1 Framwork and T value.docx

1 Framwork and T value.docx

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1FramworkandTvalue

AFRAMEWORKOFCORPORATEFINANCE

Thegoaloffinancialmanagement:

tomaximizetheshareholders’wealth.

Threequestions:

1.Whatshouldthecompanyinvest（soastoearngoodreturns）?

2.Whatisthelowestcosttogetmoney（borroworissueequity）inordertoinvest?

3.Howmuchcashneededtokeepthecompanyrunning?

WorkMap.

CurrentLiabilities

Currentassets

Networking

capital

Long-termdebt

FixedassetsShareholders’equity

Assets（investment）:

1.Evaluation

Compounding&discounting

Bondvaluation

Stockvaluation

2.CapitalBudgeting

Payback

Netpresentvalue

Internalrateofreturn

3.Return&risk

Capitalmarketefficiency（SML）

Expectedreturnsandvariance

Risks:

systematic&unsystematic（Beta

coefficient）

Diversification&portfolios

4.FinancialStatement

Cashflow

Ratioanalysis

FinancialPlanning

Liabilities&equity

1.Costofcapital

Costoflong-termdebt

Flotationcosts

Capitalstructure

Weightedaveragecostofcapital（WACC）

2.FinancialLeverage&capitalstructure

Modigliani&MillerPropositionI&II

Trade-offtheory

Peckingordertheory

3.RaisingCapital

Cashoffer,rightsoffer,privateplacement

Cash&stockdividends

Warrants

ConvertibleBonds

Thedividendpolicycontroversy

Financialleasing

4.Merger&Acquisitions

Estimatinggainsandlosses

Leveragedbuy-outs

Boots

Workingcapitalmanagement

1.Operatingandcashcycles

2.Cashbudgeting

3.Flexible&restrictivestrategies

TIMEVALUEOFMONEY

BASICPRINCIPLE:

Adollartodayisworthmorethanadollartomorrow.

WHY?

♦Sincemoneycanbe“rented”orINVESTED,ithasanOPPORTUNITYCOSTsoadollartodayhasadifferentvaluethanadollartomorrow;

♦COMPOUNDINGANDDISCOUNTINGTheyarethefinancialtoolsrequiredtomakemoneycomparableovervariousperiodsoftime.

（1）Yourunyourcreditcardtothelimitof$3,000.Theinterestrateis1.75%permonth.Howmuchwillyouoweattheendof12months?

（2）Youwillreceiveascholarshipof

$1,000oneyearfromnow.

7%interestrate.Whatisittoday?

COMPOUNDING:

FUTUREVALUE

DISCOUNTING:

PRESENTVALUE

▪Borrow---$500foroneyear

▪Interestrateperyear---9%

FV1=$500+（.09）（500）=$545

FV1=$500*（1+.09）

FV1=$500（1+r）

$500istheprincipal

$45isthesimpleinterest

COMPOUNDING:

MULTIPLEYEARS

▪Borrow---$500fortwoyears

FV1=500（1+r）

FV2=FV1（1+r）

=500（1+r）（1+r）=500（1+r）2

FV2=500（1.09）2=500（1.1881）

FV2=$594.05

Principal---$500.00

Totalinterest---$94.05

Simpleinterest---$45+$45=$90

Compoundinterest=$4.05

（Interestoninterest）

（.09）（$45）=$4.05

Generally:

FVt=Principal*（1+r）t

FUTUREVALUEINTEREST

FACTOR=（1+r）t

Notation:

FVIF（r,t）

ØThefuturevalueinterestfactorataninterestrateofrovertperiods.

DETERMININGTHEFUTUREVALUEOFTHEINVESTMENTORDEBT

Yourunyourcreditcardtothelimitof$3,000.Theinterestrateis1.75%permonth.Howmuchwillyouoweattheendof12months?

FVt=Principal*（1+r）t

FV12=$3,000*（1.0175）12

=3,000*1.2314

FV12=$3,694.32

Totalinterestpaid:

$694.32

Simpleinterest=633.00

（3000）（.0175）（12）

Compoundinginterest=$64.32

POWEROFCOMPOUNDING

ØAbout374yearsago,ManhattanIslandwassoldfor$24.Whatwouldbethevaluetoday（theFutureValue）ifthatmoneyhadbeeninvestedatacompoundinterestrateof5%peryear?

FV374=$24*FVIF5%,374

=$24*（1.05）374

FV374=$2,018,408,627.52

Simpleinterest=$448.80

（24）（.05）（374）

Compoundinterest=$2,018,408,154.72

DISCOUNTING:

PRESENTVALUE

PresentValue:

valuetodayofafuture

cashflowatanappropriate

discount（interest）rate.

▪Youwillreceiveascholarshipof$1,000oneyearfromnow.

▪7%interestrate

▪Whatisittoday?

FV1=PV*（1+r）

1,000=PV*（1.07）

PV=1,000/1.07=$934.58

DISCOUNTING:

MULTIPLEYEARS

FVt=PV*（1+r）t

PV=FVt/（1+r）t

Or

PV=FVt*1/（1+r）t

▪Youwillreceivethe$1,000scholarshipinthreeyears---whatisitsvaluetoday.

PV=FV3*1/（1+r）3

PV=1,000*1/（1.07）3

PV=1,000*.8163=$816.30

Generally:

PV=FVt*1/（1+r）t

PRESENTVALUEINTEREST

FACTOR=1/（1+r）t

Notation:

PVIF（r,t）

ØThepresentvalueinterestfactoratadiscountrateofrovertperiods.

Exercise:

Youbuyatypeofbondcalleda“stripbond”withafuturevalueof$250,000foryourretirement35yearsfromnow.Thecurrentinterestrate（discountrate）is7.5%.Howmuchwillyoupayforthestripbond?

Overview:

PV=FVt*1/（1+r）t

FVt=PV*（1+r）t

Fourfactors:

▪Presentvalue（PV）

▪Futurevalue（FVt）

▪Discountrate（r）

▪Lifeoftheinvestment（t）

Givenany3ofthefactors,youcanalwaysdeterminethe4th.

MULTIPLECASHFLOWS

ØUseourbasiccompoundinganddiscountingtechniquestodeterminethepresentorfuturevalueofaseriesofunevenpayments,overanumberofcompoundingperiods.

FVIF（r,t）=（1+r）tPVIF（r,t）=1/（1+r）t

FUTUREVALUE

TheValueat10thyearfromnow

（i）Oneyearatatimeata7%discountrate

Endof

Year1Year2Year3Year4

750800700900

*1.07=802.50

1,602.50

*1.07=1,714.68

2,414.68

*1.07=2,583.71

3,483.71

FV4=$3,483.71

FV10=$3,483.71*FVIF7%,6

FV10=$5,228.11

（ii）Eachcashflowseparatelyata7%discountrate

Endof

Year1Year2Year3Year4

750800700900

750*FVIF7%,3=918.78

800*FVIF7%,2=915.92

700*FVIF7%,1=749.00

FV4=900

=3,483.70

FV10=$3,483.71*FVIF7%,6

=$5,228.11

PRESENTVALUE

（i）OneYearatatimeata7%discountrate

Endof

0Year1Year2Year3Year4

750800700900

/1.07

841.12

1,541.12/1.07

1,440.30

2,240.30/1.07

2,093.74

2,843.74/1.07

2,657.70

PV=$2,657.70

（ii）Eachcashflowseparatelyata7%discountrate

Endof

0Year1Year2Year3Year4750800700900

750*PVIF7%,1=700.93

800*PVIF7%,2=698.75

700*PVIF7%,3=571.41

900*PVIF7%,4=686.61

PV=$2,657.70

ANNUITIES:

alevelstreamofcashpaymentsforafixedperiodoftime.

Examples:

▪Carloans

▪Mortgages

▪Rentpayments

▪Fixedcosts

▪Pensionpayment

PresentValueof=C*1–PVIF

anAnnuityr

PVA（r,t）=C*1-（1/（1+r）t）

r

Notation

PVIFA（r,t）=1-1/（1+r）t

r

EXAMPLE

ØSalaryof$60,000peryearfor4yearswitha9%discountrate.

PVA（9%,4）=60,000*（1–（1/（1.09）4）

.09

=60,000*3.23972

PVA=$194,383.19

PERPETUITY

-Anannuityinwhichthecashflow

continuesforever.

PVIFA=1–1/（1+r）t

r

-iftbecomesverylarge,then1/（1+r）t

approacheszero

So:

PVIFAperpetuity=1/r

PVperpetuity=C*1/r=C/r