Summary Corporate Finance
Excluded parts: 17.4 & Ch. 20, we eventually did not need to study these parts.
Lecture 1 Introduction to Corporate Finance 4
Chapter 19 Behavioural Finance 4
19.1 Introduction to Behavioural Finance 4
19.2 Biases 4
19.3 Framing Effects 5
Lecture 1 6
The Corporate Life Cycle The Basic Principles of Corporate Governance 6
Sources of financing 6
Overconfidence 6
Framing effect 6
Over-Optimism Confirmation Bias 6
Lecture 2/3 Raising Capital 7
Chapter 14 Raising Capital 7
14.1 The Financing Life Cycle of a Firm: Early-Stage Financing and Venture Capital 7
14.2 Selling Securities to the Public: the Basic Procedure 8
14.3 Alternative Issue Methods 8
14.4 Underwriters 8
14.5 IPOs and Underpricing 10
14.6 New Equity Sales and the Value of the Firm 11
14.7 The Costs of Issuing Securities 11
14.8 Rights 12
14.9 Dilution 13
14.10 Issuing Long-Term Debt 13
14.11 Bank Loans 13
Lecture 2 22-04-2021 14
Raising Capital at the Start up/Young Stage 14
Raising Capital through going public: IPOs 16
Lecture 3 (26-04-2021) 16
Initial Public Offering - FACEBOOK case 16
Seasoned security offering 17
Lecture 4 Capital Structure 18
Chapter 15 Financial Leverage and Capital Structure Policy 18
15.1 The Capital Structure Question 18
15.2 The Effect of Financial Leverage 18
15.3 Capital Structure and the Cost of Equity Capital 19
15.4 M&M Propositions I and II with Corporate Taxes 20
15.5 Bankruptcy Costs 22
15.6 Optimal Capital Structure 23
15.7 The Pie Again 25
15.8 Signalling 25
15.9 The pecking-Order Theory 25
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, 15.10 Observed Capital Structures 26
15.11 A Quick Look at the Bankruptcy Process 26
Lecture 4 (04-05-2021) 28
The capital structure question 28
Debt-equity trade off and effects of financial leverage 29
Optimal Capital Structure 29
Lecture 5 Payout Policy 31
Chapter 16 Dividends and Payout Policy 31
16.1 Cash Dividends and Dividend Payment 31
16.3 Does Dividend Policy Matter? 32
16.3 Real-World Factors Favouring a Low-Dividend Payout 33
16.4 Real-World Factors Favouring A High-Dividend Payout 33
16.5 A Resolution of Real-World Factors? 34
16.6 Share Repurchases: An Alternative TO Cash Dividends 35
16.7 What We Know and Do Not Know About Dividend and Payout Policies 35
16.8 Stock Dividends and Stock Splits 36
Lecture 5 (11-05-2021) 37
Cash dividends and dividend payment 37
Why do dividends matter? 38
Does dividend policy matter? 38
Why does dividend policy matter 38
Pros and cons of paying dividends 39
Stock dividend and stock splits 39
Share repurchase 39
Share repurchase and dividends 39
Lecture 6 Short-Term Financial Planning 40
Chapter 17 Short-Term Financial Planning and Management 40
17.1 Reasons for Holding Cash 40
17.2 Understanding Float 41
17.3 Investing Idle Cash 41
17.5 Credit and Receivables 42
17.6 Terms of the Sale 42
17.7 Analysing Credit Policy 45
17.8 Optimal Credit Policy 45
17.9 Credit Analysis 46
17.10 Collection Policy 46
17.11 Inventory Management 47
17.12 Inventory Management Techniques 47
Lecture 6 (18-05-2021) 49
Balance Sheet Concept of Working Capital 49
Managing working capital by ratios 49
Working capital to sales ratio (as % of sales) 49
Working Capital: the operating cycle 50
Managing Cash 52
Beau Maria Ruiter, University of Twente, International Business Administration, M7 FENSI (2020/2021) 2
,Lecture 8 Mergers & Acquisitions 54
Chapter 22 Mergers and Acquisitions 54
22.1 The Legal Forms of Acquisition 54
22.2 Accounting and Tax Considerations 56
22.3 Gains from Acquisitions 56
22.4 Some Financial Side-Effects of Acquisitions 59
22.5 The Cost of An Acquisition 59
22.6 Defensive Tactics 60
22.7 Some Evidence On Restructurings: Do M&A Pay? 62
22.8 Divestitures and Restructuring 62
Lecture 7 (26-05-2021) 63
Risk of start-ups and SMEs 63
Behavioural Aspects of Risk 64
Lecture 8 (01-06-2021) 65
Takeover methods/The legal forms of acquisition 65
Takeover methods 65
Reasons for M&As 66
Financial Side effects of Acquisitions 67
Cost of Acquisition 67
Defensive Tactics 68
Beau Maria Ruiter, University of Twente, International Business Administration, M7 FENSI (2020/2021) 3
,Lecture 1 Introduction to Corporate Finance
Chapter 19.1 - 19.3
Chapter 19 Behavioural Finance
19.1 Introduction to Behavioural Finance
- Behavioural finance: the area of finance dealing with the implications of reasoning errors on financial
decisions
- The beginning of business wisdom is to recognize the circumstances that lead to poor decisions, and thereby
cut down on the damage done by financial blunders
- Errors in reasoning are often called cognitive errors
19.2 Biases
- If your decisions exhibit systematic biases, then you will make systematic errors in judgement
- The type of error depends on the type of bias
- Five biases
● Overconfidence
● Over-optimism
● Confirmation bias
● Self-attribution bias
● The planning fallacy
Overconfidence
- Overconfidence: the belief that your abilities are better than they really are
- You are overconfident when you overestimate your ability to make the correct choice or decision
- The belief that you can forecast the future with precision is a common form of overconfidence
- Overconfidence y investors would cause them to overestimate their ability to pick the best equities, leading to
excessive trading
Over-optimism
- Over-optimism: taking an overly optimistic view of potential outcomes
- Overestimating the likelihood of a good outcome and underestimating the likelihood of a bad outcome
- Taking an overly optimistic view of potential outcomes
- Over-optimism and overconfidence are related but not the same → an over-confident individual could forecast
a bad outcome
Confirmation bias
- Confirmation bias: searching for (and giving more weight to) information and opinion that confirms what you
believe, rather than information and opinion to the contrary
- Focus more on information that agrees with your opinion, and to downplay or ignore information that doesn’t
agree with or support your position
- Confirmation bias can lead managers to ignore negative information about potential investments and focus
only on that information which proves they are correct in their opinions
- Example: 2007 Banking Crisis → all signs were there but were ignored
Self-Attribution Bias
- Self-attribution bias: relates to the feeling that when things to plan, it is because of your decisions and ability
to perform. However, when bad outcomes occur, you blame other or external events for the failure
Beau Maria Ruiter, University of Twente, International Business Administration, M7 FENSI (2020/2021) 4
, - Self-attribution bias is a close relation to confirmation bias in that you selectively perceive past events or
information as supporting your own ability, whereas confirmation bias selectively identifies information that
supports your decision and ignores everything else
- Self-attribution bias can lead managers to adhere to a poor business strategy because they believe that the
reason it is not working is because of events outside their control
- They may put any success in a company down to their decisions, leading to a further behavioural bias:
overconfidence
The Planning Fallacy
- Planning fallacy: says that managers have the natural tenancy to underestimate the costs, risks and time of
undertaking new projects
- More complex interpretation of the planning fallacy is that mangers only consider a single forecast point when
they decide to undertake new investments and ignore the overall distribution of potential outcomes that may
occur
- Fairly straightforward to mitigate the risk of underestimating the effort in a new venture
● Reference class forecasting uses large datasets of previous similar projects to allow a manager to
statistically estimate the likelihood of budget or time overruns
● Senior managers can ensure that proposers of new projects have considered in detail the assumptions
underlying each cost and income variable
19.3 Framing Effects
- You are susceptible to framing effects if your decisions depend on how a problem or question is framed
- Frame dependence: the tendency of individuals to make different (and potentially inconsistent) decisions,
depending on how a question or problem is framed
Loss Aversion
- Focussing on gains and losses instead of overall wealth is an example of narrow framing, and it leads to a
phenomenon know as loss aversion
- Loss aversion is also known as the break-even effect, because it frequently shows up as individuals and
companies hang on to bad investments and projects, hoping that something will happen that will allow them
to break even and thereby escape without a loss
- Debt financing increases the likelihood of losses, and even bankruptcy → debt avoidance could be due to loss
aversion
House Money
- Some money feels more precious than other money, but these feelings are plainly irrational, because any cash
you have buys the same amount of goods and services, no matter how you obtained that cash
- Tendency to sell winners and hold losers is known as the disposition effect
- Through time, you will mentally account for unrealized gains or losses when you compare the current price
with the purchase price, and how you feel about the investment depends on whether you are ahead or behind
→ mentally accounting
● Unknowingly have a personal relationship with each of your investments → harder to sell one of them
- Other, related types of judgement error:
● Myopic loss aversion: the tendency to focus on avoiding short-term losses, even at the expense of
long-term gains
● Regret aversion: the tendency to avoid making a decision because you fear that, in hindsight, the
decision would have been less than optimal. Regret aversion relates to myopic loss aversion
● Endowment effect: tendency to consider something that you own to be worth more than it would be
if you did not own it. Because of the endowment effect, people sometimes demand more money to
give up something than they would be willing to pay to acquire it.
Beau Maria Ruiter, University of Twente, International Business Administration, M7 FENSI (2020/2021) 5
, ● Money illusion: if you suffer from a money illusion, you are confused between real buying power and
nominal buying power
Lecture 1
The Corporate Life Cycle The Basic Principles of Corporate Governance
Sources of financing
Overconfidence
- Overconfidence: the belief that your abilities are better than they really
are
- Most business decisions require judgements about the unknown future.
Most managers are overconfident about predicting future cash flows
- Equity investors: overconfidence leads to excessive trading. Brokerage
accounts with most trading underperform the most
Framing effect
- Frame dependence (or framing effect): the tendency of individuals to make different (and potentially
inconsistent) decisions depending on how a question or problem is framed (presented, formulated)
Over-Optimism Confirmation Bias
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