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程序代写案例-FINANCE 2021
时间：2021-11-21
CORPORATE FINANCE 2021
UCL MSc Finance
1
Overview of Corporate Finance Part II
(c) Alexander S. Gorbenko 2020
The Capital Budgeting Question
• The next question:
– Which projects should the firm
invest in to maximize value?
– Should it:
• Compute the NPV?
…or use the expected return (IRR)?
…or use multiples?
– Key concepts: FCF, NPV, Beta &
Security Market Line
– Capital budgeting with leverage: the
WACC, APV, and FTE method
• So far we tried to answer the
following question:
– How should the firm raise the
capital to make investments?
– Should it:
• Borrow (issue debt)?
• Sell shares (issue equity)?
• Rely on retained earnings?
– Key concepts: Modigliani-Miller,
WACC, bankruptcy & agency costs…
Assets Liabilities
Projects & Investments
undertaken by firm
Securities
issued by firm
Debt: Standard Debt, Convertible Debt
Equity: Common Stock, Preferred Stock,
Options & Warrants
2(c) Alexander S. Gorbenko 2020
The Risk Management Question
• The next question:
– Which projects should the firm
invest in to maximize value?
– Key concepts: FCF, NPV, Beta &
Security Market Line
– Capital budgeting with leverage: the
WACC, APV, and FTE method
• Back to the right-hand side of the
balance sheet:
– Can the firm create additional value
through risk management?
– Should it manage risks with:
• Hedging contracts?
• Forwards?
• Options?
Assets Liabilities
Projects & Investments
undertaken by firm
Securities
issued by firm
Debt: Standard Debt, Convertible Debt
Equity: Common Stock, Preferred Stock,
Options & Warrants
3(c) Alexander S. Gorbenko 2020
Risk management tools: Hedging
Contracts, Forwards, Options
Value added?
Capital Budgeting in Venture Capital
• Cash flows… what cash flows?
– How should the startup evaluate
projects when cash flows are
difficult to estimate?
Should it:
• Compute the NPV?
…or use the expected return (IRR)?
…or use multiples?
…or come up with a new method?
– Key concepts: The VC method
• How can a venture capitalist
finance the entrepreneur?
– Should it:
• Provide debt financing?
• Provide equity financing?
• Combine the two?
• Include additional contract terms?
• Take seats on the Board of
Directors?
– Key concepts: valuation of options
Assets Liabilities
Projects & Investments
undertaken by firm
Securities
to compensate the VC
Convertible Preferred Equity
Contract terms: Participating Preferred,
Cumulative Dividends, Pay2Play, Board Seats
4(c) Alexander S. Gorbenko 2020
CORPORATE FINANCE 2021
UCL MSc Finance
Capital Budgeting:
Callaway Golf
5(c) Alexander S. Gorbenko 2020
Steps to Make Good Financial Decisions
• Earnings Forecasting: Forecast incremental project earnings
• From Earnings to Free Cash Flow: Obtain Free Cash Flow
• Discount FCF to today: Obtain project’s Cost of Capital
(Discount rate)
• Use NPV rule: Obtain Net Present Value
6(c) Alexander S. Gorbenko 2020
CASE: Callaway Golf FX-1
• SIZE UP
– Industry
– Geographical location: Local/global
– Size: Small/large
– Competition: Monopoly/oligopoly/competitive
– Product range: specialized/diversified
– Seasonality of sales: high/low
– Cyclicality of sales, profits: high/low
– Governance: entrenched managers, family ownership, board size
– Etc. etc. etc.
7(c) Alexander S. Gorbenko 2020
Accounting Measures
Cash & ST Investments 46,362 Accounts Payable 111,360
Accounts Receivable 118,133 Accrued Compensation 18,731
Inventory 265,110 Warranty Expenses 13,364
Other Current Assets 63,595 Line of Credit 80,000
Total Current Assets 493,200 Total Current Liabilities 223,455
Prop/Plant/Equip. (Net) 131,224 Deferred Compensation 7,210
Intangible Assets (Net) 144,326 Minority Interest 1,987
Goodwill (Net) 30,833 Other Liabilities 36,178
Other Long-Term Assets 46,364 Long-Term Debt 0
Total Assets 845,947 Total Liabilities 268,830
Total Equity 577,117
Total Liability &
Shareholder's Equity
845,947
Assets Liabilities
• Callaway Golf Balance Sheet ($000s) – End of FY 2006
8(c) Alexander S. Gorbenko 2020
Accounting Measures
Income Statement 2002 2003 2004 2005 2006
(in $ thousands)
Total Sales 793,219 814,032 934,564 998,093 1,017,907
yoy growth -2.8% 2.6% 14.8% 6.8% 2.0%
Cost of Sales -393,068 -445,417 -575,742 -583,679 -619,832
Gross Profit 400,151 368,615 358,822 414,414 398,075
Gross Margin 50% 45% 38% 42% 39%
Operating Expenses:
R&D -32,182 -29,529 -30,557 -26,989 -26,785
Selling Expenses -200,329 -207,783 -263,089 -290,074 -254,526
General and Administrative -56,580 -65,448 -89,878 -80,145 -79,709
Operating Income 111,060 65,855 -24,702 17,206 37,055
Other Income/Loss 2,271 2,452 1,189 -1,290 2,035
EBIT 113,331 68,307 -23,513 15,916 39,090
EBIT Margin 14.3% 8.4% -2.5% 1.6% 3.8%
Interest Income/Expense -1,660 -424 -200 -1,379 -4,092
Income Before Tax 111,671 67,883 -23,713 14,537 34,998
Taxes -42,225 -22,360 13,610 -1,253 -11,708
Net Income 69,446 45,523 -10,103 13,284 23,290
Net Profit Margin 8.8% 5.6% -1.1% 1.3% 2.3%
Total Shares Outstanding 66,520 66,027 67,721 68,646 67,732
EPS 1.04 0.69 -0.15 0.19 0.34
• Callaway Golf Earnings
9(c) Alexander S. Gorbenko 2020
FX-1 Incremental Earnings Impact
FX-1 Incremental Income
(With vs. Without FT-X) Year 0 Year 1 Year 2 Year 3 Year 4
Total Sales
Cost of Goods Sold
Gross Profit
Operating Expenses:
R&D
Selling, General & Admin
Depreciation/Amort
Operating Income
Other Income/Loss
EBIT
Interest Expense
Income Before Tax
Taxes
(Incremental) Net Income
(c) Alexander S. Gorbenko 2020
10
FX-1 Incremental Earnings Impact
FX-1 Incremental Income
(With vs. Without FT-X) Year 0 Year 1 Year 2 Year 3 Year 4
Total Sales
Cost of Goods Sold
Gross Profit
Operating Expenses:
R&D
Selling, General & Admin
Depreciation/Amort
Operating Income
Other Income/Loss
EBIT
Interest Expense
Income Before Tax
Taxes
(Incremental) Net Income
(c) Alexander S. Gorbenko 2020
120*80-3,125*0.16
=9,100
120*75%
*70=6,300
90*2/3*60
=3,600
60*1/4*50
=750
-120*30
=(3,600)
-90*30
=(2,700)
-60*30
=(1,800)
-15*30
=(450)
(400)
(600) 30%*9100=(2,730) (1,890) (1,080) (225)
(125) (125) (125) (125)
38.5%
*IBT
38.5%
*IBT
38.5%
*IBT
38.5%
*IBT
38.5%
*IBT
11
FX-1 Incremental Earnings Impact
12(c) Alexander S. Gorbenko 2020
• Operating Expenses
▪ S,G&A = 30% ×
Sales
▪ Depreciation =
$125/yr
FX-1 Incremental Income
(With vs. Without FT-X) Year 0 Year 1 Year 2 Year 3 Year 4
Total Sales 9,100 6,300 3,600 750
Cost of Goods Sold (3,600) (2,700) (1,800) (450)
Gross Profit 5,500 3,600 1,800 300
Operating Expenses:
R&D (400)
Selling, General & Admin (600) (2,730) (1,890) (1,080) (225)
Depreciation/Amort (125) (125) (125) (125)
Operating Income (1,000) 2,645 1,585 595 (50)
Other Income/Loss
EBIT (1,000) 2,645 1,585 595 (50)
Interest Expense
Income Before Tax (1,000) 2,645 1,585 595 (50)
Taxes 385 (1,018) (610) (229) 19
(Incremental) Net Income (615) 1,627 975 366 (31)
12
Earnings vs. Cash Flow
• What do accounting earnings represent?
– Earnings: excess of revenues over direct expenses for a given period
• Ultimately, we care about the cash available
– to invest in other projects
– to return to investors
• There are several reasons why earnings are not cash flows:
– Accruals: revenue is recognized when sale is made not when money is
received
– Inventory or receivables can use or generate cash
– Is depreciation really a cash outflow?
13(c) Alexander S. Gorbenko 2020
First Principle
of Finance:
Cash is King
Free Cash Flow
• From Earnings to Free Cash Flow (FCF)
– FCF =
EBIT – Taxes + Depreciation – Inc. in NWC – Capital Exp.
= Revenues – Costs – Taxes + Depreciation Tax Deduction – Inc. in NWC – Capital Exp.
– Depreciation provides a tax deduction. Otherwise, it is not a cash expense and
should be added back after taxes.
– Capital expenditures should be included at the time they are incurred
– NWC = Net Working Capital
= Inventory + Cash Requirements + Receivables – Payables
• This is the capital needed to “run the business”
• Adjusts for lag between when goods are manufactured and paid for, and when the
cash from the sale is actually received.
14(c) Alexander S. Gorbenko 2020
FX-1 Working Capital Requirements
Year 0 Year 1 Year 2 Year 3 Year 4
Sales 9,100 6,300 3,600 750
Accounts Receivable
Expected Sales (Units) 120 90 60 15
Inventory Units Built
Inventory Units Remaining
Inventory Cost
Net Working Capital
(AR + Inventory)
Additions to NWC
15(c) Alexander S. Gorbenko 2020
FX-1 Working Capital Requirements
Year 0 Year 1 Year 2 Year 3 Year 4
Sales 9,100 6,300 3,600 750
Accounts Receivable
Expected Sales (Units) 120 90 60 15
Inventory Units Built
Inventory Units Remaining
Inventory Cost
Net Working Capital
(AR + Inventory)
Additions to NWC
16(c) Alexander S. Gorbenko 2021
75 (120-75)
+50% x 90
+25% x 120
=120
75-120+120
=75
(90-75)
+50% x 60
+25% x 90
=67.5
75-90+67.5
=52.5
(60-52.5)
+50% x 0
+25% x 60
=22.5
52.5-60+22.5
=15
You can make a different
assumption and still get
very similar project value
0
0
25% x 9,100
=2,275
25% x 6,300
=1,575
25% x 3,600
=900 0
30 x 75
= 2,250
30 x 75
= 2,250
30 x 52.5
= 1,575
30 x 15
= 450
FX-1 Working Capital Requirements
Year 0 Year 1 Year 2 Year 3 Year 4
Sales 9,100 6,300 3,600 750
Accounts Receivable 2,275 1,575 900 0
Expected Sales (Units) 120 90 60 15
Inventory Units Remaining 75 75 52.5 15 0
Inventory Cost 2,250 2,250 1,575 450 0
Net Working Capital
(AR + Inventory)
2,250 4,525 3,150 1,350 0
Additions to NWC 2,250 2,275 -1,375 -1,800 -1,350
17(c) Alexander S. Gorbenko 2020
FX-1 Free Cash Flow
Incremental Earnings Year 0 Year 1 Year 2 Year 3 Year 4
Revenue 9,100 6,300 3,600 750
Cost of goods sold (3,600) (2,700) (1,800) (450)
Gross profit 5,500 3,600 1,800 300
R&D (400)
SG&A (600) (2,730) (1,890) (1,080) (225)
Depreciation (125) (125) (125) (125)
EBIT (1,000) 2,645 1,585 595 (50)
Taxes 385 (1,018) (610) (229) 19
Net Income (615) 1,627 975 366 (31)
Free Cash Flow Year 0 Year 1 Year 2 Year 3 Year 4
EBIT (1,000) 2,645 1,585 595 (50)
Less: Taxes 385 (1,018) (610) (229) 19
Plus: Depreciation 0 125 125 125 125
Less: Inc. in NWC (2,250) (2,275) 1,375 1,800 1,350
Less: CapEx (500)
Free Cash Flow (3,365) (523) 2,475 2,291 1,444
18(c) Alexander S. Gorbenko 2020
Project Free Cash Flow
• Summary
– Use data from marketing, operations, HR, and accounting to forecast the
incremental future consequences of the project
– Include both direct and indirect effects -- “With vs. Without”
• Calculate the project’s Free Cash Flow
– Total cash generated to be used for new projects or paid to investors
– Add back non-cash expenses (depreciation)
– Include capital expenditures and additions to net working capital
• Next Question: How do we evaluate Free Cash Flow?
19(c) Alexander S. Gorbenko 2020
Discounting Cash Flows
• Is $1 today = $1 in one year?
– Time Value of Money
– Risk
• Investors will demand a reward or return for their
– Patience
– Willingness to take risk
20(c) Alexander S. Gorbenko 2020
Second Principle
of Finance:
Sooner is Better
Third Principle of
Finance:
Safer is Better
Risk and the Cost of Capital
• Most firms/investments are risky
– Investors are risk averse
– Investors will demand a higher return to compensate them for risk
– The size of the risk premium will
depend on the amount/type of risk
– Match the return of investments
with “comparable” systematic risk
21(c) Alexander S. Gorbenko 2020
Required Return
or
Cost of Capital
Risk-Free
Interest Rate
Risk
Premium
= +
Fourth Principle of
Finance:
Risk is Systematic
Present Value Formula
• Inputs:
– is time (e.g., year from project start)
– is cash flow (positive or negative)
– is the period interest rate (in %)
– is a project’s expected life
• Output:
= 0 +
1
1 + 1
+
2
1 + 2 2
+
3
1 + 3 3
+⋯+
1 +
– In corporate finance, we almost always assume a flat structure of
interest rates
22(c) Alexander S. Gorbenko 2020
Net Present Value: Risk-Free Case
• Evaluating the FX-1 if all cash flows are risk-free
– Suppose the risk-free interest rate is 4.7%
– Realistic: in early 2007, the yield curve was almost flat at ~4.7%
– We can convert each cash flow into its equivalent PV
– Once in terms of “$ today,” they can be combined and compared
– Cost = $3,365 + 500 = $3,865 today
– Benefit = $2,258 + 1,996 + 1,202 = $5,456 today
– NPV = $5,456 – 3,865 = $1,591 today
23(c) Alexander S. Gorbenko 2021
Year 0 Year 1 Year 2 Year 3 Year 4
Free Cash Flow -3,365 -523 2,475 2,291 1,444
1.000 0.957 0.916 0.876 0.839
= Present Value (3,365) (500) 2,258 1,996 1,202
1
(1.047)
Capital Budgeting with Risky Projects
• When discounting the project’s expected free cash flows
– Use discount rate that compensates investors for risk they are taking
– Required return = return on other investments with similar maturity and
risk
• FX-1 Project
– Callaway Golf’s cost of capital
4.7% (risk-free rate) + 5.8% (risk premium) = 10.5%
• We will justify this number later
– NPV = -3365 - 474 + 2027 + 1698 + 969 = $855
Year 0 Year 1 Year 2 Year 3 Year 4
Free Cash Flow -3,365 -523 2,475 2,291 1,444
1.000 0.905 0.819 0.741 0.671
= Present Value (3,365) (474) 2,027 1,698 969
24(c) Alexander S. Gorbenko 2020
Sources of Value
• This estimate is based on a number of assumptions
– Sales volume, pricing, development costs, etc.
– Which factors are most important?
• Identify most important factors
– Scenario analysis
– Sensitivity analysis
25(c) Alexander S. Gorbenko 2020
Sources of Value
• We can use NPV analysis to determine the key assumptions in
our forecasts:
26(c) Alexander S. Gorbenko 2020
Assumption Forecast Worst Case Best Case
First Year Sales 120 90 150
First Year Ave. Price 80 70 85
Production Cost 30 32 27
Cannibalization 16% 25% 5%
Receivables 90 days 120 days 60 days
Cost of Capital 10.5% 15% 9%
Sources of Value
• Sensitivity & Break-Even Analysis
27(c) Alexander S. Gorbenko 2020
BE
100.51
19.3%
-500 0 500 1000 1500 2000
Units Sold
Ave. Price
Cost
Cannibalization
AR days
Discount Rate
Project NPV
$73.82
32 27 $35.87
25% 5% 67.1%
120 60 292
15% 9%
15090
8570
Summary: Basic Capital Budgeting
• Four steps to make good financial decisions
• Incremental earnings forecast
– CAPEX versus Depreciation
– Cannibalization
– Sunk costs
– (talked about) Tax carry-backs and carry-forwards
• Free cash flow forecast
– Advanced inventory management
– Accounts payable and receivable
28(c) Alexander S. Gorbenko 2020
Where Do We Go from Here?
• Are there simpler alternative ways to value projects?
• How should projects be prioritized when there are resource
constraints?
• How do we determine the appropriate, risk-adjusted discount
rate? In other words, what is the cost of capital?
– Deeper understanding of the connection between risk and return
• How to value projects of private firms?
29(c) Alexander S. Gorbenko 2020
学霸联盟
UCL MSc Finance
1
Overview of Corporate Finance Part II
(c) Alexander S. Gorbenko 2020
The Capital Budgeting Question
• The next question:
– Which projects should the firm
invest in to maximize value?
– Should it:
• Compute the NPV?
…or use the expected return (IRR)?
…or use multiples?
– Key concepts: FCF, NPV, Beta &
Security Market Line
– Capital budgeting with leverage: the
WACC, APV, and FTE method
• So far we tried to answer the
following question:
– How should the firm raise the
capital to make investments?
– Should it:
• Borrow (issue debt)?
• Sell shares (issue equity)?
• Rely on retained earnings?
– Key concepts: Modigliani-Miller,
WACC, bankruptcy & agency costs…
Assets Liabilities
Projects & Investments
undertaken by firm
Securities
issued by firm
Debt: Standard Debt, Convertible Debt
Equity: Common Stock, Preferred Stock,
Options & Warrants
2(c) Alexander S. Gorbenko 2020
The Risk Management Question
• The next question:
– Which projects should the firm
invest in to maximize value?
– Key concepts: FCF, NPV, Beta &
Security Market Line
– Capital budgeting with leverage: the
WACC, APV, and FTE method
• Back to the right-hand side of the
balance sheet:
– Can the firm create additional value
through risk management?
– Should it manage risks with:
• Hedging contracts?
• Forwards?
• Options?
Assets Liabilities
Projects & Investments
undertaken by firm
Securities
issued by firm
Debt: Standard Debt, Convertible Debt
Equity: Common Stock, Preferred Stock,
Options & Warrants
3(c) Alexander S. Gorbenko 2020
Risk management tools: Hedging
Contracts, Forwards, Options
Value added?
Capital Budgeting in Venture Capital
• Cash flows… what cash flows?
– How should the startup evaluate
projects when cash flows are
difficult to estimate?
Should it:
• Compute the NPV?
…or use the expected return (IRR)?
…or use multiples?
…or come up with a new method?
– Key concepts: The VC method
• How can a venture capitalist
finance the entrepreneur?
– Should it:
• Provide debt financing?
• Provide equity financing?
• Combine the two?
• Include additional contract terms?
• Take seats on the Board of
Directors?
– Key concepts: valuation of options
Assets Liabilities
Projects & Investments
undertaken by firm
Securities
to compensate the VC
Convertible Preferred Equity
Contract terms: Participating Preferred,
Cumulative Dividends, Pay2Play, Board Seats
4(c) Alexander S. Gorbenko 2020
CORPORATE FINANCE 2021
UCL MSc Finance
Capital Budgeting:
Callaway Golf
5(c) Alexander S. Gorbenko 2020
Steps to Make Good Financial Decisions
• Earnings Forecasting: Forecast incremental project earnings
• From Earnings to Free Cash Flow: Obtain Free Cash Flow
• Discount FCF to today: Obtain project’s Cost of Capital
(Discount rate)
• Use NPV rule: Obtain Net Present Value
6(c) Alexander S. Gorbenko 2020
CASE: Callaway Golf FX-1
• SIZE UP
– Industry
– Geographical location: Local/global
– Size: Small/large
– Competition: Monopoly/oligopoly/competitive
– Product range: specialized/diversified
– Seasonality of sales: high/low
– Cyclicality of sales, profits: high/low
– Governance: entrenched managers, family ownership, board size
– Etc. etc. etc.
7(c) Alexander S. Gorbenko 2020
Accounting Measures
Cash & ST Investments 46,362 Accounts Payable 111,360
Accounts Receivable 118,133 Accrued Compensation 18,731
Inventory 265,110 Warranty Expenses 13,364
Other Current Assets 63,595 Line of Credit 80,000
Total Current Assets 493,200 Total Current Liabilities 223,455
Prop/Plant/Equip. (Net) 131,224 Deferred Compensation 7,210
Intangible Assets (Net) 144,326 Minority Interest 1,987
Goodwill (Net) 30,833 Other Liabilities 36,178
Other Long-Term Assets 46,364 Long-Term Debt 0
Total Assets 845,947 Total Liabilities 268,830
Total Equity 577,117
Total Liability &
Shareholder's Equity
845,947
Assets Liabilities
• Callaway Golf Balance Sheet ($000s) – End of FY 2006
8(c) Alexander S. Gorbenko 2020
Accounting Measures
Income Statement 2002 2003 2004 2005 2006
(in $ thousands)
Total Sales 793,219 814,032 934,564 998,093 1,017,907
yoy growth -2.8% 2.6% 14.8% 6.8% 2.0%
Cost of Sales -393,068 -445,417 -575,742 -583,679 -619,832
Gross Profit 400,151 368,615 358,822 414,414 398,075
Gross Margin 50% 45% 38% 42% 39%
Operating Expenses:
R&D -32,182 -29,529 -30,557 -26,989 -26,785
Selling Expenses -200,329 -207,783 -263,089 -290,074 -254,526
General and Administrative -56,580 -65,448 -89,878 -80,145 -79,709
Operating Income 111,060 65,855 -24,702 17,206 37,055
Other Income/Loss 2,271 2,452 1,189 -1,290 2,035
EBIT 113,331 68,307 -23,513 15,916 39,090
EBIT Margin 14.3% 8.4% -2.5% 1.6% 3.8%
Interest Income/Expense -1,660 -424 -200 -1,379 -4,092
Income Before Tax 111,671 67,883 -23,713 14,537 34,998
Taxes -42,225 -22,360 13,610 -1,253 -11,708
Net Income 69,446 45,523 -10,103 13,284 23,290
Net Profit Margin 8.8% 5.6% -1.1% 1.3% 2.3%
Total Shares Outstanding 66,520 66,027 67,721 68,646 67,732
EPS 1.04 0.69 -0.15 0.19 0.34
• Callaway Golf Earnings
9(c) Alexander S. Gorbenko 2020
FX-1 Incremental Earnings Impact
FX-1 Incremental Income
(With vs. Without FT-X) Year 0 Year 1 Year 2 Year 3 Year 4
Total Sales
Cost of Goods Sold
Gross Profit
Operating Expenses:
R&D
Selling, General & Admin
Depreciation/Amort
Operating Income
Other Income/Loss
EBIT
Interest Expense
Income Before Tax
Taxes
(Incremental) Net Income
(c) Alexander S. Gorbenko 2020
10
FX-1 Incremental Earnings Impact
FX-1 Incremental Income
(With vs. Without FT-X) Year 0 Year 1 Year 2 Year 3 Year 4
Total Sales
Cost of Goods Sold
Gross Profit
Operating Expenses:
R&D
Selling, General & Admin
Depreciation/Amort
Operating Income
Other Income/Loss
EBIT
Interest Expense
Income Before Tax
Taxes
(Incremental) Net Income
(c) Alexander S. Gorbenko 2020
120*80-3,125*0.16
=9,100
120*75%
*70=6,300
90*2/3*60
=3,600
60*1/4*50
=750
-120*30
=(3,600)
-90*30
=(2,700)
-60*30
=(1,800)
-15*30
=(450)
(400)
(600) 30%*9100=(2,730) (1,890) (1,080) (225)
(125) (125) (125) (125)
38.5%
*IBT
38.5%
*IBT
38.5%
*IBT
38.5%
*IBT
38.5%
*IBT
11
FX-1 Incremental Earnings Impact
12(c) Alexander S. Gorbenko 2020
• Operating Expenses
▪ S,G&A = 30% ×
Sales
▪ Depreciation =
$125/yr
FX-1 Incremental Income
(With vs. Without FT-X) Year 0 Year 1 Year 2 Year 3 Year 4
Total Sales 9,100 6,300 3,600 750
Cost of Goods Sold (3,600) (2,700) (1,800) (450)
Gross Profit 5,500 3,600 1,800 300
Operating Expenses:
R&D (400)
Selling, General & Admin (600) (2,730) (1,890) (1,080) (225)
Depreciation/Amort (125) (125) (125) (125)
Operating Income (1,000) 2,645 1,585 595 (50)
Other Income/Loss
EBIT (1,000) 2,645 1,585 595 (50)
Interest Expense
Income Before Tax (1,000) 2,645 1,585 595 (50)
Taxes 385 (1,018) (610) (229) 19
(Incremental) Net Income (615) 1,627 975 366 (31)
12
Earnings vs. Cash Flow
• What do accounting earnings represent?
– Earnings: excess of revenues over direct expenses for a given period
• Ultimately, we care about the cash available
– to invest in other projects
– to return to investors
• There are several reasons why earnings are not cash flows:
– Accruals: revenue is recognized when sale is made not when money is
received
– Inventory or receivables can use or generate cash
– Is depreciation really a cash outflow?
13(c) Alexander S. Gorbenko 2020
First Principle
of Finance:
Cash is King
Free Cash Flow
• From Earnings to Free Cash Flow (FCF)
– FCF =
EBIT – Taxes + Depreciation – Inc. in NWC – Capital Exp.
= Revenues – Costs – Taxes + Depreciation Tax Deduction – Inc. in NWC – Capital Exp.
– Depreciation provides a tax deduction. Otherwise, it is not a cash expense and
should be added back after taxes.
– Capital expenditures should be included at the time they are incurred
– NWC = Net Working Capital
= Inventory + Cash Requirements + Receivables – Payables
• This is the capital needed to “run the business”
• Adjusts for lag between when goods are manufactured and paid for, and when the
cash from the sale is actually received.
14(c) Alexander S. Gorbenko 2020
FX-1 Working Capital Requirements
Year 0 Year 1 Year 2 Year 3 Year 4
Sales 9,100 6,300 3,600 750
Accounts Receivable
Expected Sales (Units) 120 90 60 15
Inventory Units Built
Inventory Units Remaining
Inventory Cost
Net Working Capital
(AR + Inventory)
Additions to NWC
15(c) Alexander S. Gorbenko 2020
FX-1 Working Capital Requirements
Year 0 Year 1 Year 2 Year 3 Year 4
Sales 9,100 6,300 3,600 750
Accounts Receivable
Expected Sales (Units) 120 90 60 15
Inventory Units Built
Inventory Units Remaining
Inventory Cost
Net Working Capital
(AR + Inventory)
Additions to NWC
16(c) Alexander S. Gorbenko 2021
75 (120-75)
+50% x 90
+25% x 120
=120
75-120+120
=75
(90-75)
+50% x 60
+25% x 90
=67.5
75-90+67.5
=52.5
(60-52.5)
+50% x 0
+25% x 60
=22.5
52.5-60+22.5
=15
You can make a different
assumption and still get
very similar project value
0
0
25% x 9,100
=2,275
25% x 6,300
=1,575
25% x 3,600
=900 0
30 x 75
= 2,250
30 x 75
= 2,250
30 x 52.5
= 1,575
30 x 15
= 450
FX-1 Working Capital Requirements
Year 0 Year 1 Year 2 Year 3 Year 4
Sales 9,100 6,300 3,600 750
Accounts Receivable 2,275 1,575 900 0
Expected Sales (Units) 120 90 60 15
Inventory Units Remaining 75 75 52.5 15 0
Inventory Cost 2,250 2,250 1,575 450 0
Net Working Capital
(AR + Inventory)
2,250 4,525 3,150 1,350 0
Additions to NWC 2,250 2,275 -1,375 -1,800 -1,350
17(c) Alexander S. Gorbenko 2020
FX-1 Free Cash Flow
Incremental Earnings Year 0 Year 1 Year 2 Year 3 Year 4
Revenue 9,100 6,300 3,600 750
Cost of goods sold (3,600) (2,700) (1,800) (450)
Gross profit 5,500 3,600 1,800 300
R&D (400)
SG&A (600) (2,730) (1,890) (1,080) (225)
Depreciation (125) (125) (125) (125)
EBIT (1,000) 2,645 1,585 595 (50)
Taxes 385 (1,018) (610) (229) 19
Net Income (615) 1,627 975 366 (31)
Free Cash Flow Year 0 Year 1 Year 2 Year 3 Year 4
EBIT (1,000) 2,645 1,585 595 (50)
Less: Taxes 385 (1,018) (610) (229) 19
Plus: Depreciation 0 125 125 125 125
Less: Inc. in NWC (2,250) (2,275) 1,375 1,800 1,350
Less: CapEx (500)
Free Cash Flow (3,365) (523) 2,475 2,291 1,444
18(c) Alexander S. Gorbenko 2020
Project Free Cash Flow
• Summary
– Use data from marketing, operations, HR, and accounting to forecast the
incremental future consequences of the project
– Include both direct and indirect effects -- “With vs. Without”
• Calculate the project’s Free Cash Flow
– Total cash generated to be used for new projects or paid to investors
– Add back non-cash expenses (depreciation)
– Include capital expenditures and additions to net working capital
• Next Question: How do we evaluate Free Cash Flow?
19(c) Alexander S. Gorbenko 2020
Discounting Cash Flows
• Is $1 today = $1 in one year?
– Time Value of Money
– Risk
• Investors will demand a reward or return for their
– Patience
– Willingness to take risk
20(c) Alexander S. Gorbenko 2020
Second Principle
of Finance:
Sooner is Better
Third Principle of
Finance:
Safer is Better
Risk and the Cost of Capital
• Most firms/investments are risky
– Investors are risk averse
– Investors will demand a higher return to compensate them for risk
– The size of the risk premium will
depend on the amount/type of risk
– Match the return of investments
with “comparable” systematic risk
21(c) Alexander S. Gorbenko 2020
Required Return
or
Cost of Capital
Risk-Free
Interest Rate
Risk
Premium
= +
Fourth Principle of
Finance:
Risk is Systematic
Present Value Formula
• Inputs:
– is time (e.g., year from project start)
– is cash flow (positive or negative)
– is the period interest rate (in %)
– is a project’s expected life
• Output:
= 0 +
1
1 + 1
+
2
1 + 2 2
+
3
1 + 3 3
+⋯+
1 +
– In corporate finance, we almost always assume a flat structure of
interest rates
22(c) Alexander S. Gorbenko 2020
Net Present Value: Risk-Free Case
• Evaluating the FX-1 if all cash flows are risk-free
– Suppose the risk-free interest rate is 4.7%
– Realistic: in early 2007, the yield curve was almost flat at ~4.7%
– We can convert each cash flow into its equivalent PV
– Once in terms of “$ today,” they can be combined and compared
– Cost = $3,365 + 500 = $3,865 today
– Benefit = $2,258 + 1,996 + 1,202 = $5,456 today
– NPV = $5,456 – 3,865 = $1,591 today
23(c) Alexander S. Gorbenko 2021
Year 0 Year 1 Year 2 Year 3 Year 4
Free Cash Flow -3,365 -523 2,475 2,291 1,444
1.000 0.957 0.916 0.876 0.839
= Present Value (3,365) (500) 2,258 1,996 1,202
1
(1.047)
Capital Budgeting with Risky Projects
• When discounting the project’s expected free cash flows
– Use discount rate that compensates investors for risk they are taking
– Required return = return on other investments with similar maturity and
risk
• FX-1 Project
– Callaway Golf’s cost of capital
4.7% (risk-free rate) + 5.8% (risk premium) = 10.5%
• We will justify this number later
– NPV = -3365 - 474 + 2027 + 1698 + 969 = $855
Year 0 Year 1 Year 2 Year 3 Year 4
Free Cash Flow -3,365 -523 2,475 2,291 1,444
1.000 0.905 0.819 0.741 0.671
= Present Value (3,365) (474) 2,027 1,698 969
24(c) Alexander S. Gorbenko 2020
Sources of Value
• This estimate is based on a number of assumptions
– Sales volume, pricing, development costs, etc.
– Which factors are most important?
• Identify most important factors
– Scenario analysis
– Sensitivity analysis
25(c) Alexander S. Gorbenko 2020
Sources of Value
• We can use NPV analysis to determine the key assumptions in
our forecasts:
26(c) Alexander S. Gorbenko 2020
Assumption Forecast Worst Case Best Case
First Year Sales 120 90 150
First Year Ave. Price 80 70 85
Production Cost 30 32 27
Cannibalization 16% 25% 5%
Receivables 90 days 120 days 60 days
Cost of Capital 10.5% 15% 9%
Sources of Value
• Sensitivity & Break-Even Analysis
27(c) Alexander S. Gorbenko 2020
BE
100.51
19.3%
-500 0 500 1000 1500 2000
Units Sold
Ave. Price
Cost
Cannibalization
AR days
Discount Rate
Project NPV
$73.82
32 27 $35.87
25% 5% 67.1%
120 60 292
15% 9%
15090
8570
Summary: Basic Capital Budgeting
• Four steps to make good financial decisions
• Incremental earnings forecast
– CAPEX versus Depreciation
– Cannibalization
– Sunk costs
– (talked about) Tax carry-backs and carry-forwards
• Free cash flow forecast
– Advanced inventory management
– Accounts payable and receivable
28(c) Alexander S. Gorbenko 2020
Where Do We Go from Here?
• Are there simpler alternative ways to value projects?
• How should projects be prioritized when there are resource
constraints?
• How do we determine the appropriate, risk-adjusted discount
rate? In other words, what is the cost of capital?
– Deeper understanding of the connection between risk and return
• How to value projects of private firms?
29(c) Alexander S. Gorbenko 2020
学霸联盟
