Advanced Corporate Finance

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Advanced Corporate Finance

• Getting started !
• Dividends and Repurchases (15)
• FINC 5880 SUFE-Webster University Spring 2008

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Agenda

• Fresh up FINC 5000
• FINC 5880 Introduction
• Your team
• Your SP 500 company
• Introduction Dividend Policy (ch. 15)
• Introduction Investment Banking (ch. 16)
• Your homework
• In the news

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How we will run the classes(as a business)

• Be in time (even when it snows) we will begin
  8.30 AM sharp (synchronize your watches please)
• Do not bring your entire breakfast to the class
  room please
• Switch of your mobiles exceptions can be made
  for emergencies but you will have to tell me in
  advance
• Make sure that if you bring your laptop that the
  battery is fully charged(use flash memory)
• Make sure your flash memory is compatible with
  the PC you will use to show your PPTs
• We will have one break during the morning before
  lunch and one break after lunch in the afternoon
  for the afternoon class (10.05-10.25 am and
  14.35-15.05 pm)you can ask individual/team
  questions in that period

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What is (advanced) corporate finance?

• Corporate Finance Any decision involving the
  use of money by a business (everything a
  business does)
• AdvancedApplied getting your hands dirty(work,
  work, work)

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What is it about?

• 1)Investment decisions of companies
• ROI versus a hurdle rate (WACC)
• 2)Financing decisions of companies
• Lowest WACC and target capital structure
• 3)In case the company has enough cash but not
  enough good ideashow and what of cash to return
  to shareholders
• Essentially all of these decisions have to do
  with valuationthe value you can put on a
  business

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Fresh Up your knowledge

• You did FINC5000
• You learned Financial Ratios
• You learned Time Value of Money
• Risk and Return
• Valuation-WACC and FCF
• Capital Budgeting (NPV-IRR and PBP)

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Finance is about Value!
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Value of what?
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The Firm including LT debt
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Class Assignment What is the Firm value and
Equity value?
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Equity Value is the same
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Valuation in steps
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The simplified model
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Equity valuation model
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Equity valuation using FCFs
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Firm Valuation Basic Model
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Estimating WACC
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Rf (10 year T-bond yield)
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Rf differs per country and in time
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Here are some historical Rfs
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Risk premium of the market (market spread)
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Implied premiums
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Calculation example
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Market spread (Rm-Rf) over time
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Taxes on capital gains and dividends
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What spread to use?
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Getting the beta right
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What business are you in?
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Operational leverage
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Financial leverage (Hamada)
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Cost of debt in the WACC
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Rating your company
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Rating Table
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WACC completion
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WACC
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FCF ?
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Equity or Firm approach?
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Operating Cash Flow
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Cash flow from investments
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Be careful
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WC investments
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Dividend policy
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Potential dividends
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Calculating FCF (estimated)
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Growth?
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Growth in EPS
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The professionals
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How good?
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Note
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ROE usage
Note below!
Note ROCE/(ED)ROED/(ED)(1-t)ROD
(RODi)
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Other growth estimations
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Other growth estimates
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Now value
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Tsingtao illustrated
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Tsingtao illustrated
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Tsingtao illustarted
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Tsingtao illustrated valuation
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Terminal value
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So now you can do it
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Value
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What to do with the income earned? (ch. 15)

• How much do we distribute to shareholders?
• Cash dividend or Buy backs?
• Stable pattern of payments over time?

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The big picture of finance.
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Dividends or capital gains?

• Maximize shareholders value
• What do shareholders prefer?
• Cash dividend now or..
• Plough back of money earned to generate future
  earnings?
• Remember PoD1/(Ks-g)
• Increasing D1 would lower g(rowth)
• Thus the outcome Po should be the same
• The point is now to find the balance between a
  sustainable D and g-level

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Do it now assignment

• Apply the former formula to a company that you
  know
• Take D1 as current dividend level fill in Po
  (todays share price) what is g?
• Now alter the companies D1 (dividend policy)
  lower or higher it
• Fill in Po again
• What is g now after you made this change?

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Bird in the hand theory

• Gordon-Lintner theory
• The required rate of return Ks will decreases if
  the dividend payout is increased
• The future capital gains are less certain then
  received dividend payments now

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FORTUNE (november 2004)

• CASH PAYOUTS Cashing In On Dividend Stocks Long
  derided as dowdy, shares with payouts are
  outperforming those without. Maybe the widows and
  orphans were right, after all.
• Okayso it ain't Google. But what's one of the
  best ways to outperform the market? The answer
  dividend stocks.

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• Dividend supremacy may be here to stay. For
  starters, corporations are sitting on mountains
  of cash. After slashing expenses and improving
  profits in recent years, SP 500 companies are
  reporting a 19 uptick in earnings this year, and
  cash flow has soared.

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Dividend irrelevance theory

• Miller and Modigliani-theory
• The value of the firm only depends on its basic
  earnings power and business risk
• Shareholders can construct their own dividend
  policy by selling shares for cash

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Tax Preference Theory

• There are some reasons from a tax point of view
  why shareholders do not like too much dividend
  now
• Dividends are taxed at up to 39,6 and capital
  gains at maximum 20
• Taxes on capital gains are only paid when the
  shares are sold
• If the shares are hold until you die no tax is
  due at all!

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So if Payout is increased from 0 to 100

• Lintner/Gordon (bird in hand) say the share price
  will increase!
• Modigliani/Miller (irrelevance) say the share
  price will not change
• Tax preference model says the share price will
  decrease!
• What is true/What does practice tell us?

The Experiment
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Empirical evidence shows

• For a valid statistical test we need to be able
  to use the CP assumption
• In practice CP conditions do not hold
• The cost of equity remains difficult to assess..
• Shareholders preferences differ highly for the
  same shareholdings

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Assignment Dividend Yield

• Go on the internet and find the dividend yield of
  the SP 500
• Draw your findings and show it to the class
• When was it high when was it low?
• Is there a relation with economic growth of the
  US in these periods?
• Are there any other events that cause the pattern
  that you found you think?
• What are these and why?

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Shareholders like dividend policy consistency

• Dividend policy changes trigger hefty reactions
  on a shares price
• Dividend policy that shows constant growth in
  line with sales and earnings is always preferred
  
• Shareholders do not like surprises but
  predictable dividend levels

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Dividends

• Are sticky. They do not change much over time
• Depend on earnings long term

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How to set the dividend target?

• Keep in mind Companies need to maximize
  shareholders value
• Retaining earnings instead of paying out in
  dividends is only wise if management thinks that
  the retained earnings will have better returns
  then when if the dollars are paid out as
  dividend
• Some companies have a lot of cash and not enough
  profitable plans to spend it on

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The Residual Dividend Model

• Set the capital budget (say M USD 60)
• Plan net earnings (say M USD 60)
• Use the target D/E ratio (say 40/60)
• Calculate retained earnings (60 of 60 M USD is
  36 M USD)
• Calculate what is left (residual) for paying out
  dividends(60 M USD 36 M USD 24 M USD)
• Disadvantage the paid out dividends can be very
  volatile over years..
• In practice therefore companies take a LT view
  and calculate averages over 5-10 years to base
  their target levels on

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Assignment Earnings, FCF and Dividends

• EPS can be volatile over years
• And therefore FC/PS can be volatile
• But DPS (dividend per share) normally follows a
  stable pattern
• Take your companys EPS, and Cash Flow/share over
  the past say 10 years
• Also determine the DPS
• Calculate DPS EPS
• Calculate DPS Cash Flow/share
• Which one is more stable?
• Draw your findings/be able to present

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Dividend dates

• Declaration date announcement of payout of
  dividend and date of payment
• Holder-of-record-date point in time date and
  exact time, that it is checked who is the holder
  of the shares and is entitled to the dividend
• Ex-dividend-date the date when the right to the
  dividend no longer goes with that share on this
  date normally the share price falls with the
  amount of the dividendpaid out
• Payment date date that the company sends out the
  checks to the holders of record

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Dividend Reinvestment Plans (DRIPs)

• Shareholders can reinvest their cash dividends in
  shares of the company
• The company is to decide to issue new stock or
  old stock
• A bank acts as trustee to handle this and see to
  it that all shareholders interested in DRIP get
  their pro rata portion of shares
• The advantage that these shares can be offered at
  a 3-5 discount
• The disadvantage is that shareholders have to
  still pay income tax over the cash dividends

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Stock splits

• Help to find the optimal value and EPS for a
  company (share price 20-80 range)
• Help small investors to acquire shares in the
  company
• In general increases trade in the share boosting
  value
• Normally at announcement creates equity
  value/share price increases

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Stock repurchases

• Enhance shareholders value
• Are becoming more popular
• The company has too much equity outstanding
• Acquiring shares to distribute shares to
  employees with options excercised
• Stocks repurchased are also called Treasury Stock
• Capital gains are substituted for dividends
• Since nr. Shares outstanding decrease all ratios
  improve like EPS, cash flow/share, thus
  increasing value per share

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Share repurchases

• Signal that management think the share is
  undervalued
• Often is better then increasing dividends because
  this raises expectations in the longer run
  whereas a repurchase could be the result of a ST
  cash excess
• If the repurchase follows a LT policy the
  dividend expectation can be reduced by increasing
  the dividend with small portions
• Repurchases can adjust the D/E towards target
  levels in a fast way

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Assignment Share Buy backs

• Go on the internet and find some companies that
  did a share buy back
• Indicate the size of the buy back
• The date of the buy back
• How the share price reacted to the buy back after
  the announcement
• If the companys share price has benefited up to
  now from that buy back program.
• Be able to present your findings

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Assignments Who pays dividends?

• Go on the internet
• Select about 10 companies from the SP that pay
  dividends
• Pick these companies from different sectors
  (industries, TMT, etc)
• Calculate their dividend yield
• Rank these companies by dividend yield high
  yield first
• Can you draw conclusions on the relation industry
  type and level of dividends paid out?

Announces dividend pay out
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Dividends paid out

• Have been reduced over the years in general
• This is consistent with lower interest rates
  (why?)
• And consistent with lower Cost of Equity

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Earnings and dividend (1960-2003)
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Understanding your company

• Takes a lot of reading
• Comparing
• Research and
• Analysis
• But it is fun!
• Make sure you take a company/product you like
  very much or are curious to know more about.

Global Understanding
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KEY assignment 1 Business Analysis

• In order to be able to make a correct valuation
  of your company you will have to start to make a
  Business Analysis
• You need to apply your knowledge of FINC5000 and
  MRKT5000
• The Business Analysis includes
• External Analysis
• Economic Environment of the company
• Customer analysis
• Competitor assessment
• Government/Regulatory assessment
• Internal Analysis
• The Vision and Mission of the company
• Products and services
• Product life cycles
• Pricing and differentiation
• Marketing and selling strategies
• Supply chain
• Human resources
• Investment priorities
• Finance and Accounting

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Key Assignment 1 (continued)

• The financial analysis includes
• A full list of up to date financial ratios of
  your company ( that is including Q2 2006)
• A financial ratio comparison with its main
  competitors
• The position in its industry analysis includes
• A 5 forces analysis (Porter)
• BCG Matrix analysis
• SWOT analysis

Big trouble for Merck
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Where to get information

• Website of your company (search for investor
  relations)
• Download the financial statements of your company
  over the past 5 year but preferably longer
• Balance sheets
• Income statements
• Cash flow statements
• Use Yahoo Finance http//finance.yahoo.com/
• You need help? Financial Statement Analysis a
  valuation approach, Leonard Soffer, Prentice
  Hall, isbn7-302-08257-X (China publication 46
  RMB)
• Gather the latest information on your company
  also in the press and keep track of it

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US dropsChina shops!

• A sharp slowdown in the American economy could be
  offset by the growing and largely unrecognized
  power of Asia's consumers .

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Profits and prophecies

• Chinese companies earn higher returns than is
  commonly claimed
• based on figures reported to China's National
  Bureau of Statistics (NBS) by more than 200,000
  state-owned and private companies, the profits of
  industrial companies have soared by an average of
  36 a year since 1999.