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Samenvatting / summary book Corporate Finance Principles and Practice Denzil Watson and Antony Head 6th edition
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Samenvatting / SummaryCourse: Financial Management
Corporate Finance
Principles and Practice
Sixth Edition
Denzil Watson & Antony Head
,Table of Contents
Chapter 1: The finance function.....................................................4
1.1. Two key concepts in corporate finance............................................4
1.2. The role of the financial manager...................................................4
1.3. Corporate objectives.....................................................................4
1.4. How is shareholder wealth maximized?..........................................5
1.5. Agency Theory..............................................................................5
Chapter 2: Capital markets, market efficiency and ratio analysis......6
Introduction........................................................................................6
2.1 Sources of business finance............................................................6
2.2 Capital markets .............................................................................6
2.3 Capital Market efficiency ................................................................7
2.4 Assessing financial performance ....................................................8
Chapter 3: Short-term finance and the management of working
capital........................................................................................ 11
Introduction.......................................................................................11
3.1 The objectives of working capital management..............................11
3.2 Working capital policies................................................................11
3.3 Working capital and the cash conversion cycle...............................12
3.4 Overtrading.................................................................................12
3.5 The management of inventory.......................................................12
3.6 The management of cash..............................................................13
3.7 The management of receivables....................................................14
Chapter 4: Long-term Finance: Equity Finance..............................16
Introduction.......................................................................................16
4.1. Equity Finance.............................................................................16
4.2. The stock exchange.....................................................................16
4.3. Rights Issues...............................................................................18
4.4. Scrip issues, Share Splits, Script dividends and share repurchases 19
4.5. Preference Shares.......................................................................20
Chapter 5: Long-term Finance: Debt finance, Hybrid Finance and
Leasing....................................................................................... 21
Introduction:......................................................................................21
5.1. Bonds, loan stock and debentures................................................21
5.2. Bank and institutional debt..........................................................22
5.3. International Debt finance...........................................................23
5.5. Warrants.....................................................................................24
5.6. The valuation of fixed-interest bonds...........................................24
5.7. The valuation of convertible bonds...............................................25
5.8. Leasing.......................................................................................26
5.9. Evaluation the financial effect of financing choices........................27
5.10. Conclusion................................................................................27
2
,Chapter 8: Portfolio theory and the capital asset pricing model.....28
8.1. The measurement of risk.............................................................28
8.2. The concept of diversification......................................................28
8.3. Investor attitudes to risk.............................................................29
8.4. Markowitz’s portfolio theory........................................................30
8.5. Introduction to the capital asset pricing model.............................31
8.6. Using the CAPM to value shares...................................................31
8.7. Empirical tests of the CAPM.........................................................33
8.8. Conclusion..................................................................................33
Chapter 9: The cost of capital and capital structure.......................34
Introduction:......................................................................................34
9.1. Calculating the cost of individual sources of finance......................34
9.2. Calculation of weighted average cost of capital.............................37
9.4. The CAPM and investment appraisal.............................................37
9.5. Practical Problems with calculating WACC.....................................39
9.6. WACC in the real world................................................................39
9.7. The cost of capital for foreign direct investment...........................39
9.8. Gearing: Its measurement and significance...................................40
9.9. The concept of an optimal capital structure..................................40
9.10. The traditional approach to capital structure..............................41
9.11. Miler and Modigliani (I): The net income approach.......................41
9.12. Miller and Modigliani (II): corporate tax......................................42
9.13. Market imperfections.................................................................43
9.14. Miller and personal taxation.......................................................44
9.15. Pecking order theory.................................................................44
9.16. Does an optimal capital structure exist? A Conclusion.................44
Chapter 10: Dividend policy.........................................................45
Introduction:......................................................................................45
10.1. Dividends: Operational and Practical Issues................................45
10.2. The effect of dividends on shareholder wealth............................46
10.3. Dividend irrelevance..................................................................46
10.4. Dividend relevance....................................................................46
10.5. Dividend relevance or irrelevance?.............................................47
10.6. Dividend Policies.......................................................................47
10.7. Alternatives to cash dividends....................................................48
10.8. Empirical evidence on dividend policy.........................................49
10.9. Conclusion................................................................................49
Chapter 11: Mergers and Takeovers..............................................49
11.4. Target company valuation..........................................................49
3
,Chapter 1: The finance function
(het stuk over rente, huidige waarde geld, en wat het geld over paar jaar
waard is, heb ik niet meegenomen in deze samenvatting.)
1.1. Two key concepts in corporate finance
Risk refers to the possibility that actual outcome may differ from expected
outcome.
Corporate finance (ondernemingsfinanciering): is een van de primaire
taken van de treasury (schatkist; geld van onderneming) die bestaat uit het
financieren van een onderneming op lange termijn. De treasury zorgt ervoor
dat de onderneming financierbaar blijft voor de vermogensmarkt en hierop
inspelen.
Verschil tussen accounting en (corporate) finance is dat accounting zich richt
op het van informatie voorzien van bijvoorbeeld managers, denk aan
jaarverslagen en de finance richt zich meer op de business strategie,
investeringsplannen en dividend.
Efficient en effectief management of finance omvat de volgende zaken
Provision of resources (beschikbaar stellen/hebben van fondsen)
Allocation of resources (waar fondsen op geïmplementeerd (deplay) op
zijn)
Control of rescources (zijn fondsen effectief of niet?)
Total shareholders return = ((dividend + toename waarde van aandelen
(P1-P0)) / P0) * 100)
1.2. The role of the financial manager
Financial managers decisions kunnen worden opgedeeld in drie gebieden;
Financing decisions
Dividend decisions
Invest decisions
Er is veel onderlinge relatie tussen de verschillende decisions. Zo leidt een
hogere uitkering van dividend tot minder beschikbare financiën, dus zal er
bijvoorbeeld meer geld uit externe bronnen moeten worden gehaald en
investeringen zullen wellicht moeten worden geschrapt of worden uitgesteld.
1.3. Corporate objectives
Hoofddoel van een Financial manager op lange termijn is ‘Maximalisation of
shareholder wealth’. Dit kan drie variabelen met zich mee brengen;
- Kwantitatieve problemen,
- Tijdsbestek
4
, - Gevaar van cash flows verzameld
om het bedrijf.
Daarom kunnen op kortere termijn ook
andere doelen worden nagestreefd zoals:
- winstmaximalisatie,
- verkoop maximalisatie,
- overleven
- sociale verantwoordelijkheid.
1.4. How is shareholder wealth
maximized?
NPV = net present value van alle positieve projecten binnen bedrijf
1.5. Agency Theory
The agency problem: treedt op wanneer managers beslissingen maken die
niet consistent zijn met de doelstellingen van Share Holder Wealth
Maximalisation. De volgende drie punten dragen bij aan het feit dat dit
optreedt:
Verschil tussen eigendom en zeggenschap; eigenaren managen niet,
maar bepalen dat de managers het bedrijf namens hun het bedrijf
runnen
Doelen van managers verschillen met die van de
eigenaren/aandeelhouders.
Verschil in informatie voorziening tussen managers en aandeelhouders
(aandeelhouders krijgen vaak maar eens paar jaar een jaaroverzicht en
doen aan de hand daarvan uitspraken, managers krijgen continue
informatie.)
Tekenen van the ageny problem:
Managers financieren het bedrijf grotendeels met het eigen vermogen
Managers accepteren weinig risico, kort-terug betalende investeringen
Managers wijzigen bedrijfsvoering
Managers volgen ‘pet-projects’ (=hobby projectjes?)
Managers worden beloond voor prestaties die eigenlijk onder
gemiddeld liggen
Hoe omgaan met agency problem?
Monitoring: Duur project in termen van geld en tijd. Bovendien moet dit
dan vaak gefinancierd worden door de grote investeerders. De kleine
profiteren hier lekker aan mee, maar betalen niet = ‘free-riders’.
Bovendien kunnen slechte managers via anders wegen (in het geheim)
te werk gaan.
5
, Belonen van goed gedrag. Kan op twee manieren: ‘Performance
Related Pay ‘ en ‘Executive Share Option Schemes’ (uitvoerende
aandelen optie regelingen). Beide kennen ook weer hun nadelen en
daarom is het het beste om (in) de contracten van de managers de
volgende kosten te minimaliseren:
o Financial contracting costs
o Opportunity costs of contractual contraint
o Costs of managers’ reward
o Monitoring costs
o Loss of wealth due to suboptimal behavior
Chapter 2: Capital markets, market efficiency and ratio analysis
Introduction
Capital markets are places where companies, which need long-term
finance, can meet investors who have finance to offer. It is important for
companies and investors that the capital market is efficient.
2.1 Sources of business finance
The aims of an efficient financing policy in a company will be to raise the
appropriate level of funds, at the time they are needed, at the lowest
possible cost.
2.1.1 Internal finance
By internal finance we mean cash generated by a company, which is not
needed to meet operating costs, interests payments, tax liabilities, cash
dividends or replacements of non-current assets. In corporate finance this
surplus cash is commonly called: retained earnings. Also efficiency
saving increases internal finance.
2.1.2 External finance
There are many kinds of external finance available, which can be broadly split
into debt, and equity finance. External finance can also by classified as
short term (less than 1 year), medium term (between 1 and 5 years) or
long term (more than 5 years) and whether it is traded (e.g. ordinary
shares and bonds) or untraded (e.g. bank loans). Figure 2.1 shows a range
of financial instruments and there relationships.
In chapter 3 Short-term finance is discussed.
In chapter 4 equity finance (ordinary shared and preference shared) is
treated.
In chapter 5 debt finance (corporate bonds, bank debt and leasing) is treated.
6
,2.1.3 The balance between internal and external finance
The relative proportion of internal and external finance to be used for a
capital investment project will depend on a number of factors:
The level of finance required (larger projects are likely to require funds
from outside).
The cash flow from existing operations (when this is weak -> more
external financing).
The opportunity cost of retained earnings (the best alternative way of
return for shareholders is called the opportunity cost of retained
earnings).
The costs associated with raising external finance.
The availability of external sources of finance.
Dividend policy.
2.2 Capital markets
Capital markets are markets for trading long-term securities. The most
important ones are: ordinary shares, long-term debt securities such as
secured bonds, unsecured bonds and convertible bonds and to a much lesser
extend preference shares.
Capital markets have two main functions:
1. They are a place where long-term funds can be raised by companies
from those with funds to invest, such as financial institutions and
private investors. (primary markets for new issues of equity and debt).
2. Capital markets allow investors to sell their shares and bonds, or buy
new ones to increase their portfolios. (secondary markets for dealing in
existing securities).
2.3 Capital Market efficiency
Dixon and Holmes (1992) suggested that the transaction costs on capital
markets should be as low as possible, so that barriers to trading are reduced
and operational efficiency is promoted.
2.3.1 Perfect markets and efficient markets
Perfect markets have the following characteristics:
Absence of factors inhibiting buying and selling, such as taxes and
transaction costs.
All participants have the same expectations regarding asset prices,
interests rates and other economic factors.
Entry to and exit from the market is free.
Information has no cost and is freely available to all market
participants.
7
, No stock market anywhere in the world is perfect, also companies and
investors don’t need a perfect market. They need one that is efficient and
offers fair prices.
An efficient capital market has the following features:
Operational efficiency (low transaction costs, required trading quickly
effected).
Pricing efficiency (Fair prices that fully and fairly reflect all information
concerning past events and all events that the market expects to occur
in the future).
Allocational efficiency (the capital market, through the medium of
pricing efficiency, allocates funds to where they can best be used.
2.3.2 Different forms of market efficiency
- Weak form efficient: If the current share prices reflect all historical
information, such as past share movements.
- Semi strong form efficient: If the current share prices reflect all
historical information and all publicly available information, and if share
prices react quickly and accurately to incorporate any new information
as it becomes available.
- Strong form efficient: If share price reflect all information, whether it
is publicly available or not.
2.3.3 Testing for market efficiency
- Weak from teststhe random walk hypothesis suggests that if we
know the share price at the end of one period, we cannot predict
accurately the share price at the end of one time period.
- Semi-strong hold tests:these tests look at the speed and accuracy of
share price responses to new information.
- Strong from tests: these tests are indirect in approach: they examine
how experts’ users of information perform when compared against a
yardstick, such as the average return on the capital market.
2.3.4 Implications of the efficient market hypothesis
Investor
Investment will not result in above-average return.
Studying published accounts and investment tips will not produce
above-average return.
There are no bargains on the stock market.
Company
The share price of a company fairly reflects its value and market
expectations about its future performance and return.
Cosmetic manipulation of accounting information will not mislead the
market.
8
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