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MFD 2 Summary
- Vak
- MFD 2 (EMFD)
- Instelling
- Hogere Hotelschool Den Haag
A summary of all the readings and extra informations mentioned in classes necessary to study for MFD 2.
[Meer zien]Voorbeeld 4 van de 32 pagina's
Voorbeeld 4 van de 32 pagina's
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Voorbeeld van de inhoud
Making Financial DecisionsLU 5 – LU 8
LU 5
Maximizing value
When investing your money in a company, you hope to gain more money than you lose
because of inflation. If we make it really simple, look at this example.
You invest €1000 euros in a company, together with other investors that also invest
€1000 each. These investors become shareholders of the company. With that money, the
company can operate their business and sell their product or service. If the company is
performing well, they will make profit on their sales. This company makes for every
€1000 invested, a profit of €50 for the shareholders per year, which is payed out as
dividends to the shareholders. If you, as investor, would have left your money in the
bank, you would have lost roughly 1,5% to inflation (€15,-) at the end of the year. Now,
instead of losing money, you gained €50,-. In the scenario you would have left your
money in the bank, your money would have been worth €985,- (1000*98,5%). Now,
with the dividends you received, your money is worth €1034,25. Instead of losing
purchasing power, you have gained it!
The book describes owners present value (value of investment/shares) in a company as
follows:
W0 = DIV0 + V0 [DIVt]
In which:
W0 = owners present value in the firm at present time
DIV0 = any immediate cash dividends to be paid at present time
V0 [DIVt] = the value of all future cash dividends at the present time.
Re-investment decision
Using the model above, it is your job as manager to make decisions that will maximize
Net Income. But that is not all. At the end of the year, it needs to be decided from the
profits made dividends will be declared or if it would be of more value for the owners to
re-invest the profit back into the company.
You can once again use the model mentioned above for this.
When the benefits (the current value of future dividends (V0[DIVt]))
is larger than the costs (money invested at present time INV0), then owners
value (W0) will increase.
When the costs of the investments are higher than the expected benefits, owners
value will increase.
When the costs equal the benefits, owners value remains unchanged.
Major factors determining owner's value
When assessing owner's value, there are 3 important factors to take into account:
the timing of future dividends: when will they be payed?
the magnitude of future dividends: how much dividend will be payed?
the riskiness of future dividends: how likely is it that these dividends will actually
get payed?
,Risk of new investments
Let's first make something very clear. It is important to realise that profit and
value are not the same. Here's the difference:
Profit is simply the equation of revenue - all expenses. Imagine you own a hotel in
Madrid, which made a profit of €10.000,-. You have another hotel in Cairo that also
made a profit of €10.000,-.
Whilst the equation of revenue minus expenses results in the same amount of profit,
the value of these profits is not the same. In Cairo, for that €10.000,- you can buy
10.000 kilograms of potatoes, whilst in Madrid you could only by 5.000 kilograms of
potatoes. If you look at value simply as what you can buy for your money, it seems
more valuable to operate the hotel in Cairo right? However, that is not the exact
definition of value. A simplistic way to define value is: value is risk adjusted
profit.
Time value of money
Under the previous topic we discussed that profit is not the same as value. Another
simple example is this:
In 1960, you could buy a Hershey's one-ounce chocolate bar for only $0,05. In 1970,
the same bar would cost you $0,21. If you would go to Walmart today, you would
pay $0,63 for the same one-ounce bar (the bars actually got bigger now but if you
calculate how much you would pay for one ounce it would roughly be 63 cents.)
Looking at that price progression, you can see that 5 cents in the 60's had much
more value than 5 cents do today. You could say that 5 cents in 1960 would be
worth 63 cents in 2020. This concept is called time value of money. The video
below explains this concept in more debt.
In the video, from 1:54, Philip introduces present value and future value with two
formulas. These terms and formulas will be discussed under the next
topic: compounding and discounting.
First, let's apply the present value and future value to the Hershey's bars example.
Simply said, present value is what your money is worth today,
whilst future value is what your money is worth tomorrow.
If we look back at the Hershey's bar example, in 1960, 5 cents was the present
value of a one-ounce chocolate bar 23 cents ten years later. Whereas 23 cents is
the future value (in 1970) of 5 cents in 1960.
Compounding and discounting
So now that we know what the concept of time value of money is and the difference
between present value and future value, let's start calculating with it!
When you want to know what the future value is of a present value, so an amount
of money you have today, you will have to compound that amount.
,Imagine you want to put €1200,- in a savings account on which you get an annual
interest rate of 3%. You want to know what the future value will be of that €1200,-
in 10 years from now. For this you will use the compounding formula:
Using this formula would mean that the future value of the money deposited in the
savings account will be 1200 x (1+3%)^10 = €1612,70
You can do this the other way around too. Imagine that in 10 years from now, you
want to buy a car that you estimate will cost roughly €150.000,- by then. You want
to put money in a savings account now, so that in 10 years from now you will have
enough money saved to buy that car. The future value of that car is thus €150.000,-
and you want to calculate the present value that you will have to put in the savings
account. To calculate that, you will need to discount the future value with the
following formula:
Let's assume the interest rate is still 3% that would mean that the present value that
you will need to deposit in a savings account is: 150.000 / (1+3%)^10 =
€111.614,09
, To determine which formula you need and whether you are talking about future
value or present value can be made easy when using a timeline.
If you look at the picture below, you simply can ask yourself, where in the timeline is
the amount of money that I already know/have, and is the amount I need to
calculate in the future or in the past from that? From there on you can determine
whether you need to go back in time (discount) or go ahead in time (compound).
Cash flow as investment criterion
The cash flow for investments
I can imagine this next line will get you excited: you do not have to calculate the
operating, financing and investment cash flows for all future years do determine the
cash flows for your investment. Actually, there is an easier step you can use to
approach the cash flow. Instead of creating an entire cash flow statement, you can
use the Project Income and simply add back Depreciation. In the figure below you
can see how this is done.
If your investment has a expected lifetime of 10 years, you can calculate the project
cashflow for all ten years.
However you do not always have specific revenue and expenses available for your
specific project! In that case, you can simply use Net Income and add
back Depreciation to estimate your cash flow.
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