TOPICS

in International Finance & Capital Markets

15 September 31 October 2014

Professor Giles Chance

INTRODUCTION TO CORPORATE FINANCE

Dates: 15 September 31 October 2014

Classes: 12

Credits: 2

Place: Monday Classroom 218
Friday Classroom 114

Time: 09.00-12.00
CLASS RULES
Attend Class Dont be late
Identify Yourself in Class use Name-Boards
Late assignments will not be accepted
Final Exam Date is 31 October
No date changes or exceptions
Contacts:
Email gileschance@gsm.pku.edu.cn
Cell 137-1919-2077
TA Lynn Hsu
Cell : (+86)150-1087-9389
Email : lynnhsu80@pku.edu.cn



INTRODUCTION TO CORPORATE FINANCE
Practical, operational focus
Case studies - to connect theory with reality
Class discussion & participation
Readings from textbook:
Principles of Corporate Finance by Brealey, Myers,
Allen (BMA). Edition 11
Final Exam
INTRODUCTION TO CORPORATE FINANCE
Grading

Case Studies: 48%
Bond Homework: 12%
Class Participation: 10%
Final Exam: 30%


CASES
19 Sep Making Investments: Beijing Enterprises
22 Sep Making Investments: Beijing Enterprises (2)
29 Sep Currency Evaluation: Yanjing Beer
24 Oct Raising Equity Capital: Guanghua Dot Com

Homework
13 Oct Bonds and the Yield Curve

INTRODUCTION TO CORPORATE FINANCE



What is Corporate Finance ?
INTRODUCTION TO CORPORATE FINANCE
What is Corporate Finance ?

Why Form a Company ?
INTRODUCTION TO CORPORATE FINANCE
What is Corporate Finance ?
Why Form a Company ?

A Company is a Legal Person
with Limited Liability

Advantages/Disadvantages of Incorporation?
INTRODUCTION TO CORPORATE FINANCE
What is Corporate Finance ?
Why Form a Company ?

Company:
- Ownership
- Supervision
- Management
INTRODUCTION TO CORPORATE FINANCE
What is Corporate Finance ?
Why Form a Company ?



The Shareholders (or Stockholders) are the Owners
INTRODUCTION TO CORPORATE FINANCE
What is Corporate Finance ?
Why Form a Company ?

As Agents of the Owners:
The Board supervises the Company
The Managers manage the Company

Purpose: Value Maximisation
Agency Problems?
INTRODUCTION TO CORPORATE FINANCE
What is Corporate Finance ?

What is Value ?

How is Value Measured ?
INTRODUCTION TO CORPORATE FINANCE

What is Corporate Finance ?
What is Value ? How is Value Measured ?
Accounting measures Corporate Value
Balance Sheet P&L - Cashflow
- Profits
- Net Worth
- Market Capitalisation



INTRODUCTION TO CORPORATE FINANCE

What is Corporate Finance ?
What is Value ? How is Value Measured ?


Measurement Problems with Accounting ?


INTRODUCTION TO CORPORATE FINANCE
Corporate Finance - Questions


What Investments to Make ?

How to Finance Investments ?
INTRODUCTION TO CORPORATE FINANCE
Corporate Finance Questions

What investments to make ?
Valuation
How to finance investments ?
Use Retained Earnings or Raise New Money?
Debt or Equity?
Day to Day Running of the Company
Managing Working Capital
INTRODUCTION TO CORPORATE FINANCE
Chief Financial Officer (CFO) is responsible for:
Day to day management
Distributing profit
Making good investments Valuation
Financing investments:
- Debt - bank or market
- Equity retained profits, sell new shares
INTRODUCTION TO CORPORATE FINANCE
Corporate Finance - Questions

How to Value Assets
Under certainty
In a risky environment
How to Value Currencies
How to Finance Assets
Using Financial Statements to Value Companies
Mergers & Acquisitions
Markets and Corporate Governance


VALUATION
Valuing Securities
Valuing Investments
OPPORTUNITY COST
Economics is the Science of Choosing

OPPORTUNITY COST
Economics is the Science of Choosing
Objective: Maximise Utility subject to Cost

OPPORTUNITY COST
Economics is the Science of Choosing
Objective: Maximise Utility subject to Cost
The Opportunity Cost is the next best
opportunity
In finance, Opportunity Cost means an
alternative investment of equivalent riskiness

OPPORTUNITY COST
Economics is the Science of Choosing
Objective: Maximise Utility subject to Cost
The Opportunity Cost is the next best
opportunity
In finance, Opportunity Cost means an
alternative investment of equivalent riskiness
A dollar today is worth more than a dollar
tomorrow
A safe dollar is better than a risky dollar

TIME VALUE OF MONEY

Present Value * Opportunity cost = Future Value
PV * OC = FV

Present Value = Future Value / Opportunity Cost

PV = FV / Discount Rate
PRESENT VALUE
The Present Value of Future Cashflows
CF 0, 1, N are expected periodic cashflows
(annual ?)
r is the discount rate, derived from the
opportunity cost
Discounting accounts for the timing of
cashflows no need to adjust for period
r includes the riskiness (uncertainty) of the
cashflows


NET PRESENT VALUE

The Present Value of Future Cashflows

Minus

The Investment Cost incurred to acquire them
VALUATION
Valuing Securities
Valuing Investments
Opportunity Cost
Economics is the Science of Choosing
Maximise Utility subject to Cost
The Opportunity Cost is the next best opportunity
In finance, Opportunity Cost means an alternative
investment of equivalent riskiness
A dollar today is worth more than a dollar
tomorrow
A safe dollar is better than a risky dollar

NET PRESENT VALUE (NPV)




NPV = CF0 CF1 CF2 CF3 CF
(1+r) (1+r) (1+r) (1+r)
t
t
Calculating NPVs
Carefully identify Free Cashflows
Apply Relevant Opportunity Cost
Maturity
Risk
Derive Net Present Value
NPV = future values / opportunity cost
= cashflows / discount rate
If NPV is +ve, it expands wealth
Discount Rate
The opportunity cost

Risk-Free rate choose appropriate maturity

+

A Risk Factor appropriate to the riskiness of the
cashflows

AN EXAMPLE

GEELY AUTO is developing a new model

Li Shufu, the chairman/ CEO of Geely has asked
the Finance Department if the new model is
financially viable.

How does the Finance Department approach
this problem?
CALCULATE IF THE PROJECT HAS A
NET PRESENT VALUE
GEELYS NEW MODEL
Estimate the models life as 6 years,
Price/auto RMB 30 000, Gross Margin 40%
Project the revenues, costs and operating profits
Estimate the capital investment required at RMB
1.2 bn
Model the working capital requirement
Use the GEELY discount rate for new projects: 12%
Use the average GEELY tax rate of 25%
ESTIMATING SALES
Year
RMB mn 1 2 3 4 5 6
Number Sold 5,000 50,000 80,000 70,000 60,000 50,000
Price/auto 30,000 30,000 28,000 27,000 27,000 25,000
ESTIMATING SALES
Year
RMB mn 1 2 3 4 5 6
Number Sold 5,000 50,000 80,000 70,000 60,000 50,000
Price/auto (RMB) 30,000 30,000 28,000 27,000 27,000 25,000
Sales 150 1,500 2,240 1,890 1,620 1,250
ESTIMATING GROSS PROFITS
Year
RMB mn 1 2 3 4 5 6
Number Sold 5,000 50,000 80,000 70,000 60,000 50,000
Price/auto (RMB) 30,000 30,000 28,000 27,000 27,000 25,000
Sales 150 1,500 2,240 1,890 1,620 1,250
COGS -90 -900 -1344 -1134 -972 -750
Gross Profit 60 600 896 756 648 500

ESTIMATING EBIT

RMB mn 1 2 3 4 5 6
Number Sold 5,000 50,000 80,000 70,000 60,000 50,000
Price/auto 30,000 30,000 28,000 27,000 27,000 25,000
Sales 150 1,500 2,240 1,890 1,620 1,250
COGS -90 -900 -1,344 -1,134 -972 -750
Gross Profit 60 600 896 756 648 500
SG&A -15 -150 -224 -189 -162 -125
Depreciation -200.00 -200.00 -200.00 -200.00 -200.00 -200.00
EBIT -155.00 250.00 472.00 367.00 286.00 175.00
Tax -62.50 -118.00 -91.75 -71.50 -43.75
AT EBIT -155.00 187.50 354.00 275.25 214.50 131.25
ESTIMATE WORKING CAPITAL
Working Capital RMB mn
1 2 3 4 5 6
Cash 37.5 375 560 472.5 405 312.5
Inventory 15 150 224 189 162 125
Receivables 7.5 75 112 94.5 81 62.5
Payables -18 -180 -268.8 -226.8 -194.4 -150
Increase in WC 42.00 378.00 207.20 -98.00 -75.60 -103.60
CASHFLOW START WITH AT EBIT
1 2 3 4 5 6
AT EBIT 45.00 187.50 354.00 275.25 214.50 131.25
TOTAL CASHFLOW