Summary corporate finance: Business Economics Ba2
1. Introduction
Create value for the private sector by making good optimal investment decisions (asset side of the balance sheet) and financing decisions (equity/
liability side of the balance sheet).
Theory of valuation such as time value of money -> How do you value equity and Bonds?
Income statement
Sales & revenue
- Costs
EBIT ( earnings before interest tax)
- Interest
EBT ( earnings before tax)
- Tax
Earnings ( EPS, Dividends)
Chapter 1: The Role and Objective of Financial Management
1. Decisions
Investment decision -> will a particular investment be successful? (asset side)
Financing decision -> Where will the funds come from to finance the investment? (equity/liability side)
Dividend decision -> How should cash flows be used or distributed? That is, what is the optimal dividend policy?
2. Firms cash flow generation process
1) Raising funds (to be able to do investments) -> 2 types -> External (cash
from owners through shares and through loans and bonds from creditors)
and internal (cash flow from previous operations and the sale of their
assets).
2) To investments- acquiring assets -> long-term assets and working capital (=
the capital of a business which is used in its day-to-day trading operations,
calculated as the current assets minus the current liabilities)
3) Produce and sell products/services -> services provided or inventories
converted to cash sales and accounts receivable, accounts receivable
collected and converted to cash.
4) You use that cash to pay for loans, dividends (cash to investors), the cash
(funds) that you have left, you can use to do further investments, process
begins all over again.
3. Shareholder Wealth Maximizing
Maximizing PV (=present value) of expected future cash flows -> depends on the amount of the PV, timing of the PV (one euro now is forth more
than one euro in one year), the risk of the PV ( the riskier, the higher the PV will be) -> measured by market value the firm’s common stock =>
Good decision making increases the market price of common stock.
Wealth maximization ( physical flow of cash, maximization the expected future cash flow) ≠ profit maximization (earnings)
4. Agency relationship
You need the management to make the day to day decisions, make decisions in the wellbeing of
the shareholders (creating value). Shareholders elect the board of directors and they elect the
management.
Shareholders & Management have diverging objectives -> Management may maximize its own
welfare instead of the shareholders’ wealth: consumption of on-the-job perquisites (use of
company cars, airplanes, luxurious offices), empire building (making the firm bigger, expanding ≠
creating value) -> agency problems
Agency costs are the costs to solve the agency problems (When management doesn’t do the right thing)
- Management incentives (stock options = a benefit in the form of an option given by a company to an employee to buy shares in the company
at a discount or at a stated fixed price).
- Monitor performance (audits = external firm to see if the management does well)
- Complex organization structures (multiple managers)
- Protective covenants (capital rationing = a process that companies use to decide which investment opportunities make the most sense for
them to pursue).
Chapter 5: The Time Value of Money
1. Simple and Compound Interest
One € today is worth more than one € in one year -> because of inflation or you can invest it.
, Simple Interest -> Interest paid on the principal sum only. When you put € 100 in
your bank account, you get interest on the principal value only ->
Compound Interest -> Interest paid on the principal and on prior interest
that has not been paid or withdrawn, you pay interest on your interest.
2. Future Value of a Single Payment Cash Flow
At the end of year n for a sum compounded at interest rate is FVn = PV0 (1 + i)n -> in the table FVIFi,n shows the future value of €1 invested for n
years at interest rate i: FVIVi,n = (1 + i)n -> When using the table 1 FVn = PV0 (FVIFi,n).
Tables have three variables -> Interest factors (IF), Time periods (n), Interest rates per period (i) -> If you know any two, you can solve algebraically
for the third variable.
3. Present Value of a Cash Flow
PV0 = FVn
PVIFi, n = 1
(1 + i)n
PV0 = FVn(PVIFi, n) -> in table 2
4. Interest Compounded More Frequently Than Once Per Year
Sometimes, you can get interest every half year e.g. when you have an annual interest rate of 5%, in America you get interest paid every half year.
m= # of times interest is compounded, n = # of years
future value =
present value =
Compounding and effective rates -> What would be the equivalent of a yearly interest rate? -> more than 5% because after 6 months the 2.5% you
get also compounds, also gets interest -> to calculate this we use the formula of the effective annual rate of interest -> 1 + ieff = (1 + inom/m)m
5. Annuity
In many applications, you have multiple cashflows into the future, each period the same amount -> an annuity is a series of equal cashflows (PMT
= payment) for a specified number of periods.
Ordinary annuity is where the PMT occurs at the end of each period.
Annuity due is where the PMT occurs at the beginning of each period.
6. Future Value of an Ordinary Annuity
FVAN3 = 1,000 * (1+6%)2 + 1,000 * (1+6%)1 + 1,000 *(1+6%)0
FVAN3 = 1,000 * [(1+6%)2 + (1+6%)1 + (1+6%)0]
FVIFAi, n = (1 + i)n – 1 -> formula If
i
FVANn = PMT(FVIFAi, n) -> in table 3
7. Present Value of an Ordinary Annuity
PVAN0 = …. + 1,000 + 1,000 + 1,000
(1+6%) 3 (1+6%)2 (1+6%)1
PVAN0 = 1,000 * […. + 1 + 1 + 1 ]
(1+6%)3 (1+6%)2 (1+6%)1
PVIFAi, n =
PVAN0 = PMT(PVIFAi, n) -> Table IV
Present Value of a Perpetuity (= an annuity that goes on forever) -> PVPER0 = PMT / i
8. Annuity Due
Future Value of an Annuity Due -> FVANDn = PMT(FVIFAi, n)(1 + i) in Table III
, Present Value of an Annuity Due -> PVAND0 = PMT(PVIFAi, n)(1 + i) in Table IV
