This summary of Applied Corporate Finance includes the following topics:
- Capital Structure Considerations
- International Capital Budgeting
- Political Risk
- Working Capital Management
- Behavioral Corporate Finance
- Globalizing Cost of Capital
- Private Equity
- Treasury Management
- International Banking
Capital Structure Considerations
Wholesale banking serves corporate clients in several ways:
- Capital Structure & Financing: ST vs LT, assessment of company’s optimal capital
structure and debt capacity; → Capital structure analysis, acquisition / debt capacity ,
ratings advisory
- Working Capital: Optimization of working capital, analysis based on companies
constraints; → SC finance, liquidity optimization, trade solutions
- M&A, ECM/DCM: advisory on potential current and future targets including
valuations, advice on how to finance acquisitions, capital market access; → M&A,
DCM/ECM, share buybacks
- Payments & Cash management: processing of payments and use of cash pools in
order to use cash efficiently across the organization. → domestic and international
cash pooling, bank guarantees, letters of credit, overdraft and intraday limits
ECM / DCM = equity / debt capital market issuance
DSM: from coal mining towards health and nutrition company. 2020 20% nutrition, 80%
materials
Nutrition market better ebitda margin → shareholders demand a change from material to
nutrition market. DSM currently rather in line with material peers.
EV / NTM EBITDA already 66% nutrition so valuations should have been closer to nutrition
peers instead of lower valued materials peers.
Investors perception: share price reflection of markets expectation of future cash flows →
Investor is constantly testing if his / her investment case is still holding up to the initial
perception → anything that triggers a change in perception will move share price.
Factors influencing valuation:
- Theoretical valuation models;
- Market perception;
- Investor appetite;
- Analyst coverage;
- Market communication.
,Change in credit rating leverage will only marginally change DSM’s weighted average cost of
capital.
- WACC increase is limited when the company attracts more debt;
- Market perception and investor appetite are more important factors in practice.
Opportunity: takeover of Danisco:
- Fully debt financed acquisition is challenging if DSM aims to maintain a strong
investment grade rating.
- DSM will lose A- rating after acquisition and depending on takeover multiple
downgrade by 2 notches or more.
For large acquisitions companies generally choose a financing structure which limits a rating
downgrade to maximum two notches. One notch downgrade is most common.
Takeaways:
- Equity can be financed by an equity issue or by a combination of equity and hybrids;
- Hybrids attribute ~50% equity credit according to rating methodology;
- Hybrid capacity according to S&P and Moody’s around 3BN;
- When issuing hybrids, there is less senior debt required;
- For BBB+ rating, the equity requirement could be fulfilled via 1.25BN equity and
2.5BN hybrids.
International Capital Budgeting
What are the specific challenges to capital budgeting for companies that are globally active
compared to purely domestic firms?
, Most high likelihood high impact are nature things such as climate action failure, extreme
weather, biodiversity loss, natural disasters etc.
2 specific challenges in lecture:
- Cash Flows may be denominated in different currencies.
You may only have the financial capacity for 1 project but you have to choose out of
multiple projects from different countries (currencies).
You need to value a company with activities in different currency zones.
- Projects maybe exposed to political risks
“Risk that a government action will negatively affect the cash flows of a company
conducting an international investment.”
Approach 1: CFs in different FX
Naïve approach:
- Discount both EUR and USD cash flows at discount rate of 7%;
- Translate USD NPV to EUR using spot exchange rate EUR/USD 1.12;
- Choose project with highest EUR NPV.
Problems → Does not acknowledge inflation is larger in US.
- Nominal CFs in EUR grow at 1.5%
- Nominal CFs in USD grow at 3.0%
What nominal USD discount rate would be consistent with inflation of 3%?
- Take real rate as appropriate starting point;
- Inflate real rate with US inflation to get nominal USD discount rate:
(1+5.42%) * (1+3%) - 1 = 8.58%
Failure to acknowledge differences in inflation rates leads to money illusion and bad
decision making resulting in over-selection of projects in high inflation countries.
All projects should be evaluated using the same real discount rate.
Nominal discount rates will differ across countries only because inflation rates differ, and can
be calculated by inflating the common real rate with the local inflation rate.
- Capital Structure Considerations
- International Capital Budgeting
- Political Risk
- Working Capital Management
- Behavioral Corporate Finance
- Globalizing Cost of Capital
- Private Equity
- Treasury Management
- International Banking
Capital Structure Considerations
Wholesale banking serves corporate clients in several ways:
- Capital Structure & Financing: ST vs LT, assessment of company’s optimal capital
structure and debt capacity; → Capital structure analysis, acquisition / debt capacity ,
ratings advisory
- Working Capital: Optimization of working capital, analysis based on companies
constraints; → SC finance, liquidity optimization, trade solutions
- M&A, ECM/DCM: advisory on potential current and future targets including
valuations, advice on how to finance acquisitions, capital market access; → M&A,
DCM/ECM, share buybacks
- Payments & Cash management: processing of payments and use of cash pools in
order to use cash efficiently across the organization. → domestic and international
cash pooling, bank guarantees, letters of credit, overdraft and intraday limits
ECM / DCM = equity / debt capital market issuance
DSM: from coal mining towards health and nutrition company. 2020 20% nutrition, 80%
materials
Nutrition market better ebitda margin → shareholders demand a change from material to
nutrition market. DSM currently rather in line with material peers.
EV / NTM EBITDA already 66% nutrition so valuations should have been closer to nutrition
peers instead of lower valued materials peers.
Investors perception: share price reflection of markets expectation of future cash flows →
Investor is constantly testing if his / her investment case is still holding up to the initial
perception → anything that triggers a change in perception will move share price.
Factors influencing valuation:
- Theoretical valuation models;
- Market perception;
- Investor appetite;
- Analyst coverage;
- Market communication.
,Change in credit rating leverage will only marginally change DSM’s weighted average cost of
capital.
- WACC increase is limited when the company attracts more debt;
- Market perception and investor appetite are more important factors in practice.
Opportunity: takeover of Danisco:
- Fully debt financed acquisition is challenging if DSM aims to maintain a strong
investment grade rating.
- DSM will lose A- rating after acquisition and depending on takeover multiple
downgrade by 2 notches or more.
For large acquisitions companies generally choose a financing structure which limits a rating
downgrade to maximum two notches. One notch downgrade is most common.
Takeaways:
- Equity can be financed by an equity issue or by a combination of equity and hybrids;
- Hybrids attribute ~50% equity credit according to rating methodology;
- Hybrid capacity according to S&P and Moody’s around 3BN;
- When issuing hybrids, there is less senior debt required;
- For BBB+ rating, the equity requirement could be fulfilled via 1.25BN equity and
2.5BN hybrids.
International Capital Budgeting
What are the specific challenges to capital budgeting for companies that are globally active
compared to purely domestic firms?
, Most high likelihood high impact are nature things such as climate action failure, extreme
weather, biodiversity loss, natural disasters etc.
2 specific challenges in lecture:
- Cash Flows may be denominated in different currencies.
You may only have the financial capacity for 1 project but you have to choose out of
multiple projects from different countries (currencies).
You need to value a company with activities in different currency zones.
- Projects maybe exposed to political risks
“Risk that a government action will negatively affect the cash flows of a company
conducting an international investment.”
Approach 1: CFs in different FX
Naïve approach:
- Discount both EUR and USD cash flows at discount rate of 7%;
- Translate USD NPV to EUR using spot exchange rate EUR/USD 1.12;
- Choose project with highest EUR NPV.
Problems → Does not acknowledge inflation is larger in US.
- Nominal CFs in EUR grow at 1.5%
- Nominal CFs in USD grow at 3.0%
What nominal USD discount rate would be consistent with inflation of 3%?
- Take real rate as appropriate starting point;
- Inflate real rate with US inflation to get nominal USD discount rate:
(1+5.42%) * (1+3%) - 1 = 8.58%
Failure to acknowledge differences in inflation rates leads to money illusion and bad
decision making resulting in over-selection of projects in high inflation countries.
All projects should be evaluated using the same real discount rate.
Nominal discount rates will differ across countries only because inflation rates differ, and can
be calculated by inflating the common real rate with the local inflation rate.
