The Framework of Finance Joint MBA 2014 FINC 5000/5880

What is Finance? Finance is: “Any decision in a business/organization that involves Money…” “Everything else you do in this MBA program is in favor of Finance”

The Objective in Finance: “if you don’t know where you are going, it does not matter how you get there” (Alice in Wonderland)

Fundamental Principal of Finance Maximize Firm Value Hurdle Rate reflect Risk of Investment Return reflect size and timing of Cash Flows Optimal Mix of Debt/Equity Maximizes Value The right kind of debt matches the Assets ©℗How much cash to return depend on Investment Opportunities Do your shareholders prefer Dividends or Buy Backs? Investment Decision Financing Decision Pay Out Decision Invest in Assets with Return> Hurdle Rate Find the right kind of debt and the right relation Debt/equity If you don’t have enough Investments that have a return>hurdle rate; return the cash to the owners ®

Objective Function (theory) Hire and Fire Managers Maximize Stockholders Wealth Reveal information honestly and on time Markets are efficient Debt Holders Society Stock Holders Financial Markets MANAGERS No Social Costs Costs can be traced to the firm Lend Money Protect Debt Holder interests

What is the reality? Stockholders have little control over Managers Managers put their own interest above stockholders Delay bad news or provide misleading information Markets make mistakes and are not efficient Debt Holders Society Stock Holders Financial Markets MANAGERS Significant Social Costs Some costs can not be traced to the firm Lend Money Debt holders can get ripped off…

So what do we see nowadays ? More Activists and Hostile take- overs Managers of poorly run firms are put on notice Firms are punished for misleading markets Investors and Analysts become more skeptical Debt Holders Society Stock Holders Financial Markets MANAGERS Corporate Good Citizen constraints More laws… Lend Money Protect themselves (covenants)

Maximize Firm Value Assets in Place Existing Investments Generate Cash Flow today (Fixed assets and Working Capital) Debt Fixed Claims on Cash flows (little/no role in Management Fixed Maturity Tax Deductible Growth Assets Expected Value that will be created by future Investments Equity Residual Claim on Cash flows Significant role in Management Perpetual Live ASSETS (debit) LIABILITIES (credit) CORP. BALANCE SHEET date:………..

Google Inc. Assets in Place Existing Investments Generate Cash Flow today (Fixed assets and Working Capital) Debt Fixed Claims on Cash flows (little/no role in Management Fixed Maturity Tax Deductible Growth Assets Expected Value that will be created by future Investments Equity Residual Claim on Cash flows Significant role in Management Perpetual Live ASSETS (debit) LIABILITIES (credit) CORP. BALANCE SHEET date:……….. Total Assets in Place: 58 B USD (31%) Total Debt 0 B USD Total Equity 188 B USD (100%) Total Growth Assets: 130 B USD (69%)

Walt Disney Inc. Assets in Place Existing Investments Generate Cash Flow today (Fixed assets and Working Capital) Debt Fixed Claims on Cash flows (little/no role in Management Fixed Maturity Tax Deductible Growth Assets Expected Value that will be created by future Investments Equity Residual Claim on Cash flows Significant role in Management Perpetual Live ASSETS (debit) LIABILITIES (credit) CORP. BALANCE SHEET date:……….. Total Assets in Place: 69 B USD (75%) Total Debt 30 B USD (33%) Total Equity 62 B USD (67%) Total Growth Assets: 23 B USD (25%)

AT&T Inc. Assets in Place Existing Investments Generate Cash Flow today (Fixed assets and Working Capital) Debt Fixed Claims on Cash flows (little/no role in Management Fixed Maturity Tax Deductible Growth Assets Expected Value that will be created by future Investments Equity Residual Claim on Cash flows Significant role in Management Perpetual Live ASSETS (debit) LIABILITIES (credit) CORP. BALANCE SHEET date:……….. Total Assets in Place: 269 B USD (91%) Total Debt 122 B USD (41%) Total Equity 172 B USD (59%) Total Growth Assets: 25 B USD (9%)

Facebook (estimates) Assets in Place Existing Investments Generate Cash Flow today (Fixed assets and Working Capital) Debt Fixed Claims on Cash flows (little/no role in Management Fixed Maturity Tax Deductible Growth Assets Expected Value that will be created by future Investments Equity Residual Claim on Cash flows Significant role in Management Perpetual Live ASSETS (debit) LIABILITIES (credit) CORP. BALANCE SHEET date:……….. Total Assets in Place: <1 B USD (2%) Total Debt 0 B USD (0%) Total Equity 50 B USD (100%) Total Growth Assets: >49 B USD (98%)

Worst Board…2011 Carli Fiorina bought Compaq…. The Board fired her in Mark Herd took over in The Board fired him in 2010 (Sexual Harassment) The BoD appointed Leo Apotheker (who?) An executive of SAP. He announced HP will become another IBM and sell of it’s PC business. He acquired Autonomy (UK Software) Launched Web OS (pulled the plug 2 months later) Developed and market a HP tablet (and pulled the plug 3 months later) He is expected to be fired this year… Loyal customers are doubting what is going on in HP and buying their hardware somewhere else…” HP is lost”….. Apoth….who? “ he was the best candidate for the job out of a group of very unqualified candidates” Two thirds of the BoD members voted for him without even having met him!

Or is it Yahoo! ? Refused a golden offer from Microsoft ($33 per share only 2 years ago) Flip flopped CEO’s on it’s BoD Ousted Carol Bartz as CEO Who then opened up in Fortune (“Yahoo is the worst BoD”) And was suspended immediately… Yahoo! holding back $ 10 Mln. severance pay…. THE directors of Yahoo! were “so spooked by being cast as the worst board in the country” that they fired Carol Bartz as chief executive “to show that they’re not the doofuses that they are.” Bartz never was the turnaround chief that the Yahoo board had wanted. Though she slashed costs and improved profit margins, she failed to improve revenue growth at a critical time when Yahoo has lost eyeballs and ad dollars to Google (GOOG) and Facebook. "They want revenue growth," says Bartz about the Yahoo board, "even though they were told that we would not have revenue growth until 2012."

Worst BoD 1997

In class assignment on your S&P500 Company Calpers (California) test of independent Boards Are a majority of the Directors outside directors? Is the Chairman of the BoD independent and not the CEO? Are the compensation and audit committees composed of entirely outsiders? Disney failed to score on any of these….