0
Q
Key decisions under Corporate FInance
A
- Capital investment strategy and valuation (how much capital, what to invest in)
- FInancial strategy & capital structure (how funds should be raised to maximise value of business to shareholders)
- Distribution strategy (how funds should be distributed to shareholders and in what form)
- FInancial management (Managing CFs to match requirements of investment with requirements of financiers)
- Risk management ( managing financial risk to enhance value and achieve organisation objectives)
1
Q
Managers of Financial vs Real assets (differences)
A
- FA: tradeable with transparent prices. Market makers provide liquidity. RA: balance sheet comprises mainly illiquid assets
- FA: investors can invest in part of an issue. RA: risk usually concentrated
- FA: cashflows are contractual. RA: underlying CFs non contractual
- FA: Diversification aids risk reduction. RA: diversification creates negligible value
- FA: Generally able to statistically measure risk. RA: limited ability to measure most risks due to limited observations, linkages and causal relationships
2
Q
Cash Flow from Operating Activities (Core Business)
- Inflows
- Outflows
A
Inflows: - cash collected from customers - interest and dividends received - sale proceeds from trading activities (WATCH: accountants often put interest under Operating)
Outflows
- Cash paid to employees and suppliers
- Cash paid for other expenses
- taxes paid
3
Q
Cashflow from Investing Activities (Long lived assets)
- Inflows
- Outflows
A
Inflows
- sales proceeds from fixed assets
- sale proceeds from debt and equity investments
- principal received from loans made to others
Outflows
- acquisition of fixed assets
- acquisition of debt and equity investments
- loans made to others
4
Q
Cashflow from financing activities (debt & equity)
- inflows
- outflows
A
Inflows
- proceeds from issuance of debt
- proceeds from issuing stock
Outflows
- repayment of debt principal
- repurchase of shares
- dividends paid to shareholders
5
Q
Net Cash flow =
A
Net cash flow = CFO + CFI + CFF = Change in Cash
6
Q
2 ways to calculate cashflows poo and farts
A
- Direct (extract data direct from cash account)
2. Indirect (Use NPAT as a starting point and add back non cash adjustments (eg depreciation and working capital)
7
Q
Accounts receivable at end of period = ?
Cash collections = ?
Net operating working capital = ?
A
Accounts receivable at end of period = Acc Rec @ start + revenue during the period - cash collections during period
Cash collections = Revenue during period + Acc Rec (start) - Acc Rec (end)
Net operating working capital = Inventories + Acc Rec - Acc Payable
(note increases in net working cap absorb cash while decreases will release cash)
8
Q
interest expense: converting from financial statement version to value oriented version:
A
- interest expense is often included in CFO rather than CFF under accounting stds. This mixes up operating and finance flows
- therefore move it from operating to finance by ADDING BACK AFTER TAX INTEREST EXPENSE (interest expense x (1-t)) and transfer it to FINANCE
- after tax net interest = net interest expense x (1-t)
9
Q
working capital: why exclude cashflow?
A
working capital = CA - CL
- cash is excluded because mmt in value of cash & cash equiv is what we are trying to explain
- ST debt and the current portion of LT debt are excluded - these are interest bearing debt, therefore financing rather than operating items
10
Q
Provisions:
A
- need to adjust provisions to calculate cashflow
- created via non cash expenses in income statement
- add back provisions to income.
- provisions result in a non cash gain in income statement
11
Q
Advantages of using cashflows for valuations rather than profits: (4)
A
Advantages of valuations using CFs rather than profits:
- CF are objective (not impacted by different accounting policies)
- CF reflect actual timing impact (accounting smooths out fluctuations over time
- CFs measure what is avail for distribution to shareholders and other financing
- Models based on CFs are most consistent with concept of shareholder value
12
Q
Operating Free Cashflow Model
A
OFCF model:
- uses CF generated by operations area of company, less operational reinvestment requirements
- OFCF = CFO - Investing CFs
- should always be calculated on an ungeared basis (ie add back after tax expense)
- can avoid interest calc by starting with EBITDA or EBIT
- To value an asset using OFCF; discount OFCF by the WACC. The PV then measures the value of the project
- PV of CFs = sum of OFCF(t) / ((1+k(t)) ^ t)
(where k= WACC)
- can simplify forecasts by assuming a terminal value.
- PV CFs = sum of OFCF(t) / ((1+k(t)) ^ t) + Terminal Value / ((1+k(F)) ^ F)
13
Q
Equity Free Cash Flow Model
A
Equity Free Cash Flow
- OFCF minus debt related CF = cashflows available for shareholders
14
Q
Valuations:
Value of assets =
Equity =
A
Value of assets = Equity + interest bearing debt
Equity = Value of Assets - Interest Bearing Debt
15
Q
Enterprise Value
A
Enterprise value = MV of company’s operations
= Operating Assets less Operating Liabilities
Enterprise value = Net Operating Assets = equity value + interest bearing debt
16
Q
after tax = ?
tax paid = ?
net tax provisions = ?
A
after tax = ungeared tax paid
tax paid = tax expense - (net tax provisions(t) - net tax provisions (t-1))
net tax provisions = provision for income tax + provision for deferred income taxes - provision for future tax benefits
17
Q
Expected cashflows -
- why
- how
- purpose
A
Expected cashflows -
- why: incorporate project specific risk (CAPM prices systematic risk to required return, but does not account for project specific risk)
- how: estimate, rather than formal calculation. SUpplement with sensitivity and scenario analysis
- purpose: incorporate potential outcomes into single measure; if prob distn of cfs is asymmetric, can properly weight; assessment of possible risk outcomes, reduces chance of unrealistic base case
18
Q
Terminal Value
- terminal value estimates value on last day of forecast period and needs to be discounted back to T=0
- alternatives = ?
A
Terminal value: Alternatives: 1. liquidate business (salvage value) 2. assumed sale of business at end (estimated sale price) 3. going concern (use continuing value)
19
Q
Estimated sales price
A
- eg Enterprise value /EBITDA or
Enterprise Value / EBIT - Note: MUST use multiple value which is consistent with the stage of growth for the business being sold AT THE TERMINAL VALUE DATE
20
Q
Continuing value:
A
- use continuing value when individual year forecasts have settled to a steady state
- use growing perpetuity formula (CF(F+1) / (k-g) = Terminal Value(F)
k = required return; g = perpetual growth rate - because business is continuing, there is no recovery of working capital
21
Q
Relative Valuation: Multiples
- why
- sources
- Assumptions of PE ratio
A
Relative Valuation: Multiples
- why: PV depends on projections, which could be unrealistic
- source: trading multiples; acquisition multiples (prices paid to acquire listed companies)
- Assumptions of PE ratio:
- comparable tax rates & shareholders
- similar D/E ratios
- similar stage of capital investment
- similar working capital & funding policies
22
Q
Making valuation multiples more meaningful:
A
Making valuation multiples more meaningful:
- sustainable earnings concept (remove abnormal effects on profit)
- use EBIT and EBITDA (removes effect of taxation and capital structure)
- use total value of debt plus equity (V = D+E) (ie enterprise value)
- make adjustments - eg tax losses / shleter; heavy capex or deprec; specific liabilities (eg legal exposure)
23
Q
Activity ratios : Key activity ratios: Asset Turnover = Invested Capital Turnover = Receivables Turnover = Inventory Turnover = express in terms of days f sales; eg Receivable days of sales =
A
Asset Turnover = revenue / total assets
Invested Capital Turnover = revenue / invested capital
Receivables Turnover = revenue / receivables
Inventory Turnover = COGS / inventory
express in terms of days f sales; eg Receivable days of sales = (Receivables x 365) / revenue
24
```
Profitability ratios - key ratios
ROE =
Operating Profit Margin =
Profit Margin =
Return on Invested Capital =
```
ROE = net income / equity
Operating Profit Margin = EBIT / Revenue
Profit Margin = NOPAT / Revenue
Return on Invested Capital = NOPAT / Invested Capital
25
Return on Invested Capital:
- important because:
- ROE using ROIC:
- important because: shows performance on ungeared but after tax basis
- ROE using ROIC:
ROE = [ROIC pre tax + (D/E x (ROIC pre tax - Rd)] x (1-T)
ROIC pre tax = EBIT / Invested Capital
Rd = Interest rate on debt
26
Inputs to ROIC calculation
1. Invested Capital
- Book value of net operating assets =
- Book value of net operating assets = equity attributable to shareholders in parent + interest bearing debt
27
Invested Capital vs Enterprise Value
- Invested Capital is the book value equivalent of enterprise value
- BV of net operating assets = eq attrib to shareholders in parent + interest bearing debt
- BV shows how much has been raised and how it has been spent.
- To calc BV equiv of Enterprise Value need to distingiosh between interest bearing debt & non interest bearing liabilities.
- Deduct non interest bearing liabilities from total assets to get either:
1. Invested Capital, Capital EMployed or Funds Employed
2. Net Operating Assets
Both measures give same result, one from financing and one from operating perspective.
28
Market Value Added =
| Equity Market Value Added =
Market Value Added = Enterprise Value - Invested Capital
| Equity Market Value Added = Equity Market capitalisation - BV of ordinary equity
29
NOPAT =
NOPAT = EBIT x (1-T)
= EBIT - Ungeared tax expense
Also:
NOPAT = Net Profit + Net Interest x (1-T) - Income from Non Operating Assets
30
NOPAT vs NOPLAT
- NOPLAT = Net Op Profit Less Adjusted Taxes.
- Same as NOPAT, but it DEDUCTS Ungeared Tax Paid instead of Ungeared Tax Expense
- If using NOPLAT, must adjust definition of Invested Capital. Net Tax provisions would not be deducted from Total Assets.
31
Residual Income (Economic Profit)
- what is it?
- methodology to measure
- general definition
- period of measurement
- what is it - measure whether business unit is earning adequate return on capital
- methodology to measure: eg EVA (economic value added)
- general definition:
RI(t) = NOPAT(t) - Invested Capital (t-1) x WACC(t)
[NOPAT(t): tax is based on EBIT; Invested Capital is net BV of assets at start of period]
- ALso: RI(t) = (ROIC(t) - WACC(t)) x Capital Invested (t-1)
- period of measurement: each year of project's life ie suprplus value added in that year
32
Advantages of using Residual Income as a performance measure (3)
1. Directly incorporated cost of capital into calculation (compare with ROIC which still required comparison to WACC)
2. RI incorporates ROIC, therefore can use DuPont style analysis
3. RI links measures of financial performance and DCF values. Connected in 2 ways:
a) Enterprise Value = Invested Capital (at val date) + PV of all forecast RI
b) NPV = PV of all forecast RI from project
4. When used as valuation context, ties numbers back to accounting metrics.
5. Decisions which maximise PV of RI (ie MVA) are consistent with shareholder value maximisation.
33
R(d) =
K (d) =
R(e) =
K (e) =
Return vs Cost:
R(d) = Return on debt
K (d) = Cost of Debt
R(e) = Return on equity
K (e) = COst of equity
Return and COst are the SAME THING. Just opposite sides of the equation. Pice paid = investment made
34
Price vs Value
Price is objective, value is subjective
Goal of company is to create value for shareholder
Difference is P/L
Value: analyse earnings; DCF; Multiple (eg P/E, xx times..)
Want: R > K (return > Cost)
and Value > Price (V>P
35
Statement of Cashflows
| - steps to analyse
1. Determine CFs from operating activities (ie normal activities of producing & selling G&S)
2. Make adjustments to CF for investing activities (changes to capital assets - acquisitions / sales)
3. Adjust for CFs from financing activities (net payments to creditors and owners (ex interest expense). ie, changes in debt & equity
36
Current Assets and liabilities
CA: Cash and other assets expected to convert to cash within one year. Cash &cash equiv, marketable securities, accounts receivable, inventories
CL: payments expected within one year. Acc payable, expenses payable (Inc. accrued wages & taxes), and notes payable.
37
Basic Balance Sheet =
| Cash = (rearrange B/S equation)
Balance Sheet:
Net working capital + fixed assets = LT debt + Equity
Where Net Working Cap = (cash + other current assets) - Current liabilities
Therefore:
Cash = LT Debt + Eq + Current Liabilities - Current Assets other than cash - fixed assets
38
Operating Cycle vs Cash Cycle
Operating Cycle: time taken from acquisition of inventory to receiving cash
Comprised of:
1. Inventory Period (time to acquire & then sell inventory)
2. Accounts receivable period: Time taken to collect $$
(in days)
Cash Cycle: Time between paying for inventory and receiving cash payment. Comprised of:
1. Acc Payable Period (period between acquisition & pmt)
2. Cash cycle = Operating Cycle - Accounts payable period
(in days)
39
3 methods to calculate NOPAT
1. Use EBITDA
2. Use EBIT
3. Use NPAT
```
NOPAT:
1. Use EBITDA
EBITDA - D&A = EBIT
EBIT - Tax paid on EBITDA = NOPAT
2. Use EBIT
EBIT x (1-Tc) = NOPAT
3. Use NPAT
NPAT + Interest Expense - Tax on interest = NPAT
```
40
How to check tax rate
If given Profit Before Tax and the Income Tax Expense;
| ITE / Profit = tax rate (%)
41
Create Corporate Finance Balance Sheet
+ Operating Revenue
- Operating Expense (COGS, Selling General & Administrative)
= EBITDA
- Deprec & Amort
= EBIT
- Tax (ie need ungeared)
- Net Interest Expense
- Other Non Operating
= Profit Before Tax
42
PE ratios when comparing similar companies may differ. Why.
1. Company may be over or undervalued
2. Both Div Discount Model and NPVGO model imply that the PE ratio is related to growth opportunities. A Co with higher PE ratio may have greater growth opps.
3. Discount Rate - this is negatively correlated to the firm's discount rate as it appears in the denominator. R appears in denominator of DDM and NPVGO model.
4. Accounting differences can result in higher perceived EPS.
43
Enterprise Value to EBITDA ratio
- Enterprise value = ?
- Why remove cash?
- advantage vs PE ratio
- Why use EBITDA in denominator
- Why remove D & A?
- Enterprise value = Equity + Debt - Cash
- Why remove cash? = capture productive assets rather than include excess cash (which is non productive)
- advantage vs PE ratio: companies in same industry may use different leverage. EV includes debt and equity therefore impact of leverage on EV / EBITDA ratio is less
- Why use EBITDA in denominator: numerator and denominator must be consistent. P (per share) / E (per share) is consistent (ie PER SHARE). EV (incl D+E) therefore is divided by EBITDA
- Why remove D & A? These are not cashflows, they are sunk costs.
44
PE difficulties:
| PE assumes: (4)
PE assumes that companies
1. have similar debt/equity ratios
2. have comparable tax rates and shareholders
3. are at a similar stage of capital investment
4. follow similar working capital and funding policies
45
Standardizing Statements
- why
- how
Standardize statements
- Why: need Common Size balance sheets to compare
- Also, useful to compare with competitors (eg compare cost control)
- How: Express each item as a % of total assets
46
Measures of Income
1. Net Income
2. EPS
3. EBIT
4. EBITDA
1. Net Income
- Total Revenue - Total Expenses.
- differences in cap structure & tax. Subtract Int Exp and taxes from Op Inc
- Div payout & retained earnings closely linked to NI
2. EPS
- Net Inc / # shares
3. EBIT
- Income before unusual items.
- Op exp are subtracted from Total Ops Revenue
- Abstracts from differences in firm's cap structure (int) & taxes
4. EBITDA
- EBITDA adds back 2 non cash items (D&A) and is a better view of before tax operating CF
47
Issues with Financial Statement Analysis
1. Conglomerates (firms own diff businesses which may be unrelated)
2. Globalisation (accounting standards may not be the same)
3. Seasonality
4. One-offs
Corporate Finance
flashcards
Decks in class (13)
# Cards
-
Pre-work48
-
Topic 1: Shareholder Value Maximisation23
-
Topic 2: Valuation Principles22
-
Topic 4: Project Evaluation30
-
Topic 11: Unit Overview8
-
Topic 6: WACC13
-
Topic 3: Special Topics in Valuation25
-
Topic 7: Alternative Valuation Models15
-
Topic 8: Financial Strategy and Capital Structure15
-
Topic 9: Capital Management & Equity Strategy33
-
Topic 10: Evaluating Asset Based Financings23
-
Exam41
-
Topic 5: Strategic Flexibility8
