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CORPORATE FINANCE II CORPORATE FINANCE II Teaching and learning strategies 4 hours weekly classes to impart knowledge and define the scope of coverage for self study ➢2 hour lecturer ➢2 hour exercises and seminar Assessment • Participation 10% • Mid term test 1 15% • Mid term test 2 15% • Final exam 60% Materials Learning Materials • Text book Corporate Finance (10th Edition) by Ross, Westerfield, Jaffe McGraw Hill, 2013 ISBN 978 0 07 803477 0 • Lecture notes and in class materials • Readings (i.
CORPORATE FINANCE II Teaching and learning strategies hours weekly classes to impart knowledge and define the scope of coverage for self-study ➢2 hour lecturer ➢2 hour exercises and seminar Assessment • Participation: 10% • Mid-term test 1: 15% • Mid-term test 2: 15% • Final exam: 60% Materials Learning Materials • Text book: Corporate Finance (10th Edition) by Ross, Westerfield, Jaffe McGraw-Hill, 2013 ISBN: 978-0-07-803477-0 • Lecture notes and in-class materials • Readings (if available) will be provided before each lecture Lecturer Ms Mai Tran (PhD): ngocmai@hvnh.edu.vn CORPORATE FINANCE: main areas of concern Capital Structure Where will the firm get the financing to pay for its investments? Capital Budgeting What long-term investments should the firm take? Working Capital Management How should the firm manage its everyday financial activities? Content Overview Chapter Cost of Capital Chapter Capital Structure Chapter Capital Budgeting Chapter Dividend and Other Payouts Chapter Short-term finance and Cash Management Chapter Credit and Inventory Management Learning Schedule TOPIC TIMING Readings Chapter Cost of Capital Session + Chapter 13 Chapter Capital Structure Session + 4* Chapter 15, 16, 17 Chapter Capital Budgeting Session + + 7* Chapter 18 MID-TERM TEST Session Chapter Dividend and Other Payouts Session Chapter 19 Chapter Short term Financing and Cash Management Session 10 + 11* Chapter 26, 27 Chapter Credit and Inventory Management Session 12 + 13+ 14* Chapter 28 MID-TERM TEST Session 15 Revision Session 16 Chapter COST OF CAPITAL Key Concepts and Skills • Know how to determine a firm’s cost of equity capital • Understand the impact of beta in determining the firm’s cost of equity capital • Know how to determine the firm’s overall cost of capital • Understand the impact of flotation costs on capital budgeting Where Do We Stand? • Corporate Finance I on capital budgeting focused on the appropriate size and timing of cash flows • Corporate Finance II discusses the appropriate discount rate when cash flows are risky Part Weighted Average Cost of Capital The Weighted Average Cost of Capital • The Weighted Average Cost of Capital is given by: RWACC = Equity × REquity + Equity + Debt S B RWACC = × RS + S+B S+B Debt Equity + Debt × RB ×(1 – TC) × RDebt ×(1 – TC) Steps to determine WACC • First, we estimate the cost of equity and the cost of debt – We estimate an equity beta to estimate the cost of equity – We can often estimate the cost of debt by observing the YTM of the firm’s debt • Second, we determine the WACC by weighting these two costs appropriately Examples • Equity Information – – – – 50 million shares $80 per share Beta = 1.15 Market risk premium = 9% – Risk-free rate = 5% • Debt Information – $1 billion in outstanding debt (face value) – Current quote = 110 – Coupon rate = 9%, semiannual coupons – 15 years to maturity • Tax rate = 40% Examples • What is the cost of equity? – RE = + 1.15(9) = 15.35% • What is the cost of debt? – N = 30; PV = -1,100; PMT = 45; FV = 1,000; CPT I/Y = 3.9268 – RD = 3.927(2) = 7.854% • What is the after-tax cost of debt? – RD(1-TC) = 7.854(1-.4) = 4.712% Examples • What are the capital structure weights? – – – – – E = 50 million (80) = billion D = billion (1.10) = 1.1 billion V = + 1.1 = 5.1 billion wE = E/V = / 5.1 = 7843 wD = D/V = 1.1 / 5.1 = 2157 • What is the WACC? – WACC = 7843(15.35%) + 2157(4.712%) = 13.06% Valuation with WACC • The value of the firm is the present value of expected future (distributable) cash flow discounted at the WACC • To find equity value, subtract the value of the debt from the firm value Firm Valuation: Example Consider the Good Food Corporation, a public company headquartered in Barstow, California, that is currently a leading global food service retailer It operates about 10,000 restaurants in 100 countries Good Food serves a value-based menu focused on hamburgers and French fries The company has $4 billion in market valued debt and $2 billion in market valued common stock Its tax rate is 20 percent Good Food has estimated its cost of debt as percent and its cost of equity as 10 percent Good Food is seeking to grow by acquisition and the investment bankers of Good Food have identified a potential acquisition candidate, Happy Meals, Inc Happy Meals is currently a private firm with no publicly tradable common stock but has the same product mix as Good Food and is a direct competitor to Good Food in many markets It operates about 4,000 restaurants mostly in North America and Europe Happy Meals has $1,318.8 million of debt outstanding with its market value the same as the book value It has 12.5 million shares outstanding Since Happy Meals is a private firm, we have no stock market price to rely on for our valuation Happy Meals expects its EBIT to grow 10 percent a year for the next five years Increases in net working capital and capital spending are both expected to be 24 percent of EBIT Depreciation will be percent of EBIT The perpetual growth rate in cash flow after five years is estimated to be percent If Good Food acquires Happy Meals, EBIT and depreciation of Happy Meals in the next year are expected as $150 millions and $12 millions At what price should Good Food acquire Happy Meals? Part Flotation Costs Flotation Costs • Flotation costs represent the expenses incurred upon the issue, or float, of new bonds or stocks • These are incremental cash flows of the project, which typically reduce the NPV since they increase the initial project cost (i.e., CF0) Amount Raised = Necessary Proceeds / (1-% flotation cost) • The % flotation cost is a weighted average based on the average cost of issuance for each funding source and the firm’s target capital structure: fA = (E/V)* fE + (D/V)* fD Flotation Costs: Example Spatt Company, an all-equity firm, has a cost of equity of 20% Spatt is contemplating a large-scale $100 million expansion of its existing operations The expansion would be funded by selling new stock Based on conversations with its investment banker, Spatt believes its flotation costs will run 10 percent of the amount issued When flotation costs are considered, what is the cost of the expansion? Flotation Costs: Example Suppose Spatt’s target capital structure is 60 percent equity, 40 percent debt The flotation costs associated with equity are still 10 percent, but the flotation costs for debt are percent Spatt is contemplating a large-scale $100 million expansion of its existing operations The expansion would be funded by selling new stock When flotation costs are considered, what is the cost of the expansion? Flotation Costs and NPV Suppose the Tripleday Printing Company is currently at its target debt–equity ratio of 100 percent It is considering building a new $500,000 printing plant in Kansas This new plant is expected to generate aftertax cash flows of $73,150 per year forever The tax rate is 34 percent There are two financing options: A $500,000 new issue of common stock: The issuance costs of the new common stock would be about 10 percent of the amount raised The required return on the company’s new equity is 20 percent A $500,000 issue of 30-year bonds: The issuance costs of the new debt would be percent of the proceeds The What is the NPV of the new printing plant? company can raise new debt at 10 percent Flotation Costs and Internal Equity • In reality, most firms rarely sell equity at all • Instead, their internally generated cash flow is sufficient to cover the equity portion of their capital spending • Only the debt portion must be raised externally → We assign a value of zero to the flotation cost of equity because there is such cost ● How we determine the cost of equity capital? Quick Quiz ● How can we estimate a firm or project beta? ● How does leverage affect beta? ● How we determine the weighted average cost of capital? ● How flotation costs affect the capital budgeting process? ... capital budgeting Where Do We Stand? • Corporate Finance I on capital budgeting focused on the appropriate size and timing of cash flows • Corporate Finance II discusses the appropriate discount... available) will be provided before each lecture Lecturer Ms Mai Tran (PhD): ngocmai@hvnh.edu.vn CORPORATE FINANCE: main areas of concern Capital Structure Where will the firm get the financing to pay... 1: 15% • Mid-term test 2: 15% • Final exam: 60% Materials Learning Materials • Text book: Corporate Finance (10th Edition) by Ross, Westerfield, Jaffe McGraw-Hill, 2013 ISBN: 978-0-07-803477-0