Integration of the Finance Function Timothy A. Thompson Spring, 2002

Goals of Integration of the Finance Function Enhance the quality of strategic business decision-making skills By understanding the effect of those decisions on the value of the company By understanding which value drivers are most influential on shareholder value in different situations By constructing a value-based decision making framework

Expanding skill set Investment decisions What are appropriate cash flows to use? Being consistent in treatment of inflation What decision rules are/should be used? How do I incorporate riskiness into my model? How do I incorporate real asset options into my decision?

Capital structure decisions Debt/equity What are the determinants of capital structure choice? Managerial equity ownership Do managers have appropriate incentives to maximize shareholder value? Does managerial equity ownership align incentives appropriately?

Tax shields of debt financing How much value is added to the firm by the use of debt finance rather than equity? This value is normally incorporated into firm value through the WACC (weighted average cost of capital) Alternatively, can calculate a dollar amount using the Adjusted Present Value framework (APV)

Costs of financial distress Credit rating analysis Based on financial ratios, predict the bond rating of an investment grade debt Analyze highly-leveraged transaction using dynamic coverage analysis based on Forecast free cash flows Forecast interest and required principal payments

Cost of capital basics WACC What determines my cost of capital for a Project, division, firm? Beta and CAPM-type models Peer group analysis Applications to … private companies, foreign investments … Relationship to private equity methods

Corporate valuation models Models Multiples based on comparable firms (trading multiples) Multiples based on acquisitions of comparable companies (transaction multiples) Discounted cash flow models Control premiums and Liquidity discounts When are they appropriate? How large is reasonable?

Discounted cash flow valuation of corporations Valuation by components or equity cash flows? Should I value the equity directly, or estimate the company value (total enterprise value) and subtract net debt How do I define cash flows for valuation? What should the length of my forecast window be? How do I value the company at the end of my forecast window?

DCF corporate valuation continued Corporate adjustments What assets do I add to the DCF value of the corporations? What liabilities do I consider debt (financing liabilities)? What do I do with preferred stock, minority interests? How do I handle financial leases/operating leases? What about contingent liabilities?