Financial Management (2019) summary of all slides

Part 1: Financial concepts and techniques




Chapter 1: Financial management and value creation
Managers should manage their firms resources with the objective of increasing the firm values
Value creator

Who is going to finance your project?
 Firms owners (shareholders)  Equity capital
 Debtholders (Bank)  Debt capital
Capital employed = equity capital + debt capital
Capital is costly  Cost of capital
The firm’s owner will find the project attractive only if its operating profitability exceeds the cost of
capital. Otherwise: Reduced firm value  Unable to attract equity capital
Who is the owner of the firm?
 Shareholder  Residual claimants
 Stakeholder  customers, employees, people, etc.

If a project creates value, we accept it, but how to decide this?
 NET PRESENT VALUE RULE
NPV = -Initial investment + Present value of Cash flows
Investors  Project: Investors provide the initial cash
Project  investors: The project generates future cash returns to investors
 WEIGHTED AVERAGE COST OF CAPITAL
Wacc = Cost of equity x weight (equity) + cost of debt x (1-taks) x Weight (debt)

Applications of fundamental finance principle:
1) Capital budgeting decision
Whether an investment project should be accepted or not  2 decision tools:
 Net present value rule  A project should be undertaken if its NPV is positive or zero.
 Internal rate of return rule (IRR)  A project should be undertaken if its IRR is higher than, or
equal to, its cost of capital
Internal Return Rule: Measure of the firms operating probability
-It excludes the cost of financing, so commonly used in the analysis of the capital expenditures
-You must compare the projects IRR to the cost of financing the project (WACC)

2) The pay-out policy = When and how much cash the firm should distribute to its shareholders.
A firm generates money. What to do with this money?
1) Reinvest to another profitable project

,2) Pay-out. 2 forms of pay-out:
 Dividends
-Cash dividend
-Stock dividend
 Share repurchase
-Tender offers
-Open market

3) The capital structure decision
= How much of the firm’s asset should be financed with equity and how much with debt, to maximize
firm value. We don’t have 100% debt because of financial distress cost. As long as the present value
of the expected tax savings from debt financing is higher than the present value of the expected cost
of financial distress, additional borrowing will increase the firm’s value

4) The business acquisition decision =How much should be paid to acquire another company.
NPV (acquisition) = Premium paid to acquire the target company’s assets + PV of the post-acquisition
incremental net cash flows from the merged assets

Primary markets: Investors give cash to a firm and receive Newly issued securities
 Intermarries (huwelijk aangaan) between individuals and institutions
 Cash surplus of investors and cash deficit of firms are compensated by raising new capital
through the issuance of securities.
 Investment bankers frequently involve to primary markets

Secondary markets: Investors give cash to a firm, and receive Outstanding securities
 Efficient mechanism for trading outstanding (already issued) securities
 Value creation determined by the security prices
 Investment Banks use secondary market as benchmark for newly issued securities

How can firms finance their projects in primary markets?
 Equity financing
-External  Issue shares in the equity market
-Internal  Retained Earnings
 Debt financing (always external)
-Issue debt securities in the debt market
-Short term funds  Commercial papers in money market
-Long term funds  Bonds

Financial accounting process:
 Balance sheet
Working Capital Requirement : Net investment that firm must make to support its production and
sales activities. WCR = (accountants Receivables + Inventory) – Accountants payable
 Income statement
-First we pay to debt holders
-Then pay to tax authorities
-Residual claimant goes to equity holders




Where does cash come from?

,How profitable is the firm?
 Profitability of equity capital


 Profitability of invested capital


Sales less variable and fixed expenses  Earnings before interest (EBIT)
EBIT less fixed interest expenses and variable tax expenses  Earnings after tax (EAT)

Has the firm created value?
If ROIC > WACC  creates value. If ROIC < WACC  destroys value



The role of the Chief of Financial Officer (CFO)
-Treasury management; cash and currency management
-Planning; preparation of cash and capital budgets
-Accounting; record keeping, financial statements etc.
-Monitoring risk and controlling performance
-Taxation, tax optimizations
-Advising head of the company on investment, dividend policy, acquisitions etc.

Chapter 2: Time value of Money
Present value of cash flow streams


Perpetuities



Annuities



Growing perpetuities



Growing annuities



Interest rate quotation and calculation

,  The effective annual rate(EAR): it indicates the actual amount of interest that will be earned at
the end of the year
 Annual Percentage Rates (APR): the amount of simple interest earned in one year – that is, the
amount of interest earned without the effect of compounding.




Compound interest rate
Interest per period = R/periods a year




Changes in interest rates are usually quoted in terms of basis points. 1 basis point = 0.0001

Chapter 3: Risk and return
 Measures of return




 Measures of risk
Typically, risk is measured with the variance or variability (and standard deviation = square root of
the variance)




Mean variance analysis
-Risk averse: Investor’s decision will depends on his degree of risk-aversion
-Risk neutral: He likes higher expected returns an doesn’t care about risk
-Risk seeker: He likes higher expected returns as well as higher risk. Is ready to give up some
expected return in order to get more risk (gambler)




((Return-Expected return) /10)^2 = Squared deviation
Sum of squared deviations/numbers = variance
Standerd deviation = wortel van variance * 10
Computing portfolio expected returns