Corporate Finance Everything….. R Srinivasan

Corporate Finance Valuation and Cost of capital Capital budgeting Capital structure, financing and dividend policy Working capital

Valuation Generalised valuation Arbitrage and value additivity Patterns Level perpetuity Growing perpetuity Level annuity Growing finite cash flow

Valuation Growing finite [t years] cash flow C 1 /(r-g){1-(1+g) t /(1+r) t }

Valuation Compounding intervals (1+r/m) m -1 Continuous compounding Stated and effective rates Nominal and real rates 1+r nominal =(1+r real )(1+inflation rate)

Valuation: Straight Bonds YTM Duration Sensitivity of value to changes in interest rates [1*PV(C1)/V]+[2*PV(C2)/V]+[3*PV(C3)/V]  V/V =  (1+r)/(1+r)*D

Valuation: Common Stock Perpetual growth models Sustainable growth P 0 =No-Growth +PVGO No-growth =EPS 1 /r PVGO=NPV 1 /(r-g) where NPV 1 =-INV 1 +INV 1 *ROE/r g=Ploughback*ROE EPS 1 /P 0 interpretation

Valuation Multiple stages Supernormal stage plus PV of normal growth Free cash flow NOI approach

Cost of Capital Security return and standard deviation Portfolio return and standard deviation Diversification Portfolio variance= 1/N Average Var+(N-1)/N Average covariance Systematic and unsystematic risk CAPM Opportunity cost of capital r [r A ]and Adjusted cost of capital r*

Cost of Capital 1. V L = V U +T c *D 2. WACC = D/V * (1-T c ) * r D +E/V * r E [Definition of WACC] 3. r E = r A + (r A - r D ) * (1- T c ) * D/E [MM Proposition II] 4.  E = {1+ (1- T c ) * D/E} *  A [If debt is risk free] 5. r E = r f + (r M - r f ) *  E [CAPM] 6. WACC= r A *(1- T c * D/V) MM

Valuation Contingent cash flow Call/Put American/European Binomial Black-Scholes Underlying asset price, Exercise Price, Risk- free rate, Volatility, Time

Capital Budgeting NPV and IRR not payback and accounting rate of return Accept/reject single project use NPV or IRR, unless no/multiple IRR Mutually exclusive projects: Same life and risk Use NPV [or IRR of difference between projects]

Capital Budgeting Mutually exclusive projects: Different lives same risk Use NPV-assumes replacement projects have zero NPV. OK for projects with long lives Use NPV-with specific replacements that make project with comparable lives Use replacement chain or EAC Care: Use only real cash flows for EAC

Capital Budgeting Incremental nominal cash flows with empirically measured discount rate Components of cash flow Investment in fixed assets, salvage value Investment in working capital, release Operating revenues/expenses NO INTEREST

Capital Budgeting NPV assumes “now or never” Real Option framework Abandonment Follow-up Wait and learn Flexibility

Capital structure Market Efficiency MM-1 No taxes MM-2 Corporate taxes Miller Both corporate and personal taxes G L = {1-(1-T C )*(1-T pE )/(1-T p )} Bankruptcy costs Agency costs

Dividends MM Does not matter Lintner behavioural model DIV 1 -DIV 0 =Adjustment rate*(target ratio*EPS 1 -DIV 0 ) Agency costs/signalling

Working Capital Management Operating cycle, cash conversion cycle, weighted cycles and supply chain management Investment in receivables Cash management EOQ and Miller-Orr models