FINA10200A.H2022 - BASIC CORPORATE FINANCE I. S1 & S2 - Introduction & Financial Mathematics 3 1. Introduction 3 1- The concept of value 4 2- Basic definitions 4 3- The Rule of 72 4 3. Annuities 2 1-

FINA10200A.H2022 – BASIC CORPORATE FINANCE
I. S1 & S2 – Introduction & Financial Mathematics...................................................................................3
1. Introduction................................................................................................................................................3
1- Financial Management Decision.................................................................................................................3
2- The Goal of Financial Management............................................................................................................3
3- Agency Relations.........................................................................................................................................3
4- Capital Markets...........................................................................................................................................3
2. Basic Definitions and single CF valuation...................................................................................................4
1- The concept of value...................................................................................................................................4
2- Basic Definition............................................................................................................................................4
3- Simple interest vs. Compound interest.......................................................................................................4
4- The Rule of 72..............................................................................................................................................4
3. Annuities.....................................................................................................................................................2
1- Present values of multiples cash flows (uneven cash flows)......................................................................2
2- Annuities (equal cash flows)........................................................................................................................2
4. Perpetuity...................................................................................................................................................2
Special Case: Growing Annuity........................................................................................................................2
5. Quotation of Interest Rates........................................................................................................................2
1- Various Interest Rates.................................................................................................................................2
2- Converting Interest Rates............................................................................................................................2
II. S3 & S4 – The Value of Financial Assets................................................................................................. 3
S3 – Bonds and Other Fixed Income Securities............................................................................................... 3
1. Asset Valuation...........................................................................................................................................3
1- Value VS. Price.............................................................................................................................................3
2- Definition & Characteristics of Bonds.........................................................................................................3
2. Bond Valuation...........................................................................................................................................4
1- Valuation at a coupon date.........................................................................................................................4
2- Valuation of a zero-coupon bond................................................................................................................4
3- Pricing of an unconventional bond.............................................................................................................4
4- Pricing a bond between two coupon dates................................................................................................4
3. Other Bond Types (not in the exam)...........................................................................................................4
4. Premium, Discount, At Par Bonds...............................................................................................................4
5. Risk Factors.................................................................................................................................................5
1- Default Risk (or credit risk)..........................................................................................................................5
2- Interest Rate Risk.........................................................................................................................................5
3- Duration.......................................................................................................................................................5
S4 – Shares of Common Stock and Hybrid Securities.......................................................................................6
1. Asset Valuation, Common & Preferred Stock Features..............................................................................6
2. Stock Valuation...........................................................................................................................................6
1- Constant dividend.......................................................................................................................................6
2- Constant dividend growth...........................................................................................................................6
3- Dividends with growth in multiples stages.................................................................................................6
4- Alternative ways of valuing stocks..............................................................................................................6
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III. S5 – Investment Criteria........................................................................................................................ 7
1. Context.......................................................................................................................................................7
2. Average Accounting Return (AAR)..............................................................................................................7
3. Payback Period (PP)....................................................................................................................................7
4. Net Present Value (NPV).............................................................................................................................7
5. Profitability Index (PI).................................................................................................................................8
6. Internal Rate of Return (IRR)......................................................................................................................8
IV. S6 & S7 – Capital Budgeting & Project Cash Flow...................................................................................9
1. Determining Relevant CFs..........................................................................................................................9
2. Corporate Taxation.....................................................................................................................................9
1- Taxation for Revenues & Expenses.............................................................................................................9
2- Assets...........................................................................................................................................................9
3- The Case of Depreciation..........................................................................................................................10
3. Steps for NPV Calculation.........................................................................................................................10
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I. S1 & S2 – Introduction & Financial Mathematics
1. Introduction
Finance  Studying different variables to make-money related decisions.
Corporate Finance  Financial decision-making for a company, Managing the company
overall financial situation.
1- Financial Management Decision
Capital Budgeting (investment decisions)
What LT investment (assets)/projects should the firm undertake?
Capital Structure (funding decisions)
Where & How to secure LT financing projects and assets?
Working Capital Management (short assets & liabilities)
How do we manage the day-to-day finances of the firm?
2- The Goal of Financial Management
Setting objectives  Maximize profit/market share/the current value of the company’s stock?
Equival+ goals of financial management  Maximize shareholder wealth, share price, firm
value
Limitations of this objective to maximize owner wealth
Corporate social responsibility and ethical investing
In line with LT goals
Agency problem – sometimes managers are not always acting in the best interest of
shareholders.
3- Agency Relations
Agency relationship  Stockholders (principal) hires managers (agents) to run the company.
Agency problems  Conflicts of interest can exist between the principal and the agent; not
necessarily fraud, just biased.
Agency costs  Costs resulting from agency problems, and shareholders have to support
these costs. (company-owned assets used for the well-being of the manager like limousine...).
To reduce those costs, several means are put in place:
- Managerial compensation (Shares or Options)
- Active and independent Board of Directors
4- Capital Markets
2 types of financial markets:
Money market  Short term debt securities
Capital markets  Long term debt and share of stock (TSX exchange is a capital market).
Capital Markets
Primary market  The original sale of securities by governments and corporations. The
money goes to the issuer (government or corporations) of the stock.
Secondary market  Transfer of ownership of securities between investors – Markets where
securities are bought and sold after the original sale.
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2. Basic Definitions and single CF valuation
1- The concept of value
Financial value is based on the future. It’s the max price an individual is willing to pay for
asset.
Financial Value = Sum of all future cash flows generated by the asset, discounted using the
expected rate of return for the asset.
Price  Sum of money required to purchase an asset, and there is only one price per asset
(set by supply and demand).
Future cash flows  Can be + or – and it is not the same as profits/losses. We can add,
subtract or compare two cash flows only if they are valued at the same moment of time.
Expected rate of return  Varies across firms and people – how much would make you happy
to invest?
3 components of interest rate (=required rate of return)
Time premium: People are impatient (premium for deferred consumption).
Inflation premium: Prices rise.
Risk premium: We want to be incentivized to take on risk (for the variability & uncertainty).
2- Basic Definition
A few Basic Principles
- When we capitalize an amount, value generally goes up.
- When we discount an amount, value generally goes down.
- The higher the expected rate of return, the higher the future value.
- The higher the expected rate of return, the lower the present value.
- The higher the holding period, the higher the future value.
- The higher the holding period, the lower the present value.
3- Simple interest vs. Compound interest
Simple interest: Earn interest each period on principal only.
Compound interest: Earn interest each period on principal & reinvested interest.
4- The Rule of 72
The Rule of 72 is used to estimate the number of years required to double the invested
money at a given annual rate of return  Years ¿ Double= 72
Interest Rate
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Capitalization:
The value of an amount in the future.
FV =PV ( 1+r )t
Discounting:
Bring a future amount to an earlier date.
PV = FV
(1+r )t