Summary Corporate Finance, global edition

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Summary 1:

  • Corporate Finance, global edition
  • Jonathan Berk, Peter DeMarzo
  • or
  • 2nd
  • 2011

Summary - Corporate Finance, global edition

  • 10 Capital Markets and the Pricing of Risk

  • What's volatility?
    The standard deviation of a return
  • What's realized return?
    The return that actually occurs over a particular time period
  • Two difficulties when using past returns to predict the future:
    1. We don't know what investors expected in the past; we can only observe the actual returns that were realized
    2. The average return is just an estimate of the true expected return, and is subject to estimation error
  • Risk unrelated across stocks is called
    Firm-specific, diversifiable, idiosyncratic, unique risk
  • Risk that is correlated and that's due to market-wide news is called
    systematic, undiversifiable, market risk
  • Risk premium of diversifiable risk is zero, so investors are not compensated for holding firm-specific risk --> diversification needed
  • The risk premium of a security is determined by its systematic risk and does not depend on its diversifiable risk
  • The efficient portfolio...
    is a portfolio that fluctuates solely to systematic risk
  • The beta of a security is
    the expected % change in its return given a 1% change in the return of the market portfolio
  • Market Risk Premium = E[Rmkt] - rf
  • Estimating the cost of capital of an investment from its beta:
  • 11 Optimal Portfolio Choice and the Capital Asset Pricing Model

  • Portfolio weights
    The fraction of the total investment in the portfolio held in each individual investment in the portfolio
  • Covariance
    The expected product of the deviations of two returns from their means
  • Correlation
    The strength of the relationship between two stocks
  • Inefficient portfolio
    There's a possibility to find another portfolio that is better in terms of both expected return and volatility
  • Long position
    A positive investment in a security
  • Short position
    A negative amount invested in stock by engaging in a short sale: a transaction in which you sell a stock today that you do not own, with the obligation to buy it back in the future
  • Buying stocks on margin
    Borrowing money to invest in stocks
  • Sharpe Ratio:

    Portfolio Excess Return / Portfolio Volatility

    Measures the ratio of reward-to-volatility provided by a portfolio. Optimal portfolio is the one with the highest Sharpe Ratio
  • CAPM assumptions:

    1. Investors can buy and sell all securities at competitive market prices (without incurring taxes or transaction costs) and can borrow and lend at the risk-free rate
    2. Investors hold only efficient portfolios of traded securities - portfolios that yield the maximum expected return for a given level of volatility
    3. Investors have homogeneous expectations regarding the volatilities, correlations and expected returns of securities
  • The beta of a portfolio is the weighted average beta of the securities in the portfolio
  • CAPM conclusions:
    1. The market portfolio is the efficient portfolio --> the highest expected return for any given level of volatility is obtained by a portfolio on the capital market line, which combines the market portfolio with risk-free saving or borrowing
    2. The risk premium for any investment is proportional to its beta with the market. Therefore, the relationship between risk and the required return is given by the Security Market Line 
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Summary 2:

  • Corporate Finance, Global Edition
  • Jonathan Berk Peter DeMarzo
  • 9780273792062 or 0273792067
  • 2013

Summary - Corporate Finance, Global Edition

  • 1.1 Maart 2015

  • Assume perfect capital markets without taxes. One way to calculate whether a firm should use debt or equity to finance a project is to see which type of financing leads to the lowest WACC.
  • Risk shifting refers to the concept that managers, who perceive the firm’s equity to be underpriced, prefer to fund investments with retained earnings, or debt, rather than equity.
  • Holding cash has the opposite effect on risk and return of equity claims than leverage.
  • In perfect capital markets, as there are no corporate taxes, we can strictly rank the different costs of capital of a firm with leverage according to the following order: Rd<Rwacc<Ra<Re
  • A board of directors is said to be captured if the CEO also serves as chairman of the board
  • Since depreciation is not a cash expense, it does not affect operating cash flows.
  • b. When making investment decisions, a company should include opportunity costs of required resources.
  • Since sunk costs have already been realized, a company should include them when making their investment decision.
  • In which direction will a company’s (after-tax) WACC rate change when it sells off a business unit with lower systematic risk and uses all proceeds to retire debt?
    The WACC rate increases
  • Using the WACC method, the value of a project is based on free cash flows, which ignore interest and debt payments.
  • The Flow-to-Equity (FTE) method is based on free cash flows to equity holders, which takes all payments from and to debt holders into account.
  • The FTE Method uses the weighted average cost of capital to discount cash flows to equity holders.
  • Implementing the APV method with a constant debt-equity ratio is complicated because it requires simultaneous solving for a projects debt and total value.
  • Personal taxes have the potential to offset some of the corporate tax benefits of leverage if interest income is taxed at a higher rate than dividends or capital gains.
  • If capital gains are taxed at a higher rate than dividends, which has been true until the most recent change to the tax code in the US, shareholders will prefer share repurchases over dividends.
  • Shareholders typically must pay taxes on the dividends they receive. Likewise, they must also pay capital gains taxes when they sell their shares.
  • Because long-term investors defer capital gains tax until they sell their shares, there remains effectively a tax advantage for share repurchases over dividends even if dividends and capital gains are taxed at the same rate
  • Which of the following actions cannot be directly initiated by shareholders of a publicly traded company
    Remove an incumbent management team
  • Transcontinental Inc. has a value of $500M if it continues to operate, but has outstanding debt of $600M. If Transcontinental declares bankruptcy, bankruptcy costs will equal $50M, and the remaining $450M will go to creditors. Instead of declaring bankruptcy, Transcontinental proposes to exchange the firm’s debt for a fraction of its equity in a workout. What would be the minimum fraction of the firm’s equity that Transcontinental needs to offer its creditors for the workout to be successful?
  • V+U Corporation has no debt on its balance sheet, but paid $500M in taxes last year. To decrease the tax burden, management decides to issue $600M in debt at a rate of 8%. Assume that V+U’s marginal corporate tax rate is 35%. Furthermore, V+U’s investors pay a 25% tax rate on income from equity and 35% tax rate on interest income. If the company maintains this level of debt in perpetuity, what is the present value of the created tax shield?
  • Consider an all-equity firm that is run by a manager who acts in the best interest of existing shareholders. The value of the firm’s assets in place is either $225M or $200M. The firm has an investment project that requires an investment of $33.75M. The only way to finance this project is by issuing equity to new investors in a competitive stock market. The project generates a certain, risk-free cash flow of $50M next year (i.e. this cash flow does not depend on the value of assets in place). Everyone is risk neutral and there is no discounting. Suppose there is asymmetric information, i.e. the manager knows the true value of assets in place, while investors believe assets to have a value of $225M with 80% probability and a value of $200M with 20% probability. Which of the following statements holds?
    Both types of firms will issue equity and undertake the project.
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Sources of Funding
  • Angel investors, succesvolle ondernemer die investeert in start-up
  • Venture capital firms: limited partners (bv pensioenfonds) en venture capitalists die eea runnen. Vaak grote bemoeienis in bedrijf waarin geinvesteerd wordt, voor bedrijven die meer kapitaal nodig hebben in tweede fase. Door grotere controle ook meer positieve bemoeienis
  • Private Equity firm: vergelijkbaar maar niet start/scale up maar bestaande bedrijven met beoogd groot belang te verwerven/overname te plegen. Bedoeling om public van de markt te halen (LBO leverage buy out)
  • Institutional investors: bv pensioenfonds/verzekeraars direct of via venture capital firm
  • Corporate investors: investeren vanuit strategisch belang, meer dan vanuit financiële overwegingen
Voorbeelden short term secured financing
  • Lenen op basis van debiteuren als onderpand(via factoring mij)
  • lenen op basis van voorraad als onderpand (% van de waarde) (bv cardealers via transamerica distribution finance)
  • kosten afhankelijk van risico voor de verstrekker 
Welke kosten rekent de bank?
  • Commitment fee: maximaal bedrag beschikbaar: rente over het gebruikte en fee over de rest
  • Loan origination fee: kosten van inregelen lening; in mindering van te lenen bedrag
  • compensating balance req: bedrag als borgstelling op aparte rekening; in mindering van te lenen bedrag
Welke vormen van leningen zijn er?
  • Vast bedrag vaste looptijd, aflossen eind vd looptijd
  • rekening courant /krediet limiet (line of credit) beschikbaarheid tot bepaalde max + betalen rente over opgenomen bedrag
  • overbruggingskrediet (bridge loan) bv tot lange termijn krediet mogelijk is / opstart activiteiten bouw / wachten op verzekeringsuitkering
Wat is Matching Principle
Korte termijn behoefte financieren met korte termijn financiering/schuld/lening & lange termijn behoefte financieren met lange termijn bronnen:
  • permanent werkkapitaal met lange termijn financiering (lagere transactiekosten)
  • tijdelijk werkkapitaal (bv door seizoensinvloeden) financieren met korte termijn financiering

Verschil tussen laagste en hoogste NWK behoefte = tijdelijke behoefte. Risicospreiding/kosten spelen een rol bij de keuzes hoe te financieren.
Redenen korte termijn/kort durende financieringsbehoefte
  • Seizoen variabelen bv decembermaand, tuinartikelen etc. Sales varieert enorm, vaste kosten blijven gelijk en voorraad groeit bij gelijkblijvende productie = beslag op cash = behoefte additionele tijdelijke financiering
  • onverwachte negatieve cash flow bv ongeplande investering ivm defect materieel (overbruggen neg cash flow)
  • onverwachte positieve cashflow bv nieuwe deal die meer sales genereert maar voordat die daadwerkelijk geeffectueerd wordt eerst extra voorraad en marketingkosten (overbruggen neg cash flow)
Wat is de quick ratio?
Berekenen of bedrijf voldoende liquide middelen heeft om aan korte termijn verplichtingen te voldoen:

(vlottende activa - voorraad + liquide middelen) / kortlopende schulden
Cash management
Bedrijven hebben cash nodig om te voorzien in dagelijkse behoefte (transactions balance/quick ratio) , als buffer om voldoende cashflow te hebben (precautionary balance) , als eis van financiers (compensating balance)

bedrijven kunnen ervoor kiezen overtollige liquide middelen te investeren met oog op rendement. Keuzes afhankelijk van moment het weer nodig is.  Korte termijn investeringen op geldmarkt bv
Wat is relevant tav inventory management
  • De middelen die vast liggen in voorraad; niet teveel niet te weinig
  • keuze maken wanneer voorraad houden opportuun is zeker irt seizoenartikelen (gedurende hele jaar produceren met relatief hoge voorraad vs piek productie met extra kosten seizoensarbeid en belasting materieel)
  • JIT vraagt voorspelbare afname en strakke afspraken met leveranciers (omloopsnelheid?)
Hoe monitoren accounts payable?
  • via accounts payable outstanding: aantal dagen daadwerkelijk betaald vs overeengekomen krediet voorwaarden
NB niet voldoen aan afspraken kan resulteren in gewijzigde betalingscondities als bv COD cash on delivery of helemaal uitsluiten van zaken