Corporate Finance 2

oilquartzManagement

Nov 10, 2013 (4 years ago)

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Corporate
F
inance

2

Contact, home page

2


Professor:
M. Banu Durukan


E
-
mail:
banu.durukan@ef.uni
-
lj.
si


Home page
:


http://www2.ef.uni
-
lj.si/predmeti32/_struktura/opredmetu.asp?id=196238&lan=eng&tippred
meta=2&site=ang


Password for study materials:
C
or
F
in2

Lectures and
E
xercises

3


Lectures + exercises


1 break
during

lectures


Exercises will be held in
the

second

half

of
the

class



Come prepared (
have your answers to the assigned cases and
exercises ready to be submitted and presented
) !


They will follow the term plan (see home page)


Read the chapters in advance!!!


Questions, comments


very welcome


Turn
-
off mobile phones!!!


Be on time
for lectures and exercises
!

Literature

4

Mandatory:


Textbook:

Brigham &
Ehrhardt
:

Financial
Management
: Theory and Practice
,
11
th

ed.,
Thomson, South Western, 200
5

(chapters: 1, 2
,
8
,

12,
16
-
21, 23
-
25 and Web Chapter 30
)



available in
Ekonomist


Additional study materials that come with the textbook

and posted at the course web site
: slides,
assignments,
cases, etc.



Assignments and
Final Exam

5


Exams
:


80%


There will be 4 exams


Each exam is 20% of the overall grade


Quizes, assignments and class participation: 2
0%


Assignments (
10 points
)


Attendance and Participation in class discussions (
10 points
)

Contents

6


An Overview of Financial Management and the Financial Environment
,
Corporate Governance


Time value of money


Financial Options and their Valuation




Real Options


Capital Structure


Dividend Policy


Lease Financing


Hybrid Financing: Preferred Stock, Warrants, and Convertibles


Initial Public Offerings, Investment Banking and Financial Restructuring


Bankruptcy, Reorganization and Liquidation


Mergers , LBOs, Divestitures, and Holding Companies



Derivatives and Risk Management


Financial Management in Non
-
for Profit Businesses


7

WHAT IS FINANCIAL MANAGEMENT?

WHY ARE YOU IN
THIS COURSE?

CHAPTER 1

An Overview of Financial Management

Financial Management Decisions


Capital budgeting


What long
-
term investments or projects should the business
take on?


Capital structure


How should we pay for our assets?


Should we use debt or equity?


Working capital management


How do we manage the day
-
to
-
day finances of the firm?

Goal Of Financial Management


What should be the goal of a corporation?


Maximize profit?


Minimize costs?


Maximize market share?


Maximize the current value of the company’s stock?


Does this mean we should do anything and
everything to maximize owner wealth?

The basic goal:

to create stock
-
holder value

What is an agency relationship
?

An agency relationship arises whenever one or more
individuals, called
principals
, (1) hires another individual or
organization, called an
agent
, to perform some service and
(2) then delegates decision
-
making authority to that agent.

If you are the only employee, and only
your money is invested in the business,
would any agency

problems exist?

No agency problem would exist. A potential agency
problem arises whenever the manager of a firm owns
less than 100 percent of the firm’s common stock, or
the firm borrows. You own 100 percent of the firm.

If you expanded and hired additional people
to help you, might that give rise to agency
problems?

An agency relationship could
exist between you and your
employees if you, the
principal, hired the employees
to perform some service and
delegated some decision
-
making authority to them.

If you needed additional capital to buy
computer inventory or to develop software,
might that lead to agency problems?

Acquiring outside capital could lead to agency problems.

There are 2 potential agency
conflicts:


Conflicts between
stockholders
and
managers
.


Conflicts between
stockholders

and
creditors
.

Two Primary Mechanisms of Corporate
Governance


“Stick”


Provisions in the charter that affect takeovers.


Composition of the board of directors.


“Carrot: Compensation plans.

Entrenched Management


Occurs when there is little chance that poorly performing
managers will be replaced.


Two causes:


Anti
-
takeover provisions in the charter


Weak board of directors

How are entrenched managers harmful
to shareholders?


Management consumes perks:


Lavish offices and corporate jets


Excessively large staffs


Memberships at country clubs


Management accepts projects (or acquisitions) to make firm
larger, even if MVA goes down.

Board of Directors


Weak boards have many insiders (i.e., those who also have
another position in the company) compared with outsiders.


Interlocking boards are weaker (CEO of company A sits on board
of company B, CEO of B sits on board of A).

Stock Options in Compensation Plans


Gives owner of option the right to buy a share of the company’s
stock at a specified price (called the exercise price) even if the
actual stock price is higher.


Usually can’t exercise the option for several years (called the
vesting period).


Can’t exercise the option after a certain number of years (called
the expiration, or maturity, date).


Would potential agency problems
increase or decrease if you expanded
operations to other
locations
?

Increase.

You could not physically
be at all locations at the same time.
Consequently, you would have to
delegate decision
-
making authority
to others.

If you were a bank lending officer looking at
the situation, what actions might make a
loan feasible?

Creditors can protect themselves by


(1) having the loan secured and


(2) placing
restrictive covenants

in debt
agreements.



They can also charge a
higher than normal interest
rate

to compensate for risk.

Would going public in an IPO increase
or decrease agency problems?

By going public through an IPO, your
firm would bring in new shareholders.
This would
increase

agency
problems, especially if you sell most
of your stock and buy a yacht. You
could
minimize

potential agency
problems by staying on as CEO and
running the company.

24


Why might you want to (1) inflate your
reported earnings or (2) use off balance
sheet financing to make your financial
position look stronger?

A manager might inflate a firm's reported earnings or make its
debt appear to be lower if he or she wanted the firm to look
good temporarily. For example just prior to exercising stock
options or raising more debt.

What are the potential consequences
of inflating earnings or hiding debt?

If the firm is publicly traded, the stock price will probably drop
once it is revealed that fraud has taken place. If private, banks may
be unwilling to lend to it, and investors may be unwilling to invest
more money.


“Reasonable” annual salary to meet living expenses


Cash (or stock) bonus


Options to buy stock or actual shares of stock to reward
long
-
term performance


Tie bonus/options to EVA

What kind of compensation program
might you use to minimize agency
problems?

Is it easy for someone with technical skills
and no understanding of financial
management to move higher and higher in
management?

No. Investors are forcing managers to focus on value
maximization. Successful firms (those who maximize
shareholder value) will not continue to promote
individuals who lack an understanding of financial
management.

Why might someone interviewing for an
entry level job have a better shot at getting
a good job if he or she had a good grasp of
financial management?

Managers want to hire people who can make decisions with
the broader goal of corporate value maximization in mind
because investors are forcing top managers to focus on value
maximization.

Students who understand this focus have a major advantage in
the job market. This applies both to the initial job, and the
career path that follows.


FINANCIAL MARKETS AND
INSTITUTIONS

Financial Markets


Physical Asset Markets vs Financial Asset Markets


Spot Markets vs Futures Markets


Money Markets vs Capital Markets


Primary Markets vs Secondary Markets

Financial Markets


Firms



Investors

Secondary
Market

money

securities

Sue

Bob

Stocks and
Bonds

Money

Primary Market

Financial
Institutions


Investment banks


Financial Intermediaries


Commercial banks


Insurance companies


Mutual funds

COST OF MONEY AND

INTEREST RATES

Determinants of Market Interest Rates


r = nominal or quoted rate of interest


r* = real risk free rate of interest


IP = Inflation premium


DRP =
Default risk premium


LP =
Liquidity premium


MRP = Maturity risk premium

r = r* + IP + DRP + LP + MRP

r = Risk free rate+ DRP + LP + MRP


Term Structure of Interest Rates


Term structure is the relationship between time to maturity
and yields, all else equal
.


It is important to recognize that we pull out the effect of
default risk, different coupons, etc.


Yield curve


graphical representation of the term structure


Normal


upward
-
sloping, long
-
term yields are higher than
short
-
term yields


Inverted


downward
-
sloping, long
-
term yields are lower than
short
-
term yields

Upward
-
Sloping Yield Curve

Downward
-
Sloping Yield Curve

What determines the shape of the Yield Curve?



International Risk Factors


Country risk


Exchange rate risk


Economic Factors


Budget deficit or surpluses


International trade deficits or surpluses


Business activity