Transcript Dear user, - Solvay Brussels School of Economics and

FINANCE
1. Introduction
Professor André Farber
Solvay Business School
Université Libre de Bruxelles
Fall 2002
18/07/2015
A.Farber MBA 01 Introduction
Solvay Business School – Université Libre de Bruxelles
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Who am I?
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André Farber
Professor of Finance at Solvay Business School since….
Director of the MBA program 1990-2002
Past President of Solvay Business School
Dean, Faculty of Social Sciences, Politics and Economics, Solvay
Business School (known as Soco)
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18/07/2015
A.Farber MBA 01 Introduction
Solvay Business School – Université Libre de Bruxelles
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Practical matters
• Reference:
– Ross, Stephen A., Randolph W. Westerfield and Jeffrey F. Jaffe,
Corporate Finance, 6th edition, McGraw-Hill Irwin 2002
• Website: www.ulb.ac.be/cours/solvay/farber
• Slides
• Excel files
• Past exams
• Grading:
• Midterm (40%)
• Final (60%)
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A.Farber MBA 01 Introduction
Solvay Business School – Université Libre de Bruxelles
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Course outline
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1. Introduction
2. Financial statement analysis and forecasting
3. Present value
4. Bond and stock valuation
5. Stock valuation (cont.)
6. Capital budgeting
7. More on capital budgeting
8.Capital Market Theory
9. Portfolio selection
10. Risk and expected returns – CAPM
11. Risk, return and capital budgeting
12. Review session
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What is Corporate Finance?
• INVESTMENT DECISIONS: Which REAL ASSETS to buy ?
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Real assets: will generate future cash flows to the firm
Intangible assets : R&D, Marketing, ..
Tangible assets : Real estate, Equipments,..
Current assets: Inventories, Account receivables,..
• FINANCING DECISIONS: Which FINANCIAL ASSET to sell ?
• Financial assets: claims on future cash flows
• Debt: promise to repay a fixed amount
• Equity: residual claim
• DIVIDEND DECISION: How much to return to stockholders?
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A.Farber MBA 01 Introduction
Solvay Business School – Université Libre de Bruxelles
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Accounting View of the Firm
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Balance sheet
Net
Working
Capital
Income statement
Current
liabilites
Current
assets
Long-term
debt
Fixed
assets
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Shareholders’
equity
Sales
– Operating expenses
= Earnings before interest and taxes
(EBIT)
– Interest expenses
– Taxes
= Net income (earnings after taxes)
• Retained earnings
• Dividend payments
A.Farber MBA 01 Introduction
Solvay Business School – Université Libre de Bruxelles
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Cash Flows between the Firm and the Financial Markets
Firm issue
securities
Firm invest
Firm
Cash flow from
operations
Financial
markets
Dividend and
debt payments
Timing of cash flows
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A.Farber MBA 01 Introduction
Solvay Business School – Université Libre de Bruxelles
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Market values
Total capital
employed
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Equity
Market
value of
equity
Debt
Market
value of
debt
Cash flow
A.Farber MBA 01 Introduction
Solvay Business School – Université Libre de Bruxelles
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Value creation
• Market value added (MVA)
• = Market value of the firm’s capital – Total capital employed
Market value of equity
+ Market value of debt
Stockholders’ equity
+ Financial debt
• VALUE CREATION : 2 strategies
• Strategy 1
• Buy assets at a cost lower than the value of the future revenues
– real assets
– financial assets
• Strategy 2
• Sell financial assets for a price higher than the value of future
payments
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A.Farber MBA 01 Introduction
Solvay Business School – Université Libre de Bruxelles
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The Capital Investment Trade-off
• The firm can always give cash back to the shareholders
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Project
Cash
Stockholder
Investment
opportunities in
capital markets
• Capital employed by the firm has an opportunity cost
• The opportunity cost of capital is the expected rate of return offered
by equivalent investments in the capital market
• The weighted average cost of capital (WACC) is the (weighted)
average of the cost of equity and of the cost of debt
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A.Farber MBA 01 Introduction
Solvay Business School – Université Libre de Bruxelles
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Economic Value Added (EVA)
• EVA = Earnings after tax – WACC  Total capital
Example:
EVA calculation
Equity
Debt
Total capital
$10b
$10b
$20b
EBIT
Tax rate
WACC
$2.5b
40%
11%
Earnings after tax = $2.5b (1-0.40) = $1.5b
EVA = $1.5b – 11%  $20b
= $1.5b – $2.2b
= – $700m
(EVA is explained RWJ Chapter 12 – Appendix)
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A.Farber MBA 01 Introduction
Solvay Business School – Université Libre de Bruxelles
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How to measure value creation ?
• 1. Compare market value of equity to book value
Stock price
Market- to - book(M/B)
Book valueper share
• Value creation if M/B > 1
• 2. Compare return on equity to the opportunity cost of equity
Net Income
Return on equity ( ROE) 
Stockholders' equity
• Value creation if ROE > Opportunity Cost of Equity
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A.Farber MBA 01 Introduction
Solvay Business School – Université Libre de Bruxelles
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M/B vs ROE
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Simplifying assumptions:
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Expected net income income = constant
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Net income = dividend
Market value determination:
Net income = Expected return  Market value of equity
NI
=
r
 MVeq
ROE (definition):
Return on equity = Net income / Book value of equity
ROE
=
NI
/
BVeq
= r  MVeq / Bveq
• Conclusion: in this simplified setting,
– M/B = MVeq/BVeq > 1
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ROE> r
A.Farber MBA 01 Introduction
Solvay Business School – Université Libre de Bruxelles
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M/B vs ROE: example
• Suppose:
• Book equity ( = total asset) = € 500,000
• Expected annual net income = € 100,000
• Payout ratio (Dividend / Net income) = 100%
• Expected return = 10%
• Market value of equity determination:
• Dividend ( = Net income) = 10% × Mkt Value of Equity
• Mkt Value of Equity = €100,000 / 10% = € 1,000,000
• M/B = 1,000,000 / 500,000 = 2 > 1
• Return on Equity (ROE):
• ROE = Net Income / Book Equity
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= 100,000 / 500,000 = 20% > 10%
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A.Farber MBA 01 Introduction
Solvay Business School – Université Libre de Bruxelles
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The Top Companies 2001
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GE
Microsoft
Exxon
Pfizer
Citigroup
Wal-Mart
AOL Time W.
BP
IBM
NTT Docomo
American Intl
Intel
Vodafone
US
US
US
US
US
US
US
UK
US
Japan
US
US
UK
Mkt
Value
$ bil.
Price/
Book
ROE
%
487
369
307
271
261
231
230
200
197
192
189
181
175
9.6
8.8
4.4
16.8
4.1
7.4
1.4
2.7
9.5
7.9
4.5
4.9
0.9
29.5
24.1
25.3
23.5
21.3
20.2
Neg
15.9
39.0
10.6
14.0
22.3
2.0
A.Farber MBA 01 Introduction
Solvay Business School – Université Libre de Bruxelles
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The Top Companies 2002
Mkt Cap
$ billions
Price/Book
ROE %
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General Electric
US
309
5.6
26.6
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Microsoft
US
276
5.8
13.4
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Exxon Mobil
US
271
3.7
16.7
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Wal-Mart Stores
US
241
6.7
19.3
5
Citigroup
US
223
2.7
19.2
6
Pfizer
US
217
11.9
45.3
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Royal Dutch / Shell
EU
194
3.5
19.4
8
BP
EU
192
2.6
13.3
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Johnson & Johnson
US
187
7.7
24.3
10
Intel
US
185
5.2
4.9
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A.Farber MBA 01 Introduction
Solvay Business School – Université Libre de Bruxelles
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Q&D financial analysis
• PROFITABILITY (du Pont system)
Net Income
ROE 
Book Equity
• Three determinants :
ROE 
13.4%
Profit
Margin
•Microsoft - 2002 US$ bil.
•Net Income
7,721
•Sales
25,296
•Assets
59,257
•Book equity
57,619
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Net Incom e

Sales
Sales

Assets
Asset
Turnover
Financial
Leverage
0.43
1.03
30.5%
A.Farber MBA 01 Introduction
Solvay Business School – Université Libre de Bruxelles
Assets
Equity
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References
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Suggested text for this course
– Ross, Stephen A., Randolph W. Westerfield and Jeffrey F. Jaffe, Corporate Finance, 6th
edition, McGraw-Hill Irwin 2002
Corporate finance textbooks (MBA level)
– Brealey, Richard and Steward Myers, Principles of Corporate Finance, xth edition, McGrawHill 2000
– Damorada, Aswath, Corporate Finance: Theory and Practice, Wiley 1997
Corporate finance texts for executives
– Bertoneche, Marc and Rory Knight, Financial Performance, Butterworth Heinemann 2001
– Hawawini, Gabriel and Claude Viallet, Finance for Executives: Managing for Value Creation,
South-Western College Publishing, 1999
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A.Farber MBA 01 Introduction
Solvay Business School – Université Libre de Bruxelles
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