Topic Flow ChartGoal of Finance = Maximize Value of Firm

HOW? Get the most cash

Steps

1. Methods to evaluate projects cash flow (NPV, IRR, etc)

2. Develop risk adjusted discount rates for use in NPV

3. Apply NPV, IRR, Decision Trees, PVI, etc to capital budgeting decisions

4. Changes in capital structure influence discount rates

5. Financial Distress can result form changes in capital structure

Efficient Capital Markets

• Switches gears

• Past lectures decided how to spend money (invest)

• Today’s lecture deal with raising money (financing decisions)

• Fisher Separation Theorem

Market Efficiency Theory sez

Capital markets reflect all relevant information. You can not consistently earn excess profits.

Efficient Capital Markets

Efficient Capital Markets

DS

R

Qty

Cost of Capital = Price of Money

Type of Market Efficiency

• Weak Form Efficiency

• Semistrong Form Efficiency

• Strong Form Efficiency

Efficient Market Theory

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Efficient Market Theory

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-30

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Efficient Market Theory

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IPO

Matched Stocks

IPO Non-Excess Returns

Year After Offering

Efficient Market Theory

Strong-Form Efficiency Test

Historical performance

1.4-1.6%-1.1%-% 1.6-Returns

AbnormalFunds

Mutual

Advisors

Investment

Companies

Insurance

Banks

Random Walk Theory

S&P 500 Five Year Trend?or

5 yrs of the Coin Toss Game?

80

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Random Walk Theory

S&P 500 Five Year Trend?or

5 yrs of the Coin Toss Game?

80

130

180

230

Month

Lev

el

Efficient Market Theory

Fundamental Analysts– Research the value of stocks using NPV and

other measurements of cash flow

Efficient Market Theory

Technical Analysts– Forecast stock prices based on the watching the

fluctuations in historical prices (thus “wiggle wiggle watcherswatchers”)

Market Efficiency Theory

Conflicts in Theory

• Stock market crash of 1987

• Daily fluctuations

Culprits?

• Arbitrage

• Computers

• Institutions

Efficient Market Theory

1987 Stock Market Crash

119310.114.

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DivindexPV

Efficient Market Theory

1987 Stock Market Crash

119310.114.

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DivindexPV

Efficient Market Theory

2000 Dot.Com Boom

883,1208.092.

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gr

DivindexPV

Lessons of Market Efficiency

Markets have no memoryTrust market pricesRead the entrailsThere are no financial illusionsThe do it yourself alternativeSeen one stock, seen them all

Corporate Financing

Types of Financing

1 - Equity

2 - Debt

3 - Hybrids

Corporate Financing

• READ TEXT FOR TERMINOLOGY

Initial Offering

Initial Public Offering (IPO) - First offering of stock to the general public.

Underwriter - Firm that buys an issue of securities from a company and resells it to the public.

Spread - Difference between public offer price and price paid by underwriter.

Prospectus - Formal summary that provides information on an issue of securities.

Underpricing - Issuing securities at an offering price set below the true value of the security.

General Cash Offers

Seasoned Offering - Sale of securities by a firm that is already publicly traded.

General Cash Offer - Sale of securities open to all investors by an already public company.

Shelf Registration - A procedure that allows firms to file one registration statement for several issues of the same security.

Private Placement - Sale of securities to a limited number of investors without a public offering.

Rights Issue

Rights Issue - Issue of securities offered only to current stockholders.

Example - Lafarge Corp needs to raise €1.28billion of new equity. The market price is €60/sh. Lafarge decides to raise additional funds via a 4 for 17 rights offer at €41 per share. If we assume 100% subscription, what is the value of each right?

Rights Issue

Current Market Value = 17 x €60 = €1,020 Total Shares = 17 + 4 = 21 Amount of funds = 1,020 + (4x41) = €1,184 New Share Price = (1,184) / 21 = €56.38 Value of a Right = 56.38 – 41 = €15.38

Example - Lafarge Corp needs to raise €1.28billion of new equity. The market price is €60/sh. Lafarge decides to raise additional funds via a 4 for 17 rights offer at €41 per share. If we assume 100% subscription, what is the value of each right?

Rights Issue - example

• YRU Corp currently has 9 million shares outstanding. The market price is $15/sh. YRU decides to raise additional funds via a 1 for 3 rights offer at $12 per share. If we assume 100% subscription, what is the value of each right?

« Current Market Value = 9 mil x $15 = $135 mil

« Total Shares = 9 mil + 3 mil = 12 mil

« Amount of new funds = 3 mil x $12 = $36 mil

« New Share Price = (136 + 36) / 12 = $14.25/sh

« Value of a Right = 15 - 14.25 = $0.75