Fundamentals of Corporate Finance (2nd European Edition)
Samenvatting: Fundamentals of
Corporate Finance
Second European Edition
Hillier, Clacher, Ross, Westerfield & Jordan
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,Fundamentals of Corporate Finance (2nd European Edition)
Inhoudsopgave
Chapter 1 - Introduction to Corporate Finance ............................................................................................................ 3
Chapter 2 - Corporate Governance .............................................................................................................................. 6
Chapter 3 - Financial Statement Analysis ................................................................................................................... 11
Chapter 4 - Introduction to Valuation: The Time Value of Money ............................................................................ 20
Chapter 5 - Discounted Cash Flow Valuation ............................................................................................................. 24
Chapter 6 - Bond Valuation ........................................................................................................................................ 31
Chapter 7 - Equity Valuation ...................................................................................................................................... 45
Chapter 8 - Net Present Value and Other Investment Criteria .................................................................................. 53
Chapter 9 - Making Capital Investment Decisions ..................................................................................................... 62
Chapter 10 - Project Analysis and Evaluation............................................................................................................. 68
Chapter 11 - Some Lessons from Recent Capital Market History .............................................................................. 75
Chapter 12 - Return, Risk and the Security Market Line ............................................................................................ 81
Chapter 13 - Cost of Capital........................................................................................................................................ 91
Chapter 15 - Financial Leverage and Capital Structure Policy.................................................................................... 99
Chapter 20 - Financial Risk Management ................................................................................................................. 112
Chapter 21 - Options and Corporate Finance .......................................................................................................... 118
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,Fundamentals of Corporate Finance (2nd European Edition)
Chapter 1 - Introduction to Corporate Finance
What is corporate finance, and what is the role of the financial manager in the corporation? What is the goal of
financial management? For many companies, share price valuation is an exceptionally important issue, so this
book will also take a look at the financial markets and their impact on corporate decision-making.
1.1 Corporate Finance and the Financial manager
What Is Corporate Finance?
If you start your own business, you would have to answer three questions:
1. What long-term investments should you make? That is, what lines of business will you be in, and what
sorts of buildings, machinery and equipment will you need?
2. Where will you get the long-term financing to pay for your investment? Will you bring in other owners, or
will you borrow the money?
3. How will you manage your everyday financial activities, such as collecting from customers and paying
suppliers?
These are the most important questions. Corporate finance is the study of ways to answer these three questions.
The Financial Manager
The owners (the shareholders) of large corporations are not usually directly involved in making business
decisions, particularly on a day-to-day-basis. These corporations employ managers to represent the owners’
interests and make decisions on their behalf. The financial manager would be in charge of answering the three
questions from above.
The financial management function is usually associated with a top officer of the firm, such as a finance director
(FD) or chief financial officer (CFO). Figure 1.1. (p. 5). The finance director co-ordinates the activities of the
treasurer (finance function: responsible for managing the firm’s cash and credit, financial planning and capital
expenditures) and the controller (accounting function: handles cost and financial accounting, tax payment and
management information systems). The finance function of the firm is related to the three general questions
raised earlier. The accounting function takes all the financial information and data that arises as a result of
ongoing business activities, and presents this in ways that allow management to assess the performance and risk
of their firm (financial accounting) and make informed decisions on future corporate activity (management
accounting).
To ensure that all firms provide comparable information, there are generally accepted accounting standards. In
the EU all firms that are listed on a stock exchange must follow International Accounting Standards (IAS), as set by
the International Accounting Standards Board (IASB).
Financial Management Decisions
1) Capital budgeting: The process of planning and managing a firm’s long-term investments.
The financial manager tries to identify investment opportunities that are worth more to the firm than
they cost to acquire (the value of the cash flow generated by an asset exceeds the cost of that asset). The
types of investment opportunity that would typically be considered depend in part on the nature of the
firm’s business. Financial managers must be concerned not only with how much cash they expect to
receive, but also with when they expect to receive it, and how likely they are to receive it. Evaluating the
size, timing and risk of future cash flows is the essence of capital budgeting.
2) Capital structure (financial structure): The mixture of long-term debt and equity maintained by a firm.
The mixture of long-term debt and equity the firm uses to finance its operations. The financial manager
concerns ways in which the firm obtains and manages the long-term financing it needs to support its long-
term investments.
Long-term debt: Long-term borrowing by the firm (longer than one year) to finance its long-term
investments.
Equity: The amount of money raised by the firm that comes from the owners’ (shareholders’) investment.
The financial manager has two concerns in this area:
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,Fundamentals of Corporate Finance (2nd European Edition)
1. How much should the firm borrow? That is, what mixture of debt and equity is best? The mixture
chosen will affect both risk and the value of the firm.
2. What are the least expensive sources of funds for the firm?
The firm’s capital structure determines what percentage of the firm’s cash flow goes to creditors and
what percentage goes to shareholders.
In addition to deciding on the financing mix, the financial manager has to decide exactly
how and where to raise the money.
3) Working capital: A firm’s short-term assets and liabilities.
Managing the firm’s working capital is a day-to-day activity which ensures that the firm has sufficient
resources to continue its operations and avoid costly interruptions. Some questions about working capital
must be answered:
1. How much cash and inventory should we keep on hand?
2. Should we sell on credit? If so, what terms will we offer, and to whom will we extend them?
3. How will we obtain any needed short-term financing? Will we purchase on credit, or will we borrow in
the short term and pay cash? If we borrow in the short term, how and where we do it?
1.2 The Goal of Financial Management
In for-profit businesses, the main goal of financial management is to make money or add value for the owners.
Possible Goals
Possible financial goals: survive – avoid financial distress and bankruptcy – beat the competition – maximize sales
or market share – minimize costs – maximize profits – maintain steady earnings growth. These possibilities
present problems as a goal for the financial manager. These goals tend to fall into two classes: profitability and
controlling risk. These two classes are contradictory. The pursuit of profit normally involves some element of risk,
so it isn’t really possible to maximize both safety and profit. We need a goal that encompasses both factors.
An Appropriate Goal
The financial manager in a corporation makes decisions for the shareholders of the firm. So, from the
shareholders’ point of view, what is a good financial management decision? If we assume that shareholders buy
shares to seek to gain financially, the answer is obvious: good decisions increase the value of the equity, and poor
decisions decrease the value of the equity. The appropriate goal for the financial manager can be stated:
maximize the current value per share of the existing equity. There is no ambiguity. Keep in mind that the
shareholders in a firm are residual owners, they are entitled only to what is left after employees, suppliers, and
creditors (and anyone else with a legitimate claim) are paid their due. If any of these groups go unpaid, the
shareholders get nothing. If shareholders are winning, everyone else is also winning.
We could have defined corporate finance as the study of the relationship between business decisions and the
value of the equity in the business.
A More General Goal
Given the preceding goal, an obvious question comes up: what is the appropriate goal when the firm has no
traded equity? It’s difficult to say what the value per share is at any given time. The total value of the equity in a
corporation is simply equal to the value of the owners’ equity. Therefore a more general goal is: maximize the
market value of the existing owners’ equity. Good financial decisions increase the market value of the owners’
equity, and poor financial decisions decrease it. The financial manager best serves the owners of the business by
identifying goods and services that add value to the firm because they are desired and value in the free
marketplace.
1.3 Financial Markets and the Corporation
In most countries the financial markets play a fundamental role in the operations of large corporations. Even if a
firm is not traded on a stock exchange, the stock market is important, because it can inform management of the
performance of their competitors, suppliers, customers and the economy as a whole. The primary advantage of
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, Fundamentals of Corporate Finance (2nd European Edition)
financial markets is that they facilitate the flow of money from those that have surplus cash to those that need
financing.
Cash Flows To and From the Firm
The interplay between the corporation and the financial markets is illustrated in figure 1.2. (p. 9). A financial
market is just a way of bringing buyers and sellers together. In financial markets it is debt and equity securities
that are bought and sold. Financial markets differ in detail, the most important differences concern the types of
security that are traded, how trading is conducted and who the buyers and sellers are.
Primary versus Secondary Markets
The term primary market refers to the original sale of securities by governments and corporations. the secondary
markets are those in which these securities are bought and sold after the original sale. Equities are issued solely
by corporations. Debt securities are issued by both governments and corporations.
In a primary market transaction the corporation is the seller, and the transaction raises money for the
corporation. Corporations engage in two types of primary market transaction:
1. Public offerings: Involves selling securities to the general public.
2. Private placements: A negotiated sale involving a specific buyer.
by law, public offerings of debt and equity must be registered with the securities regulator in the country where
the offerings are made (The Netherlands: Authority for Financial Markets). Registration requires the firm to
disclose a great deal of information before selling any securities. Private placements do not normally have to be
registered with securities regulators, and do not require the involvement of underwriters.
A secondary market transaction involves one owner or creditor selling to another. Therefore the secondary
markets provide the means for transferring ownership of corporate securities.
There are two kinds of secondary market:
1. Auction markets: An auction market (exchange) has a physical location. The primary purpose of an auction
market is to match those who wish to sell with those who wish to buy.
2. Dealer markets: Dealers buy and sell for themselves, at their own risk. Many dealers are connected
electronically, most dealer markets have no central location. Most of the buying and selling is done by the
dealer. Dealers play a limited role.
- Over-the-counter (OTC) markets: Dealer markets in equities and long-term debt. Over the counter
refers to days of old when securities were literally bought and sold at counters in offices around the
world.
The equity shares of most large firms trade in organized auction markets. Because of globalization, financial
markets have reached the point where trading in many investments never stops; it just travels around the world.
Securities that trade on an organized exchange are said to be listed on that exchange. To be listed, firms must
meet certain minimum criteria concerning. These criteria differ from one exchange to another.
1.4. Corporate Finance in Action: The Case of Google
So What is Corporate Finance?
Many people who think of corporate finance tend to consider valuation as being most important. Others think of
risk assessment, while many think that capital structure should be emphasized. For a business to be truly
successful, the management of a firm and its shareholders must have a solid understanding of all corporate
finance areas, and not just one or two topics.
Summary and Conclusions
1. Corporate finance has three main areas of concern:
a) Capital budgeting: what long-term investments should the firm take?
b) Capital structure: where will the firm get the long-term financing to pay for its investments? In other
words, what mixture of debt and equity should the firm use to fund operations?
c) Working capital: how should the firm manage its everyday financial activities?
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