International Investing Prof. Ian Giddy New York University.
Copyright ©2004 Ian H. Giddy Corporate Finance 1 Finance in the Corporation Chairman of the Board...
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Transcript of Copyright ©2004 Ian H. Giddy Corporate Finance 1 Finance in the Corporation Chairman of the Board...
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Prof. Ian GiddyNew York University
Applied Corporate Finance
IBM
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Copyright ©2004 Ian H. Giddy Corporate Finance 4
What the Course is About...
Corporate finance: shareholder value can be affected by financial decisions: investment, financing, payout & risk management. Restructuring may be needed to realize latent value.Corporate investment decisionsCorporate financing choicesRisk managementM&A and restructuring
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Copyright ©2004 Ian H. Giddy Corporate Finance 9
The Decisions that Create Shareholder Value
CREATINGCORPORATEECONOMICVALUE
CORPORATEINVESTMENTDECISIONS
CORPORATEFINANCINGCHOICES
CORPORATEPAYOUTPOLICIES
CORPORATERISKMANAGEMENT
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Finance in the Corporation
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Copyright ©2004 Ian H. Giddy Corporate Finance 16
Finance in the Corporation
Chairman of the Board andChief Executive Officer (CEO)
Board of Directors
President and ChiefOperations Officer (COO)
Vice PresidentMarketing
Vice PresidentFinance (CFO)
Vice PresidentProduction
Treasurer Controller
Cash Manager Credit Manager Tax ManagerCost AccountingManager
CapitalExpenditures
FinancialPlanning
FinancialAccountingManager
Data ProcessingManager
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Copyright ©2004 Ian H. Giddy Corporate Finance 17
Corporate Investment Decisions: Build or Buy?
TheVirtual
Corporation
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Copyright ©2004 Ian H. Giddy Corporate Finance 18
Capital Budgeting: Present Valueof Cash Flow Streams
Consider SBC Communications’ projections of an investment in South Africa’s Telkom. How much is it worth investing?
Time
$1,000
? $300$400-$100
$900
What is the cost of funding this investment?
What is the required return on this investment?
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Copyright ©2004 Ian H. Giddy Corporate Finance 19
How Much Debt? What Kind?
Valueof future
cash flows ?
Assets Liabilities
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Copyright ©2004 Ian H. Giddy Corporate Finance 20
How Much Debt? What Kind?
Valueof future
cash flows
Claims onthe cash flows
Assets Liabilities
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Copyright ©2004 Ian H. Giddy Corporate Finance 21
When Debt and Equity are Not Enough
Valueof future
cash flows
Contractual int. & principalNo upsideSenior claimsControl via restrictions
Assets LiabilitiesDebt
Residual paymentsUpside and downsideResidual claimsVoting control rights
Equity
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Copyright ©2004 Ian H. Giddy Corporate Finance 22
Corporate Balance Sheetand Allocation of Cash Flows
Total Value ofFirm’s Assets
Total Value of the Firmto Investors in
the Financial Markets
Assets Liabilitiesequal
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Copyright ©2004 Ian H. Giddy Corporate Finance 23
Corporate Balance Sheetand Allocation of Cash Flows
Total Value ofFirm’s Assets
Total Value of the Firmto Investors in
the Financial Markets
B. Firm invests in assets
Current Assets
Fixed Assets
C. Cash flow from firm’s assets
D. Government(taxes)
E. Retained cash flows
A. Firm issues securities, gets money
F. Dividends, buybacks and debt payments
FinancialMarkets
Short-term debtLong-term debtEquity shares
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Copyright ©2004 Ian H. Giddy Corporate Finance 24
Sources of Corporate Financial Risk
Uncertain Markets
UncertainExposures
MistakenViews
Wrong Risk Measurement Methods
Risk!
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Corporate Finance:The Context
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Copyright ©2004 Ian H. Giddy Corporate Finance 27
The Firm Must Attract Investors
TheEconomy
InvestorsFinancialMarkets
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Copyright ©2004 Ian H. Giddy Corporate Finance 28
Investors Have Choices
Money market instruments - Short-term debt instruments, like deposits and bills
Bonds - used by businesses and governments to raise money
Common Stock - Units of ownership, interest, or equity
Preferred Stock, Convertibles, other hybrids - A form of ownership with features of both debt and common stock
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Copyright ©2004 Ian H. Giddy Corporate Finance 29
Investors Compare Possible Investments Against Market Benchmarks
Source: Bloomberg.com
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Copyright ©2004 Ian H. Giddy Corporate Finance 30
Total Yield is What Investors Seek
“Yield to maturity” combines coupons and capital gains - all cash flows.
The yield to maturity on any bond, is the rate that will make the present value of the cash flows from the investment equal to the price of the investment.
Also known as the internal rate of return or IRR.
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Copyright ©2004 Ian H. Giddy Corporate Finance 31
Term Structure of Interest RatesMore commonly known as a yield curve, it shows the
relationship between the interest rate, or rate of return, and the time to maturity of securities with similar issuer characteristics
Yield curves can be downward-sloping, flat, or upward sloping
The three theories of term structure are the expectations hypothesis, liquidity preference theory, and market segmentation theory
A normal yield curve is upward-sloping
Longer-Term Investments Generally Offer Higher Interest Rates
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Copyright ©2004 Ian H. Giddy Corporate Finance 32
The US Treasury Yield Curve
January 2003Source: bondsonline.com
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Copyright ©2004 Ian H. Giddy Corporate Finance 33
Interest Rate Fundamentals The interest rate is the "price" of borrowed funds The required return is the owner's expected return The real rate of interest (k*) is the cost of money that
balances the supply of and demand for funds The risk-free rate of interest (RF) represents the real rate
of interest plus inflationary expectations The nominal rate of interest (k) is the actual rate of
interest charged by the supplier of funds Interest rates differ between currencies, based on
exchange-rate expectations
Interest Rates and Required Rates of Return
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Copyright ©2004 Ian H. Giddy Corporate Finance 34
Risk and ReturnA positive relationship exists between risk and nominal
or expected return The actual return earned on a security will affect the
subsequent actions of investors Investors must be compensated for accepting greater
risk with the expectation of greater returnReturn
Risk
Risker Investments Have to Offer Higher Returns
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Copyright ©2004 Ian H. Giddy Corporate Finance 35
Risker Investments Have to Offer Higher Returns: Example
Source: bondsonline.com
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The Value of Money
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Copyright ©2004 Ian H. Giddy Corporate Finance 37
The Role of Time Value in Finance
Future Value versus Present Value A dollar tomorrow is worth less than a
dollar today Compounding is used to find future
value Discounting is used to find present
value
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Copyright ©2004 Ian H. Giddy Corporate Finance 38
The Concept of Future Values
Time
FVn = Future value at the end of the year n
PV = Present value, or original principal amount
r = Annual rate of interest paid
n = Number of periods (usually years) separating the
present value and the future value, or number of years
the money is left on deposit
Note: The term (1+r)n
is the future value of interest factor, or
FVIFr,n
FVn = PV (1+r)n
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Copyright ©2004 Ian H. Giddy Corporate Finance 39
If IBM deposits $8 million today in a Eurodollar account paying 9% annual interest, how much will IBM have at the end of three years?
PV = $8 m FV3?
0 1 2 3
PV = $8, r = 9% , n = 3FV3 = $8 X (1 + .09)3 = $8 X (1.295) = $10.36 m.
IBM’s Eurodollars
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Copyright ©2004 Ian H. Giddy Corporate Finance 40
Compounding More FrequentlyThan Annually
New variable: m = number of compounding periods per yearDivide r by mMultiply m times n
Thus: FVn = PV x (1 + r/m)mxn
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Copyright ©2004 Ian H. Giddy Corporate Finance 41
The Effective Rate of Interest
reff = (1 + r/m)m - 1
r is the nominal, or stated, ratereff is the effective rate
m is the number of times per year interest is paid
Only $499 a month!Only 11.99% APR!
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Copyright ©2004 Ian H. Giddy Corporate Finance 42
Effective Rate of Interest
Nominal Rate, r, = 12%Compounding EffectivePeriod m reff = (1+r/m)m 1 Rate
Annual 1 (1 +.12/1) -1 = 1 +.12 -1 = .12 = 12.00%Semiannual 2 (1 + .12/2)2 -1 = 1.1236 -1 = .1236 = 12.36%Quarterly 4 (1 + .12/4)4 -1 = 1.1255 -1 = .1255 = 12.55%Monthly 12 (1 + .12/12)12 -1 = 1.1268 -1 = .1268 = 12.68%Daily 360 (1 + .12/360)360 -1 = 1.1275-1 = .1275 = 12.75%
Continuously (1 + .12/ )1 = e r -1 = .1275 = 12.75%
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Copyright ©2004 Ian H. Giddy Corporate Finance 43
Future Value of an Annuity
An annuity is a series of equal payments over time
FVAn = PMT x (FVIFAr,n)Where: PMT = payment, or the amount of one
cash flow; n is the number of payments.FVIFA factors are found in table; or:
FVIFA r rrr n
tn
t
n
, ( ) ( )
1 1 11
1
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Copyright ©2004 Ian H. Giddy Corporate Finance 44
Future Values: Summary
Single amount:the amount times the future value of interest factor, or
FVIFk,n :
Annuity:the periodic payment times the future value of annuity
factor, or FVIFAr,n :
FVA PMTxFVIFA PMTx rrr n r n
n
, ,( )
1 1
FV PVxFVIF PVx rr n r nn
, , ( ) 1
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Copyright ©2004 Ian H. Giddy Corporate Finance 45
Present Value
Present Value is the current dollar value (today's value) of a future amount of money
Time
$1,000
?
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Copyright ©2004 Ian H. Giddy Corporate Finance 46
Present Value of a Single Amount
PVn = FV /(1+r)n
= FVn x (PVIFr,n)
PVIFr,n or (1+r)n is called the present value of interest factor. PVIF factors can be computed or found in tables.
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Copyright ©2004 Ian H. Giddy Corporate Finance 47
Present Valueof Cash Flow Streams
Present Value Of A Mixed StreamMixed streams are non-annuity cash flows, i.e.
they reflect no particular pattern. Consider projections of a new investment’s profits:
Time
$1,000
? $300$400$100
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Copyright ©2004 Ian H. Giddy Corporate Finance 48
Present Value of an Equal Stream of Payments
PVAn = PMT x (PVIFAk,n)
Where:PVIFAk,n is the present-value interest factor for an
annuity, found from tables, or:
PVIFA r rrr n
tn
t
n
, /( ) /( )
1 1 1 1 1
1
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Copyright ©2004 Ian H. Giddy Corporate Finance 49
Brotherly Love
You lend $300 to your brother; he says he can repay it in 3 installments of $100 on your birthday. The current Treasury note rate is 6%. What’s brotherly love worth?
The PV of a three-year annuity of $100 discounted at 6% can be found by discounting each cash flow by the appropriate PVIF.
Value: Yr 1: $100 x (.943) = $ 94.30 Yr 2: $100 x (.890) = 89.00
Yr 3: $100 x (.840) = 84.00 Total $267.30
or can be simplified as $100 (.943 + .890 + .840) = $100 x (2.673).
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Copyright ©2004 Ian H. Giddy Corporate Finance 50
Present Values: Summary
Single amount:
the amount times the present value of interest factor, or
PVIFr,n :
Annuity:
the periodic payment times the present value of annuity
factor, or PVIFAr,n :
PVA PMTxPVIFA PMTx rrr n r n
n
, ,/( )
1 1 1
PV FVxPVIF FVxrr n r n n, , ( )
1
1
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Copyright ©2004 Ian H. Giddy Corporate Finance 51
Present Value Of A Perpetuity
A perpetuity is an annuity that goes on forever...
and (1/k) is the present value interest factor
for a perpetuity,
PV PMTr
PVIFArr, 1
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Copyright ©2004 Ian H. Giddy Corporate Finance 52
Application: Basic Bond Pricing
Time
$1,000
?$100 $100 $100 $100
INTERESTPRINCIPAL
The formula for a bond’s price is
B Ik
Ik
Mk n0 1 21 1 1
( ) ( )
...( )
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Copyright ©2004 Ian H. Giddy Corporate Finance 115
Contact
Prof. Ian GiddyNYU Stern School of Business44 West 4th StreetNew York, NY 10012
Tel 212-998-0426; Fax [email protected]