Corporate Finance

CORPORATE FINANCE

INTRODUCTION

Firms are:

PRODUCTSSERVICES

Financing cycle:

Raise capital - Manage the operations - Return the capital/reinvest

Invest in valuable projects

There are four pillars of corporate finance:

1. Governance
2. Real decisions
3. Financing
4. Valuation

Each of them are connected to each other.

Financial manager:

• Investment decisions: capital budgeting, what projects should be invested in?
• Raising capital: capital structure, determining the mix of debt and equity
• Dispersing excess capital: dividend policy, share repurchases, repaying debt

Raising capital

There are two different ways:

1. Debt
   • Banks
   • Bond market
   • Finance companies
   • Commercial paper market
2. Equity
   • Individuals
   • Investment banks
   • Market making
   • Institutional investors
   • Institutions

The debt has a specified interest payment, a fave value and a fixed maturity; in case of default it has a first priority. It has also bond covenants, interest is tax-deductible for the corporation.

Equity has dividends set by the board of directors but a minimal par value, moreover it has the last priority in case of default so who choose equity is a residual claimant. It has no maturity but voting rights in the board of directors and dividend payments are not tax deductible.

The source of equity are:

• private equity

CORPORATE FINANCE

INTRODUCTION

Firms are:

• workers (labor)
• raw materials
• technology

Financing cycle:

• Raise capital
• Manage the operations
• Invest in valuable projects
• Return the capital/reinvest

There are four pillars of corporate finance:

1. Governance
2. Real decisions
3. Financing
4. Valuation

Each of them are connected to each other.

Financial manager:

• investment decisions: capital budgeting, what projects should be invested in?
• raising capital: capital structure, determining the mix of debt and equity
• dispersing excess capital: dividend policy, share repurchases, repaying debt

Raising capital

There are two different ways:

1. Debt
   • Banks
   • Bond market
   • Finance companies
   • Commercial paper market
2. Equity
   • Individuals
   • Investment banks
   • Market making
   • Institutional investors
   • Institutions

The debt has a specified interest payment, a face value and a fixed maturity; in case of default it has a first priority. It has also bond covenants, interest is tax-deductible for the corporation.

Equity has dividends set by the board of directors but a minimal par value, moreover it has the last priority in case of default so who choose equity is a residual claimant. It has no maturity but voting rights in the board of directors and dividend payments are not tax deductible.

The source of equity are:

• private equity

When the risk of a project is similar to the average risk of the firm's assets the cost of capital for the project is its WACC.

If the firm maintains a constant debt to equity ratio we can get the levered NPV by discounting the FCF using the WACC.

WACC method:

• determine the free cash flow of the project
• Compute the weighted average cost of capital
• Compute the NPV of the project, including the tax benefit of leverage, by discounting the free cash flow on the project using the WACC

Project has comparable risk than the rest of the firm's assets, taking the project will not alter the debt to equity ratio.

APV method:

• APV separates the effects of financial structure from other effects
• APV incorporates the value of the tax shield directly rather than adjusting the discount rate
• The valuation is done in two steps:
• Value the project as if no interest were paid and no tax shelter were available
• Add the value of the tax shield

V_L: APV = V_U + PV (interest tax shield)

APV unlevered cost of capital reflecting the risk of the assets, weighted average cost of capital without tax.

Pre tax WACC is: r₀ = E / (E + D) r_e + D / (E + D) r₀

Value the FCF using r if u as if all equity financed

Value the tax shield using r u the TS has the same risk as the project.

The firm's unlevered cost of capital equals its pretax WACC because it represents investors required return for holding the entire firm, equity and debt. This argument relies on the assumption that the overall risk of the firm is independent of the choice of leverage.

The tax shield will have the same risk as the firm if the firm maintains a target leverage ratio; the firm adjust its debt p