MBA Corporate Finance Highlights

Quick learning tips….

Fundamentals of Corporate Finance:

• Types of markets: Capital market, Internet market, Product markets, FED
• Corporate Finance: Investment across time, locations while factoring in risks. Decide which critical investments to make, where they get the money, and how they keep the day-to-day business going.
• For regular companies, it’s PE: Profit / Earnings for startups its PD: Profit/Dream ratio.
• Give the right incentives to CEOs to work for the company’s wellbeing. Most CEOs don’t execute all their options. No CEO compensation can be framed well. Higher incentives may not give positive results.
• Today ESG is linked to money — a Higher ESG rating is good for the company.

Present and Future Value

• Time value of Money — A dollar now may not hold the same value next year. Have to take into consideration — inflation, discount rate, and interest rate,
• Finance managers deal with Stocks, Bonds, and Projects.
• Present Value (PV) — earlier money on a timeline
• Future Value (FV) — later money on a timeline
• Interest rate (r) — “exchange rate” between earlier money and later money
• Time period (t) — number of periods between present and future
• Currencies deal with the exchange rate and the same currency has to deal with Interest rates. Hence time value of money is important
• Formula to calculate Future value: FV = PV(1 + r)t
• An annuity islike a Mortgage, and Perpetuity is like Bonds/ Preferred stock
• Tip: If you ever win a lottery, take all the money at once and not in installments
• Annual Percentage Rate (APR) = period rate times the number of periods per year
• Effective Annual Percentage Rate (EAR) = also known as EAR, EAPR, or annual percentage yield (APY), takes the effects of compound interest into account. Most credit card companies never talk about EAR as they legally don’t need to.

Types of loans:

• Pure Discount Loans — Pay back the whole amount after the due date, e.g. Treasury Bills
• Interest-only Loans — Pay interest monthly and at the end, pay the principal amount
• Amortized Loans — House mortgage — pay interest +principle

Net Present Value (NPV)and Other Investment Criteria

• Net Present Value, Payback, Discounted Payback, Average Accounting Return, Internal Rate of Return IRR, Profitability Index,
• When there is a high risk, there is a high return.
• Key questions to ask — Does it consider the time value of money, risk, and does it create value to the firm?
• Net Present Value = Difference between the project’s market value and cost. If NPV is positive, accept the project. NPV helps us to know if it will create value for the firm. NPV considers Time value for money Risk and indicates the value it makes for the firm. Excel formula NPV(rate, CP1:CPN)+CP Out
• Payback Period: The payback period is a significant consideration for every project, business, or organization, it tells us how soon we can recover our investment, and the investment can be utilized for other business needs/projects later on.
• Discounted Payback = Takes into TVOM and discount into account. If the projected is rejected in payback, it will also be rejected in discounted payback. It does not tell us if it will bring value to the company. Accept the project if it pays back on a discounted basis within the specified time
• Average Accounting Return = Average net income / average book value. Accept the project if the AAR is greater than a preset rate. Do not consider TVOM, Rate, Value. Don’t consider AAR. The project will fail. It’s easy to calculate.
• Internal Rate of Return = IRR makes project comparison easy. It is based entirely on the estimated cash flows and is independent of interest rates found elsewhere. IRR is the return that makes the NPV = 0. Accept the project if the IRR is greater than the required return. We have to find out the Risk % in this case. It considers TVOM, rate, the value created to the firm. It is a simple way to communicate the value of a project to someone who doesn’t know all the estimation details ß If the IRR is high enough, you may not need to estimate a required return, which is often a difficult task.
• IRR is not applicable for unconventional cash flow and mutually exclusive projects.
• NPV directly measures the increase in value to the firm. Whenever there is a conflict between NPV and another decision rule, you should always use NPV. IRR is unreliable in the following situations: Non-conventional cash flows, Mutually exclusive projects
• Profitability Index = Measures the benefit per unit cost, based on the time value of money. A profitability index of 1.1 implies that for every $1 of investment, we create an additional $0.10 in value (discounted, like NPV) . This measure can be beneficial in situations in which we have limited capital. Cash Inflow / Cash Outflow. If it’s greater than 1 accept the project.
• Capital Budgeting = We should consider several investment criteria when making decisions. NPV and IRR are the most commonly used primary investment criteria. Payback is a widely used secondary investment criterion.
• In business, it’s difficult to predict the cash flow. The goal is to make fewer errors than your competitor. Always choose projects with the highest NPV. If NPV is the same for the given projects, choose the project with the highest IRR. If NPV, IRR remains the same for the given projects, choose the projects with an early payback period.
• Key formulas:
• NPV = All Cash Inflows — Cash Outflows
• PI = All Cash Inflows / Cash Outflows
• IRR = Discount rate at which the NPV becomes zero, this tells us what the percent of return for the project is.

Operating Cash Flow

· Cost of Equity = Dividend Next year/Share price + Growth Rate

· SLM/CAPM = Risk-Free rate + Beta*(Expected Market Return — Risk-Free Rate)

· CAPM = Risk Free rate + Beta * Market Risk Premium

· Security Market Line is propitiated to risk to reward ration

· Systematic risk is equal to Beta of the company

· WACC (Weighted Average) = Equity Return + Preferred Return + Cost of Debt

· Market Value of the firm = Outstanding shares * Current Stock Price

· Book Value = Outstanding shares * Cost of share when they were issued.

· Depreciation is not part of cash flow but helps in calculating income after tax. It helps to save tax

· In the working cash flow don’t add sunk costs like business investment, R&D, market research in cash flow. You have to add built up inventory

· There are 2 types of calculating depreciation in finance: Straight line + MACRS. MACRS: Modified Accelerated cost recovery system — is given for each industry. This has a tax benefit.

· NPV is just estimates, so forecast risk. how sensitive is our NPV to changes in the cash flow estimates; the more sensitive, the greater the forecasting risk

• Best case — high revenues, low costs
• Worst case — low revenues, high costs

· Making money in accounting and finance sense is different. In finance, we are compensated for taking a risk.

· There are 3 Break-Even Analysis: Cash, Accounting, Financial

· Accounting Break Even: The quantity that leads to a zero net income. It’s like keeping money under the pillow. Accounting break-even is often used as an early-stage screening number: Easy to explain and compute. Calculates Depreciation

· Cash Break Even: Same as Accounting but does not calculate depreciation. So if you don’t sell you will have to keep paying the fixed cost.

· Financial Break-Even: Find our IRR by keeping NPV 0

· Short sellers: They identify overpriced shares, sell them and then expose how a company is cooking its book. Muddy waters are famous for exposing financial frauds.

Cost of Capital

· Understanding the risk and return trade-off is the first step to determining the cost of capital. There are 2 types of risk: Financial risk and Business Risk. Financial risk is when a company borrows a lot of money, Business risk is Financial crises, operating crises, inflation, shortage of labor and raw materials + Operating leverage

· High operating leverage is when a firm has huge fixed costs like the airlines industry

· Social Media and Market Efficiency are deeply connected

· Traders pay to get early access to analytics data

· How can you compete with algorithm trading. Institutional Investors used to have their serves next to NY stock exchange

· Most stocks are moving with the market eg GDP, Inflation and interest rates

· Systematic Risk: Risk factors that affect a large number of companies & assets eg: GDP, Inflation, Interest rates. Systematic Risk is called Beta of the company.

· Unsystematic Risk: Risk factors that affect a limited number of assets eg: Labor strike, Shortage of goods. When you diversify your investment portfolio you can get covered from unsystematic risk. eg: Owning shares of Apple and Samsung

· Total Return = expected return + systematic portion of unexpected return+ unsystematic portion of unexpected return

· Own 50 stocks that span 20 different industries, then you are diversified.

· Highest the beta the greater the risk premium

· Stock beta is different year to year

· Cost of Equity: There are two major methods for determining the cost of equity Þ Dividend growth model. SML or CAPM

· Determining the Cost of Capital: Using Dividend Growth Model and CAPM to determine cost of equity capital.

· The cost of debt is the required return on our company’s debt. We usually focus on the cost of long-term debt or bonds

The Weighted Average Cost of Capital WACC: We can use the individual costs of capital that we have computed to get our “average” cost of capital for the firm. This “average” is the required return on the firm’s assets, based on the market’s perception of the risk of those assets. The weights are determined by how much of each type of financing is used.

Capital Structure

· Financial Leverage impacts cash flow and capital Structure. Higher Leverage — Buyback shares. Lower Leverage — Offer shares, Raise equity by SEO (Seasonal Equity Offerings)

· Leverage ratio = Debt to equity ratio

· EPS goes up with higher leverage

· With no corporate tax and bankruptcy — value of the firm wont be effected

· With corporate tax = High debt can bring higher value to the firm

· Probability Expected = Probability Bankruptcy * Cost Bankruptcy

· Higher D to E ratio = Higher bankruptcy cost

· Firms which has more liquid assets can take more leverage

· Bankruptcy is difficult when you have more tangible and intangible assets

· Opposite to Capital structure is Pecking order = which means first use internal cash and then depend on external debt to fund your projects. Cash-> debt -> Equity

· Hi-tech has low Debt to equity ratio while airlines have high (liquidation)

M&M 1 and 2 Theory

Dividend policy & IPO

· Cash dividends are given in various phases — Annually, extra, special and liquidity

· When a company gives dividends, it shows its growth. They can choose to give dividends or reinvest in the company which makes your share more valuable

· Share prices reduce when you pay dividends

· Buyback shares — means shares are overvalued

· Don’t change or reduce your dividends — consumers will feel the org is not doing well

· Underwriters: Lead Underwriters, buy shares and sell them with a 7% to 8% margin, they take a complete risk, they choose whom to allocate the shares to. Investment Banks offer star Analyst, offer complete service, conduct roadshows — get them to meet investors and let the firm pitch them about the companies growth prospective, determine the demand and supply, and determine the price called Book bidding price

· 3 Popular types of underwriters: Firm commitment, best effort(no guarantee), Dutch Auction (not available any more thx to investment banks)

· Google was the only firm to do a Dutch auction and it was not successful

· IPO underpricing: Underpricing is the practice of listing an initial public offering (IPO) at a price below its real value in the stock market. When a new stock closes its first day of trading above the set IPO price, the stock is considered to have been underpriced. Especially for startups that are not that well knows.

· Investment banks roles: IPO, Analysis, Brokerage trading, Private banks for CEOs.

· Traditional transfer of wealth is always between IBankers, Institutional investors, entrepreneurs — an ecosystem that cant be broken. To de-centralize it we need blockchain and cryptocurrency.

· Risk-free rate products are treasury bills, security bills

· YTM — Yield to maturity is only for Bonds it is also called the Market interest