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1、ADVANCE FINANCIAL MANAGEMENT,Dr.R.KabirDepartment of Finance,Tilburg University,The NetherlandsTeaching:Corporate Finance/Financial ManagementEmpirical Corporate FinanceSeminar in FinanceResearch:Corporate finance,Corporate governance,Financial market regulationInternet address:www.tilburguniversity
2、.nl,What is Finance?,Finance is usually concerned with the way in which funds for a firm are raised and investedFinance consists of four interrelated areas:Corporate Finance(Financial Management)Investments(Asset Pricing)Financial Markets(Money and Capital Markets)Banking,What is(Corporate)Financial
3、 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 perspective of a finance manager of a firm
4、 to understand these issues.,Role of the Finance Manager,Stands between the firms operations and the financial marketsInvolved with the flow of cash from investors to the firm and back to the investors againInvolved with the use of cash to invest in firms real assets,Role of the Financial Manager,Fi
5、nancial,manager,Firms,operations,Financial,markets,Different forms of firms,Firms are usually classified according to their form of ownership:Sole proprietorshipPartnershipCorporation,Typical Features of a Corporation,Board of Directors,Management,Assets,Debt,Equity,Shareholders,Debtholders,Advantag
6、es and disadvantages of corporations,Advantages:Separate legal entityEasy transfer of ownershipCorporation has unlimited lifeShareholders have limited liabilityDisadvantages:Double taxation:corporate and personal income taxSeparation of ownership and control leads to agency problems between managers
7、 and shareholders,Objectives/Goals of a business,Popular objectivesMaximisation of(accounting)profitMaximisation of salesMaximisation of return on investmentSurvivalStabilityGrowth,Why not profit maximization?,There are problems in the use of accounting profit(earnings)Ignores time value of moneyIgn
8、ores riskCalculated 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 is the value that shareholders place on their securities today.It depen
9、ds 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 objectivesIt may not be a perfect description of what firms seek to achieveBut,it is probably the most objective me
10、asureMarket 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 sheetBook value of assets suffers from same problems like earningsBook value of assets fails to
11、 consider inflation,technological change and organizational capitalBook value ignores intangible assets,future liabilities(off-balance sheet)Book value is not a forward looking measure.,Sources of Financing,Short-term and Long-term sourcesHow much short-term cash flow does a company need to pay its
12、bills?How much long-term cash flow does a company need to pay for its investments?Internal and External sourcesHow much of the earnings should be retained?How much should be financed by Equity,Debt(Bank debt,Bonds),Warrants,Convertibles,etc?,Ways firms can issue shares,Initial Public Offering(IPO):I
13、t 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 issueGeneral Cash OfferRights Offering,1.Dividend Valuation Model:Share price equals the present value of all expected future dividends
14、.,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/rIf dividends are expected to grow at a constant rate,we will then value the share as follows:Po=Div1/(r-g)This formula is popularly known as Gordo
15、n 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 three 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
16、 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 indefinitely,we will then value the stock as a PERPETUITY.,Assumes all earnings are paid to shareholders.,2.Comparable Firm Valuation Model:
17、Many relate price-earnings(P/E)ratio of comparable firms to determine the current share price.Po=Expected EPS x P/EAnalysts also relate variables other than P/E ratio to share pricePrice/Cash Flow RatioPrice/Sales RatioPrice/Book(or,Market to Book)Ratio,Valuation of a common share,How to find compar
18、able firms?Use firms operating in the same industryWhat constitutes an industry?There is still potential for misuse with comparable firms,Valuation 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 v
19、alue 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(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 tot
20、al value of the firm.r=10%and g=6%,Example,Example,Evaluating the Discounted Cash Flow approach to valuation,StrengthsRecognizes that value is created when invested capital earns returns above its opportunity costsAttempts to value directly the benefits that accrue to investorsCan be applied to all
21、types of firmWeaknessesForecasting future cash flows is not easyEstimating cost of capital for a private firm is not easy,Free Cash 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 meas
22、urement of PV than either Dividend or Earnings Per Share.,Framework for Valuation(Copeland,Koller and Murrin),Steps in valuationForecast free cash flowsAfter-tax operating earnings+non-cash expenses(depreciation)-investmentsEstimate cost of capitalCost of equity and cost of debtTarget weights(based
23、on market value)Estimate continuing valueCalculate and Interpret results,Case Study:KPN,Follow DCF approach onlyConsider forecast assumptions(longterm prospects)Forecast cash flows 1993-1998After-tax operating earnings+non-cash expenses(depreciation)-investmentsEstimate weighted average cost of capi
24、talCost of equity(CAPM)and cost of debt(7.1%)Target weights(based on market value)Estimate 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
25、 IPOs are cash offers.Two ways shares are made available to public:“Old shareholders are selling out=secondary offeringCreation 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
26、)To allow the owners to sell their stakes(diversification-risk sharing 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 o
27、f IPO,BenefitsAccess to new sources of financeMore liquidity for existing shareholdersEnhanced company image and employee motivationCostsDirect cost(investment bank fees,legal,administrative)Indirect cost(obligation to provide information)Ongoing costAgency costDanger of loss of control,Profile of a
28、n IPO candidate,“Old shareholders wish to cash in“Old shareholders wish to keep control“Old shareholders want an internal restructuring of current shareholder structureCompany needs additional equityDifficulties to find a suitable financial and industrial partner,Mechanics of going public,The choice
29、 of a market(stock exchange)Producing a 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 in
30、vited to participate in an issue.Fixed Price Method:offer for sale at fixed priceIssuing firm pre-announces price and number of shares soldIndividual investors specify number of shares they wantIf oversubscription,rationing takes placeIf undersubscription,part of shares remains unsoldOne-stage/Two-s
31、tage(Bookbuilding)fixed price,Price Driven Method/Auction/Tender method:offer for sale by tenderPublic is invited to bid at a price over a stated minimum priceThe issuing price is determined at a level where demand equals supply(principle practice?),Offer/Flotation/Introduction methods,Role of inves
32、tment banker,Investment banking services(syndication,book-building,allocation,etc.)are specified in the underwriting contract“Firm commitment clauseInvestment banker commits to purchase all unsold shares at predetermined price(below pre-announced offer price)“Best efforts clauseInvestment banker onl
33、y 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 have timing abil
34、ity?,Empirical Issues(2),Initial underpricingHow to measure it?What are the explanations?Long-run underpricingHow to measure it?What are the explanations?Long-run underperformanceHow to measure it?What are the explanations?,Read“Stylized Facts”by Jenkinson and LjungsvistIf you are interested and hav
35、e time tonight,then read the two recommended papers,For tomorrow,Why do companies go public?(Pagano,Panetta&Zingales,JF 1998),PurposeAnalyse ex-ante characteristics of IPO companiesAnalyze ex-post consequences of IPOData11 years:1982-1992Compares Firms eligible to go public vs Firms went public 139
36、new listings on the MSEEliminated:bank,insurance,financial companiesFinal sample:69 firms of which 29 are curve-outsClustering of IPOs in 1986 and 1987,Testable predictions,Information asymmetry hypothesisThe probability of going public should be positively related with the age and/or the size of a
37、firmFinancing constaint hypothesisThe probability of going public should be positively related with investments,leverage and growth of a firmDiversification hypothesisThe 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,
