Corporate finance
CHAPTER 1: GOALS AND GOVERNANCE OF THE FIRM ..................................................................... 3
GOAL OF A COMPANY ................................................................................................................................. 3
GOVERNANCE .......................................................................................................................................... 3
CHAPTER 2: BASIC VALUATION CONCEPTS .................................................................................... 5
CHAPTER 3: VALUING BONDS AND STOCK ..................................................................................... 7
VALUING BONDS ....................................................................................................................................... 7
VALUING STOCKS ...................................................................................................................................... 7
CHAPTER 6: INVESTMENT ANALYSIS .............................................................................................. 8
WHAT IS AN INVESTMENT? ........................................................................................................................... 8
INVESTMENT EVALUATION METHODS .............................................................................................................. 9
Net present value ................................................................................................................... 9
Internal rate of return .............................................................................................................. 9
Payback period .....................................................................................................................10
Profitability index ..................................................................................................................10
DETERMINING THE RELEVANT CASH FLOWS ................................................................................................... 10
CHAPTER 7: FURTHER REFINEMENTS ON INVESTMENT ANALYSIS ..................................................11
IMPACT OF INFLATION ............................................................................................................................... 11
CAPITAL RATIONING ................................................................................................................................. 12
PROJECTS WITH DIFFERENT LIFETIMES .......................................................................................................... 12
IN PRACTICE? ......................................................................................................................................... 13
CHAPTER 4: RELATIONSHIP BETWEEN THE REQUIRED RATE OF RETURN & RISK .............................13
RISK-RETURN ASSUMPTIONS ...................................................................................................................... 13
RISK & DIVERSIFICATION ........................................................................................................................... 14
CAPITAL ASSET PRICING MODEL (CAPM): THE MODEL ................................................................................... 16
WHAT ABOUT OTHER RISK FACTORS? ........................................................................................................... 18
CHAPTER 8: COST OF CAPITAL......................................................................................................18
WACC ................................................................................................................................................. 18
COST OF DEBT ........................................................................................................................................ 19
CHAPTER 9 + 10: CAPITAL STRUCTURE ..........................................................................................20
INTRODUCTION ....................................................................................................................................... 20
STATIC TRADE-OFF THEORY ........................................................................................................................ 20
Perfect markets: irrelevance of capital structure .......................................................................20
Impact of taxes .....................................................................................................................22
Impact of financial distress ....................................................................................................23
Static trade-off theory ............................................................................................................24
PECKING ORDER THEORY .......................................................................................................................... 25
CHAPTER 17: FINANCIAL MANAGEMENT .......................................................................................26
SETTING THE STAGE .................................................................................................................................. 26
STATIC APPROACH ................................................................................................................................... 27
Book value ...........................................................................................................................27
Multiples or comparable transactions .....................................................................................27
DYNAMIC MODEL: DISCOUNTED CASH FLOW ................................................................................................. 28
1
, Estimating free cash flows ......................................................................................................28
Discounting all future free cash flows ......................................................................................29
2 phase DCF model ...............................................................................................................29
CHAPTER 15: WORKING CAPITAL MANAGEMENT ...........................................................................30
WORKING CAPITAL REQUIREMENT ............................................................................................................... 30
TRADE CREDIT......................................................................................................................................... 30
HOW TO FINANCE WORKING CAPITAL REQUIREMENT? ...................................................................................... 30
CHAPTER 16: CASH MANAGEMENT ...............................................................................................32
CHAPTER 12: ISSUING SHARES ....................................................................................................33
PUBLIC EQUITY OFFERINGS ........................................................................................................................ 33
IPO (initial public offering) ......................................................................................................34
Crowdfunding (CF) ................................................................................................................35
PRIVATE EQUITY ISSUES ............................................................................................................................. 35
CHAPTER 13: FINANCIAL DEBT .....................................................................................................35
2
,CHAPTER 1: GOALS AND GOVERNANCE OF THE FIRM
Goal of a company
What should be the main • Profit maximization → not optimal
goal for a for-profit firm? ➢ Ignores the amount invested & the amount of risk
• Profits compared with investments → relative manner
➢ ROA = return on assets
➢ EPS = earnings per share
• Maximize market value for shareholders
➢ Market value = f(profitability and risk)
➢ Profitability → return on investment (including timing)
➢ Risk → probability of return
Whose interest should be • In Anglo-Saxon environment (VS & UK) → shareholder focus
given priority? Share- • In these countries also dividends are more important than job security
holders or stakeholders
From shareholder to • Milton Friedman → shareholder theory
stakeholder theory • Richard Freeman → stakeholder theory
➢ Any group or individual affected by the achievement of the firm’s objective
Is ESG compatible with • Environment, Social, Governance
shareholder value • Yes, governance & ESG has positive LT shareholder effects
maximization ➢ Good governance ⟹ strengthens shareholder value
Corporate governance • Good governance brings long-run discipline to capital allocation decisions ⟹
capital grows for long-run sustainability → benefits all stakeholders
ESG materiality • Looks for investment value in ESG performance by focusing on ESG issues that
framework are important to shareholders and other stakeholders
Governance
Corporate governance • Thinking about how we should structure our organization in such a way that we
can achieve this goal of maximizing shareholder value
Why do we need to think • In a organisation there are different indivudals, actors, groups… → they all have
about it different objectives
• Contracts are needed to manage these relationships & objectives → agency
relationships
Agency relationships • A contract whereby 1 person (principal) authorizes another person (the agent)
to act on his behalf
• Eg. shareholders are principles & they ask manager to run company on their
behalf → with idea of maximizing shareholder value
➢ But not all managers will try to maximize this value
➢ They want to achieve their own objectives
Different actors • Diverging objectives
• Information asymmetries
• ⟹ agency problems & agency costs
Agency problems • Shareholders vs managers → especially if dispersed ownership
➢ More shareholders → lower incentive of each shareholder to control
managers
• Shareholders vs creditors
• Company vs society
Listed company • Dispersed ownership
(shareholder vs manager) • Managers are appointed & controlled by shareholders
3
, • Information asymmetries
• Free cash flow problem
➢ If company is generating a lot of free cash flow which you don’t necessarily
need → either return to shareholder or hold it in company for their own good
How can we solve this? • Directors who more closely follow up the managers
• Give managers stocks → if company is doing well, they also benefit
Shareholders vs creditor • Shareholder → want higher dividends, risky investment projects, take on more
debt → not benefiting creditors
• Creditors → need to be repaid first, so they don’t want the company to take
more risks because if company can’t pay them back → they lose
Assumptions in financial • Listed companies
theory • A perfect world
➢ But there are taxes, no perfect competition, there is difference between
lending & borrowing interest rate, securities are not infinitively divisible
• Market efficiency
➢ All publicly available & relevant information is immediately reflected in
prices
➔ Eg. reutrns or dividend announcement, acquisition announcement,
inflation…
➔ You cannot systematically realize excess returns on information →
because everyone trades immediately on this information
➢ Profit only can be made due to unexpected information
➢ Price changes follow a random walk
➢ Price can still deviate from actual value
3 types of market • Weak form efficiency
efficiency (vraag chatgpt)) ➢ Share prices reflect all public information from the past
➢ Impossible to develop profitable investment strategy
• Semi-strong form efficiency
➢ Not possible to obtain excess returns by trading promptly on news releases
➢ We live in this
• Strong form efficiency
➢ Not possible to obtain excess returns based on inside information
➢ But this is still possible, even though it’s illegal
Book value vs economic • total assets: 15 billion, debts: 7 billion
value • total assets & total liabilities shoud equal ⟹ book value of equity should be 8
billion
• But here we use market value (economic value) → this is 11 billion
➢ We value company 11 billion because we believe it has growth potential
• The 3 billion on the left side are growth option
• For young companies these differences are higher
4
CHAPTER 1: GOALS AND GOVERNANCE OF THE FIRM ..................................................................... 3
GOAL OF A COMPANY ................................................................................................................................. 3
GOVERNANCE .......................................................................................................................................... 3
CHAPTER 2: BASIC VALUATION CONCEPTS .................................................................................... 5
CHAPTER 3: VALUING BONDS AND STOCK ..................................................................................... 7
VALUING BONDS ....................................................................................................................................... 7
VALUING STOCKS ...................................................................................................................................... 7
CHAPTER 6: INVESTMENT ANALYSIS .............................................................................................. 8
WHAT IS AN INVESTMENT? ........................................................................................................................... 8
INVESTMENT EVALUATION METHODS .............................................................................................................. 9
Net present value ................................................................................................................... 9
Internal rate of return .............................................................................................................. 9
Payback period .....................................................................................................................10
Profitability index ..................................................................................................................10
DETERMINING THE RELEVANT CASH FLOWS ................................................................................................... 10
CHAPTER 7: FURTHER REFINEMENTS ON INVESTMENT ANALYSIS ..................................................11
IMPACT OF INFLATION ............................................................................................................................... 11
CAPITAL RATIONING ................................................................................................................................. 12
PROJECTS WITH DIFFERENT LIFETIMES .......................................................................................................... 12
IN PRACTICE? ......................................................................................................................................... 13
CHAPTER 4: RELATIONSHIP BETWEEN THE REQUIRED RATE OF RETURN & RISK .............................13
RISK-RETURN ASSUMPTIONS ...................................................................................................................... 13
RISK & DIVERSIFICATION ........................................................................................................................... 14
CAPITAL ASSET PRICING MODEL (CAPM): THE MODEL ................................................................................... 16
WHAT ABOUT OTHER RISK FACTORS? ........................................................................................................... 18
CHAPTER 8: COST OF CAPITAL......................................................................................................18
WACC ................................................................................................................................................. 18
COST OF DEBT ........................................................................................................................................ 19
CHAPTER 9 + 10: CAPITAL STRUCTURE ..........................................................................................20
INTRODUCTION ....................................................................................................................................... 20
STATIC TRADE-OFF THEORY ........................................................................................................................ 20
Perfect markets: irrelevance of capital structure .......................................................................20
Impact of taxes .....................................................................................................................22
Impact of financial distress ....................................................................................................23
Static trade-off theory ............................................................................................................24
PECKING ORDER THEORY .......................................................................................................................... 25
CHAPTER 17: FINANCIAL MANAGEMENT .......................................................................................26
SETTING THE STAGE .................................................................................................................................. 26
STATIC APPROACH ................................................................................................................................... 27
Book value ...........................................................................................................................27
Multiples or comparable transactions .....................................................................................27
DYNAMIC MODEL: DISCOUNTED CASH FLOW ................................................................................................. 28
1
, Estimating free cash flows ......................................................................................................28
Discounting all future free cash flows ......................................................................................29
2 phase DCF model ...............................................................................................................29
CHAPTER 15: WORKING CAPITAL MANAGEMENT ...........................................................................30
WORKING CAPITAL REQUIREMENT ............................................................................................................... 30
TRADE CREDIT......................................................................................................................................... 30
HOW TO FINANCE WORKING CAPITAL REQUIREMENT? ...................................................................................... 30
CHAPTER 16: CASH MANAGEMENT ...............................................................................................32
CHAPTER 12: ISSUING SHARES ....................................................................................................33
PUBLIC EQUITY OFFERINGS ........................................................................................................................ 33
IPO (initial public offering) ......................................................................................................34
Crowdfunding (CF) ................................................................................................................35
PRIVATE EQUITY ISSUES ............................................................................................................................. 35
CHAPTER 13: FINANCIAL DEBT .....................................................................................................35
2
,CHAPTER 1: GOALS AND GOVERNANCE OF THE FIRM
Goal of a company
What should be the main • Profit maximization → not optimal
goal for a for-profit firm? ➢ Ignores the amount invested & the amount of risk
• Profits compared with investments → relative manner
➢ ROA = return on assets
➢ EPS = earnings per share
• Maximize market value for shareholders
➢ Market value = f(profitability and risk)
➢ Profitability → return on investment (including timing)
➢ Risk → probability of return
Whose interest should be • In Anglo-Saxon environment (VS & UK) → shareholder focus
given priority? Share- • In these countries also dividends are more important than job security
holders or stakeholders
From shareholder to • Milton Friedman → shareholder theory
stakeholder theory • Richard Freeman → stakeholder theory
➢ Any group or individual affected by the achievement of the firm’s objective
Is ESG compatible with • Environment, Social, Governance
shareholder value • Yes, governance & ESG has positive LT shareholder effects
maximization ➢ Good governance ⟹ strengthens shareholder value
Corporate governance • Good governance brings long-run discipline to capital allocation decisions ⟹
capital grows for long-run sustainability → benefits all stakeholders
ESG materiality • Looks for investment value in ESG performance by focusing on ESG issues that
framework are important to shareholders and other stakeholders
Governance
Corporate governance • Thinking about how we should structure our organization in such a way that we
can achieve this goal of maximizing shareholder value
Why do we need to think • In a organisation there are different indivudals, actors, groups… → they all have
about it different objectives
• Contracts are needed to manage these relationships & objectives → agency
relationships
Agency relationships • A contract whereby 1 person (principal) authorizes another person (the agent)
to act on his behalf
• Eg. shareholders are principles & they ask manager to run company on their
behalf → with idea of maximizing shareholder value
➢ But not all managers will try to maximize this value
➢ They want to achieve their own objectives
Different actors • Diverging objectives
• Information asymmetries
• ⟹ agency problems & agency costs
Agency problems • Shareholders vs managers → especially if dispersed ownership
➢ More shareholders → lower incentive of each shareholder to control
managers
• Shareholders vs creditors
• Company vs society
Listed company • Dispersed ownership
(shareholder vs manager) • Managers are appointed & controlled by shareholders
3
, • Information asymmetries
• Free cash flow problem
➢ If company is generating a lot of free cash flow which you don’t necessarily
need → either return to shareholder or hold it in company for their own good
How can we solve this? • Directors who more closely follow up the managers
• Give managers stocks → if company is doing well, they also benefit
Shareholders vs creditor • Shareholder → want higher dividends, risky investment projects, take on more
debt → not benefiting creditors
• Creditors → need to be repaid first, so they don’t want the company to take
more risks because if company can’t pay them back → they lose
Assumptions in financial • Listed companies
theory • A perfect world
➢ But there are taxes, no perfect competition, there is difference between
lending & borrowing interest rate, securities are not infinitively divisible
• Market efficiency
➢ All publicly available & relevant information is immediately reflected in
prices
➔ Eg. reutrns or dividend announcement, acquisition announcement,
inflation…
➔ You cannot systematically realize excess returns on information →
because everyone trades immediately on this information
➢ Profit only can be made due to unexpected information
➢ Price changes follow a random walk
➢ Price can still deviate from actual value
3 types of market • Weak form efficiency
efficiency (vraag chatgpt)) ➢ Share prices reflect all public information from the past
➢ Impossible to develop profitable investment strategy
• Semi-strong form efficiency
➢ Not possible to obtain excess returns by trading promptly on news releases
➢ We live in this
• Strong form efficiency
➢ Not possible to obtain excess returns based on inside information
➢ But this is still possible, even though it’s illegal
Book value vs economic • total assets: 15 billion, debts: 7 billion
value • total assets & total liabilities shoud equal ⟹ book value of equity should be 8
billion
• But here we use market value (economic value) → this is 11 billion
➢ We value company 11 billion because we believe it has growth potential
• The 3 billion on the left side are growth option
• For young companies these differences are higher
4
