Corporate finance and Financial institutions - appunti completi

{chapter 1}

Corporate finance : introduction

WHAT IS CORPORATE FINANCE?

- Deal with the issues relating with the money of corporate : everything in a tackles with finance

Cash is the main thing that this course takes into consideration

‣

- I have to find a way to ensure enough cash → plan : about the future (≠ accounting : about past)

· The financial managers works with the future, forecasts it

- There are three pillars : corporate finance

investment financing liquidity

Capital budgeting : Capital structure : Short-Term financial planning :

- - -

includes all the issues related to choose the best financing for ensure enough cash and

choosing the best asset investment, finance my projects inventory

anything related with long term Proportional debt with respect - Liquidity : what do you need to

- - debt

investment decisions run a firm on an dry day basis?

with its equity ( )

" equity

- what do you need to start a financing : cash invested in assets

firm? -

must be matched by an equal

investment in :

‣ amount of cash raised by

inventory

• financing

machinery (equipment)

• land

• labour

• "

- Why is forecasting so important?

Knowing what is going to happen, allows me to have more time to manage problems and also to

‣ manage money in a better way

What if I have asked too many money to the bank, now i need more money, bu i can not ask

• money to the bank? I need to shut down

→ For this reason it is important to forecast my future (prevent the shut down to happen)

THE BALANCE SHEET MODEL OF THE FIRM

-

- Balance sheet shows value : Value of the firm = value of bonds + value of shares

- Corporate finance circuit : from the financial manager point of view

Goal : represent the way of functioning of a company through a financial division point of view

‣ Accountant point of view (the balance sheet)

‣ Assets Liabilities

- Short-term (current) - Short term (current)

Inventories Loan and

‣ ‣ obligations that

- Long term (non-current) must be payed in

Tangible : buildings,

‣ one year

machinery, - Long term (non current)

equipment Debt

‣

" Intangible : patents

‣ and trademarks

" 1 - 5

" {chapter 1}

- Before investing in an asset a company must obtain financing (= raise money)

Right side represents the ways a company has to rise cash (there are different technical ways)

‣ Issue (sell) bonds, debt or loan agreements, or shares, certificates representing ownership of the

• firm

- Shareholders’ equity shows the difference between the value of the firm's assets and liabilities

It is a residual claim on the firm’s assets

‣

- Put money in the net working capital → produce new cash

Sourcing of financing (from the outside) : convince investors to put money in my company, that will be

‣ used to buy assets for my core business = i will be able to produce = I will have more cash that in

part will stay in the company and part will be used to pay back my investors (pay dividends to share

holder, taxes to government)

Corporate finance point of view = circuit related to liquidity

•

- Investors : general category

- Questions :

In which long-lived assets should the firm invest? → Capital budgeting

‣ How can the firm raise cash for requires capital expenditures? → Capital structure

‣ How should short-term operating cash flows be managed? → Associated with net working capital

‣ : Glencore International

Example

- In June, 2019, Glencore International, a global commodities and

raw materials firm, announced its financial results for the first

quarter.

- In June 2019, the company had $36.69 billion in tangible non-

current assets and only $0.15 million in intangible non-current

assets. Current assets amounted to $46.75 billion and current

liabilities (liabilities due within one year) were $39.6 billion.

What is the Balance Sheet model?

‣ "

CAPITAL STRUCTURE

-

- Fincing arrangements determine how the value of the firm is sliced up

- How is capital structure determined? The amount of debt respect to equity

People that buy debt from the firm are called : creditors, boundholders, debtholders

‣ Few years ago Apple had no debt : in some ways could produce value (theoretically)

•

The holder of equity : shareholder, equity holders

‣

- Think of the firm as a pie : - Initially : size depends on how well the firm has

made its investment decisions

- After it has invested : it determines the value of

its assets (buildings, land, inventories)

- Then can determine the capital structure (affect

" how the pie is sliced

- Value of the firm = value of bonds (debt) + value of shares (equity)

THE FINANCIAL MANAGER

-

- Finance activity associated with the Chief Financial Officer (CFO), makes decisions

Reporting to the financial manager : treasurer and financial controller

‣

- Most important role of the financial manager : create value (maximize value) from the firm’s capital

budgeting, financing and net working capital " 2 - 5

" {chapter 1}

- How do they create value?

Buy assets that earn more cash than they cost

‣ Choose long-term investments that increase

‣ firm value

Raise cheap external financing, cheaper way

‣ Ensure efficient tax policy

‣ Sell bonds, shares and other financial

‣ instruments that rise more cash than they cost "

- Corporate finance ≠ accounting point of view [cash flow ≠ accounting flow] | Different perspective :

In identification

‣ Accounting figure : depreciation and amortization has a cost, cash not touched, used for balance

• sheet, no cash outflow

Corporate finance does not take it into account not relevant

• With the corporate finance perspective you take into consideration only cash movements

✦

In timing

‣ Take time into consideration : prefer receive cash flows earlier rather than later

•

In risk

‣ Cash flows taken into account by corporate finance in our risk (investors are risk averse)

•

Identifications of Cash Flows

- : Midland plc

Example

- Midland plc is an Irish firm that refines and trades gold. At the

end of the year, it sold 2,500 ounces of gold for €1.67 million.

The company had acquired the gold for €1 million at the

beginning of the year. The company paid cash for the gold when

it was purchased. Unfortunately it has yet to collect from the

customer to whom the gold was sold.

- We have to cover one million "

Timing of Cash Flows : Montana SpA

Example

- The Italian firm, Montana SpA, is attempting to choose between two

proposals for new products. Both proposals will provide additional cash

flows over a four-year period and will initially cost €10,000. The cash

flows from the proposals are as follows →

The timing is relevant in our point of view

‣ "

Risk of Cash Flows Example : Norwegian firm, Fjell ASA

- The Norwegian firm, Fjell ASA, is considering expanding

operations overseas, and it is evaluating the Netherlands and

South Africa as possible sites. The Netherlands is

considered to be relatively safe, whereas operating in South

Africa is seen as considerably more risky. In both cases the

company would close down operations after one year "

- After undertaking a complete financial analysis, Fjell has

come up with the following cash flows of the alternative

plans for expansion under three scenarios—pessimistic,

most likely, and optimistic: " 3 - 5

" {chapter 1}

THE GOAL OF FINANCIAL MANAGEMENT

-

- Goal of making money or add value is vague

There are more precise definition

‣

- Possible Goals

Survive, avoid financial distress and bankruptcy, beat the competition, maximize sales or market

‣ share, minimize costs, maximize profits, maintain steady earning growth

- The financial manager in a corporation makes decisions for the shareholders of the firm

From shareholders’ point of view, what is a good Financial Management decision?

‣ Good decision : increase value of company’s shares

•

From our observations financial managers act in the shareholders best interest

‣ the goal of financial management is to maximize the value of a company's equity share

-

The triple bottom line

-

- Shareholder value maximisation (profit objective) has attracted criticism :

Ignores employees (social objective), sustainability (environment objective)

‣ Companies have a responsibility not only to shareholders, but society as well

•

- Triple bottom line is an attempt to bring this to the center of corporate decisions-making

THE FINANCIAL MARKETS

-

- When firms require cash to invest In new projects, they have to choose the most efficient and cost-

effective financing option from a range of appropriate alternatives

borrow money (debt) give up a fraction of ownership in the firm (equity)

Money takes out a loan and agrees to pay back Sell a part of their company for a set cash amount,

the borrowed amount plus interest, to compensate ate the end of this process, the firm will end up

the lender for giving the money to the borrower with the cash it needs

Go to a bank for a loan or can issue debt Can be done through private negotiation or a

securities public sale, which is undertaken through marketing

and sale of equity securities

Debt securities = contractual obligations to

‣ repay corporate borrowing Equity securities = shares that represent non-

‣ contractual claims to the residual cash flow of

the firm

Issue of debt and equity that are publicly sold are traded in the financial markets, such as stock markets

- Where do companies get financing?

Different source of financing : Private investors, Bank loans - Equity (can include many kinds of

‣ shareholders) - Bond (long term investing perspective - there are many types of bonds) - Short term

financing (respond to everyday financing needs)

Many sub categories

•

Money vs. Capital markets

-

The financial markets are composed of money markets and capital markets :

-

- Money markets :

Trade debt securities with maturities of one year or less, little or no risk of capital loss, but low return,

‣ short-term

- Capital markets : long-term debt and equity (does not have a technical maturity (≠ bond), for this reason

is in capital market)

Trade debt (bonds) and equity (stock) instruments with maturities of more than one year, substantial

‣ risk of capital loss, but higher promised return, long-term

" 4 - 5

" {chapter 1}

PRIMARY VERSUS SECONDARY MARKETS

-

Primary markets

-

- Used to sell securities

Corporations engage in two types of primary market sales of debt and equity : public offerings and

‣ private placements

- IPO (initial public offering occurs when a company decides to issues stock going public for the first time)

After that the second share issue is called seasoned offering (second issuing of instrument)

‣ IPOs belong to the primary market

‣

- In the primary market : companies issue money, they raise money issuing equity or bond instruments

Secondary markets

-

- A secondary markets involves one owner or creditor selling to another

Provide the means for transferring ownership of corporate securities

‣ Although a corporation is only directly involved in a primarily market transaction (when it sells

• securities to rise cash), the secondary markets are still critical to large corporations

Reason : investors are more willing to purchase securities in a primary market transaction when

✦ they know those securities can be later resold if desired

- Companies do not rase money

- Profit is gained from selling (exchange does not affect company)

Related to instruments already issued and now they circulate among investors (trade, but company

‣ does not raise money)

Investors trade security with each other

• Money raised goes to seller of securities, not to the company

✦ Google

Example :

- - When Google went public to the market, they issued shares, its stock were listed in the public stock

market

In that occasion the investors, bought stocks, google raised money through : IPO (first time in the

‣ listed market)

- Once it was already public, it issued other stock and raised money again : seasoned offering we are still

in the first market (it allows to finance and rise money)

- Once that instrument (stocks) circulate in the market (= there are at least two investors trading )

I am in the second market I am not financing google directly I am just making a trade (profit form me

‣ and whom i am trading with) " 5 - 5

" {appendix chapter 3}

Finance planning : planning over time

LONG-TERM FINANCIAL PLANNING

- Financial statement can be used to plan over the long term

The percentage sales approach to financial planning used to estimate the EFN

‣

- The finale result of the financial activity is the External Financing Needed EFN

KEY CONCEPTS AND SKILLS

-

Why financial planning?

-

- Compute external financing needed

Ensure feasibility and internal consistency of strategies

‣ Identify the determinants of a firm’s growth

‣ Understand how capital structure policy and dividend policy affect a firm’s ability to grow

‣ It is useful to compute how much finance I will need, in order to know in advance if in the next period I

‣ a particular amount of money

I need to invest in a new machine, it is better to know it before so i am able to find the best solution

•

- You can have in your mind the best strategy or project and then discover that you can not afford it, or it is

not feasible

Financial Planning is the key point to ensure the feasibility

‣ Common to every division, each team in my company needs to focus on the future in order to

• implement strategies

When your boss gives you a budget you have to take into consideration the financial constraints

✦

- It is relevant to identify the determinants of a firm grow

How policy can affect the ability of the firm to grow

‣ Dividend and capital structure policies

•

Key elements

- Investment in new assets

1. Capital budgeting decisions

‣ Do we need to buy new machine? Or increase our production stock? Are we operating full

• capacity?

Degree of financial leverage

2. Capital structure decisions

‣ Decide how to finance those investments (fix our capital structure policy high or low leverage debt

• or equity?

Cash paid to shareholders

3. Dividend policy decisions

‣ Do I want to keep my dividends policy constant? Do i want to change it?

• Dividends perceived as a signal of the wealth of that company some companies decide anyway to

• distribute dividends although they are suffering losses in order not to let other investors know

(using debt)

Negative bad circle (performing losses = use debt to pay dividends = greater losses)

✦

Liquidity requirements

4. Net working capital decisions

‣ When network in capital increases : you have less liquidity | if it decreases i have more liquidity

• Components : new inventory

✦ ! 1 - 10

! {appendix chapter 3}

FINANCIAL PLANNING PROCESS

-

- First decision about time horizon : short run decisions are easier to predict and access the other

components, in long run instead the assessments of the components is quite complicated (forecast the

future)

Short-run decisions (usually next 12 months)

• Long-run decisions (usually 2 – 5 years)

•

Time horizon must be consistent with the reality of the situation and with your assumptions

‣

- Aggregation : financial division has to aggregate everything in just one plan - different capital budgeting

decisions have to be combined in just one project, plan

Combine capital budgeting decisions into one large project

‣

- Assumptions and Scenarios

Make realistic assumptions about important key variables

‣ Since we have to asses the future we have to use assumptions to forecast the future

•

Run several scenarios where you vary the assumptions by reasonable amounts

‣ Draw up another version of your plan according to different assumptions and hypothesis that you

• have

Determine, at a minimum, worst case, normal case, and best case scenarios : 3 versions

‣

- Sensitivity analysis definition :

I change my financial plan when i change just some key variables

‣ ≠ scenario : change totally the case (not just stressing some key elements)

•

For instance I prepare the base case scenario I want to stress it by changing some key elements :

‣ how much does it change? → sensitive analysis : Covid period study

Example

difficulty of the FSO to produce a plan of the future in this period,

suggestion : do not extend the time horizon too much

FINANCIAL PLANNING MODEL INGREDIENTS

-

- Sales forecast : Many cash flows depend on the level of sales : how can i forecast them?

With the growth rate according to our estimate i can produce a

‣

- Pro forma statement: Shows future results (forecasted financial Statement (ex ante))

Is the plan based on the projected financial statement according to the set of assumptions that we are

‣ using

- Asset requirements : if I am increasing sale (projected sales increase) I need to check if I have enough

assets that allow me to reach that level of projected sales [key ingredient of FP model]

- Financial requirements: amount of financing needed tok pay for the required assets

Increase sales : need to invest to get assets check that someone will finance it invest in asset and

‣ investment

- Plug variable : not just one content, it can be different depending on the different decisions took by our

managers

Can be debt, dividends, equity or a mix of them, it represents the type of financing decided by the

‣ management of the company to make the balance sheet balance

Increase sales → increase assets → need to adjust the right side with either debt or equity in order

• to make balance sh