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Summary Advanced Corporate Finance | Msc Finance VU
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Summary of all lectures for the course Advanced Corporate Finance. Including example questions useful for the exam!
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Advanced Corporate FinanceTopic 1: Short term financial management Topic 4: Structured corporate finance
Topic 2: Long term financial management - Topic 5: Credit risk measurement and pricing
capital structure
Topic 3: Equity risk pricing Topic 6: Option pricing in corporate finance
General
Overall framework: business risk, finance risk, equity and credit risk measurement, expected
returns for debt and equity, cost of capital WACC, comparison ROIC and WACC. Proxies for
LT financing risk and short-term financing risk. Concept of Market Balance sheet vs Book
balance sheet
Corporate finance
- Managing the balance sheet
- Matching assets with funding
Market balance sheet
Assets: Free cash flow of the company (engine)
Market value of equity: share price times total shares
E D
Value of a company: FCF /(1+r )t t = WACC = ∗r e + ∗r
E+ D E+D d
Business
- FCF t
- Business risk equity risk (manager interested in upside of the company)
beta aim return on equity
- Financing risk credit risk (manager interested in downside of the
company) spread return on debt
NWC
Short term finance: working capital, liquidity risk:
TA
D
Long term finance: Capital structure:
E
Cash Management: organization of the payments flow
Topic 1: Short term financial management
First understanding of a business by looking at financial ratios
- Profitability analysis
o Dupont formula: ROE * ROA = (Net profit margin * asset turnover * EM)
o Added value: Gross margin ratio = (net sales – COGS) / net sales
1
, o Fixed vs variable costs: Break even analysis
- Efficiency, leverage, liquidity, coverage, growth and ratio’s with market value
information
- Dupont analysis: analyzing fundamental performance, decompose drivers of ROE
(Measured: operating efficiency, asset use efficiency and financial leverage). Identify
strengths or weaknesses that should be addressed.
- Increase ROE: Profit margin or asset turnover increase sign of good company
management
- Increase ROE: greater amount of financial leverage risky investment
Business performance; key drivers of sales, cost structure and profitability, solvency,
liquidity, coverage ratio
Cash conversion cycle provides insight in the financing need for working capital how
efficiently a company's managers are managing its working capital. It measures the length of
time between a company's purchase of inventory and the receipts of cash from its accounts
receivable
- CCC = Days Inventory outstanding + Days sales outstanding – Days payable
outstanding
- Working capital needed to overcome cash conversion cycle
- Negative conversion cycle positive for startups (e.g. Mojo music events)
- it could be good as a company with negative working capital funds its growth in sales
by effectively borrowing from its suppliers and customers.
- Tools to lower CCC leasing, inventory ownership, make or buy
Largest listed global companies can afford more payment days outstanding in cash
conversion cycle due to powerful in supply chain. (increase in DPO)
- Difficulty in funding themselves Lower the value of assets
- Supplier receives money earlier than expected
- Buyer can extent their DPO and use the available cash for short-term investments
and to increase their working capital and free cash flow.
- Banks receives more interest
- Win, win, win
2
, Exam question: a) The CCC has a direct link with corporate financing need. Explain: b) Give a
cost/benefits analysis for the small supplier engaging in supply chain finance with a large
client (with a good credit rating) .
a) Multiplication the CCC with sales (or COGS or something in between) gives directly
the financing need for working capital
b) costs are a discount on their invoices to large clients. Benefits are the access to
cheaper funds of debt via the good credit rating of the large client.
At the end the benefits should outweigh the costs. In other words, the discount on
their invoices should outweigh the capital costs which would have been made if the
small supplier would have financed the accounts receivable himself.
Corporate Liquidity Management
“The key issues in liquidity management are how much to invest in each component of
current assets and current liabilities and how to manage these investments effectively and
efficiently in order to minimize insolvency risk”
- Cash ratio, current ratio, quick ratio, net working capital ratio
Conservative finance:
- Long term higher equity and Short term higher NWC
Most of the improvements for net working capital can be reached in changes in inventory
No short-term debt and no cash, the networking capital over total assets is pushed down.
Cash position
FCF = Cash income – cash outflow – inv CF delta cash balance. Shift sales two months
ahead/ backwards
Operational cash flows: Net income + depreciation – change in working capital
Investment cash flows: Investments in fixed assets
Financing cash flows: dividend, loan payback at maturity, issue new shares
Cash budget: look in the future (sales forecasts), working capital targets, establish external
financing need, financing working capital
Aggressive vs conservative ST finance
- Low interest costs (flexibility), high renewal risk and interest risk, more risk liquidity
position.
Short-term financial planning
Forecasting short-term financing needs: forecast future cash flows surplus or deficit.
Negative or positive cash flow shocks, seasonality.
Matching principle: ST needs should be financed with ST debt and LT with LT. Permanent
and temporary working capital.
Short-term financing with bank loans: small firms
Short-term financing with commercial paper: large, well-known firms
Short-term financing with secured financing: factoring, inventory as collateral
3
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