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Corporate Finance

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XYZ company: Creation. Actors: Engineer X (innovative project, ... Mr Z: $200K investment as a credit. XYZ company: Creation. An option for opportunistic behavior: – PowerPoint PPT presentation

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Title: 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
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