Corporate Finance

B_L = B_u*(1+(1-t)(D/E))

%change in EBIT / %change in Revenues

• Riskfree rate + Beta_L * (Risk premium)
• Rf + B_levered * (Rm - Rf)

Annual dividends per share / Price per share

Dividend yield + Price appreciation

• Current Beta
• _________________
• (1+(1+t)(Average D/E)

Weighted Average Cost of Capital

B_unlevered * (1+(1-t)(D/E))

K_e*(E/E+D) + K_d*(D/E+D)

(after tax K_e)

B_L = B_u * (1+(1-t)(D/E))

Invest in assets that generate more than the minimum acceptable return (hurdle rate).

The mix of Debt and Equity should maximize the value of the investments.

If firms doesn't find investments that earn their minimum required return (hurdle rate) then the excess cash must be returned to the owners in form of dividends.

• 1. Retained earnings
• 2. Straight debt
• 3. Convertible debt
• 4. Common stock
• 5. Straight preferred stock
• 6. Convertible preferred.

• 1. Threat of bankruptcy increases with more debt.
• 2. Higher risk in the firm resulting in higher interest rates (agency costs).
• 3. Bond holders can reduce firm's flexibility with bond covenants.
• 4. When general interest rates go up, so does the interest expenses.

• 1. Interest is tax-deductible.
• 2. Increased debt increases discipline to choose good investments to be able to pay interests.
• 3. Leverage on the equity.

K_e * (E/E+D) + K_d * (D/E+D)

(R_f + spread) * (1-t)

You have high fixed costs. When revenues increase, the profit increases relatively more and vice verse.

It increases the Equity Beta. High FL equals high interest costs --> profit varies more when revenues vary.

• If High D/E-ratio --> Value decreases as tax shield decreases.
• If low D/E-ratio --> Value increases as tax expenses decreases.

• Enterprise value = shares / (WACC-R_f)
• Equity = Enterprise value * (E/E+D)
• Value per share = Equity / Shares

• 1. Type of business (Cyclical? Discretionary products?)
• 2. Degree of Operating Leverage.
• 3. Degree of Financial Leverage.

Elaborate.

Stock Value (P) = D / (k - G

• D = Dividends
• k = Cost of Equity
• G = Growth

Value of Equity AND Value of Debt.

• Earnings Before Taxes
• (as you get tax deductions on interest expenses).

Growth / ROC

where ROC is Return on Capital.

Dividends / Earnings

• 1-Dividend Payout Ratio
• How much of the earnings are reinvested in the firm.
• Higher tends to lead to higher growth.

• 1. No opportunistic managers.
• 2. Lenders are protected.
• 3. Managers don't mislead or lie to financial markets.
• 4. No social costs i.e. all cost are transferred to firm.

Market Price. NPV of perfect information business plan. NPV of oeprating synergies - dissynergies. Market price plus control premium. Value creation or destruction.

• Auction.
• Bilateral.
• Public to Private (P2P)
• Leveraged Buy Out (LBO)
• Hostile bid (aka Unsolicited)
• Asset deal

• Market value based.
• Contribution based.
• Merger of Equals (MOE)
• Dual headed structure.

Target firm becomes part of acquiring firm.

Target and Acquiring firm becomes a new firm.

Target firm continues to exist while dissident stockholders hold out. Merges eventually.

Target firm remains as a shell but assets are transferred to to acquiring firm. Usually liquidated in the end.

Target firm continues to exist but as a private business.

• 1. Lack of a Post-Merger Plan to Deliver on Synergy and Control.
• 2. Lack of accountability (Nobody takes responsibility for living up to expectations)
• 3. Culture shock.
• 4. Failure to consider external constraints (Want to lay off people but unions constrain part of plans).
• 5. Managerial egos (Managers from both firms may struggle about power leading to less efficiency).
• 6. The Market Price Hurdle (When bidding wars push up premiums beyond reason).

• 1. Undervalued firm.
• 2. Diversify to reduce risk.
• 3. Create Operating of Financial Synergy.
• 4. Take over poorly managed firms and Change Management.
• 5. Managerial self-interest. (Empire building, Macho-test in bidding wars, new wages after acquisition).

• Free Cash Flow to Equity
• Cash left (Net Income) after operating expenses, interest expenses, net debt payments and reinvestment needs.

• Free Cash Flow to Firm.
• Cash left (Net Income) after operating expenses, taxes and reinvestment needs BUT before any debt payments.

(Firm value * Cost of Capital - CF) * (Firm value + CF)

• 1. Raise voice on AGM.
• 2. Vote on AGM.
• 3. Demand for better and more updated info.
• 4. Large shareholders becoming part om management.
• 5. Institutional investors take a seat in Nomination Committee.

Credible signal about increasing future cash flows which makes the market adjust its future forecasts.