十一Corporate Finance Corporate Investing and Financing Decisions.docx

十一Corporate Finance Corporate Investing and Financing Decisions.docx

《十一Corporate Finance Corporate Investing and Financing Decisions.docx》由会员分享，可在线阅读，更多相关《十一Corporate Finance Corporate Investing and Financing Decisions.docx（23页珍藏版）》请在冰豆网上搜索。

十一CorporateFinanceCorporateInvestingandFinancingDecisions

十一CorporateFinance:

CorporateInvestingandFinancingDecisions

1.A:

AnOverviewofFinancialManagement

a:

Discusspotentialagencyproblemsofstockholdersversus1）managersand2）creditors.

Anagencyrelationshipiscreatedwhendecision-makingauthorityisdelegatedtoanagentwithouttheagentbeingfullyresponsibleforthedecisionthatismade.Anagencyrelationshipoccursintwocommoncorporatescenarios:

1.thecompany’sstockholdersdelegatedecision-makingauthoritytothemanagers（agents）,butthemanagersdonotreceivethefullbenefitorcostoftheirperformance,

2.thecompany’sdebtholdersdelegateauthoritytomanagerswhoactonbehalfoftheshareholders.Inthefirstscenario,managementwillnotbearthefullimpactoftheirdecisionssincetheydonotown100percentofcompany.

Inthesecondscenario,agencyrelationshipmayoccurwhencreditorslendmoneytocorporations.Creditorslendbasedonspecificbusinessandfinancialriskexpectations.Thestockholders/managementwillbenefitfromriskystrategiesthatsimultaneouslyincreasetheprobabilityofsuccessandbankruptcy.Themanagerreceivesthefullbenefitofsuccess,butthecreditorbearstheresponsibilityforthebankruptcy.Thisisonereasonloansincludemanyrestrictivecovenantsonthecorporation’sbehavior.

b:

Describefourmechanismsusedtomotivatemanagerstoactinstockholders'bestinterests.

1.Managerialcompensation.Thetotalmanagerialsalarypackagemustcompensatemanagersfortheirperformance.Thisiscommonlydonethroughannualperformancebonusesandlong-termstockoptions,inadditiontoanannualsalary.Therearetwomainmethodsthatareusedtograntsharestomanagement:

1.Performanceshares:

Themanagerreceivesacertainnumberofsharesbasedonthecompanyachievingpredefinedperformancebenchmarks.

2.Executivestockoptions:

Managementisgrantedanoptiontobuythefirm’ssharesatapre-specifiedpriceonaspecificfuturedate.Executivestockoptionsaretypicallyissued¡°out-of-the-money¡±togivemanagementtheincentivetotakeactionsthatwillboostthecompany’sstockprice.

2.Directinterventionbyshareholders.Aslargeinstitutionsincreasinglyownshares,theseinstitutionshavethepowerandsophisticationtopersuasivelyinterveneoncorporateissues.

3.Thethreatoffiring.Shareholderscannominateandelecttheirownboardofdirectorsorpersuadetheboardto¡°encourage¡±thecurrentmanagementtoquitorbefired.

4.Thethreatoftakeovers.Ifmanagement’spoorperformanceisreflectedinalowstockprice,acompetitormaybuyenoughsharestohaveacontrollinginterest.Atthatpoint,theacquirercanreplacemanagementwiththeirownmanagementteam.

1.B:

TheCostofCapital

a:

Explainwhythecostofcapitalusedincapitalbudgetingshouldbeaweightedaverageofthecostsofvarioustypesofcapitalthecompanyuses.

Howacompanyraisescapitalandhowtheybudgetorinvestitareconsideredindependently.Mostcompanieshaveseparatedepartmentsforthetwotasks.Thefinancingdepartmentisresponsibleforkeepingcostslowandusingabalanceoffundingsources:

commonequity,preferredstock,anddebt.Generally,itisnecessarytoraiseeachtypeofcapitalinlargesums.Thelargesumsmaytemporarilyoveremphasizethemostrecentlyissuedcapital,butinthelongrun,thefirmwillascribetotargetweightsforeachcapitaltype.Becauseoftheseandotherfinancingconsiderations,theinvestmentdecisionmustbemadeassumingaweightedaveragecostofcapitalincludingeachofthedifferentsourcesofcapitalandusingthelong-runtargetweights.

b:

Defineandcalculatethecomponentcostof:

1）debt2）preferredstock3）retainedearnings（3differentmethods）and4）newlyissuedstockorexternalequity.

Theafter-taxcostofdebt[kd（1-t）]isusedtocomputetheweightedaveragecostofcapital.Itistheinterestrateonnewdebt（kd）lessthetaxsavingsduetothedeductibilityofinterest（kdt）.

After-taxcostofdebt=interestrate-taxsavings=kd-kd（t）

Aftertaxcostofdebt=kd（1-t）

Example:

InkInc.isplanningtoissuenewdebtataninterestrateof8%.Inkisinthe40%marginalfederal-plus-statetaxrate.WhatisInk’scostofdebtcapital?

kd（1-t）=8%（1-.4）=4.8%

Note:

thecostofdebtistheinterestrateonnew（marginal）debt,nottheinterestratepaidonexistingorolddebt.Alsonotethatifitweren’tfortheincreasingriskofbankruptcywitheverincreasingleverage,thetaxdeductibilityofinterestwouldleadto100%debtinthecapitalstructure.

Preferredstockisaperpetuitythatpaysafixeddividend（Dps）forever.Thecostofpreferredstock（kps）is:

Costofpreferredstock=kps=Dps/Pnet

Where:

Dps=preferreddividends.

Pnet=netissuingpriceafterdeductingflotationcosts.

Example:

SupposeInkhaspreferredstockthatpaysan$8dividendpershareandsellsfor$100/share.IfInkweretoissuenewsharesofpreferred,itwouldincuraflotation（orunderwriting）costof5%.WhatisInk’scostofpreferredstock?

kps=Dps/Pnet

Pnet=100（1-.05）=$95

kps=$8/$95=.084=8.4%

Thecostofretainedearnings（ks）istherateofreturnstockholdersrequireontheequitycapitalthefirmretainsfromearnings.ksistheopportunitycostofretainingearnings.Youshouldknowthatifastockisinequilibrium,therateofreturninvestorsrequireistoequaltherateofreturntheyexpecttoget.Inequilibrium:

requiredrateofreturn（ks）=expectedrateofreturn（ks）

TheCAPMapproach:

Step1.Estimatetherisk-freerate,kRF.Theshort-termT-Billrateisusuallyusedbutsomeanalystsfeelthelong-termtreasuryrateshouldbeused.

Step2:

Estimatethestock’sbeta（B）.Thisisthestock’sriskmeasure.

Step3:

Estimatetheexpectedrateofreturnonthemarket（kmarket）.

Step4:

UsetheCAPMequationtoestimatetherequiredrateofreturn,ks=kRF+（kmarket-kRF）Beta

Example:

SupposekRF=6%,kmarket=11%andInkhasabetaof1.1.ThentherequiredrateofreturnforInk’sstockisks=6%+（11%-6%）（1.1）=11.5%

Thecostofretainedearnings（ks）istherateofreturnstockholdersrequireontheequitycapitalthefirmretainsfromearnings.ksistheopportunitycostofretainingearnings.Youshouldknowthatifastockisinequilibrium,therateofreturninvestorsrequireistoequaltherateofreturntheyexpecttoget.Inequilibrium:

requiredrateofreturn（ks）=expectedrateofreturn（ks）

Thebond-yieldplusrisk-premiumapproach:

Analystsoftenuseanad-hocapproachtoestimatetherequiredrateofreturn.Theyaddarisk-premium（3to5percentagepoints）totheinterestrateofthefirm’slong-termdebt.

Example:

Ink’sinterestrateonlong-termdebtis8%.Supposetherisk-premiumisestimatedtobe5%.ThenInk’scostofequityestimateis:

ks=8%+5%=13%

Thecostofretainedearnings（ks）istherateofreturnstockholdersrequireontheequitycapitalthefirmretainsfromearnings.ksistheopportunitycostofretainingearnings.Youshouldknowthatifastockisinequilibrium,therateofreturninvestorsrequireistoequaltherateofreturntheyexpecttoget.Inequilibrium:

requiredrateofreturn（ks）=expectedrateofreturn（ks）

Thediscountedcashflowordividendyieldplusgrowthrateapproach:

Ifdividendsareexpectedtogrowataconstantrate¡°g¡±thenthecurrentpriceofthestockisgivenbythedividendgrowthmodel:

P0=D1/（ks-g）,whereD1=nextyear’sdividend,ks=theinvestor’srequiredrateofreturn,andg=thefirm’sexpectedconstantgrowthrate.Rearrangingthetermsyoucansolveforks:

ks=（D1/P0）+g.Inordertouseks=（D1/P0）+gyouhavetoestimatetheexpectedgrowthrate（g）.

Example:

SupposeInk’sstocksellsfor$21,nextyear’sdividendisexpectedtobe$1,Ink’sexpectedROEis12%andInkisexpectedtopayout40%ofitsearnings.WhatisInk’scostofequity?

g=（ROE）（RetentionRate）,g=（.12）（1-.4）=.072=7.2%,andks=（1/21）+.072=.12or12%.

Thecostofnewcommonequity（ke）willbehigherthanthecostofretainedearningsbecauseoftheexistenceofflotationcosts.Costofnewcommonequityisgivenby:

ke=[D1/（P0（1-F））]+g,whereF=thepercentageflotationcostincurredinsellingnewstock.

F=（currentstockprice-fundsgoingtocompany）/currentstockprice

Example:

AssumethatInkInchasaflotationcostof10%.ThenthecostofnewequityforInkis:

ke=[1/（21（1-.1））]+.072=.125or12.5%

Notethatthecostofnewequity（12.5%）ishigherthanthecostofretainedearnings（12%）.Rememberbecauseofflotationcostske>ks.

1.C:

TheBasicsofCapitalBudgeting

a:

Definecapitalbudgeting.

Capitalbudgetingistheprocessofanalyzingprojectsforinclusioninfixedassets.Capitalbudgetingisperhapsthemostimportantfunctionafinancialmanagermustperformforanumberofreasons.First,sinceacapitalbudgetingdecisioninvolvesthepurchaseofalong-termassetwithalifeofmanyyears,thefirmlosessomeflexibilityintermsofbeing¡®lockedin’forthedurationoftheasset’slife.Second,anacquisitionofanassettoexpandoperationsisbasedonitsexpectedfuturerevenues,soadecisiontobuyanassetwillrequireforecastsofrevenueovertheasset’slife.Finally,afirm’scapitalbudgetingdecisionsdefineitsstrategicplan.

b:

Describeandcalculatefourmethodsusedtoevaluatecapitalprojects:

paybackperiod,discountedpaybackperiod,netpresentvalue（NPV）,andinternalrateofreturn（IRR）.

Example:

Evaluatethecashflowsforthefollowingtwoprojects:

Notethatthecumulativenetcashflowisjusttherunningtotalofthecashflows