Advanced Corporate Finance Module

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Questions and Answers

What does the evaluation of financing and investment policies in corporate finance involve?

Examining the use of gearing and advanced valuation techniques (correct)

Analyzing the company's marketing strategy

Focusing solely on historical financial performance

Determining employee satisfaction levels

Which aspect is NOT part of assessing corporate expansion feasibility?

Mergers and acquisitions

Forming strategic partnerships

Evaluating capital structure

Expanding customer base no matter the cost (correct)

What is a key factor in evaluating bankruptcy risk?

Employee turnover rates

Constant revenue growth

Solvency and profitability measures (correct)

Market share percentage

Which of the following skills is essential for successfully communicating complex corporate finance concepts?

Effective oral and written communication skills Signup and view all the answers

What type of skills does the module aim to improve in addition to subject-specific knowledge?

Time management and self-motivation skills Signup and view all the answers

What is the weighted average cost of capital (WACC) for Firethorn Plc?

10.8% Signup and view all the answers

How is the equity value (E) for Firethorn Plc calculated?

Number of shares multiplied by share price Signup and view all the answers

What is the after-tax cost of debt (rd(1-T)) for Firethorn Plc?

3.2% Signup and view all the answers

If the corporate tax rate is 20%, what would be the adjusted cost of debt if the original rate is 5%?

4% Signup and view all the answers

What is the overall investment (V) for Firethorn Plc?

£7.50 million Signup and view all the answers

What does the net present value (NPV) criterion indicate for the project with a positive NPV?

The project should be accepted. Signup and view all the answers

What is the initial investment required for the project?

£1,000,000 Signup and view all the answers

How is the expected rate of return determined in this context?

It is calculated using the Capital Asset Pricing Model (CAPM). Signup and view all the answers

What is the primary objective of shareholder's wealth maximization?

To maximize the current market value of shareholder’s investment Signup and view all the answers

Which financial decision is concerned with how a corporation should pay for its investments?

The capital structure decision Signup and view all the answers

What are agency costs associated with in public corporations?

Losses in value due to the separation of ownership and control Signup and view all the answers

What does the term 'discount rate' refer to in calculating present values?

The rate at which future cash flows are reduced to present value Signup and view all the answers

Which of the following best describes the investment trade-off for corporations?

Choosing between reinvesting cash or distributing it to investors Signup and view all the answers

What is meant by the weighted-average cost of capital (WACC)?

The composite cost of capital that accounts for the proportion of each capital source Signup and view all the answers

What is the opportunity cost of reinvesting cash for a corporation?

The rate of return that could have been earned on financial assets instead Signup and view all the answers

How do investors typically manage their own savings and investment plans in well-functioning financial markets?

By diversifying their portfolio and adjusting their timing of consumption Signup and view all the answers

Study Notes

Module Introduction

The module focuses on advanced corporate finance concepts, including financial policy, valuation techniques, mergers, acquisitions, and bankruptcy risk.
It aims to critically evaluate financing and investment policies, assess corporate expansion feasibility, and examine advanced corporate finance topics like options and dividend policy.
The module includes weekly lectures and seminars with pre-seminar questions and assigned readings.

Module Team and Approach

The module is led by Wansu Hu, with support from Mathew Potter, Bola Babajide, and Navpreet Cheema.
Students are expected to actively participate in lectures and seminars, complete pre-seminar questions, and engage in independent study.

Learning Outcomes

Students will gain critical evaluation skills for corporate financing and investment policies, including leveraging and advanced valuation techniques.
Students will be able to assess the feasibility of mergers, acquisitions, and other strategies for corporate expansion.
Students will learn how to evaluate bankruptcy risk using alternative models, including solvency and profitability measures.
Students will understand the role of options and dividend policy in corporate finance.
Students will develop proficiency in utilizing finance-related electronic databases for research.
Students will enhance their numeracy and quantitative skills, including data analysis, interpretation, and extrapolation.
Students will develop time management and self-motivation skills for independent study.
Students will develop effective communication skills to convey complex financial concepts both orally and in writing.

Shareholder Wealth Maximization

Corporations are legal entities separate from their owners (shareholders).
The primary objective of corporate finance is shareholder wealth maximization, which involves maximizing the current market value of shareholder investments.
Shareholders can manage their own investment strategies, and managers are responsible for increasing the overall market value of shareholder investments within the corporation.
Corporations face two primary financial decisions: the investment decision (what projects to invest in) and the financing decision (how to finance those projects).
The separation of ownership and control in corporations can lead to agency problems, where managers act in their own interests rather than in the best interests of shareholders.
Agency costs are the losses in value caused by the conflicts of interest between managers and shareholders.

The Investment Trade-Off

Corporations can either reinvest their cash or return it to shareholders.
If cash is reinvested, the opportunity cost is the expected rate of return that could have been earned by investing that cash in financial assets.

NPV and Cost of Capital

Net present value (NPV) is a valuation method used to assess the profitability of potential projects by discounting future cash flows to their present-day value.
The weighted-average cost of capital (WACC) represents the average cost of financing a company’s assets from different sources like debt and equity.

Calculating Present Values

The present value (PV) of a future cash flow is the current value of that future cash flow, discounted by the discount rate to reflect the time value of money.

Worked Example

Firethorn Plc is financed through ordinary shares and a bank loan.
The shareholders expect a return of 12%, and the company’s current share price is £1.30.
The bank loan has an interest rate of 4%.
The corporation tax rate is 20%.
To calculate the WACC, it is necessary to determine the weightings of equity (E) and debt (D) in the capital structure.
The WACC is calculated as the weighted average of the cost of equity (re) and the after-tax cost of debt (rd(1-T)).
The calculated WACC for Firethorn Plc is 10.8%.

Another Worked Example

A project requires an initial investment of £1,000,000 and is expected to generate pre-tax cash flows of £600,000 for two years and £500,000 in year three.
The company finances its operations through ordinary shares and a bank loan.
The expected rate of return on equity is 11%, and the interest rate on the bank loan is 5.2%.
The corporation tax rate is 30%.
The NPV of the project is calculated by discounting the after-tax cash flows to their present value using the calculated WACC.
The project has a positive NPV, suggesting that it is worth pursuing.

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Description

This quiz covers advanced corporate finance concepts such as financial policy, valuation techniques, and risk assessment of mergers and acquisitions. Students will explore critical evaluation of corporate financing and investment strategies through lectures and seminars. Engage in independent study and in-depth discussions on complex financial topics.