CORPORATE
FINANCIAL
MANAGEMENT
3.4
Docent:
A.B.
Dorsman
Book:
Corporate
Finance
(Berk
&
Demarzo)
(exam
=
80%
van
het
cijfer)
Chapter
14-‐19
+
29
14.
CAPITAL
STRUCTURE
PERFECT
MARKET
15.
DEBT
AND
TAXES
16.
FINANCIAL
DISTRESS
17.
PAYOUT
POLICY
18.
CAPITAL
BUDGETING
AND
VALUATION
WITH
LEVERAGE
19.
VALUATION
AND
FINANCIAL
MODELING
29.
CORPORATE
GOVERNANCE
My
Finance
lab
5
tests
(opgaven
=
20%
van
het
cijfer)
3rd
edition:
XL1P-‐710N-‐0020-‐9M02
Premaster
voorbereiding:
voorbereidende
hoofdstukken
niet
gelezen
Appendix
CH3
The
price
of
risk
-‐
When
cash
flows
are
risky,
we
cannot
use
the
risk-‐free
interest
rate
to
compute
present
values.
Instead,
we
can
determine
the
present
value
by
constructing
a
portoflio
that
produces
cash
flows
with
identical
risk,
and
then
applying
the
Law
of
One
Price.
So,
we
can
discount
the
expected
cash
flows
using
a
discount
rate
that
includes
an
appropriate
risk
premium.
-‐
The
risk
of
a
security
must
be
evaluated
in
relation
to
the
fluctuations
of
other
investments
in
the
economy.
A
security’s
risk
premium
will
be
higher
the
more
its
returns
tend
to
vary
with
overall
economy
and
the
market
index.
If
the
security’s
returns
vary
in
the
opposite
direction
of
the
market
index,
it
offers
insurance
and
will
have
a
negative
risk
premium.
-‐
When
there
are
transactions
costs,
the
prices
of
equivalent
securities
can
deviate
from
each
other,
but
nog
by
more
than
the
transactions
costs
of
the
arbitrage.
-‐
Risk
aversion:
Investors
don’t
like
risk,
they
prefere
safety.
(example:
you
prefer
to
not
lose
1
dollar
in
hard
times
vs.
getting
1
dollar
in
good
times)
Investors
have
a
different
degree
of
risk
aversion.
-‐
Expected
return
averaged
expected
return
Formule:
expected
gain
at
end
of
the
year
/
initial
cost
-‐
Risk
premium
difference
between
the
risk
free
interest
rate
and
the
risk
interest
rate,
the
additional
return
that
risky
investors
receive
on
an
investment
with
risk.
Session
1
Introduction
College:
-‐
CFM
gaat
over
de
rechterkant
van
de
balans
(Passiva)
-‐
Doel
=
zo
laag
mogelijke
cost
of
capital.
-‐
Bij
My
Finance
lap
moet
je
de
US
style
gebruiken,
dus
.
ipv
,
en
andersom.
Je
naam
moet
je
als
volgt
doen:
First
name:
Martijn
de
Last
name:
Jager
AD
1
Goal
of
the
firm
1.
Maximalisation
of
the
value
of
the
firm?
2.
Maximalisation
of
value
of
the
equity?
Value
of
a
firm
=
Equity
+
Debt
of
a
firm
ZIE
AANTEKENINGEN
VOOR
GRAFIEK
Maximalisation
of
the
equity
is
almost
always
the
same
as
maximalisation
of
the
value,
but
not
if
a
company
is
in
financial
trouble.
1
,In
the
US
(Anglo-‐Saxon
model)
the
shareholder
is,
by
far,
the
most
important
person
for
a
company.
In
Europe
(Rhineland
model)
it
is
also
important,
but
there
are
other
factors
involved
as
well.
In
Europe
companies
pay
more
attention
to
employers
and
collective
responsibility.
In
the
US
the
market
rules.
Ad
2
Assumptions
1.
Decision
makers
behave
rational
Shell
never
decreased
it’s
dividend
each
year.
A
washing
machine
is
an
investment,
so
you
pay
while
of
after
you
use
it.
A
holiday
is
consumptions
so
you
pay
upfront.
We
assume
that
decisionmakers
behave
rational,
but
in
practise
that
is
nog
always
the
case.
2.
One
period
model:
expected
return-‐risk
ZIE
VOORBEELD
IN
AANTEKENINGEN
3.
One
type
of
equity
Types
of
equity:
-‐
preferred
stocks
(preferential
dividend,
special
voting
rights)
-‐
priority
stocks
(special
voting
rights)
-‐
warantie
4.
One
type
of
bond
Types
of
debt:
-‐
bond
-‐
mortgage
bond
-‐
callable
bond
-‐
conventible
bond
-‐
contingent
convertible
(coco’s)
5.
One
tax
rate
In
the
US
there
is
one
taxrate.
In
Europe
there
are
different
taxrates
and
that’s
what
caused
the
development
of
letterbox
companies;
big
international
companies
who
benefit
from
the
different
tax
rules
and
rates
in
Europe.
6.
One
capital
structure
Risks
are
different
in
eacht
country
7.
Return
investor
(R)
=
Cost
of
company
(K)
Not
always
excatly
the
same.
AD
3
Risk,
Earnings
and
Value
-‐
We
now
live
in
a
buyers
market,
while
a
few
decades
ago,
due
to
the
fact
that
there
was
little
offer
in
goods,
we
lived
in
a
sellers
market.
-‐
Technical
lifetime
vs.
economic
lifetime:
economic
lifetime
became
shorter
the
last
decades.
Vb.
Nokia
vs.
Apple.
A
few
decades
ago
the
economic
lifetime
was
the
same
as
the
technical
lifetime.
-‐
There
is
a
change
from
focussing
on
profit
to
value.
-‐
Book
vs.
market
value.
There
is
a
difference
in
accouting
&
finance!!
-‐
Accountants
first
looks
at
the
debet
side
and
than
to
the
debt
and
the
result
is
the
equity
of
a
firm.
Finance
first
looks
at
the
equity,
than
to
the
debts
and
the
result
is
the
debet
side.
-‐
Depreciation
is
a
well-‐estimated
guess,
because
it
depends
on
a
lot
of
things.
-‐
Embedded
value:
value
of
contracts
for
insurance
companies.
It
is
difficult
to
calculate
the
exact
real
value.
Used
in
the
insurance
sector.
Session
2
CH14
Capital
Structure
in
a
Perfect
Market
14.1.
Equity
versus
debt
financing
-‐
The
collection
of
securities
a
firm
issues
to
raise
capital
form
investors
is
called
the
firm’s
capital
structure.
The
most
common
choices
for
financing
a
company
is
through
equity
alone
or
through
equity
and
debt.
When
equity
is
used
without
debt,
the
firm
is
said
to
be
unleverd.
Otherwise
the
amount
of
debt
determines
the
firm’s
leverage.
2
,-‐
With
leverage
the
return
becomes
higher,
but
the
risk
also
becomes
higher.
-‐
The
Law
of
One
Price
makes
the
cost
of
capital
with
or
without
leverage
the
same,
because
the
risk
on
equity
increases
if
the
debt
increases.
-‐
The
owner
of
a
firm
should
choose
the
capital
structure
that
maximizes
the
total
value
of
the
securities
isssued.
14.2
Modigliani-‐Miller
I:
leverage,
arbitrage
and
firm
value
-‐
Perfect
capital
markets:
1. Investors
and
firms
can
trade
the
same
set
of
securities
at
competitive
market
prices
equal
to
the
present
value
of
their
future
cash
flows.
2. There
are
no
taxes,
transation
costs,
or
issuance
costs
associated
with
security
trading.
3. A
firm’s
financing
decisions
do
not
change
the
cash
flows
generated
by
its
investments,
nor
do
they
reveal
new
information
about
them.
-‐
Preposition
1:
In
a
perfect
capital
market,
the
total
value
of
a
firm
is
equal
to
the
market
value
of
the
total
cash
flows
generated
by
its
assets
and
is
not
affected
by
its
choice
of
capital
structure.
-‐
Homemade
leverage:
investors
can
use
leverage
in
their
own
portofolio
when
a
firm
doesn’t
use
leverage.
With
a
perfect
capital
market
this
is
a
perfect
subsititute
for
firm
leverage.
-‐
If
otherwise
identical
firms
with
different
capital
structures
have
different
values,
the
Law
of
One
Price
would
be
violated
and
an
arbitrage
opportunity
would
exist.
-‐
Market
value
balance
sheet:
is
similair
to
an
accounting
balance
sheet,
with
two
inmportant
distinctions:
1)
all
assets
and
liablities
of
the
firm
are
included.
2)
all
values
are
current
market
values
rahter
than
historical
costs.
Assets
Liablities
Tangible
assets
Debt
-‐
cash
-‐
short-‐term
debt
-‐
plant,
property
&
equipment
-‐
long-‐term
debt
-‐
inventory
and
other
working
capital
-‐
convertible
debt
and
so
on….
Intangible
assets
Equity
-‐
intellectual
property
-‐
common
stock
-‐
reputation
-‐
preferred
stock
-‐
human
capital
-‐
warrants
(options)
and
so
on
….
-‐
A
firm
can
change
its
capital
structure
at
any
time
by
issuing
new
securities
and
using
the
funds
to
pay
its
existing
investors.
Leveraged
recapitalization
(a
company
repurchases
a
significant
percentage
of
its
outstanding
shares)
is
a
good
example.
Proposition
1
implies
that
this
wil
not
change
the
share
price.
14.3
Modigliani-‐Miller
II:
leverage,
risk
and
the
cost
of
capital
-‐
Preposition
2:
The
cost
of
capital
of
levered
equity
increases
with
the
firm’s
market
value
debt-‐equity
ratio.
-‐
debt-‐to-‐value
ratio:
D
/
(E
+
D)
want
E
+
D
=
Value
-‐
According
to
MM
Proposition
II,
the
cost
of
capital
for
levered
equity
is
Re
=
Ru
+(D/E)
*
(Ru
–
Rd)
example
14.5
-‐
Debt
is
less
risky
than
equity,
so
it
has
a
lower
cost
of
capital.
Leverage
increases
the
risk
of
equity,
however,
raising
the
equity
cost
of
capital.
The
benefit
of
debt’s
lower
cost
of
capital
is
offset
by
the
higher
equity
cost
of
capital,
leaving
a
firm’s
weighted
average
cost
of
capital
(WACC)
unchanged
with
perfect
capital
markets:
Rwacc
=
Ra
=
Ru
=
*(E/E
+
D)
*
Re
+
D/(E
+
D)
*
Rd
example
14.6
&
14.7
-‐
The
market
risk
of
a
firm’s
assets
can
be
estimated
by
its
unlevered
beta:
ßU
=
(E/E
+
D)
*
ßE
+
(D/E
+
D)
*
ßD
example
14.8
-‐
Leverage
increases
the
beta
of
a
firm’s
equity:
ßE
=
ßU
+
(D/E)
*
(ßU
-‐
ßD)
example
14.9
3
, -‐
A
firm’s
net
debt
is
equal
to
its
debt
less
its
holdings
of
cash
and
other
risk-‐free
securities.
We
can
compute
the
cost
of
capital
and
the
beta
of
the
firm’s
business
assets,
excluding
cash,
by
using
its
net
debt
when
calculating
its
WACC
or
unlevered
beta.
14.4
Capital
structure
fallacies
(2
veel
gehoorde
drogredenen)
-‐
Leverage
can
raise
a
firm’s
expected
earnings
per
share
and
its
return
on
equity,
but
it
also
increases
the
volatility
(beweeglijkhei)
of
earnings
per
share
and
the
riskiness
of
its
equity.
As
a
result,
in
a
perfect
market
shareholders
are
not
better
off
and
the
value
of
equity
is
unchanged.
-‐
As
long
as
shares
are
sold
to
investors
at
a
fair
price,
there
is
no
cost
of
dilution
associated
with
issuing
equity.
While
the
number
of
shares
increases
when
equity
is
issued,
the
firm’s
assets
also
increase
because
of
the
cash
raised,
and
the
per-‐share
value
of
equity
remains
unchanged.
14.5
Modigliani-‐Miller:
beyond
the
propositions
-‐
With
perfect
capital
markets,
financial
transactions
are
a
zero-‐NPV
activity
that
neither
add
nor
destroy
value
on
their
own,
but
rather
repackage
the
firm’s
risk
and
return.
Capital
structure
-‐
and
financial
transactions
more
generally
-‐
affect
a
firm’s
value
only
because
of
its
impact
on
some
type
of
market
imperfection.
-‐
Conservation
of
value
principle:
with
perfect
capital
markets,
financial
transactions
neither
add
nor
destroy
value,
but
instead
represent
a
repackaging
of
risk
(and
therefore
return)
College:
Herhaling
&
vervolg
college
1
-‐
V
=
D
+
E
-‐
Earnings
are
important
for
a
company
-‐
Every
year
a
company
has
a
impairment
test
(onderzoek
naar
bijzondere
waardevermindering,
er
wordt
gecheckt
of
de
balanswaarden
juist
zijn
gewaardeerd)
-‐
If
solvancy
of
a
company
goes
down,
the
cost
of
capital
goes
up
and
the
debt
goes
down.
Bijv:
1000,-‐
lening,
waarde
daalt
naar
800,
de
solvancy
daalt,
maar
de
schuld
is
nog
steeds
1000
en
de
cost
of
debt
stijgt
terwijl
de
lening
in
waarde
daalt.
-‐
In
de
crisis
hebben
banken
veel
slechte
(onder
water)
leningen
teruggekocht.
4.
Case
Brown
LTD
Rwacc:
10%
Expected
cash
flows:
-‐10,
80,
80,
80
Investment
T=0:
100
TIME
0
1
2
3
4
FCF
-‐100
-‐10
80
80
80
DEPRECIATION
-‐25
-‐25
-‐25
-‐25
EARNINGS
-‐35
55
55
55
NPV
=
72
IRR
=
31.76%
Future
cashflows:
172
(ZIE
GRAFIEK
AANTEKENINGEN)
-‐
Als
shareholder
wil
je
graag
dat
een
investering
beter
rendement
maakt
dan
voorspeld.
Als
het
rendement
precies
uitkomt
zoals
verwacht,
ben
je
lichtelijk
teleurgesteld
ipv
tevreden.
Als
CEO/bedrijf
speel
je
hier
op
in
door
redelijk
conservatieve
voorspellingen
te
doen.
Dit
geeft
de
indruk
dat
jij
het
goed
hebt
gedaan.
Je
geeft
bijvoorbeeld
aan
dat
je
extra
afschrijvingen
moest
doen
of
extra
investeren.
CEO’s
maken
in
het
1e
jaar
vaak
een
negatief
resultaat,
want
dan
ze
de
vorige
CEO
nog
de
schuld
geven,
worden
de
verwachtingen
voor
hen
zelf
lager
en
kunnen
ze
daarna
dus
meer
winst
dan
verwacht
boeken.
Dan
lijkt
het
alsof
zij
het
extra
goed
gedaan
hebben.
Session
of
today:
AD
1
.
Case
Claudius
Construction
company
Claudius
decides
to
start
a
project
in
belgium
on
january
1
2012.
Claudius
therefore
founds
a
new
company:
Claudius
Belgium
(cb).
On
January
1
2012
Claudius
provides
€
4
