Overview of FINC2012 Intermediate Corporate Finance
Lecture 1 Investment Decision and NPV
Only cash flow is relevant. Estimation is based on an incremental of cash flow.
Nominal vs Real cash flow, treat inflation consistently
The proceeds from financing decisions should not affect investment decision.
Free Cash Flow (FCF)/Net Cash Flow (NCF)=
Cash flow from capital investment and disposal +
Cash flow from changes in working capital +
Operating cash flow
Change of working capital
- Change of accounts receivable, inventory, accounts payable.
The effect of depreciation schedule (e.g. straight line, MACRS) on NPV estimation.
Investment timing decision
Long vs Short projects
Equivalent annual cost (EAC) =NPV/annuity factor
Annuity Factor =
Lecture 2 Risk and Cost of Capital
Company cost of capital vs Project cost of capital
( ) ( )
V
E
V
D rrr equitydebtassets COC +==

Cost of debt : expected return on debt : YTM on bonds
Cost of equity : expected return on equity : CAPM
Weighted Average Cost of Capital (WACC) :
Security Market Line (SML)
Market Beta, market risk, systematic risk
Regression estimation of beta
Company Cost of Capital






+





=
V
E
V
D
equitydebtassets βββ

The average beta of the assets is based on the % of funds in each asset.
Operating leverage and asset risk






+=
=
PV(asset)
cost) PV(fixed
1β
PV(asset)
cost) ePV(variabl-)PV(revenue
ββ
revenue
revenueasset

Fudge factor
Certainty equivalent cash flow (CEQ), hair-cut for risk
t
f
t
t
f
tt
t
t
r
CEQ
r
Ca
r
C
PV
)1()1()1( +
=
+
=
+
=
Lecture 3 Project Analysis
Capital investment procedure
Sensitivity analysis
Scenario analysis
Simulation analysis (Monte Carlo)
Modelling, Probability Distribution, Simulation Cash Flow, Distribution of NPV
Break-even analysis
Accounting beak-even vs NPV break-even
BE units = FC/ contribution margin
Contribution margin = price – VC per unit
Degree of operation leverage
Fixed cost includes both fixed cost and depreciation.

Decision tree analysis

Lecture 4 Understanding Options
Calls, Puts Options
Option intrinsic value
Diagrams to show option intrinsic value vs share price
Put-call parity
Break-even point of intrinsic option value
Straddle : long call and long put position
Option Value (call option)
Stock Price (+), Exercise Price (-), Interest Rate (+), Time to expiration (+), Volatility of stock
price (+)
Option Valuation
Hedging portfolio : option delta= spread of possible option prices/spread of possible share
prices
Binomial Pricing
Black-Sholes Option Pricing Model
   )(PV)()( 21 EXdNPdNOC −=
tv
tr
d
vP )()ln(
2EX
1
2
++
=
, tvdd −= 12

Lecture 5 Real Options
Intrinsic Value + time premium = option value
What are the real options?
Real option value = NPV with option – NPV without option
Timing Option
Option to Abandon
Options on Flexible Production
Limitations of real option value estimation

Lecture 6 Agency Problem
Agency Problem (reduced effort, perks, empire building, entrenching investment ) and risk
taking
- Incentive
o Gambling for redemption
o Hesitate to curtail risky activities
- Compensation
o Option and risk taking
o Golden parachute
o Process of determining compensation packages
- Monitoring (board, auditors, lenders, shareholders, rival companies)
Economic value added (EVA)=income earned – cost of capital*investment =(ROI-r)*capital
invested
Pros and cons of EVA measurement
Economic Profit
Accounting vs Book measurements of EVA


Lecture 7 Corporate Financing
Internal funds, equity issuance, debt issuance
Debt ratios
Holdings of corporate equity, holdings of corporate bond
Angel fund, venture capital and private equity
Common equity, preferred stock
Corporate debt, convertible bond
IPO (initial public offering), SEO (seasonal equity offering), private placement
Underwriter, underwriter spread, prospectus, under-pricing of an IPO
Rights Issue

Lecture 8 Capital Structure in perfect market
M-M Theory Proposition I
Assumptions, portfolio replication, conclusion
M-M Theory Proposition II
the expected rate of return on common stock of a levered firm increases in proportion to
the debt-equity(D/E) ratio.
( )
E
D
rrrr DAAE −+=


WACC, after tax WACC






+





−=
V
E
r
V
D
Tcr ED )1(WACC


Lecture 9 Capital Structure with market frictions
Interest tax shield = Tc * D
Firm Value = value of all equity firm + PV tax shield
Personal and Corporate Tax (Relative Advantage Formula)：debt vs equity
1-Tp
1-TpE( ) 1-Tc( )

Cost of financial distress : direct & indirect cost
Conflict of interest between debtholder and shareholders
• Cash In and Run, Playing for Time, Bait and Switch
Pecking order theory
Trade off theory

Lecture 10 Finance and Valuation
Tax adjusted WACC & interest tax shield
Firm valuation
H
H
H
H
)WACC1(
PV
)WACC1(
FCF
...
)WACC1(
FCF
)WACC1(
FCF
PV
2
2
1
1
+
+
+
++
+
+
+
=

FCF = Profit after tax + depreciation - investment in fixed assets - investment in working
capital
Horizon value = PVH=FCFH+1/(WACC-g)
PV(firm)=PV(FCF)+PV(Horizon value)
Preferred stock






+





+





−= EPD r
V
E
r
V
P
r
V
D
Tc)1(WACC

WACC and different debt ratios
APV=base case NPV + PV impact (cost / benefit directly from financing)
Assumptions on debt to value ratio and discounting factors


Lecture 11 Payout Policy
Cash dividend, Dividend payment process
Stock repurchase : buy from opening market, tender offer, private negotiation
Information content of dividend payment
M-M dividend theory : no impact on the value of the firm
Dividend increases or decreases firm value
Market imperfections and clientele effect
Tax & dividend yield, capital gain
- Different tax rate, delayed payment, corporate tax on dividend proceeds
- Double taxation & Australia imputed tax system
Residual dividend policy

Lecture 12 Cash Management
Changes in cash flows
Net income, depreciation, inventory, accounts payable, debt issuance
Uses of cash flow
Operating activity (e.g. accounts receivable), investing activities, financial activity (e.g.
dividend payment, marketable securities etc.)
Cash conversion cycle
Cash conversion cycle
= + inventory period + receivables period − accounts payable period
COGS/365 annual
payable accounts
=period payable Accounts
sales/365 annual
receivable accounts
=period sreceivable Accounts
COGS/365 annual
inventory
=period Inventory

Cash Budgeting
Goals of financial planning
assetsnet
equity
equity
incomenet
incomenet
earnings retained
=
assetsnet
earnings retained
=rategrowth Internal


equityon return ratioplowback =rategrowth eSustainabl 