théorie financière 2007-2008 1. introduction professeur andré farber

Théorie Financière2007-20081. Introduction

Professeur André Farber

Tfin 2007 01 Introduction |2April 18, 2023

Organisation du cours

• Ouvrages de référence:Brealey, R., Myers, S. and Allen, F.

Principle of Corporate Finance8th ed., McGraw-Hill 2006

Farber,A. Laurent, M-P., Oosterlinck, K., Pirotte, H. (FLOP)Finance

Pearson Education, 2004

• Site web: www.ulb.ac.be/cours/solvay/farber• Copie des transparents (PowerPoint)• Glossaire anglais - français• Notes pédagogiques, exercices, anciens examens• Liens vers d’autres sites

• Examen(s)


Exercices

• Assistants:

• Benoit Dewaele

• Ritha Sukadi

• 6 séances (Vendredi 10-12), 4 groupes

• Groupe 1: A à F

• Groupe 2: G à L

• Groupe 3: M à P

• Groupe 4: Q à Z

Semaines 2, 4, 6, 9, 11, 13

Semaines 3, 5, 8, 10, 12, 14


Plan du cours

• 1. Introduction

• 2. Valeur actuelle

• 3. Cash flows, planning financier

• 4. Evaluation d’entreprises

• 5,6. Analyse de projets d’investissement

• 7,8. Rentabilité attendue et risque

• 9,10. Options

• 11, 12. Evaluation et financement


What is Corporate Finance?

• INVESTMENT DECISIONS: Which REAL ASSETS to buy ? • Real assets: will generate future cash flows to the firm

• Intangible assets : R&D, Marketing, ..

• Tangible assets : Real estate, Equipments,..

• Current assets: Inventories, Account receivables,..

• FINANCING DECISIONS: Which FINANCIAL ASSET to sell ?• Financial assets: claims on future cash flows

• Debt: promise to repay a fixed amount

• Equity: residual claim

• DIVIDEND DECISION: How much to return to stockholders?


Accounting View of the Firm

• Balance sheet Income statement

Sales

– Operating expenses

= Earnings before interest and taxes (EBIT)

– Interest expenses

– Taxes

= Net income (earnings after taxes)

• Retained earnings

• Dividend payments

Current assets

Fixed assets

Current liabilites

Long-term debt

Shareholders’ equity

Net Working Capital


Cash Flows of the Firm

Firm Financial markets

Firm issue securitiesFirm invest

Cash flow from operations Dividend and

debt payments

Timing of cash flows + uncertainty

Investors


Market Value of the Firm

Total capital

Fixed Assets

+

Net Working Capital

Book equity

Debt

Book values Market values

Market value of equity

Market value of

debt

Market capitalization


Value creation

• Market value added (MVA)• = Market value of the firm’s capital – Total capital employed

• VALUE CREATION : 2 strategies• Strategy 1

• Buy assets at a cost lower than the value of the future revenues– real assets– financial assets

• Strategy 2• Sell financial assets for a price higher than the value of future

payments

Market value of equity + Market value of debt

Stockholders’ equity + Financial debt


Examples

Microsoft Wal-Mart

Market Cap $billion (Sept 18, 2006) 267.69 201.03

Stockholders’ Equity $b 40.10 53.17

Revenues 44.28 315.65

Net Income $b 12.6 11.2

Price/Book 6.67 3.78

Return on Equity (ROE) 31.42% 21.12%

Price-Earnings Ratio (P/E) 21.25 17.90


The Cost of Capital

• The firm can always give cash back to the shareholders

• Capital employed by the firm has an opportunity cost

• The opportunity cost of capital is the expected rate of return offered by equivalent investments in the capital market

• The weighted average cost of capital (WACC) is the (weighted) average of the cost of equity and of the cost of debt

Project Cash

StockholderInvestment opportunities in capital markets

?


Stockholders’ problem

equity rs'Stockholde

IncomeNet ROE

InvestmentInitial

GainCapitalDivr

1

Capital marketCompany

ROEReturn on Equity

rExpected return


How to measure value creation ?

• 1. Compare market value of equity to book value

• Value creation if M/B > 1

• 2. Compare return on equity to the opportunity cost of equity

• Value creation if ROE > Opportunity Cost of Equity

shareper Book value

priceStock book(M/B)-to-Market

equity rs'Stockholde

IncomeNet )(equity on Return ROE


Value creation: Example

• Data:

• Book value of equity = € 10 b

• Net income = € 2 b / year

• Cost of equity r = 10%

• Return on equity ROE = 2 / 10 = 20% > 10%

• Market value of equity = NI / r = 2 / 10% = € 20 b

• Market value added: MVA = 20 – 10 = €10 b

• Market to Book M/B = 20 / 10 = 2


M/B vs ROE

• Simplifying assumptions:

• · Expected net income income = constant

• · Net income = dividend

• Market value determination:

• Net income = Expected return Market value of equity

• NI = r MVeq

• ROE (definition):

• Return on equity = Net income / Book value of equity

• ROE = NI / BVeq

• = r MVeq / Bveq

• Conclusion: in this simplified setting,

– M/B = MVeq/BVeq > 1 ROE> r


Drivers of ROE

• PROFITABILITY (du Pont system)

• Three determinants :

Equity

Assets

Assets

Sales

Sales

Net IncomeROE

EquityBook

IncomeNet ROE

Financial Leverage

Asset Turnover

Profit Margin


Example

Microsoft Wal-Mart

Return on Equity (ROE) 31.42% 21.12%

Profit Margin 28.45% 3.56%

Asset Turnover 3.50 3.43

Leverage 0.32 1.73

Foundations of Finance


Theory of finance

• A young science

• Finance has been around for many centuries, of course…

• Main problem: calculation!!

• Imagine having to calculate the future value of 1 euro invested for 13 years when the annual interest rate is 4.35% (with annual compounding):

Future value = (1.0435)13

• A nightmare…..

• This problem disappeared after WWII with the development of computers.

• Now we have calculators and spreadsheets….

• We also have large data bases


Irving Fisher

• Finance has its roots in economics

• Irving Fisher laid the foundations of modern theory of finance.

• Takes into account the time dimension of financial decisions

• Main ideas:

• Decisions should based on present value

• Net Present Value (NPV): a measure of additional wealth

• With perfect capital markets: independent of preferences


Present value: 1 period, certainty

• Perfect capital market

• Interest rate: r

• Future cash flow C1

• Present value:

• or: r

CCPV

1)( 1

1

PV(C1) = DF1 C1

Interpretation: DF1 = discount factor

price of 1€ to be received in one year

price of unit zero coupon

with r

DF

1

11


Microeconomics: a review

• Consumption over time:

• 1 periods, certainty

• Perfect capital markets => budget constraint

» Slope = -(1+r)

» Intercept = W0(1+r)

• Optimum:

» Marginal Rate of Substitution (MRS) = 1+r

» Optimal consumption independent of timing of income

1 10 0 0

0 1 1 0

1 1

Q YQ Y W

r rQ DF Q W


Economic foundations of net present value

100

105

200Euros now

Euros next year

50

165

Slope = - (1 + r) = - (1 + 5%)

I. Fisher 1907, J. Hirshleifer 1958

Perfect capital markets

Separate investment decisions from consumption decisions

157.5

52.5

150

Y0

Y1


Net Present Value

NPV = -I + DF1 C1

= -50 + 0.9524 60 = 7.14

Consider the following investment project:

Initial cost: I (50)

Future cash flow: C1 (60)

Budget constraint with project:

0 1 1 0 1 1 1 0( ) ( )Q DFQ Y I DF Y C W NPV


Fisher Separation Theorem

100

105

200Euros now

Euros next year

50

165

207.14

NPV

Slope = - (1 + r) = - (1 + 5%)

-50

I. Fisher 1907, J. Hirshleifer 1958

Perfect capital markets

Investment decision independent of:- initial allocation- preferences (utility functions)


Enterprise Valuation

Suppose an all equity financed company is created for this project.

Step 1: Creation

Step 2: Equity offering + investment

t = 0 t = 1-50 +60

Assets 50 Equity 50 t = 0 t = 1+60

Cash flows

Assets 0 Equity 0

Market Cap.

6050 7.14

1.05 NPV =

I+NPV =60

57.141.05


0

C1

-I

Slope = -(1+r)

NPV

Market value of company


Entreprise Value Maximisation

0

Investment

Euros today

Euros next year

NPV

Investment opportunities

Market value of company

Numerical exampler = 5%

Project CF0 CF1 NPV1 -100 115 9.52 -100 110 4.83 -100 105 0.04 -100 103 -1.9

CF1 MktVal Inv NPV1 115 109.5 100 9.5

1,2 225 214.3 200 14.31,2,3 330 314.3 300 14.3

1,2,3,4 433 412.4 400 12.4


Uncertainty: 1952 – 1973- the Golden Years

• 1952: Harry Markowitz*

– Portfolio selection in a mean –variance framework

• 1953: Kenneth Arrow*

– Complete markets and the law of one price

• 1958: Franco Modigliani* and Merton Miller*

– Value of company independant of financial structure

• 1963: Paul Samuelson* and Eugene Fama

– Efficient market hypothesis

• 1964: Bill Sharpe* and John Lintner

– Capital Asset Price Model

• 1973: Myron Scholes*, Fisher Black and Robert Merton*

– Option pricing model


References

• Corporate finance textbooks (MBA level)

– Brealey, Richard, Steward Myers and Franklin Allen, Principles of Corporate Finance, 8th edition, McGraw-Hill 2006

– Ross, Stephen A., Randolph W. Westerfield and Jeffrey F. Jaffe, Corporate Finance, 6th edition, McGraw-Hill Irwin 2002

– Damoradan, Aswath, Corporate Finance: Theory and Practice, Wiley 1997

• Ouvrages de référence en français:

– Bodie, Z. et Merton, R. Finance (édition française dirigée par C. Thibierge) Pearson education 2000

• Corporate finance texts for executives

– Bertoneche, Marc and Rory Knight, Financial Performance, Butterworth Heinemann 2001

– Hawawini, Gabriel and Claude Viallet, Finance for Executives: Managing for Value Creation, South-Western College Publishing, 1999

théorie financière 2007-2008 1. introduction professeur andré farber

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