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1、ADVANCE FINANCIAL MANAGEMENT,Dr. R. Kabir Department of Finance, Tilburg University, The Netherlands Teaching: Corporate Finance / Financial Management Empirical Corporate Finance Seminar in Finance Research: Corporate finance, Corporate governance, Financial market regulation Internet address: www.
2、tilburguniversity.nl,What is Finance?,Finance is usually concerned with the way in which funds for a firm are raised and invested Finance consists of four interrelated areas: Corporate Finance (Financial Management) Investments (Asset Pricing) Financial Markets (Money and Capital Markets) Banking,Wh
3、at is (Corporate) Financial Management?,Financial Management primarily addresses the following three questions: 1. What long-term investments should the firm engage in? 2. How can the firm raise the money for the investments? 3. How much short-term cash flow does a company need? We take the perspect
4、ive of a finance manager of a firm to understand these issues.,Role of the Finance Manager,Stands between the firms operations and the financial markets Involved with the flow of cash from investors to the firm and back to the investors again Involved with the use of cash to invest in firms real ass
5、ets,Role of the Financial Manager,Financial,manager,Firms,operations,Financial,markets,Different forms of firms,Firms are usually classified according to their form of ownership: Sole proprietorship Partnership Corporation,Typical Features of a Corporation,Board of Directors,Management,Assets,Debt,E
6、quity,Shareholders,Debtholders,Advantages and disadvantages of corporations,Advantages: Separate legal entity Easy transfer of ownership Corporation has unlimited life Shareholders have limited liability Disadvantages: Double taxation: corporate and personal income tax Separation of ownership and co
7、ntrol leads to agency problems between managers and shareholders,Objectives / Goals of a business,Popular objectives Maximisation of (accounting) profit Maximisation of sales Maximisation of return on investment Survival Stability Growth,Why not profit maximization?,There are problems in the use of
8、accounting profit (earnings) Ignores time value of money Ignores risk Calculated on the basis of accounting rules “Creative Accounting” Ignores investment / growth opportunities of a firm,Objective / Goal of a Finance Manager,Maximize Market Value / Wealth for the Owners (Shareholders) Market value
9、is the value that shareholders place on their securities today. It depends on the future cash flows that they expect to receive. Market value is forward looking.,Why focus on Market Value?,This objective takes into account the valuable features of all other objectives It may not be a perfect descrip
10、tion of what firms seek to achieve But, it is probably the most objective measure Market value of shares is calculated as the share price multiplied by the number of outstanding shares.,Why we do not focus on book value?,Book Value is the value of the firm according to the balance sheet Book value o
11、f assets suffers from same problems like earnings Book value of assets fails to consider inflation, technological change and organizational capital Book value ignores intangible assets, future liabilities (off-balance sheet) Book value is not a forward looking measure.,Sources of Financing,Short-ter
12、m and Long-term sources How much short-term cash flow does a company need to pay its bills? How much long-term cash flow does a company need to pay for its investments? Internal and External sources How much of the earnings should be retained? How much should be financed by Equity, Debt (Bank debt,
13、Bonds), Warrants, Convertibles, etc?,Ways firms can issue shares,Initial Public Offering (IPO): It is the first public equity issue made by a company. Public firms (those already listed on a stock exchange) can issue shares in different ways: Private placing Public issue General Cash Offer Rights Of
14、fering,1. Dividend Valuation Model: Share price equals the present value of all expected future dividends.,Valuation of a common share,If we expect no growth of dividends, and plan to hold the share indefinitely, we will then value the share as follows: Po = Div / r If dividends are expected to grow
15、 at a constant rate, we will then value the share as follows: Po = Div1 / (r - g) This formula is popularly known as Gordon Growth Model,Valuation of a common share,Valuation of a common share,An Example: Current forecasts are for XYZ Company to pay dividends of $3, $3.24, and $3.50 over the next th
16、ree years, respectively. At the end of three years you anticipate selling your stock at a price of $94.48. What is the price of the stock given a 12% expected return?,Valuation of a common share,Valuation of a common share,If we forecast no growth of dividend of $3, and plan to hold the stock indefi
17、nitely, we will then value the stock as a PERPETUITY.,Assumes all earnings are paid to shareholders.,2. Comparable Firm Valuation Model: Many relate price-earnings (P/E) ratio of comparable firms to determine the current share price. Po = Expected EPS x P/E Analysts also relate variables other than
18、P/E ratio to share price Price/Cash Flow Ratio Price/Sales Ratio Price/Book (or, Market to Book) Ratio,Valuation of a common share,How to find comparable firms? Use firms operating in the same industry What constitutes an industry? There is still potential for misuse with comparable firms,Valuation
19、of a common share,3. Discounted Cash Flow Model: Current share price is derived from the value of a business which is usually computed as the discounted value of future Free Cash Flows of the firm. In practice, people use the following approach:,PV (free cash flows for a certain number of years),PV
20、(horizon value),Valuation of a common share,Example,Given the following free cash flows, calculate the PV of near term cash flows, PV (horizon value), and the total value of the firm. r=10% and g= 6%,Example,Example,Evaluating the Discounted Cash Flow approach to valuation,Strengths Recognizes that
21、value is created when invested capital earns returns above its opportunity costs Attempts to value directly the benefits that accrue to investors Can be applied to all types of firm Weaknesses Forecasting future cash flows is not easy Estimating cost of capital for a private firm is not easy,Free Ca
22、sh Flow approach to valuation,When valuing a business, Free Cash Flows (FCF) should be the theoretical basis for all Present Value (PV) calculations. FCF is a more accurate measurement of PV than either Dividend or Earnings Per Share.,Framework for Valuation (Copeland, Koller and Murrin),Steps in va
23、luation Forecast free cash flows After-tax operating earnings + non-cash expenses (depreciation) - investments Estimate cost of capital Cost of equity and cost of debt Target weights (based on market value) Estimate continuing value Calculate and Interpret results,Case Study: KPN,Follow DCF approach
24、 only Consider forecast assumptions (longterm prospects) Forecast cash flows 1993 -1998 After-tax operating earnings + non-cash expenses (depreciation) - investments Estimate weighted average cost of capital Cost of equity (CAPM) and cost of debt (7.1%) Target weights (based on market value) Estimat
25、e continuing value (1999 up to infinity) Calculate value per share of KPN,Initial Public Offering (IPO),Basic features Going public involves the shares of a company getting quotation (listing) on a stock exchange. All IPOs are cash offers. Two ways shares are made available to public: “Old“ sharehol
26、ders are selling out = secondary offering Creation of new shares (increase in share capital) = primary offering,Why IPO (Go Public)?,To raise additional capital (for further expansion like new investments, acquisitions; repay debt) To allow the owners to sell their stakes (diversification - risk sha
27、ring benefits) To increase liquidity benefits to shareholders To escape control/monitoring of banks To enhance companys visibility, status and prestige To provide incentive compensation scheme for managers / employees,Benefits and Costs of IPO,Benefits Access to new sources of finance More liquidity
28、 for existing shareholders Enhanced company image and employee motivation Costs Direct cost (investment bank fees, legal, administrative) Indirect cost (obligation to provide information) Ongoing cost Agency cost Danger of loss of control,Profile of an IPO candidate,“Old“ shareholders wish to cash i
29、n “Old“ shareholders wish to keep control “Old“ shareholders want an internal restructuring of current shareholder structure Company needs additional equity Difficulties to find a suitable financial and industrial partner,Mechanics of going public,The choice of a market (stock exchange) Producing a
30、prospectus (Registration) Marketing (undertake road shows) Pricing (Fixed or Variable) Allocation (Fair or Discriminatory) Offer / Flotation method (Private or Public),Offer/Flotation/Introduction methods,Private Placement: customers (usually institutional investors) are invited to participate in an
31、 issue. Fixed Price Method: offer for sale at fixed price Issuing firm pre-announces price and number of shares sold Individual investors specify number of shares they want If oversubscription, rationing takes place If undersubscription, part of shares remains unsold One-stage / Two-stage (Bookbuild
32、ing) fixed price,Price Driven Method / Auction / Tender method: offer for sale by tender Public is invited to bid at a price over a stated minimum price The issuing price is determined at a level where demand equals supply (principle practice?),Offer/Flotation/Introduction methods,Role of investment
33、 banker,Investment banking services (syndication, book-building, allocation, etc.) are specified in the underwriting contract “Firm commitment“ clause Investment banker commits to purchase all unsold shares at predetermined price (below pre-announced offer price) “Best efforts“ clause Investment ban
34、ker only takes care of the practical realisation of the offer (e.g. collect and process the bids of the investors),Empirical Issues (1),Which factors affect the likelihood of an IPO? When do firms go public? Is IPO volume determined by growth opportunities and/or stock market valuation? Do firms hav
35、e timing ability?,Empirical Issues (2),Initial underpricing How to measure it? What are the explanations? Long-run underpricing How to measure it? What are the explanations? Long-run underperformance How to measure it? What are the explanations?,Read “Stylized Facts” by Jenkinson and Ljungsvist If y
36、ou are interested and have time tonight, then read the two recommended papers,For tomorrow,Why do companies go public? (Pagano, Panetta & Zingales, JF 1998),Purpose Analyse ex-ante characteristics of IPO companies Analyze ex-post consequences of IPO Data 11 years: 1982-1992 Compares Firms eligible t
37、o go public vs Firms went public 139 new listings on the MSE Eliminated: bank, insurance, financial companies Final sample: 69 firms of which 29 are curve-outs Clustering of IPOs in 1986 and 1987,Testable predictions,Information asymmetry hypothesis The probability of going public should be positive
38、ly related with the age and/or the size of a firm Financing constaint hypothesis The probability of going public should be positively related with investments, leverage and growth of a firm Diversification hypothesis The probability of going public should be positively related with the riskiness of a firm,PPZ (1998),Median IPO is twice as large as the median potential IPO, but not more profitable,Does the decline in managerial ownership (associated with an IPO) mean a decline in company performance?,Mikkelson, Partch ,