FINM2415 Corporate Finance
Lecture 1: Introduction and Review on
Time Value of Money, Cost of Capital
Reference: Textbook Chapters 4, 12
CRICOS code 00025B
 Course information
 What we study in this course
 Review on time value of money
 Review on cost of capital
What we study this week
Lecture 1 2
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• Lecturer: Dr. Lily Nguyen
Email: lily.nguyen@business.uq.edu.au
• Tutors:
Staff Contact
Lecture 1 3
Tutors Email
Ann Le a.le@uq.edu.au
Zeyu (Jack) Wang zeyu.wang@business.uq.edu.au
Chris Zhang chunhong.zhang@business.uq.edu.au
Ling Xiong z.xiong1@uq.edu.au
 Regarding tutorials, your tutor should be your first point of contact
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Timetable for the course
4
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Activity Day Start Time End Time Location/Zoom link Staff Recorded
Lecture LEC1/01 Tuesday 8:00 AM 10:00 AM https://uqz.zoom.us/j/87658523286 Nguyen, Lily Yes
Tutorial TUT1/01 Monday 2:00 PM 4:00 PM https://uqz.zoom.us/j/84189057221 Ann Le Yes
Tutorial TUT1/04 Monday 8:00 AM 10:00 AM 47A-341 - Sir James Foots Building, Collaborative Room Ann Le No
Tutorial TUT1/06 Monday 4:00 PM 6:00 PM 83-C416 - Hartley Teakle Building, Collaborative Room Zeyu Wang No
Tutorial TUT1/01 Tuesday 10:00 AM 12:00 PM 69-401 - Building 69, Collaborative Room Chris Zhang No
Tutorial TUT1/02 Tuesday 12:00 PM 2:00 PM 69-401 - Building 69, Collaborative Room Chris Zhang No
Tutorial TUT1/03 Wednesday 8:00 AM 10:00 AM 32-208 - Gordon Greenwood Building, Collaborative Room Ling Xiong No
Tutorial TUT1/05 Wednesday 10:00 AM 12:00 PM 32-210 - Gordon Greenwood Building, Collaborative Room Ling Xiong No
Tutorial TUT1/07 Wednesday 12:00 PM 2:00 PM 32-210 - Gordon Greenwood Building, Collaborative Room Ling Xiong No
Tutorial TUT1/08 Friday 8:00 AM 10:00 AM 32-209 - Gordon Greenwood Building, Collaborative Room Zeyu Wang No
• All zoom links are also available through Blackboard under the folder Zoom link on the left panel
• Timetable issue: Should you need help with your timetable and/or allocation of classes, please ensure you
email business.mytimetable@uq.edu.au from your UQ student email account with your full name, student ID
and the course code FINM2415.-
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Consultation
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Consultation Monday 10:30am 11:30am https://uqz.zoom.us/j/82771880222 Ann Le
Consultation Tuesday 10:30am 11:30am https://uqz.zoom.us/j/81203185030 Lily Nguyen
Consultation Wednesday 9:00am 10:00am Building 39, Room 115 Zeyu Wang
Consultation Thursday 9:00am 10:00am https://uqz.zoom.us/j/82300829201 Ling Xiong
Consultation Friday 3:00pm 4:00pm Building 31 B, Room 210 Chris Zhang
Starting from Week 2
• All zoom links are also available through blackboard under the folder Zoom link on the left panel
.
CRICOS code 00025B
• The prescribed textbook: Corporate Finance, by Berk and DeMarzo.
the Fifth Edition.
• You can buy the textbook from UQ Bookshop or directly from
Pearson’s
• If you buy directly from Pearson, click on the link below
https://www.pearson.com/store/p/corporate-finance-global-
edition/P200000003710/9781292366630#
- Remember to add a promotion code BTUQLD at check out to
receive an additional 5% off already discounted prices.
Required Textbook
Lecture 1 6
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Learning activities
Lecture 1 7
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Date Week Lecture (2 hours) Textbook Tutorial (2 hours)
25-Jul 1 Introduction Chapters 4 & 12
1-Aug 2 Project evaluation
Chapters 7, 8, 22 & reference
readings Tutorial on Lecture 1
8-Aug 3 Capital structure I Chapter 14 Tutorial on Lecture 2
15-Aug 4 Capital structure II Chapters 15 & 16 Tutorial on Lecture 3
22-Aug 5 Capital structure III Chapter 16 Tutorial on Lecture 4
29-Aug 6 Mid-semester exam No tutorials
5-Sep Corporate valuation I Chapter 18 Tutorial on Lecture 5
12-Sep 7 Corporate valuation II Chapter 19 Tutorial on Lecture 6
18-Sep 8 Raising capital Chapter 23 Tutorial on Lecture 7
26-Sep Mid-semester break No tutorials
3-Oct 9 Mergers and acquisitions Chapter 28 Tutorial on Lecture 8
10-Oct 10 Payout policy Chapter 17 Tutorial on Lecture 9
17-Oct 11 Corproate governance and social responsibility Chapters 29, 4, & reference readings Tutorial on Lecture 10
24-Oct 12 Review Tutorial on Lecture 11
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(1) Mid-Semester Test: 25%
- Date and time: during the lecture time from 8:00am to 9:40am on Tuesday 29 August 2023
- Type: Online exam via Blackboard and the exam contains multiple choice questions.
- Coverage: Lectures 1-4 and Tutorials 1-4
- More detailed information will be be posted on the Blackboard.
(2) Group Assignment: 20%
- Group registration date: Friday 11 August 2023
- Question release date: Friday 18 August 2023
- Submission date: 14:00 on Friday 6 October 2023
- Peer assessment submission date: 17:00 on Friday 6 October 2022
- Group size: 4-5 individuals, you form your group with any other students in this course
- Coverage: Lectures 1-7 and Tutorials 1-7
- More detailed information will be posted on the Blackboard
(3) Final Exam: 55%
- Date: During the university’s examination period
- Coverage: Lectures 5-12 and Tutorials 5-12
- More detailed information will be posted on Blackboard
Assessments
Lecture 1 8
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• Prepare before attending lectures
- Read the lecture slides and attempt all lecture examples
- Read the relevant chapters of the textbook
• Prepare before attending tutorials:
- Complete tutorial questions independently
• Attend lectures and tutorials regularly
- Lectures will be recorded and available by the end of each week
- You need to sign on and attend your tutorial class
- All tutorial classes will start from next week (Week 2)
• Actively take part in lectures/tutorials by asking or answering questions
- It is much easier to remember/understand lecture/tutorial contents by asking and answering questions
- Bring your UQ approved calculator so that you can work on questions/examples during lectures and tutorials
• Start early
- Do your work weekly, do not wait until the day before the exam
- Spend at least 10 hours per week on this course
- Email us or see us during our consultation time if you have questions
How to succeed in this course?
Lecture 1 9
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• Pre-requisites: FINM1415 or FINM2401 or FINM2411 or FINM2412
• Background knowledge:
- Concepts of risk and returns
- Concepts of equity (stocks) and debt (bonds)
- Techniques to value equity and debt securities such as CAPM
- Time value of money
- Cost of capital
- Fundamental of capital budgeting
Assumed knowledge
Lecture 1 10
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• What is corporate finance? Every decision that a firm makes has financial implications, and any decision
that affects the finances of a firm is a corporate finance decision.
• Why should we study corporate finance? Understanding of why and how corporate finance decisions
are made is essential for the operation and growth of any company
• Two important corporate finance decisions:
(1) Investment decision:
o Which projects should a firm invest in?
(2) Financing decision:
o Capital structure: How a firm finances its investments: Should it use equity or debt or internal profits? Is there an
optimal structure of these sources of funds?
o Capital raising: How a firm issues its stocks (bonds) to raise equity (debt) capital
o Payout policy: Should a firm retain its earnings for investments or pay out as dividends to its shareholders?
What we study in this course
Lecture 1 11
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Investment Decision (Project Evaluation)
Lecture 1 12
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Financing Decision (Capital Structure I, II, III)
Lecture 1 13
How a firm
finances its
investment:
should it use
equity or debt or
internal funds?
Is there an
optimal structure
of debt and
equity capital?
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Financing Decisions (Payout Policy)
Lecture 1 14
Should a firm
retain its
earnings for
investments or
pay out as
dividends to its
shareholders?
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Corporate Valuation
Lecture 1 15
Equity valuation
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Capital Raising: IPOs
Lecture 1 16
How to issue
stock (bonds) to
raise equity
(debt) capital?
Corporate
Valuation
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Mergers and Acquisitions
Lecture 1 17
Mergers and
Acquisitions
Corporate Valuation
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• What is time value of money?
- Time value of money means that a dollar today is
………………a dollar in the future
- Why?
• To value/compare/combine cash flows occurring at
different points in time, we need to take into
account the time value of money and use a
“timeline” to model the timing and amount of all of
cash flows:
- Time 0 represents today or present
- Cash outflows (costs) are negative values
- Cash inflows (benefits) are positive values
Time Value of Money
Lecture 1 18
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• Future value (FV) of a cash flow or an
investment is given by:
= × 1 +
where:
o FV = future value of investment at the end of
period n
o PV = initial investment or present value (CF0)
o r = the rate of interest per period
o n = the number of investment periods
• Future value (FV) of a series of cash flows is
given by:
Future Value of Cash Flows (Rule 2)
Lecture 1 19
Present Value (PV) of Cash Flows (Rule 3)
= 1 +
• Present value of a series of cash flows is calculated as:
• Present value of a cash flow is calculated as:
= 0 + 11 + + 21 + 2 + ⋯+ 1 + = �
=0

1 +
= 0 × 1 + + 1 × 1 + −1 + ⋯
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• What is the cost of capital of a company?
- Returns/Compensation demanded by investors when they invest in the firm/supply funds to the company
 Cost of funds used to finance a firm’s business activities such as investment projects
• A company normally can finance its investment projects through the following sources of fund:
- Equity (issuing stocks)
- Debt (borrowing by issuing bonds)
- A combination of both equity and debt
• Cost of capital can generally be referred to as:
- Cost of equity
- Cost of debt
- A combination of cost of debt and equity:
 Asset cost of capital and
 Weighted average cost of capital
Cost of Capital
Lecture 1 20
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• Cost of equity is the expected return required by shareholders
• The capital asset pricing model (CAPM):
= + −
o - The cost of equity
o - The risk-free rate: Returns earned from investing in risk-free securities such as Treasury bonds
o () −
- The market risk premium or market excess return
- A benchmark to assess investors’ willingness to hold market risk
- Estimated using the historical market index returns such as S&P500
o : Equity beta: the systematic (or market) risk of the security
Estimate beta:
2 = 22 + ∈2 => Total Risk = Systematic Risk + Unsystematic Risk
=> Systematic risk or market risk (not the unsystematic risk) determines the cost of equity. Why?
Cost of Equity
Lecture 1 21
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Example: Suppose that you estimate that Disney’s stock (DIS) has a volatility of 20% and a beta of 1.25
and Chipotle’s stock (CMG) has a volatility of 30% and a beta of 0.55. If the risk-free rate is 3% and you
estimate the market’s expected return to be 8%.
- Which stock carries more total risk?
- Which has more market risk?
- Which has a higher cost of equity?
Example
Lecture 1 22
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- Use historical returns and linear regression to estimate beta
- Identify the best-fitting line in the plot of the security’s excess return versus the market excess return. =>Linear regression equation: − = + − +
~ = + + - : the intercept of the regression; a risk-adjusted performance of the stock based on historical returns. If αi is positive (negative), the stock has performed better (worse) than predicted by the CAPM- : the slope of the regression- : the error term and represents the deviation from the best-fitting line and is zero on average.
- Case study: Use the regression analysis and the data provided in the spreadsheet provided to
estimate the beta of Nike stock based on their monthly returns from 2011-2015.
Estimate equity beta
Lecture 1 23
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• Cost of debt () is the expected return required by lenders (bond investors, bond holders)
 investors’ expected return on a bond
• Cost of debt and taxes: because interest payments on debt reduce corporate taxable income. This reduction
reduces the effective cost of debt. If is before-tax (or pretax) cost of debt and t is the corporate tax rate,
then after-tax cost of debt = (1 − )
• Yield to maturity of a bond is the IRR (internal rate of return) an investor will earn from holding the bond to
maturity and receiving its promised payments.
Cost of Debt
Lecture 1 24
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• Can we use yield to maturity of a bond as an estimate of the cost of debt?
- If there is little risk the firm will default, yield to maturity is a reasonable estimate of the cost of debt
- If there is significant risk of default, yield to maturity overestimate investors’ expected return on a bond
= − × __
where the probability of default is often estimated below (Table 12.2) and the Expected Loss Rate is the expected loss per $1 of debt in
the event of default.
Cost of Debt
Lecture 1 25
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• Can we use CAPM to estimate of the cost of debt?
- Yes or No?
- Can we estimate Beta using historical bond return data? Yes or no?
Corporate bonds are traded infrequently. We can approximate beta using estimates of betas of bond indices
by rating category as shown below (Table 12.3)
Debt beta
Lecture 1 26
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Example
Lecture 1 27
Example: Homebuilder KB Home has outstanding 6-year bonds with a yield to maturity of 6% and a B credit rating with the
expect loss rate of 60%. If the corresponding risk-free rate is 1% and the market risk premium is 5% and the corporate tax rate
is 30%.
a. Given the expected default rate in Table 12.2, estimate the cost of debt using the yield to maturity
b. Given the estimate of beta in Table 12.3, estimate the cost of debt using CAPM and the corresponding after-tax cost of debt.
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• For a firm, we have the firm’s (1) asset cost of capital and (2) weighted average cost of capital (WACC).
• (1) Asset cost of capital (~ return on assets ()~ Pretax WACC (_) ~ unlevered cost of capital ())
o The expected return required by investors when holding the firm’s assets
=> pretax consideration => weighted average of the firm’s equity and pretax debt costs of capital => Pretax WACC
= + = + = _ =
o Firm asset (unlevered) beta
• (2) Weighted average cost of capital (WACC): based on the after-tax cost of debt
= + 1 − or = + 1 −
o – the market value of equity = (number of outstanding shares) x (price per share)
o the market value of debt (number outstanding bonds) x (bond price)
o market value of the firm = D + E
Weights: = ⁄ proportion of equity financing; = ⁄ proportion of debt financing
Asset cost of capital and weighted average cost of capital
Lecture 1 28
U E D
E D
β = β + β
E+D E+D
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Project Cost of Capital
Lecture 1 29
• To estimate a project’s cost of capital, the most common method is to identify a comparable firm in the
same line of business as the project (having the same business risk).
Why? The project is generally not a publicly traded security.
• If the project is financed by all equity, we use the comparable firm’s return on assets () or the pretax
WACC as the project cost of capital.
Why? Does the project has the tax benefits of debt? Is the project similar to the comparable firm’s asset?
-> The firm’s asset beta as the beta of the project
• If the project is financed by both debt and equity, we use the comparable firm’s WACC as the project cost
of capital.
Why? Does the project has the tax benefits of debt? Why the comparable firm’s WACC (not the pretax WACC)?
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Alpha Corp. has a market capitalization of $100 million, and $25 million in outstanding debt. The firm’s cost
of equity and cost of debt are 10% and 6%, respectively. If the corporate tax rate is 40%.
a. Calculate the asset cost of capital or pretax WACC
b. Calculate WACC
c. If project A has the same risk and the same mix of debt and equity financing as Alpha, estimate the project cost of
capital
d. If project B has the same risk as Alpha but is financed by all equity, estimate the project cost of capital
Example
Lecture 1 30
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