.4 Other governance mechanisms: ................................................................................. 80
5.5 Risk Management as a Corporate Governance Mechanism ......................................... 81
6. Mergers and acquisitions ................................................................................................... 82
6.1 Background and historical trends ............................................................................... 82
6.1.1 Types of mergers ............................................................................................................................82
6.2 Market reaction to a takeover .................................................................................... 83
6.3 Reasons to acquire ..................................................................................................... 83
6.4 Valuation and the takeover process............................................................................ 87
6.4.1 Valuation ........................................................................................................................................87
6.4.2 The offer .........................................................................................................................................87
6.4.3 Tax and accounting issues ..............................................................................................................89
6.4.4 Board and shareholder approval ...................................................................................................89
6.5 Takeover defenses ..................................................................................................... 89
, 6.6 Who gets the value added from a takeover ................................................................ 91
7. Sustainability & ethics in finance ........................................................................................ 93
7.1 What are ethics? ........................................................................................................ 95
7.1.1 Why are ethical issues important?.................................................................................................95
7.1.2 How is unethical behavior possible? Poor regulation? ..................................................................95
7.1.3 Some examples…............................................................................................................................96
7.1.4 The rankings ...................................................................................................................................96
7.2 The green movement ................................................................................................. 97
7.3 Globalization and discontent ...................................................................................... 97
7.4 Corporate social responsibility (CSR) & ESG ................................................................ 98
, 1. Review of key concepts in corporate finance
1.1. Financial markets
FIRST THINGS FIRST …
What is a strategic financial decision? A decision on how you either spend or raise money.
• Investment decisions: allocating capital
• Financing decisions: paying for investments/expenses
What is the goal of a corporation?
→ Old view: maximize the firm’s value for firm’s shareholders.
→ Modern view: maximize the firm’s value for all stakeholders (e.g; employees, suppliers,
community).
Examples of strategic financial decisions:
- Whether to discontinue operations in a particular industry or country.
- Whether to take up a new investment in a particular industry or country.
- Whether to expand business in a particular product segment.
- How to finance an expansion.
- Whether to go for an initial public offering.
- Whether to acquire and merge with another company.
! Finance decisions are influenced by other business discipline functions.
TYPES OF FINANCIAL MARKETS AVAILABLE FOR MANAGERS ’ FINANCIAL DECISIONS ;
• Foreign exchange market
• International money market (< 1 year)
• International credit market (1-5 years)
• International bond market (>5 years)
• International stock market (>5 years)
a. Foreign exchange market
o Exchange of one currency for another.
o The rate at which one currency can be exchanged for another = exchange rate.
o Facilitates financial transactions and international trade for MNC’s.
o The intermediary = commercial bank.
o Works with spot markets (cash market/contante markt).
o The US dollar ($) is the commonly accepted medium of exchange.
o At any given time, somewhere around the world, a bank is open. But not all at the same
time, because of time zones!
o Spot market liquidity = the more buyers and sellers, the more liquidity.
Bid is ALWAYS < ask.
So spread is always > 0.
→ Covers the bank’s cost of conducting foreign exchange transactions.
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