Corporate Finance

1

• Corporate Finance
• in Lilliputian Style
• Alexander Bukhvalov
• MCF 2010

2
XYZ company Creation

• Actors
• Engineer X (innovative project, 200K life
  savings)
• Mrs Y (doing nothing, wealthy, has fortunate
  inheritance 730K)
• Mr Z (a legal company partner, has bonus of
  250K)

3
XYZ company Creation

• Project needs 1M for implementation.
• Actors behavior
• Engineer X does not wish to spend any penny from
  his life savings
• Mrs Y is light-minded about her unexpected
  inheritance
• Mr Z as a professional thinks about investment
  thoroughly

4
XYZ company Creation

• Solution
• Engineer X CEO, 100K investment in equity, 50
  ownership
• Mrs Y 700K investment in equity, 50 ownership
• Mr Z 200K investment as a credit.

5
XYZ company Creation

• An option for opportunistic behavior
• Assume that Mr X (but not Mrs Y and Mr Z) knows
  that with probability 0.5 the value of the
  company in year will be either 100M (success) or
  100K (failure and liquidation). This is
  asymmetry of information, which is typical for
  agency problem.
• Without opportunistic behavior of Mr X we have
  the following outcomes in the case of
  liquidation Mr X and Mrs Y get nothing, Mr Z
  gets 100K since debt claims have higher
  subordination in the case of liquidation.
• Assuming opportunistic behavior Mr X sets his
  annual salary as an employee at 100K. Now he
  gets 100K what is perfect offset of his
  investment (employees salary have the highest
  subordination) whereas Mr Z unexpectedly gets
  nothing. He had no voice to confirm CEOs salary.
  Mrs Y had her voting rights to approve or
  disapprove CEOs salary but she were too much
  believing in success.

6
The Role of Financial Assets

• Transfer of capital
• Allocation of risks
• Notice that in transfer of capital Mr X was
  forced to make binding investment as an attempt
  to cure potential agency problem.
• Notice individual risk preferences, which depend
  not only on behavioral patterns but on current
  circumstances as well.

7
Policy vs Strategy

• Policy is about general rules applied in specific
  type of decisions
• Strategy is about competitive advantages in the
  products market
• Real Options Analysis concept links finance and
  strategy.

8
XYZ company IPO

• IPO Initial Public Offering
• Legally Private company becomes public
• Value Company without value becomes company
  with market value (capitalization)
• Investments Equity financing

9
XYZ company Debt

• Investments Debt financing (leverage)
• V E D
• Debt policy
• Irrelevance theorems
• MM-theorem (leverage, dividends, risk),
  separation of investment and financing decisions

10
XYZ company Valuation

• DCF model (future profits from production)
• Multiples model (comparables)
• Tobins Q (QCap/BV)
• Market model capitalization
• Fundamental valuation accounting