Corporate Finance. Capital budgeting. Standalone risk of capital project

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1 Corporae Finance Capial budgeing Iniial oulay = FCInv + NWCInv Sal afer ax operaing cashflow = 0 + T ( Sal0 B0 ) ( R C)( 1 ax) + ax Ter min al year non opereaing cashflow = Sal T Dep + NWCInv ax ( Sal B ) T T Sandalone risk of capial projec Sensiiviy analysis calculaes he effec on he NPV of changes in ONE inpu variable a a ime. Scenario analysis creaes scenarios ha consis of changes in several of he inpu variables and calculaes he NPV for each scenario. Simulaion analysis (or Mone Carlo Simulaion) is a procedure for esimaing a probabiliy disribuion of oucomes, such as for he NPV and IRR, raher han jus a limied number of oucomes as wih sensiiviy analysis or scenario analysis. Real Opions Timing opions Insead of invesing now, he company can delay invesing. Sizing opions If afer invesing, he company can abandon he projec when he financial resuls are disappoining, i has an abandonmen opion. Conversely, if he company can make addiional invesmens when fuure financial resuls are srong, he company has a growh opion or an expansion opion. Flexibiliy opions Oher operaional flexibiliies such as price-seing opion, which can increase prices of he producs, and as producion-flexibiliy opions. Fundamenal opions The whole invesmen is essenially an opion. The payoffs from he invesmen are coningen on an underlying asse, jus like mos financial opions.

2 Economic income is he profi realized from an invesmen = cash flow + change in marke value = cash flow + (Ending marke value beginning marke value) = cash flow economic depreciaion Economic profi, or Economic Value Added (EVA) EP = NOPAT $ WACC = EBIT ( 1 ax) WACC * capial= 1 = NPV = EP = MVA = ( WACC) The NPV of an invesmen (also is marke value added, MVA) is he presen value of fuure EP discouned a he WACC. The oal value of he company is he original invesmen plus he NPV. Residual income RI = Ne = Ne = NI Income Equiy Income r equiy BV ( book value r ) 1 charg e equiy NPV = = RI ( r ) equiy Two beas calculaion β, = β L projec β equiy = β asse U, comparable 1 + D ( ) E ( 1 ) projec D E projec projec

3 Counry equiy premium = Sovereign yield Annualized s an dard deviaion of equiy index spread Annualized sadard deviaion of he sovereign bond marke in erms of he developed marke currency Marginal Cos Break Poin Amoun of capial a which he source' s cos of capial changes Break poin = Pr oporion of new capial raised from he source Core aribues of an effecive corporae governance sysem Delineaion of he righs of shareholders and oher core sakeholders; Clearly defined manager and direcor governance responsibiliies o sakeholders; Idenifiable and measurable accounabiliies for he performance of responsibiliies; Fairness and equiable reamen in all dealings beween managers, direcors, and shareholders; and Complee ransparency and accuracy in disclosures regarding operaions, performance, risk, and financial posiions Concerns Sole proprieorships Parnerships Corporaions Since he owner and Similar o sole Corporae shareholders manager of a sole proprieorship ypically have no inpu in proprieorship is he same day-o-day managemen of person, conflics beween he firm and have difficuly manager and owner do no monioring a firm s exis. Conflics of ineres operaions and he acions for a sloe proprieorship of managers. The lack of ypically involve crediors owner conrol creaes

4 and suppliers. poenial conflics wih managers and direcors. Valuaion Implicaions of Corporae Governance Weak corporae governance sysems pose he following risks o value of invesmens in he company Accouning risk The risk ha a company s financial saemen recogniion and relaed disclosures, upon which invesors base heir financial decisions, are incomplee, misleading, or maerially missaed. Asse risk The risk ha he firm s asses, which belong o invesors, will be misappropriaed by managers or direcors in he form of excessive compensaion or oher perquisies. Liabiliy risk he risk ha managemen will ener ino excessive obligaions, commied o on behalf of shareholders, ha effecively desroy he value of shareholders equiy; hese frequenly ake he form of off-balance-shee obligaions. Sraegic policy risk he risk ha managers may ener ino ransacions, such as mergers and acquisiions or incur oher business risks, ha may no be in he bes long-erm ineres of shareholders, bu which may resul in large payoffs for managemen or direcors.

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6 Dividend Policy Descripion Residual dividend Longer-erm residual dividend Dividends available only when earnings lef Cash dividend Less sable More sable Share repurchase No flexible Lon-run Long-erm capial susainable budgeing earnings More flexible Dividend sabiliy Targe payou raio Fairly consisen due o inflaion Mainain he payou raio and move oward his goal Fairly consisen due o formula

7 Types of Merger Horizonal merger Verical merger Conglomerae merger Descripions Combinaions of wo firms in he same line of business Involves companies a differen sages of producion Involves companies in unrelaed lines of businesses Merger Calculaion Gain = PV PV + PV AB Cos = cash ( ) NPV = gain cos = ΔPV A paid PV B B AB = ΔPV AB ( cash PV ) B Resrucuring 1. Divesiures The mos common form of divesiure involves he sale of a division of he paren company o anoher firm. 2. Equiy carve-ous An equiy carve-ou is a variaion of a divesiure ha involves he sale of an equiy ineres in a subsidiary o ousiders. The sales may no necessarily leave he paren company in conrol of he subsidiary. A new legal eniy is creaed wih a sockholder base ha may be differen from ha of he paren selling company. The divesed firm has a differen managemen eam and is run as a separae company. 3. Spin-offs In a sandard spin-off, new shares are issued, bu he shares are disribued o sockholders on a pro raa basis. Therefore, he sockholder base in he new company is he same as ha of he old company. The spun-off firm has is own managemen and is run as a separae company. A spun-off normally does no provide he paren wih a cash infusion, bu a divesiure does. Equiy carve-ous Spin-offs New legal eniy Yes Yes Differen managemen eam Yes Yes Shareholders New Old (he same as he paren company) Cash flow o paren Posiive No

8 company Price More expensive Less expensive Law requiremen High Low 4. Spli-offs Some of he sockholders in he paren company are given shares in a division of he paren company, which is spli off in exchange for heir shares in he paren company. 5. Spli-ups In a spli-up, he enire firm is broken up ino a series of spin-offs. The end resul of his process is ha he paren company no longer exiss, leaving only he newly formed companies. The sockholders in he companies may be differen because sockholders exchange heir shares in he paren company for sales in one or more of he unis ha are spun off.

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