Samenvatting
Summary Corporate Financial Management
- Instelling
- Universiteit Van Amsterdam (UvA)
Summary of all the Lectures
[Meer zien]Voorbeeld 3 van de 30 pagina's
Voorbeeld 3 van de 30 pagina's
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Door: jmiguelg • 2 jaar geleden
Voorbeeld van de inhoud
CFM Week 11 Discounting
This course is all about making decisions that add value to a company. Any decision has a financial
component to it. So any decision will cost you money, and for this reason it is good to learn more
about finance. We will study how various alternatives influence the value of the company.
Why focus on shareholder value?
Because it corresponds to the nature of the contract between companies and shareholders:
shareholders are residual claimants which have no guarantee of getting any return on their
investment, but they are entitled to everything that remains after other claims have been settled.
This nature of the contract means that maximizing total value for the company and maximizing
shareholders value is essentially the same thing. So the focus on shareholder value is logical given the
way the legal contract works. However there is of course tension there. This will be discussed in week
6. This also requires finance to understand the situations.
Cash flows = is the value I’m getting out of something worth at least as much as I’m paying for it?
Difficulty is that cash flows aren’t matched in time. Expenditure and revenues come at different
moments.
Example having €900 now or the chance to have €1000 in two years, there is the risk that you don’t
know what will happen in time and the risk that you will not get your money back if you invest in
someone for example, this is called credit risk.
Principal problems with cash flows (CFs) in the future:
- They’re risky (the amount may change);
- There is a time value of money: a fixed amount of cash may not have the same value (e.g.
due to inflation or different exchange rates), and we cannot use the money right now, so we
forego (afzien) the use of it for a while, reducing its usefulness. (nuttigheid)
This is all likely to reduce the value of the cashflow. So we have to take the risk into account.
In order to compare a future cash flow (say, revenue from a product to be developed) with one today
(the developments costs) we need to discount the future cash flow. The general formula (in case of a
time difference of a single period) for that is:
The discount rate r combines all elements that make a future cash flow have less value compared to
one today: riskiness (risico) and time preference. It’s a positive number, often quoted as a
percentage (4% means r = 0,04 in formula).
To summarize:
- The discount rate looks at the time value of money and how risky the investment is.
- How risky the investment is depends on the risk of the project (compliance, environmental
risk etc), but also the market conditions. So it can be that the risk of the project is constant,
but the price the market wants to offer for this is not. So market conditions play a important
role in this interaction.
2 Net Present Value – NPV
Net Present Value = combines cash flows from different periods, each discounted back to the current
time.
, - If we have the discount rate r, we can compare (for example) expenditure today with
revenue in the next period. The result of adding all cashflows – positive and negative – after
they have been discounted tell us how much value we create or loose from a decision.
- A set of cash flows that has a positive NPV adds value to your company, a negative value
implies a loss of value.
- Crucial for the NVP rule are the discount rate and the cash flows themselves. If they
numbers used are not appropriate, this will influence the outcome.
3 Discount rates
Discount rates are closely tied to risk: the riskier the cash flow, the more expected return is required
to make investors / companies take on the risk.
- Market values: crucial insight of finance is that risk is also a tradable good, with its own price.
- There may be different discount rates for different time periods: the interest rate for a loan
starting now and maturing in 30 days is different from that for a loan maturing in 10 years.
Again, this is duo to difference in risk and time value of money.
Interest rates and discount rates are related, so factors driving interest rates are also relevant:
- Inflation: markets set interest rates such that the reduction of purchasing power caused by
inflation is at least compensated. ( the interest rate you pay/receive is the nominal interest
rate, subtract the inflation rate and you have the real interest rate.
- (Expected future) government policies, central bank actions, and simply supply and demand
The discount rate r will be regarded as given for now, later we will explore how to determine an
appropriate discount rate.
Ways of quoting an interest rate
- You need the interest rate per period. It’s common (gebruikelijk) to have periods that are
different from 1 year, yet to quote interest rates on an annual basis.
- If you have an Effective Annual Rate (EAR), that is what you will truly receive (or pay). An EAR
of 5% which periods lasting 6 months, is in fact 2,47% per period, so that (1.0247)^2=1.05.
Je berekent die 2,47% door: 1.05^(6/12) = 1,02469 -1 * 100 = 2,469 % = 2,47%
- If you have an Annual percentage Rate (APR) it’s a simple interest rate, which disregards
compounding. Paying an APR of 18%, with monthly compounding is actually even more
expensive. 18/12=1,5% a month. 1,015^12= 1.196, so the EAR is 19,6%.
4 Cash flows – market values
- Source of the cashflows: these will usually come from outside finance: marketeers, fiscal
experts, accountants.
- !!NPV analysis requires us to use market values!! The reason is that if we don’t, we ignore
the law of one price, which states that, under perfect competition, investment opportunities
that are equal, should trade at an equal price. So if we don’t follow the market values we are
going to get inconsistent calculations, even if we bring them back to the present value the
cashflows will not be comparable. We need comparability because we have to think about
the competition.
- This is a driving force behind many results in Finance, as it rules out arbitrage profits,
meaning we can depend on the price reflecting competitive market conditions.
, 5 Arbitrage
Arbitrage = Making money out of price differences for the same good is called arbitrage.
- It’s a riskless profit.
- Financial markets are quite efficient at setting prices such that there is no arbitrage, so prices
are the same. The market price is the only (relevant_ price).
- If we value a good at $40, and the market price is $50, we shouldn’t be using it, but selling it
for 50. We’re leaving a $10 profit on the table.
- If our valuation is above the market’s, you should buy the good in the market.
6 Market values vs. book values
Yet market prices / values aren’t necessarily the same as book values. The principles behind them
differ:
- book values reflect what is present right now, as an accumulation of past actions.
- Market values reflect what is expected in the future: they derive their value based on what
future user are willing to pay. Expectations feature heavily in these values, so they mainly
depend not on the past, but on future potential.
In essence the difference between book and market values boils down to the microeconomic
concepts of sunk costs and opportunity costs (next lecture). Market values are based solely on the
latter, what has been paid in the past is irrelevant. Opportunity cost are market values and the sunk
costs we ignore.
If we want to make decisions in finance, for example the NVP calculation we focus on market values,
because it is forward looking and looks at the alternative which we want to use in decision making.
Perpetuities & Annuities (eeuwigduren & lijfrenten)
PVperpetuity = CF * 1/R = CF / R Example: 200 euros every year for ever, at 5%. Is worth now?
PVperpetuity = 200 * 1/0,05 = ,05 = 4000 euro.
We can use this to quickly calculate the value of a stream of CFs that lasts for
a long time, but not perpetually. This is called an annuity (even if the periods
aren’t years, but for example months).
Perpetuities with a growth rate
- If we however suppose that the perpetuity increases every period with a certain percentage,
the value will rise.
PVperpetuity with growth rate g = C / (R-G)
- That means that the formulas for annuities can be adjusted in the same way.
7 Implementation
Bringing back a cash flow one period is time requires discounting by 1/(1+r), bringing it back 2 period
requires a discount rate of 1/(1+r)^2.
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