Corporate Finance PDF

**CORPORATE FINANCE** Governance of a company: - 3 actors: - Shareholders who hold a part a company by investing money resulting by having dividends - Bord of director will be all the representative of the shareholders in the company to assure the link with the CEO and the deci...

**CORPORATE FINANCE** Governance of a company: - 3 actors: - Shareholders who hold a part a company by investing money resulting by having dividends - Bord of director will be all the representative of the shareholders in the company to assure the link with the CEO and the decisions.they are lead by a chair-on - CEO: main actors of the company **WHAT IS CORPORATE FINANCE?** The 2 key missions: →To ensure the company has enough funds to finance its expansion and meet its obligations. →To ensure that over the long run the company uses the resources investors put at its disposal to generate a rate of return at least equal to the rate of return the investors require. **it includes:** Time value of money Risk-return relationship Cash Flow calculation, Cost of capital, Investment rules Long term financing issues (bank loans, seasoned equity offering) REMINDERS: -income statement -balance sheet ( what we own versus what we owe) -cashflow statement BALANCE SHEET MODEL OF A FIRM: The assets of the firm are on the left-hand side of the balance sheet →Current Assets include short-lived assets such as Cash, Inventories and Accounts receivable. →Fixed Assets include Investments (financial assets), Tangible assets (buildings, equipment, etc.) and Intangible assets (goodwill, patents, trademarks, etc.). To invest in assets, firms must obtain financing. Financing is represented on the right-hand side of the balance sheet. →Current liabilities are obligations to be repaid within one year: →Accounts payable (suppliers, tax payable, social security, prepayments by customers, etc.) and Short-term debt. →Long-term debt includes bank loans and bonds that do not have to be repaid within one year. →Shareholders' equity is the difference between the value of assets and the liabilities of the firm. The main items are preferred stocks, common stocks, additional paid-in-capital and retained earnings. a capital employed perspective Balance sheet can be analyzed through two perspectives: A Solvency-Liquidity perspective A Capital Employed perspective The Capital Employed perspective is useful for two main purposes: To understand how a company is financing its operating assets To measure its economic performance: the Return on Capital Employed (ROCE). You need to have a low working capital ( INV+AR-AP)   THE 3 ISSUES OF CORPORATE FINANCE: 1\. In what assets should the firm invest? This question is related to the left-hand side of the balance sheet. We use the term **capital budgeting** to deal with the process of selecting and accepting an investment project 2\. How to raise cash to finance our investment projects? This question is related to the right-hand side of the balance sheet. We use the term **capital structure** to deal with the choice of any financial mix (debt versus equity) 3\. How should short-term cash flows be managed ? This question is related to the **net working capital**. We use the term **cash management** to deal with issues associated with the potential mismatch between the timing of short-term cash inflows and cash outflows. This course will focus on the two first issues **PART 1: FROM INVESTMENT TO VALUE CREATION (ROCE)** **Return on capital employed (ROCE)** The fundamental rule in Finance can be expressed as follows A firm can create value for shareholders if and only if its return on capital employed is greater or equal to its cost of capital.  **NOPAT\*= NET OPERATING PROFIT AFTER TAX** **OPERATING PROFIT RATE: how much profitable i am with my sales, after my first investment.** same thing:  **SESSION 2: FROM INVESTMENT TO CREATION → CASH FLOW** **CASH FLOW STATEMENT/ INCOME STATEMENT:TIME DIFFERENCE→CASH FLOW: REAL PAYMENT / INCOME STATEMENT: DOCUMENT THAT IS REFERRING ALL THE PAYEMENT (NOT PAID YET)** **+** **INCOME STATEMENT: NON FINANCIAL SECTION ( THINGS THAT WE ARE NOT PAYING → DEPRECIATION)** **CASH FLOW: ONLY SECTIONS WE PAID** **What is Cash Flow ?** **Cash flow** is central in Finance as it allows to pay dividends to shareholders, to repay principals and interests to creditors (bondholders and banks) and to increase the firm's operating assets. **Cash flow analysis** is also central in the understanding of shareholder value creation. One of its main purposes is to ensure that the firm will provide a sufficient remuneration to investors for the risk assumed. **If a firm runs out of cash, it goes bankrupt**  **CASH FLOW:** **-OPERATING CASH FLOW**  **-INVESTING CASH FLOW** **-FINANCING CASH FLOW**   **DIRECT METHOD:** **INDIRECT METHOD:**  **FREE CASH FLOW= OPERATING CF + INVESTING CF**  The Accounting Statement of Cash Flow is the third most important Financial Statement next to the Income Statement and the Balance Sheet. The purpose of the Accounting Statement of Cash Flow is to provide information about a firm's cash inflows and outflows. In the Accounting Statement of Cash Flow, cash flows are reported according to the following classification: Operating activities Investing activities Financing activities. The net change from operating, investing and financing activities should be equal to the net change in the firm's cash position. **SESSION 3: THE COST OF CAPITAL** Relationship between risk, return and the cost of capital The returns that shareholders can expect to obtain in the capital markets, for a given level of risk, are the ones they will require from firms, for the same level of risk, when the firms evaluate risky investment projects. The shareholders' required return is then the firm's cost of equity. To determine a firm's cost of equity we need to define: a measure of financial returns, a measure of return dispersion (a measure of risk), and a model to link risk and returns. **« How much return do we get for each euro/dollar invested? »** **RETURN ON CAPITAL:** Return statistics -- an example (solution) Suppose you are considering to purchase 100 shares of stock A at the beginning of the year at a price of €43 per share. Suppose that over the year the stock paid a dividend of €2.25 per share. Lastly, suppose that at the end of the year the market price of the stock is €47.75 per share. 1\) What would be your total wealth at the end of the year ? Beginning of the year wealth = 100 x €43 = €4,300. End of year wealth = 100 x €47.75 + 100 x €2.25 = €4,775 + €225 = €5,000. 2\) What would be your total return at the end of the year ? R = 2.25/43 + (47.75 -- 43)/43 = 5.23% (dividend yield) + 11.05% (capital gain) = 16.28% Of course =\> €4,300 x (1+16.28%) = €5,000. **Average Stock Return** To estimate the yearly return an investor could have expected over a specific period of time, you can use the average return formula. In the US, for large-company stocks, the average return from 1926 to 2002 was 12.2%. In means, that, on average, during that period, an investor could have expected to earn a 12.2% return per year  **Reminder:** The shareholders' required return is the firm's cost of equity. The shareholders' required return is positively linked to the level of risk that they incur when investing their money : **The higher the risk, the higher the rate of return required by investors.** To determine the cost of equity, we need to determine the risk born by an investor when investing in a company's stock.  USING "BETA EQUITY" TO ESTIMATE THE COST OF EQUITY If an investor could invest in a risk-free asset, he/she gets a risk-free rate of return (noted Rf). Of course at risk, he/she will ask a risk premium.  Researchers have demonstrated that the Risk Premium is a function of Market Risk, that is to say, a direct function of the beta coefficient. The model is called : Capital Asset Pricing Model **(CAPM).** Shareholders' expected return (equity cost of capital) can then be written as follows:   The weighted average cost of capital (WACC) The cost of equity is the cost of capital (required return) if the firm is only financed by equity. However, in real life situation, most companies are financed with a mix of equity and debt. In that case, the cost of capital is the average between the required rate of returns of shareholders and debt holders. If the firm and/or the project is only financed with equity, the cost of capital is the cost of equity. However, if the firm is financed with a mix of debt and equity, then the required return is an average cost of capital,called the weighted average cost of capital (WACC)  EXERCICE: Re: 3% +1,25 \* 6% = 10,5% Rd: 4% \* (1-35%)= 2,6 % WACC: (100/400)\*10,5 +( 300/400)\* 4%\* (1-0,35)=4,57% **SESSION 4: TIME VALUE OF MONEY** In finance, €1 today is not equivalent to €1 in one year. This is because individuals have the opportunity to invest their money and earn interest or returns over time. An investment decision is essentially the comparison of cash flows occurring today with those in the future. Financial calculation allows to articulate together the four key parameters at play in any investment: Cash outflows (investment) Cash inflows (returns) Interest rate or market rate of return (discount rate) Time  **THE ONE PERIOD CASE:** **Notations :** PV = Present Value (the value today) FVt = Future Value at date t (also called compound value at date t) R = effective annual interest rate FV 1year = €100 + €100 x 10% = €100 x (1 + 10%) = €110 EXERCICE: You are trying to sell a piece of land in France. Today, you are offered €10,000 for the land (offer A). Another individual offered you €11,424 to be paid in one year (offer B). Imagine that you can invest in the bank at an interest rate of 12%, which offer should you accept? FV= 10000 \* (1+ 12%) FV=11200 € 11 200 \< 11 424 so we should wait one year to be paid. **THE MULTI-PERIOD CASE:** **FV= PV\*(1+R)\^n**  **EXAMPLE:** Ibbotson and Sinquefield have calculated what the stock market returned as a whole from 1926 through 2001 (76 years). The average yearly return was 10.71%. Suppose your grand parents invested \$1,000 in 1926. What would be the value of their investment in 2001? **FV= 1000\* (1+10,76%)\^76** **FV= 2 281 395 €** **COMPOUNDING PERIODS:** So far we have assumed that cash flows occur yearly. Sometimes cash flows occur more than once a year. For example, suppose that you invest €1,000 in a financial instrument that pays a 10% interest rate compounded semi-annually. At the end of the first semester your wealth can be written as : €1,000 x (1+10%/2) = €1,050 At the end of the first year, your wealth can be written as : €1,050 x (1 + 10%/2) = €1,000 x (1+ 10%/2)² = €1,102.50 With : R = the stated annual interest rate (also known as Annual Percentage Rate) m = the number of times your investment is compounded per year, i.e. within a year The general compounding formula over many years can be written as follows: **THE EFFECTIVE INTEREST RATE** The effective interest rate can be defined as an equivalent effective annual interest rate, to be received on an investment that would be compounded only once a year. The effective annual interest rate is an important concept in Finance because it is used to compare different products that calculate compounded interest differently. **(1 + REAR) = (1 + R/m)m** **REAR = (1 + R/m)m -1** Remark: Sometimes the effective interest rate is also called as the real interest rate, however we prefer using that for interest rate -/- inflation. **EXAMPLE:** Suppose that you can choose between two investments A et B. Investment A. The stated interest rate is 10% compounded semi-annually Investment B. The stated interest rate is 9.85% compounded monthly. Which investment should you choose? (A or B) A= (1+10%/2)\^2 -1 A= 10, 25 % B= (1+9,85%/12)\^12 - 1 B=10,31% We should take B, because we will have a higher effective interest rate. **SIMPLIFICATIONS** **Five main simplifications:** ** Perpetuity** ** Growing perpetuity** ** Annuity** ** Future value of annuity** ** Average Return.** **PERPETUITY:**  Example: Suppose that you own a perpetual bond (a long-term debt with no principal payment that pays a constant interest rate forever). Assume this bond will pay €50 coupon per year forever. What is the theoretical price of this bond (i.e. its present value) if the market interest rate is 2%, 5% or 10% p.a.? 50/2%= 2500 50/5%=1000 50/10%=500 **GROWING PERPETUITY:** PV= 10000/ (10%-3%) PV= 142 857, 14 € IF each semestre PV= 10000/ ((10%-3%)/2) PV= 285 714, 29 € **⚠⚠If the value given is "end of the year" we take it, if not we have to multiply by the interest rate for the present year** **PRESENT VALUE OF ANNUITY:**  **EXCEL FORMULA:** **= VPM ( RATE, NUMBER OF PERIOD, PV)** Example: You want to invest in a new apartment to rent it. You expect to rent it for €7,200 per year for the next 10 years. Ten years from now, you expect to sell it for €120,000. The market interest rate is 2%. What is the price beyond which you should not buy this property? PV=7 200/2%\*(1-(1+2%)\^-10 PV rent= 64 674, 612 € PV sale= 120 000 / (1+2%)\^10 PV sale=98 441, 79 € PV max of all futur cash flow= PVrent+ PVsale PV= 64 674, 612 + 98 441, 79 PV=163 116, 402 **FUTUR VALUE OF ANNUITY** Example. Suppose that you want to invest €1,000 per year at the end of each year, for the next 3 years. The interest is 5% per year. What will be the future value of your investment? FV= 1000/5%\*((1+5%)\^3-1) FV=3 152, 5€ **AVERAGE RETURN**  **SESSION 5: TIME VALUE OF MONEY (CONTINUATION)** **EXERCICES:** ***EX1:*** ***FV= PV\*(1+4%)\^10*** ***FV=2000\*1,04\^10*** ***FV= 2960, 49 €*** ***FV= 2000\* 1,08\^10*** ***FV= 4 317, 85 €*** ***FV= 2000 \* 1,08\^20*** ***FV= 9321, 91 €*** ***EX2:*** ***PV= FV\*(1-R)\^-n*** ***PV= 2000\*1,1\^-7*** ***PV= 1026, 32 €*** ***PV=3000\*1,1\^-1*** ***PV=2727, 27 €*** ***PV= 400\*1,1\^-8*** ***PV=186,6 €*** ***EX3:*** ***PV= 2000\* 1,08\^-10*** ***PV= 926,37*** ***926,37 \< 1000*** ***We should accept the 1000 euros today rather than 2000 in 10 years. For more profit.*** ***EX4:*** ***PV= 5000000\* (1,02)\^-27*** ***PV= 2 929 310, 22*** ***THE FIRM MUST INVEST 2 929 310, 22 € to pay 5 millions in 27 years.*** ***EX5:*** ***a PV= 10 000 000\*1\^-1*** ***PV= 10 000 000*** ***PV = 20 000 000\*1\^-5*** ***PV=20 000 000*** ***b PV= 10 000 000\* 1,1\^-1*** ***PV= 9 090 909, 091 €*** ***PV=20 000 000 \* 1,1\^-5*** ***PV=12 418 426, 46*** ***c PV= 10 000 000 \* 1,2\^-1*** ***PV= 8 333 333, 33€*** ***PV=20 000 000 \* 1,2\^-5*** ***PV= 8 037 551, 44€*** ***EX6:*** ***PV = 115 000 €*** ***or*** ***PV= 150 000\*1,1\^-3*** ***PV= 112 697,2201 €*** ***EX7:*** ***Cost 340 000*** ***FORMULA:*** ***PV revenues=*** ***100000/10%\*(1-1,1\^-5)*** ***PV= 379 078, 67*** ***PV COSTS=*** ***10 000 + 10000/10%(1-1,1\^-4)*** ***PV= 41 698,65*** ***PVR-PVC= 379 078,67-41 698,65*** ***= 337 380,02*** ***You shouldn't invest in the machine, because after 5 years the benefices of machine could be inferior to the cost of sale.*** ***EX8:*** ***PV= FV\* (1+r)\^-n*** ***10 000 = 80 000 \* (1+r)\^-12***  ***R= 80 000/10000\^1/12 -1*** ***R= 0, 189*** ***R= 18,9 %*** ***EX9:*** ***PV = 1000 \* 25,5*** ***pv = 25500*** ***45,56\*1000= 25500\*(1+r)\^10*** ***45 560= 25500\*(1+r)\^10*** ***45560/25500= 1+r\^10*** ***R= (45560/25500)\^1/10-1*** ***R=0,0597*** ***R= 5,97%*** ***SESSION 7: CAPITAL BUDGETING- INVESTMENT RULES FOR INVESTMENT IN REAL ASSETS*** Capital budgeting is related to the decision-making process for accepting or rejecting investment projects. In Finance, we summarise an investment project as a stream of cash-flows. The **Net Present Value (NPV)** is then the first method to be considered. The NPV-method is based on the fact that one cannot compare cash-flows with different timing. We can only compare Present Value with Present Value   Which cash-flows should we take into account when implementing NPV-method? **CASH FLOW TO BE INCLUDED** →Incremental cash-flows. In calculating the NPV of a project, you should only use incremental cash-flows, that is to say those cash-flows that occur as a direct consequence of accepting the project; →Opportunity costs. If a firm is considering selling an asset and if this asset is used in the new project, then the lost revenues (from the sale) should be considered as costs. **CASH FLOW TO BE EXCLUDED** × Sunk costs. A sunk cost is a cost that has already occurred in the past. You should ignore this cost. For example, if a firm invested a huge amount of money in R&D in the past, then these investments should not be taken into consideration; × Allocated costs. If a firm's expenditure benefits to several projects including your new project, accountants will allocate part of this costs to your project. However, in the NPV calculation, you should not take it into account, except if it is an incremental cost of the project. EXERCICE: sum of cash flow= 800+850+950+1075+1125 = 4800 PV OF EACH CASH FLOW 2018 800/1,10 = 727 2019 850 / (1,10)\^2= 702 2020 950/ (1,1)\^3 = 713 2021 1075/ (1,1)\^4= 734 2022 1125/(1,1)\^5 = 760 SUM of PV of cash flow: 3638 NPV= 3638-3600 = 138 NVP POSITIVE, so accept project **Applying NPV to choose between two mutually exclusive projects** In many business situations you face mutually exclusive investment decisions: It means that you can accept project A or accept project B, or reject both of them but you cannot accept A and B. For example, on a piece of land you own, you can either build an apartment house or develop a new venture. In that case, the NPV decision rule is very simple: →(1) if both projects A and B have a negative NPV, then you should reject both; →(2) If at least one project has a positive NPV, then you should accept the one with the highest NPV. EXERCICE 1: you have been offered a unique investment opportunity. If you invest 10 000 today, you will receive 500 next year, 1500 in 2 years, and 10 000 in 3 years A. sum of cash flow = 12000 Interest rate 6% PV OF EACH YEAR 500 = 500/ 1,06 = 471,7 1500= 1500/ (1,06)\^2 = 1334,9 10 000= 10000 / (1,06)\^10 = 5583,9 Sum of PV = 471,7+ 1334,9 + 5583,9 =7390,5 NPV= 7390,5 - 10 0000 = - 2609,4 SHOULD NOT INVEST IN THE PROJECT B. sum of cash flow = 12000 Interest rate 2% PV OF EACH YEAR 500 = 500/ 1,02 = 490,2 1500= 1500/ (1,02)\^2 =1441,8 10 000= 10000 / (1,02)\^10 = 8203,5 Sum of PV =8203,5 +1441,8 +490,2 =10 135, 5 NPV= 10 135,5 ,- 10 0000 = 135,5 SHOULD INVEST IN THE PROJECT EXERCICE 2 the Management of comfy hotel is attempting to evaluate the feasibility of investing 125 000 in upgrading and extending its bar kitchen and dining room, the scheme is to assume to have a 10 year life with value of 0 at the end, increasing annual profit by 15000 euros each year minus annual depreciation of 12500. discount rate of 12%. sum of cash flow = (15000+12500) \* 10= 275 000 Interest rate 12% PV OF EACH YEAR ( Formula for PV of annuity;  SUM OF PV = 27 500/0,12 \* (1-(1/1,12)\^10) = 155 381, 13 NPV= 155 381 - 125 000 = 30 381 SHOULD INVEST IN THE PROJECT EXERCICE 3 You are considering investing in a new gold mine in South Africa. The mine will require an initial investment of \$50 million. Once this investment is made, the mine is expected to produce revenues of \$30 million per year for the next 5 years. It will cost \$10 million per year to operate the mine. After 5 years, the gold will be depleted. The mine must then be stabilized on an ongoing basis, which will cost \$2 million per year in perpetuity. Assume the discount rate is 10%. Calculate the NPV of this project. 30-10/0,1 \* (1-1/(1,1)5 + 2/1,1\* (1,1)\^-5 75,8 -1,1= 76,9 NPV = 76,9 -50 = 26,9 **PART 4. CAPITAL BUDGETING** **2. INVESTMENT RULE FOR INVESTMENT IN REAL ASSETS -- OTHER RULES** The Internal Rate of Return (IRR) is the discount rate at which, when applied to future cash- flows, the NPV of the project is zero. The rationale behind the IRR-method is that it provides a single number that does not depend on the market conditions (such as risk-free rate and risk premium). Example. Consider a project with an initial investment of 100 and one future cash flow of 110.  **Solving for IRR with the linearization procedure** The "trial and error"-procedure can be quite time consuming. To optimise the computation, we can use a linearization procedure or use Excel. This linearization procedure relies on the fact that around the IRR, we can hypothesize that the relationship between NPV and the applied discount rate is linear. We will not apply this method that remains time consuming and will calculate the IRR with Excel **Two problems with IRR approach -- Problem 1 - Mutually exclusive projects:** IRR and NPV often lead to the same decision when analysing a single investment project. However, with mutually exclusive projects, it may happen that IRR and NPV methods lead to different decisions. In that case, you should always prefer NPV. Example  conclu: - if IRR superior to WACC then NPV is greater than 0 so must invest - if not superior to WACC NOV negative, you must not invest - cannot be use if you have negative cashflows value - NPV will be always choose in priority **PAYBACK PERIOD METHOD**  **Payback Period decision rules:** **(1) Select a particular cut-off date ("horizon");** **(2) Accept all projects with a PP before the cut-off date;** **(3) With mutually exclusive projects, choose the one with the quickest PP** **PROFITABILITY INDEX** Definition. The profitability index (PI) is the ratio of the NPV divided by the (absolute value of the) initial investment**.**  Profitability Index decision rules: \(1) Accept an independent project if and only if ; \(2) With mutually exclusive projects, you should prefer NVP-rules as PI can lead to false conclusions; \(3) With non-mutually exclusive projects AND capital rationing, you should prefer PI-rules and rank projects according to their PI EXERCICES: *Exercice 1:* **SESSION 9: CAPITAL STRUCTURE** *I- STRUCTURE DECISION & LONG TERM FINANCING* Two main measures: Debt-to-Equity Ratio: D/E Debt Ratio: D / (D+E) Which are best: Book or Market Values? Market Value of debt and equity is usually preferred by economists as it reflects the current true value of Debt and Equity. However, these measures are very sensitive to stock market volatility. Book Value of debt and equity are usually preferred by investors and credit rating firms (Standard & Poor's; Moody's, etc.). Moreover, most debt covenants are expressed in book values.  **The trade-off model. The costs of debt** Debt provides tax benefits to the firm.( → If i pay interest i will pay minus taxes) However, Debt puts pressure on the firm as debt repayments are contractual obligations. We can identify three main types of debt costs: A loss of financial flexibility; Agency costs associated with behaviours that are not optimal (underinvestment, investing in high-risk projects, etc.); Financial distress costs (also called bankruptcy costs). →Bankruptcy costs are defined as a decrease in firm value (market value of assets) in the event of bankruptcy. The costs of bankruptcy / financial distress may then offset the benefits of debt. **The trade-off model. Optimal level of debt** The trade-off model tells us that with financial distress costs, the firm value is not a positive linear relationship of debt but rather a inverted U-shape relationship of debt. It means that when you first increase the debt-to-equity ratio then the firm value starts to increase because of the positive tax effect of debt. However, up to specific debt-to-ratio level, the firm value is declining because of an increasing probability of default. **II-EQUITY FINANCING** **Ordinary share: One share= one vote** **Preferred share: Contract that stipulate some conditions ( double vote...)** **Ordinary shares** Ordinary shares represent the basic voting shares of a firm. Holders of ordinary shares are entitled to one vote per share and to dividends (if any). An ordinary share represents equity ownership in a firm, proportionally with all other shareholders according to their percentage ownership in the firm. Shareholders' rights: Elect directors, who in turn elect corporate officers (CEO, etc.); Share proportionally in dividends paid; Share proportionally in assets remaining after liabilities have been paid in a liquidation; Vote on matters of great importance (e.g. mergers); Share proportionally in new stock sold (cf. pre-emptive rights→ the entreprise propose you to rebuy a percentage of the company to keep your ownership before proposing to someone that is out of the company) **Ordinary shares -- market value and book value** Total shareholders' equity = Common Stock + Additional Paid-in Capital + Retained Earnings -- Treasury Shares. → common stock = par value : (ex: 1 share, 10€, 10%) → Additional Paid-in Capital : imagine you want to sale a share at 50 € you have to right + 40 in this section to equal the price in the equity) → treasury shares: when the company is rebuy it's proper share to maximize its earning per shares.  EXERCICE1: 1. Book value per share: 55+347+389,5-26= 765,5 765,5/15= **51, 03** 2. Market value per share 845/15**= 56,3** **Ordinary shares -- main financial ratios** To analyse common stocks most analysts use to following financial ratios: Earnings per share (EPS) Dividend per share (DPS) Dividend Yield Pay-out ratio  Price/Earnings ratio (P/E) Return on Equity. CONSOLIDATE NET INCOME= TOTAL of all the net income owned by the company. **EXERCICE:** **EPS: 21 044 000 000/ 2 572 182 025 = 7, 98** **DPS price in euro 3,81, change into dollars= 3,81\* 1,0538 = 4,01** **Dividend yield: 4,01/ 59;97 = 0,0668 (6,7%)** **payout ratio** **→ TOTAL DIVIDEND = 4,01\* 2 572 182 025= 10 314 449 920** **10 314 449 920/ 20 526 000 000= 0,50 (50%)** **PER= 59,97/ 7,98 = 7,51** **ROE= 20 526 000 000/111 736 000 000 = 0,1837 ( 18,4%)** **Preferred shares** Preferred stock represents equity of a corporation. It is different from common stock because it has a preference over common stock in the payment of dividends. Preference means that the holder of preferred shares MUST receive a dividend before holders of common shares. Usually preferred shares do NOT carry voting rights. Sometimes preferred stock also yields more than common stock (from a higher dividend). Usually, preferred stocks are issued with a fixed par value and pay dividend based on a percentage of that par value at a fixed date. EXERCICE 1: A.COMMON STOCK / PRICE= 135 430 / 2 = 67 715 B; 135 430 + 203 145 / 67 715 = 5€ C. 2 708 600 / 67 715 = 40€ EXERCICE 2:  **SESSION 10 : EQUITY VALUATION** Previously we have addressed: Equity Book value: observed in the balance sheet Equity Market value: observed on the stock market (market price) A third value of equity is: Theoretical equity value: estimated using **Dividend Discount Model** (i.e. the sum of the present value of expected future dividends) We know that the value of any asset is equal to the present value of its future cash flows. Suppose that an investor is buying a common stock at t0 and selling it at t 1.From t 0 to t 1 this common stock provides investors with two types of cash flows: First, the dividend paid at t 1 for the period t 0-t 1 , and Second, the price when he/she sells the stock at t 1 The value of this common stock can then be written as: With Pto the stock price at t0 ; the dividend paid at t1and P1 the price of the stock at t1   EXERCICE: **⚠⚠ we take the dividend of the next year so you need multiply by growth to obtain the +1 of the futur dividend.** D= 0,25 R = 8% G= 2% Pt0= 0,25\* ( 1,02) / ( 8% - 2%) = 4,25  **EXERCICE 1:** D= 0,15 R = 10 % G = 20% → 3 years , then 5% Pn = Y1= 0,15 \* (1+20%) = 0,18 Y2= 0,15 \* 1,2\^2= 0,216 Y3= 0,15\* 1,2 \^3= 0,2592 Y4= 0,2592\* 1,05= 0,27216 Pn = 0,27216/ 5% = 5,44€ Pt0= 0,18/1,1+ 0,216 / 1,1\^2 + 0,2592/ 1,1\^3 + 5,44/ 1,1\^3= 0,16+ 0,1785+ 0,1947+ 4,0871 = 4,62 **EXERCICE 2:** 0,20\* 1,05/ 5% = 4,2 € **EXERCICE 3:** **Y1 → 0,65\ Y2→0,728\ Y3 = 0,815\ Y4=0,913** **Y5=1,023\ \ Y6 → 1,023\* 1,02= 1,0435** **Pn= 1,0435/ 6%** **= 17,391** **pt0= 15,1** **EXERCICE 4:** **SESSION 11: EQUITY ISSUANCE** **example:**  **-Book value = equity** **- market value = price od dividend divided by cost of equity minus growth multiplied by the number of shares.** **1-Market value = 21,5/ 10%-2% = 215 \* 20 000 = 4,300 000** **2-New shares issued** **new stock = 1 075 000 / 215 = 5000** **3-What would be the impact of this equity issue on the voting rights of A,B,C and D Dilution impact on voting rights:** Investor D will receive 5,000 stocks in exchange for €1,075,000. The total number of shares outstanding will be 20,000 + 5,000 = 25,000. Thevoting rights of investor A will become 10,000 / 25,000 = 40%; Thevoting rights of investors B & C will become 5,000 / 25,000 = 20% each; Thevoting rights of investor D is 5,000 / 25,000 = 20%. 4-What would be the impact of theis equity issue on XYZ's Blance sheet?  A capital increase is a sale of new shares issued by a firm; It allows the issuing firm to raise equity capital from existing or new shareholders; A capital increase can be realised on the public stock market or on the private equity market; There are two alternative generic issue methods: cash offer and rights offering; The first public issue of stocks is referred to as an initial public offering (IPO). An IPO is always a cash offer; New issues after the IPO are referred as secondary equity issue (or seasoned equity offering -- SEO). With **a public offering**, firms raise capital from a large number of institutional investors and individuals, usually through investment banks and/or the stock markets. With **a private offering,** firms raise capital from a limited number of investors: Private Equity firms, Wealthy families (family offices, etc.), Private corporations, Venture capital firms, Individual investors (business angels, etc.) **2 OPTIONS:** **The Cash offer** In a cash offer, stocks are sold to all interested investors. If the cash offer is a public one, investment banks are usually involved to: Test appetite among their clients; Price the new share; Sell the new share (cf. primary market); Guarantee a minimum sales amount on their own books; Support the price in the introduction period. Determining the offering price is difficult: If the price is too high, the issue may be unsuccessful and withdrawn; If the price is too low, the existing shareholders will experience an opportunity loss. **Rights offering mechanisms** When new shares are issued to the public, the proportionate ownership of existing shareholders is likely to be reduced (as investor A in the previous example): "dilution"; However, IF a pre-emptive rights exists (which is always the case in France but not in the US), the firm MUST offer any new issue of common stocks to existing shareholders first; This is realised through RIGHTS OFFERING MECHANISMS. Before a new equity issue, the firm must issue Preferential Subscription Rights; Existing shareholders receive one PSR for each common stock owned; Each new share is sold at a specific offering price + a given number of PSRs (we will see later how to determine this number); To buy a new share, any investor must send a payment (the offering price) to the firm's subscription agent (an investment bank) and turns in the required number of PSRs; An existing shareholder can (1) use his/her PSRs to buy new shares or (2) sell his/her PSRs (if the firm is traded on a stock market, then these PSRs will be traded too for a limited period of time -- e.g. 2 or 3 months); To buy one new share, a new shareholder MUST first buy the needed given number of PSRs and then pay the offering price.    **EXERCICE:** a. **100 000 \* 25 + 10 000 \* 20 = 2 700 000** b. **100 000 / 10 000 = 10** c. **25 000 \* 25 = 625 000** - **625 000 - 11 250= 613 750 in stock** **New voting right:** **25 000 / 110 000 = 22,73%** **SESSION 12 : DEBT FINANCING- BANK LOAN FINANCING**  **1. [Debt is not an ownership] interest in the firm;** **2. Debt payments, principal and interest, are [obligations] (from a contract) whereas dividend payments are not;** **3. The payment of interest on debt is [tax-deductible];** **4. Default on debt payments can result in liquidation and bankruptcy.**  **The basics of Debt Financing** →Debt represents an amount of money that must be repaid. →It is the result of borrowing money. →Banks or investors making the loan are called creditors or lenders. →When firms or governments borrow, they promise to make regularly scheduled interest payments and to repay the principal. →Debt is a liability of the firm. →The firm / government is called the borrower or issuer. Repayment Debt is repaid in regular amounts over the life of the debt; The last date of debt repayment is called the maturity date; The repayment of principal by instalments is called amortisations. Indenture or Prospectus The written contract between the issuer and lenders (banks or investors) is called indenture or Prospectus, which sets forth: Maturity date; Repayment schedule; Interest rates; Restrictions placed on the issuer by the lenders (called covenants) such as: Restrictions on further indebtedness; A maximum on the amount of dividends to be paid; A maximum level of Working Capital Requirement; Etc. AMORTISED LOANS / BASICS Long-term loans can be repaid in a series of payments (annually, monthly, etc.); To calculate the payment amount, all terms of the loan must be known: interest rate, timing of payments (e.g., monthly, quarterly, annually, etc.), length of loan, amount of loan; Borrowers should understand how loans are amortised, how to calculate payments and remaining balances as of a particular date, and how to calculate the principal and interest portions of the next payment; Payments can be: equal total payments(equal payement every month ) or equal principal payments,(change in interest every payement time) AND with or without delay in first repayments.    **EXEMPLE 1:** **Exemple 2 :**   **EXMPLE 4:**   **aussi appeler TRI en francais**  **EXERCICE:** **1- =20000\*(4%/12)/(1-(1+4%/12)\^-60)= 368, 33€** **2- 368,33\* 60 - 20000 = 2099, 82€** **EXERCICE 2:** **ending balance = beggining balance- principle** **total payement = principal + interst** **SESSION 13: ESG- BEYOND THE FINANCIAL PERFORMANCE** **ESG is a performance measure** of publicly listed companies (listed on stock exchanges around the world). ESG stands for **Environmental, Social, and Governance** dimension of a listed company. Each dimension can then be broken down into several aspects. For example the Environmental dimension can be broken down into climate aspect and sustainability aspect. ESG is based on self-reporting. Top management of each company discusses ESG in financial statements. They typically brag about how good they are in ESG. We will see the examples later on. On the other hand, some investors will question ESG performance of some companies and will criticize them at the general shareholders meeting. Financial companies collect data on ESG disclosed by management and create ESG scores. Then, they sell the ESG scores to investors and researchers. These firms include Bloomberg, Refinitiv, S&P Global, MSCI and many more. If you use Refinitiv, you should have access to ESG scores as well. What is corporate governance? Set of rules that prevents fraud and corruption in companies. The rules can be company-specific and/or imposed by regulation. Why is it so important? If corporate governance fails and regulators discover fraud, companies suffer huge damage that may lead to bankruptcy. Fraud is usually committed by top management and leads to: 1) loss of reputation, confidence, and trust in the company; 2) damage in equity and debt valuations; 3) loss of suppliers and customers; 4) mass layoffs of employees. Investors and regulators want to avoid corporate governance failures because they are too costly both for the economy and society. **ENRON (2001)** Company called ENRON is a synonym of bad corporate governance. Because of fraud it had to file for bankruptcy in 2001. Largest bankruptcy in the US history connected to fraud. ENRON had about 20,000 employees. The stock price of ENRON went effectively to zero. Before bankruptcy, ENRON was considered one of the most innovative companies in the US (for 6 consecutive years) focused on energy and energy trading. Because of ENRON and other corporate governance failures, US congress introduced Sarbanes and Oxley (SOX) Act of 2002 that imposed on companies stricter corporate governance rules. Because of SOX, stock exchanges introduced stricter listing requirements for listed companies. Since that time regulators around the world started paying more attention to corporate governance. **LEHMAN BROTHERS (2008)** Lehman Brothers was 4th largest investment bank in the US but it went bankrupt on 15 September 2008 helping the global financial crisis unfold. Lehman was a 158-year old bank and had 25,000 employees. More on Lehman here It went bankrupt due to the mismanagement of risk. Because global banks are interconnected through asset holdings and the credit market, the collapse of Lehman had an adverse effect on other banks around the world and even sovereign countries (e.g., the country of Iceland defaulted on its debt in 2008). Events in the US with the bankruptcy of Lehman in the middle, led to the European debt crisis. Many European countries went through deep recessions. The fact is, however, that West European countries were heavily indebted. For example, in France GDP per capita in 2022 is still lower than the level of GDP per capita in 2008 and remained lower in each year since 2008. **VOLKSWAGEN (2015)** In 2015 the US agency found out that diesel cars produced by Volkswagen emitted about 40 times more NO and NO2 (nitrogen oxides) above the legal limit. Volkswagen was installing illegal software in its cars that during laboratory testing activated controls that were reducing NO and NO2. The moment the laboratory tests were completed, the same software turned off the controls and the cars who were later sold were emitting about 40 times more NO and NO2 above the allowed limit. Volkswagen paid so far \$33.3 billion in fines, penalties, and settlements. In January 2017, Volkswagen plead guilty to criminal charges (effectively VW committed a crime). Volkswagen CEO, Martin Winterkorn, was charged with fraud and conspiracy. According to the report, top managers asked Volkswagen engineers to develop devices thanks to which its cars could pass the emission tests (engines in itself were not good enough to pass these tests without cheating) **DANSKE BANK (2017-2018)** Money laundering in the amount of around 200 billion euros between years 2007 and 2015 Money flew through the Estonian-based branch of Danske Bank from sources located in Russia, Latvia, Estonia, Cyprus, UK and a few other countries. Possibly the largest money-laundering scandal in Europe and one of the largest in the world. Unfortunately we do not know much about the details. European Banking Authority refused to publish the findings of its investigation. Multiple whistleblowers were involved as early as 2013 but none of them was taken seriously enough until 2015. Unlike in all previous corporate governance scandals not a single top manager from Danske Bank was charged with any wrongdoing **IMPORTANCE OF CORPORATE GOVERNANCE** Sound corporate governance is crucial for the performance and survival of the companies. Corporate governance failures may lead to bankruptcies and massive layoffs of employees, as well as financial and economic crises. Regulators should impose strict rules that would prohibit corporate governance failures. Unfortunately, every year there are new corporate governance misconducts (see recent Wirecard scandal in Germany and the controversial role of an auditor Ernst & Young). Money laundering practices at Danske Bank and lack of disclosure about it show that banking sector in Europe is inefficient in detecting criminal activity. Intuition tells us that environment is extremely important because none of us wants to live by the contaminated river, breathe polluted air, and drink toxic water. Damaged environment leads to damaged health and serious (lethal) diseases that affect people of all ages including children. In most cases, the government and activists monitor the condition of the environment and have moral obligation to disclose the quality of the environment in areas inhabited by people. Moreover, governments have moral obligation to protect the inhabitants from environmental disasters. Why would companies care about the environment? As we know, companies care about profits and value, and do not care much about anything else that is not related to profit and value. Arguably, companies care about environment only because if they do not, they would need to pay the price that in consequence would diminish their profits and value, and ultimately their chance of survival (self-serving motive). So companies care about the environment because it pays off to do so. That's already good enough compared to the past where companies did not have to pay for the environmental damage they were causing.