Ringkasan Manajemen Keuangan

Disusun oleh : Muhammad Firman (Akuntansi FE UI 2012)
MANAJEMEN KEUANGAN
Cash Flow Risk
CHAPTER 1 The role of the financial manager is to deal with the
uncertainty associated with investment decisions.Assessing
WHAT IS CORPORATE FINANCE ? the risk associated with the size and timing of expected
future cash flows is critical to investment decisions.
What is Corporate Finance? Which is the better project?
Corporate finance attempts to find the answers to the
following questions:
–What investments should the business take on?
THE INVESTMENT DECISION
–How can finance be obtained to pay for the required
investments?
THE FINANCE DECISION
–Should dividends be paid? If so, how much?
THE DIVIDEND DECISION
The Financial Manager
Financial managers try to answer some or all of these Capital Structure
questions. The top financial manager within a firm is A firm’s capital structure is the specific mix of debt and
usually the General Manager–Finance. equity used to finance the firm’s operations.Decisions need
–Corporate Treasurer or Financial Manager,oversees cash to be made on both the financing mix and how and where
management, credit management, capital expenditures and to raise the money.
financial planning.
–Accountant,oversees taxes, cost accounting, financial Working Capital Management
accounting and data processing. How much cash and inventory should be kept on hand?
Should credit terms be extended? If so, what are the
The Investment Decision conditions?
Capital budgetingis the planning and control of cash How is short-term financing acquired?
outflows in the expectation of deriving future cash inflows
from investments in non-current assets. Dividend Decision
Involves the decision of whether to pay a dividend to
Involvesevaluatingthe: shareholders or maintain the funds within the firm for
–sizeoffuturecashflows internal growth.Factors important to this decision include
–timingoffuturecashflows growth opportunities, taxation and shareholders’
–riskoffuturecashflows. preferences.
Cash Flow Size Corporate Forms of Business Organisation
Accounting income does not mean cash flow.For example, a The three different legal forms of business
sale is recorded at the time of sale and a cost is recorded organisation are:
when it is incurred, not when the cash is exchanged.
sole proprietorship
Cash Flow Timing partnership
A dollar today is worth more than a dollar at some future company.
date.There is a trade-off between the size of an
investment’s cash flow and when the cash flow is received. Sole Proprietorship
Which is the better project? The business is owned by one person.
The least regulated form of organisation.
Owner keeps all the profits but assumes unlimited liability
for the business’s debts.
Life of the business is limited to the owner’s life span.
Amount of equity raised is limited to owner’s personal
wealth.
Partnership
M a t a k u l i a h l a i n y a n g b e l u m a d a d i P D F i n i a k a n s a y a u p d a t e d i w w w . a k u n t a n s i d a n b i s n i s . wo rd p re s s . c o m
Contac t me : muhammad.f irman177@gmail.com /@f irmanmhmd (Line) 1959
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The business is formed by two or more owners.

All partners share in profits and losses of the business and Cash Flows between the Firm and the Financial Markets
have unlimited liability for debts.
Easy and inexpensive form of organisation.
Partnership dissolves if one partner sells out or dies.
Amount of equity raised is limited to the combined personal
wealth of the partners.
Income is taxed as personal income to partners.
Company
A business created as a distinct legal entity composed of
one of more individuals or entities.
Most complex and expensive form of organisation.
Shareholders and management are usually separated.
Ownership can be readily transferred.
Both equity and debt finance are easier to raise.
Life of a company is not limited.
Owners (shareholders) have limited liability.
Possible Goals of Financial Management
Survival
Avoid financial distress and bankruptcy
Beat the competition
Maximise sales or market share
Minimise costs Financial Markets
Maximise profits Financial marketsbring together the buyers and sellers of
Maintain steady earnings growth debt and equity securities.
Money marketsinvolve the trading of short-term debt
Problems with these Goals securities.
Each of these goals presents problems. Capital marketsinvolve the trading of long-term debt
These goals are either associated with increasing securities.
profitability or reducing risk. Primary marketsinvolve the original sale of securities.
They are not consistent with the long-term interests of Secondary marketsinvolve the continual buying and selling
shareholders. of issued securities.
It is necessary to find a goal that can encompass both
profitability and risk. Structure of Financial Markets
The Firm’s Objective

The goal of financial management is to maximise
shareholders’ wealth.
Shareholders’ wealth can be measured as the current value
per share of existing shares.
This goal overcomes the problems encountered with the
goals outlined above.
Agency Relationships
The agency relationshipis the relationship between the
shareholders (owners) and the management of a firm.
The agency problemis the possibility of conflict of interests
between these two parties. Two-period Perfect Certainty Model
Agency costsrefer to the direct and indirect costs arising Explains the behaviour of firms and individuals.
from this conflict of interest. Relies on three assumptions:
 –perfect certainty
Do Managers Act in Shareholders’ Interests?  –perfect capital markets
The answer to this will depend on two factors:  –rational investors.
how closely management goals are aligned with
shareholder goals The certainty model uses two periods—now (period 1) and
the ease with which management can be replaced if it does the future (period 2).Individuals make consumption choices
not act in shareholders’ best interests. based on their tastes and preferences and the investment
opportunities available to them.
Alignment of Goals
The conflict of interests is limited due to: Utility curves represent indifference between period 1
management compensation schemes (consume now) and period 2 (invest now, consume later)
monitoring of management consumption.
the threat of takeover
other stakeholders.
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Utility curves Optimal Investment Policy
Representation of Opportunities
Opportunities facing firms in a two-period world include:
 –investment/production
 –payment of dividends. Fisher’s Separation Theorem
In a perfect capital market, it is possible to separate the
The production possibility frontier represents attainable firm’s investment decisions from the owners’ consumption
combinations of period 1 (pay dividend now) and period 2 decisions.
(invest now, pay dividend later) dollars from a given
endowment of resources. The Investment Decision
The point of wealth and utility maximisation for all
Production possibility frontier shareholders can be reached through one of two rules:
–Net present value rule: invest so as to maximise the net
present value of the investment.
–Internal rate of return rule: Invest up to the point at which
the marginal return on the investment is equal to the
expected rate of return on equivalent investments in the
capital market.
Implications of Fisher’s Analysis
It is only the investment decision that affects firm value.
Firm value is not affected by how investments are financed
or how the distribution (dividends) are made to the owners.
CHAPTER 2
FINANCIAL STATEMENTS, TAXES,AND CASHFLOW
Utility Maximisation The Statement of Financial Position

Firms should invest funds until they reach a point on the
production frontier that is just tangential to the market line. Shows a firm’s accounting value on a particular date.
This then places the owner on the highest possible utility
curve given the resources available.At this point, the Equation:
owner’s utility is maximised.However, a problem exists if Assets = Liabilities + Shareholders’ Equity
there is more than one owner.
Assets are listed in order of liquidity.
Solution for Multiple Owners
Introduce a capital market—resources can be transferred Net working capital = Current Assets –Current Liabilities
between the present and the future.
Add the market line. Liquidity
This produces an optimal investment policy where The speed and ease with which an asset can be converted
production possibility frontier is tangential to the market to cash without significant loss of value.
line. Current assets are liquid (e.g. debtors).
Consumption decisions can be made using the capital The more liquid a business is, the less likely it is to
market. experience financial distress, but liquid assets are less
profitable to hold.
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The Statement of Financial Performance (Income

Statement of financial position statement)
Measures a firm’s performance over a period of time.
Equation:
Revenues –Expenses = Profit
The difference between net profit and cash dividends is
called retained earnings, which is added to the retained
earnings account in the Statement of Financial Position.
Example—Statement of Financial Performance
Debt versus Equity

Creditors have first claim on a firm’s cash flow; equity Example—Statement of Financial Position
holders have a residual claim.Financial leverage is the use of
debt in a firm’s capital structure.Financial leverage increases
the potential reward to shareholders, but also increases the
potential for financial distress and business failure.
Market Value versus Book Value
Generally Accepted Accounting Principles (GAAP) require
audited financial statements to show assets at historical
cost or book value.Revaluations of assets to fair value are
permitted.The value of a firm relates to market value, or the
price that could be obtained in the current market place.
Example—Market Value versus Book Value
ABC Company has fixed assets with a book value of $1700 Recording of Financial Statement Entries
but they have been revalued to have a market value of The realisation principle is to recognise revenue at the time
$2000. Net working capital has a book value of $1000, but if of sale.Costs are recorded according to the matching
all current accounts were liquidated, the company would principle, that is, revenues are identified and costs
collect $1400. ABC Company has $1500 in long-term debt— associated with these revenues are matched and recorded.
both book value and market value.
Differences
The figures on the Statement of Financial Performance may
differ from actual cash inflows and outflows during a period
due to:
–Revenues and costs being recorded when they are
realised, not when they are received or paid.
–The existence of non-cash items such as depreciation.
Corporate and Personal Tax Rates
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Tax Rates Statement of Financial Performance or Income statement

The average tax rateis the total tax bill divided by taxable ('000s)
income, that is, the percentage of income that goes in
taxes.. The marginal tax rateis the extra tax paid if one more
dollar is earned.A flat rateis where there is only one tax rate
that is the same for all income levels. An example is the tax
rate that applies to companies in Australia.
Example—Tax Rates
An individual has a taxable income of $28 500.
Total tax liability is $4930 (based on the current tax scales).
The average tax rate is 17.30 per cent.
The marginal tax rate is 30 per cent.
Cash Flow from Assets
The total cash flow from assets consists of:
–operating cash flow—the cash flow that results from day-
to-day activities of producing and selling; less Cash flow from assets
–capital spending—the net spending on non-current assets;
less
–additions to net working capital (NWC)—the amount spent
on net working capital.
Cash Flow from Assets
Cash flow from assets = cash flow to debtholders + cash
flow to shareholders
The cash flow to debtholders includes any interest paid less
the net new borrowing.The cash flow to shareholders
includes dividends paid out by a firm less net new equity
raised.
Cash Flow Summary
Operating cash flow = Earnings before interest and taxes
(EBIT) + Depreciation –Taxes
Net capital spending = Ending net fixed assets –Beginning
net fixed assets + Depreciation
Change in NWC = Ending NWC –Beginning NWC
Statement of Financial Position ('000s) Cash Flows to Debtholders and Shareholders
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CHAPTER 3
WORKING WITH FINANCIAL STATEMENTS
Cash
Cash is generated by selling a product or service, asset or
security.Cash is spent by paying for materials and labour to
produce a product or service and by purchasing assets.
Statement of Cash Flows
Recall: A statement that summarises the sources and uses of cash.
Cash flow from assets = Cash flow to debtholders + Cash Changes are divided into three main categories:
flow to shareholders –Operating activities—includes net profit and changes in
most current accounts
Cash Flow –Investment activities—includes changes in fixed assets
Sources of cashare those activities that bring in cash.Uses of –Financing activities—includes changes in notes payable,
cashare those activities that involve spending cash.The long-term debt and equity accounts as well as dividends.
firm’s statement of cash flowsis the firm’s financial
statement that summarises its sources and uses of cash Operating activities
over a specified period. + Net profit
+ Depreciation
Statement of Financial Position ('000s) + Any decrease in current assets (except cash)
+ Increase in accounts payable
–Any increase in current assets (except cash)
–Decrease in accounts payable
Investment activities
+ Ending fixed assets
–Beginning fixed assets
+ Depreciation
Financing activities
–Decrease in notes payable
+ Increase in notes payable
–Decrease in long-term debt
+ Increase in long-term debt
+ Increase in ordinary shares
–Dividends paid
Statement of Financial Performance ('000s)

Putting it all together, the net addition to cash for the
period is:$91.55 –145.00 + 58.45 = $5.00
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‘Players’ in Accounting Standards

AccountantsGovernment
RegulatorsOther users
Ratio Analysis
Financial ratiosare relationships determined from a firm’s
financial information.Used to compare and investigate
relationships between different pieces of financial
information, either over time or between companies.Ratios
eliminate the size problem.
Categories of Financial Ratios
Liquidity—measures the firm’s short-term solvency.
Capital structure—measures the firm’s ability to meet long-
run obligations (financial leverage).
Asset management (turnover)—measures the efficiency of Profitability Ratios
asset usage to generate sales.
Profitability—measures the firm’s ability to control
expenses.
Market value—per-share ratios.
Liquidity Ratios
Capital Structure Ratios
Market Value Ratios
The Du Pont Identity

Breaks ROE into three parts:
–operating efficiency
–asset use efficiency
–financial leverage
Turnover Ratios
Uses for Financial Statement Information

Internal uses:
–performance evaluation
–planning for the future
External uses:
–evaluation by outside parties
–evaluation of main competitors
–identifying potential takeover targets
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Benchmarks for Comparison

Ratios are most useful when compared to a benchmark.
Time-trend analysis—examine how a particular ratio(s) has
performed historically.
Peer group analysis—using similar firms (competitors) for
comparison of results.
Global Industry Classification Standard (GICS) used by ASX is Assume that:
a useful way to find a peer company. 1.Sales are projected to rise by 25 per cent
2.The debt/equity ratio stays at 2/3
Problems with Ratio Analysis 3.Costs and assets grow at the same rate as sales
No underlying theory to identify correct ratios to use or
appropriate benchmarks. Pro-Forma Financial Statements
Benchmarking is difficult for diversified firms.
Firms may use different accounting procedures.
Firms may have different recording periods.
One-off events can severely affect financial performance.
CHAPTER 4
LONG-TERM FINANCIAL PLANNING AND CORPORATE

GROWTH
What is Financial Planning? What is the plug?

Formulates the way financial goals are to be Notice that projected net income is $12.50, but equity only
achieved.Requires that decisions be made about an increases by $7.50. The difference, $5.00 paid out in cash
uncertain future.Recall that the goal of the firm is to dividends, is the plug.
maximise the market value of the owner’s equity—growth
will result from this goal being achieved. Percentage of Sales Approach
A financial planning method in which accounts are varied
Dimensions of Financial Planning depending on a firm’s predicted sales level.
The planning horizonis the long-range period that the
process focuses on (usually two to five years).Aggregationis Dividend payout ratiois the amount of cash paid out to
the process by which the smaller investment proposals of shareholders.
each of a firm’s operational units are added up and treated Retention ratiois the amount of cash retained within the
as one big project.Financial planning usually requires three firm and not paid out as a dividend.
alternative plans: a worst case, a normal case and a best Capital intensity ratiois the amount of assets needed to
case. generate $1 in sales.
Accomplishments of Planning Example—Financial Performance Statement
Interactions—linkages between investment proposals and
financing choices.
Options—firm can develop, analyse and compare different
scenarios.
Avoiding surprises—development of contingency plans.
Feasibility and internal consistency—develops a structure
for reconciling different objectives.
Elements of a Financial Plan
An externally supplied sales forecast (either an explicit sales
figure or growth rate in sales).
Projected financial statements (pro-formas).
Projected capital spending.
Necessary financing arrangements. Example—Pro-Forma Financial Performance Statement
Amount of new financing required (‘plug’ figure).
Assumptions about the economic environment.
Example—A Simple Financial Planning Model
Recent Financial Statements
Example—Steps
Use the original financial position statement to create a pro-
forma; some items will vary directly with sales.
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Calculate the projected addition to retained earnings and

the projected dividends paid to shareholders.
Calculate the capital intensity ratio.
Example—Financial Position Statement
Example—Results of Model
The good news is that sales are projected to increase by 25
per cent.The bad news is that $535 of new financing is
required.This can be achieved via short-term borrowing,
long-term borrowing and new equity issues.The planning
process points out problems and potential conflicts.
Assume that $225 is borrowed via notes payable and $310
is borrowed via long-term debt.
‘Plug’ figure now distributed and recorded within the
financial position statement.
A new (complete) pro-forma financial position statement
can be derived.
Example—Pro-Forma Financial Position Statement
Example—Partial Pro-Forma Financial Position Statement
External Financing and Growth

The higher the rate of growth in sales/assets, the greater
the external financing needed (EFN).Need to establish a
relationship between EFN and growth (g).
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Example—Statement of Financial Performance If the required increase in assets exceeds the internal
funding available (that is, the increase in retained earnings),
then the difference is the external financing needed(EFN).
Example—External Financing Needed

Increase in total assets= $1000 ×20%= $200
Addition to retained earnings = 0.14($500)(36%) ×1.20= $30
The firm needs an additional $200 in new financing.
$30 can be raised internally.
The remainder must be raised externally (external financing
needed).
Ratios Calculated Relationship

p(profit margin)=14%
R(retention ratio)=36%
ROA (return on assets)=7%
ROE (return on equity)= 12.7%
D/E(debt/equity ratio)=.818
Growth
Next year’s sales forecasted to be $600. Setting EFN to zero, gcan be calculated to be 2.56 per cent.
Percentage increase in sales: This means that the firm can grow at 2.56 per cent with no
external financing (debt or equity).
Increase in Assets Financial Policy and Growth
What level of asset investment is needed to support a given The example so far sees equity increase (via retained
level of sales growth? earnings), debt remain constant and D/Edecline.
For simplicity, assume that the firm is at full capacity. If D/Edeclines, the firm has excess debt capacity.
The indicated increase in assets required equals: If the firm borrows up to its debt capacity, what growth can
A×g be achieved?
where A= ending total assets from the previous period
Sustainable Growth Rate (SGR)
How will the increase in assets be financed? The sustainable growth rateis the growth rate a firm can
maintain given its debt capacity, ROE and retention ratio.
Internal Financing
Given a sales forecast and an estimated profit margin, what
addition to retained earnings can be expected?
Example—Sustainable Growth Rate
This addition to retained earnings represents the level of Continuing from the previous example:
internal financingthe firm is expected to generate over the
coming period.
The expected addition to retained earnings is:
Where The firm can increase sales and assets at a rate of 4.82 per
S= previous period’s sales cent per year without selling any additional equity and
g= projected increase in sales without changing its debt ratio or payout ratio.
p= profit margin
R= retention ratio Growth rate depends on four factors:
External Financing Needed –profitability (profit margin)
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–dividend policy (dividend payout) –interest earned$33.10

–financial policy (D/Eratio)
–asset utilisation (total asset turnover) Using simple interest, the total interest earned would only
have been $30. The other $3.10 is from compounding.In
Do you see any relationship between the SGR and the Du general, the future value, FVt,of $1 invested today at r per
Pont identity? cent for tperiods is:
Summary of Growth Rates The expression (1 + r)tis the future value interest
1.Internal growth rate factor(FVIF).
This growth rate is the maximum growth rate that can be
achieved with no external debt or equity financing. Example—Future Value of a Lump Sum
Whatwill$1000amounttoinfiveyearstimeifinterestis12perce
2.Sustainable growth rate ntperannum,compoundedannually?
The SGR is the maximum growth rate that can be achieved
with no external equity financing while borrowing to
maintain a constant D/Eratio.
Important Questions From the example, now assume interest is 12 per cent per
It is important to remember that we are working with annum, compounded monthly.Always remember that tis
accounting numbers and we should ask ourselves some the number of compounding periods, not the number of
important questions as we go through the planning process. years.
How does our plan affect the timing and risk of our cash
flows?
Does the plan point out inconsistencies in our goals?
If we follow this plan, will we maximise owners’ wealth?
CHAPTER 5 Interpretation
The difference in values is due to the larger number of
periods in which interest can compound.Future values also
FIRST PRINCIPLES OF VALUATION : THE TIME VALUE depend critically on the assumed interest rate—the higher
OF MONEY the interest rate, the greater the future value.
Future Values at Different Interest Rates
Time Value Terminology
Future value (FV) is the amount an investment is worth

after one or more periods.Present value (PV) is the current
value of one or more future cash flows from an investment.
The number of time periods between the present value and
the future value is represented by ‘t’.The rate of interest for
discounting or compounding is called ‘r’.All time value
questions involve four values: PV, FV, rand t. Given three of
them, it is always possible to calculate the fourth.
Interest Rate Terminology Future Value of $1 for Different Periods and Rates
Simple interestrefers to interest earned only on the original
capital investment amount.Compound interestrefers to
interest earned on both the initial capital investment and on
the interest reinvested from prior periods.
Future Value of a Lump Sum

You invest $100 in a savings account that earns 10 per cent
interest per annum (compounded) for three years.
After one year:$100 x(1 + 0.10) = $110
After two years: $110 x(1 + 0.10) = $121
After three years:$121 x(1 + 0.10) = $133.10
Future Value of a Lump Sum
The accumulated value of this investment at the end of
three years can be split into two components:
–original principal$100
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Given any three factors in the present value or future value

Present Value of a Lump Sum equation, the fourth factor can be solved.r can be solved in
Youneed$1000inthreeyearstime.Ifyoucanearn10per one of three ways:
Centperannum,howmuchdoyouneedtoinvestnow? Use a financial calculator
Take the nthroot of both sides of the equation
Use the future value tables to find a corresponding value.
In this example, you need to find the rfor which the FVIF
after 21 years is 5 (500/100).
Interpretation The Rule of 72

In general, the present value of $1 received in tperiods of The ‘Rule of 72’ is a handy rule of thumb that states:If you
time, earning per cent interest is: earn r per cent per year, your money will double inabout
72/rper cent years.For example, if you invest at 6 per cent,
your money will double in about 12 years.This rule is only
an approximate rule.
Future Value of Multiple Cash Flows
The expression (1 + r)–tis the present value interest
factor(PVIF).
Example—Present Value of a Lump Sum
Your rich grandmother promises to give you $10 000 in 10 You can solve by either:
yearstime. If interest rates are 12 per cent per annum, how –compounding the accumulated balance forward one year
much isthat gift worth today? at a time
–calculating the future value of each cash flow first and
then totalling them.
Solutions
Solution 1
Present Values at Different Interest Rates –End of year 1:($1000 1.10) + $1500 =$2600
–End of year 2:($2600 1.10) + $2000 =$4860
–End of year 3:($4860 1.10) + $2500 =$ 846
Solution 2
Future value calculated by compounding forward one

period at a timeTime(years)
Present Value of $1 for Different Periods and
RatesPresentvalueof $1 ($)
Future value calculated by compounding each cash flow

separately (Calculation of FV for Multiple Cash Flow Stream)
Solving for the Discount Rate

You currently have $100 available for investment for a 21yrs
period. At what interest rate must you invest this amount in
order for it to be worth $500 at maturity?
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Present Value of Multiple Cash Flows Example 1

You will deposit $1500 in one year’s time, $2000 in two You will receive $500 at the end of each of the next five
years time and $2500 in three years time in an account years. The current interest rate is 9 per cent per annum.
paying 10 per cent interest per annum. What is the present What is the present value of this series of cash flows?
value of these cash flows?
You can solve by either:
–discounting back one year at a time
–calculating the present value of each cash flow first and
then totalling them.
Solution 1
Example 2
You borrow $7500 to buy a car and agree to repay the loan
by way of equal monthly repayments over five years. The
current interest rate is 12 per cent per annum, compounded
monthly. What is the amount of each monthly repayment?
Solution 2
Present value calculated by discounting each cash flow Future Value of an Annuity
separately
The compounding term is called the future valueinterest

factor for annuities (FVIFA).
Example :
What is the future value of $200 deposited at theend of
every year for 10 years if the interest rate is6 per cent per
annum?
Present value calculated by discounting back one period at a

time Perpetuities
The future value of a perpetuity cannot be calculated as the
cash flows are infinite.The present value of a perpetuity is
calculated as follows:
Comparing Rates
Annuities The nominal interest rate(NIR) is the interest rate expressed
An ordinary annuityis a series of equal cash flows that occur in terms of the interest payment made each period.The
at the end of each period for some fixed number of effective annual interest rate(EAR) is the interest rate
periods.Examples include consumer loans and home expressed as if it was compounded once per year.When
mortgages.A perpetuityis an annuity in which the cash flows interest is compounded more frequently than annually, the
continue forever. EAR will be greater than the NIR.
Present Value of an Annuity Calculation of EAR
m = number of times the interest is compounded

C= equal cash flow
The discounting term is called the present value interest Comparing EARS
factor for annuities(PVIFA Considerthefollowinginterestratesquotedbythreebanks:
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–Bank A:15%, compounded daily Bond Yields

–Bank B:15.5%, compounded quarterly Yield to maturityis the market interest rate that equates a
–Bank C:16%, compounded annually bond’s present value of interest payments and principal
repayment with its price.There is an inverse relationship
between market interest rates and bond price.
Bond Price Sensitivity to Interest Rates (YTM)
Which is the best rate? For a saver, Bank B offers the best
(highest) interest rate. For a borrower, Bank C offers the
best (lowest) interest rate.The highest NIR is not necessarily
the best.Compounding during the year can lead to a
significant difference between the NIR and the EAR.
Types of Loans
A pure discount loanis a loan where the borrower receives
money today and repays a single lump sum in the future.An
interest-only loan requires the borrower to only pay interest
each period and to repay the entire principal at some point Bond Value
in the future.An amortised loanrequires the borrower to
repay parts of both the principal and interest over time.
Amortisation of a Loan
Example 1—Bond Value
Example 2—Bond Value

CHAPTER 6
VALUING SHARES AND BONDS
Debt Securities
Debt securities are issued when an organisation wishes to
borrow money from the public on a long-term basis.Bonds
are issued by the government.Debentures are secured and
issued by a corporation.Notes are unsecured debt securities
issued by a corporation.More recently, these are all known
as bonds. Interest Rate Risk
Interestrateriskistheriskthatarisesforbondholdersfromchang
Bond Features esininterestrates.All other things being equal, the longer the
Coupon paymentsare the stated interest payments. time to maturity, the greater the interest rate risk.All other
Payment is constant and payable every year or half- things being equal, the lower the coupon rate, the greater
year.Face value(par value) is the principal amount repayable the interest rate risk.
at the end of the term.Coupon rateis the annual coupon
divided by the face value.Maturityis the specified date at
which the principal amount is payable.
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Interest Rate Risk and Time to Maturity
Example—Constant Growth Dividend

Company XYZ has just paid a dividend of 15 cents per share,
which is expected to grow at 5 per cent per annum. What
price should you pay for the share if the required rate of
return on the investment is 10 per cent?
Non-constant Growth Dividend

The growth rate cannot exceed the required rate of return
indefinitely but can do so for a number of years.Allows for
‘super normal’ growth rates over some finite length of
time.The dividends have to grow at a constant rate at some
point in the future.
Computing Yield to Maturity Example—Non-constant Growth Dividend

Yield to maturity (YTM) is the rate implied by the current A company has just paid a dividend of 15 cents per share
bond price.Finding the YTM requires trial and error if you do and that dividend is expected to grow at a rate of 20 per
not have a financial calculator and is similar to the process cent per annum for the next three years, and at a rate of 5
for finding rwith an annuity.If you have a financial per cent per annum forever after that.Assuming a required
calculator, enter N, PV, PMT and FV, remembering the sign rate of return of 10 per cent, calculate the current market
convention (PMT and FV need to have the same sign, PV the price of the share.
opposite sign).
Solution—Non-constant Growth Dividend
YTM with Annual Coupons
Ordinary Share Valuation

Share valuation is more difficult than debenture valuation
for a number of reasons:
–uncertainty of promised cash flows
–shares have no maturity
–observing the market rate of return is not easy.
The market value of a share is the present value of all
expected net cash flows to be received from the share,
discounted at a rate of return that reflects the riskiness of
those cash flows.The expected net cash flows to be received
from a share are all future dividends.Dividend growth is an
important aspect of share valuation.
Zero Growth Dividend
Shares have a constant dividend into perpetuity, with no
growth in dividends.The value of a share is then the same as
the value of an ordinary perpetuity.
Constant Growth Dividend

Dividends grow at a constant rate each time period. Called
the constant dividend growth model.
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Share Price Sensitivity to Dividend Growth, g Net present value is a measure of how much value is
created by undertaking an investment.Estimation of the
future cash flows and the discount rate are important in the
calculation of the NPV.
Steps in calculating NPV:
The first step is to estimate the expected future cash flows.
The second step is to estimate the required return for
projects of this risk level.
The third step is to find the present value of the cash flows
and subtract the initial investment.
NPV Illustrated
Share Price Sensitivity to Required Return, r
An investment should be accepted if the NPV is positive and

rejected if it is negative.NPV is a direct measure of how well
the investment meets the goal of financial management—to
increase owners’ wealth.A positive NPV means that the
investment is expected to add value to the firm.
Payback Period
The amount of time required for an investment to generate
cash flows to recover its initial cost.Estimate the cash
flows.Accumulate the future cash flows until they equal the
initial investment.The length of time for this to happen is
the payback period.An investment is acceptable if its
Components of Required Return calculated payback is less than some prescribed number of
Payback Period Illustrated
CHAPTER 7 Advantages of Payback Period

Easy to understand.
Adjusts for uncertainty of later cash flows.
NET PRESENT VALUE AND OTHER INVESTMENT Biased towards liquidity.
CRITERIA
Disadvantages of Payback Period
Time value of money and risk ignored.
Net Present Value (NPV) Arbitrary determination of acceptable payback period.
Net present valueis the difference between an investment’s Ignores cash flows beyond the cut-off date.
market value (in today’s dollars) and its cost (also in today’s Biased against long-term and new projects.
dollars).
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Discounted Payback Period A project is accepted if ARR > target average accounting
The length of time required for an investment’s discounted return.
cash flows to equal its initial cost.Takes into account the
time value of money.More difficult to calculate.An Example—ARR
investment is acceptable if its discounted payback is less
than some prescribed number of years.
Example—Discounted Payback
Assume initial investment = $240
Discounted payback period is just under three years

Ordinary and Discounted Payback
Disadvantages of ARR
The measure is not a ‘true’ reflection of return.
Time value is ignored.
Arbitrary determination of target average return.
Uses profit and book value instead of cash flow and market
value.
Ordinary payback? Advantages of ARR
Discounted payback? Easy to calculate and understand.
Accounting information almost always available.
Advantages and Disadvantages of Discounted Payback
Advantages Internal Rate of Return (IRR)
-Includes time value of money The discount rate that equates the present value of the
-Easy to understand future cash flows with the initial cost.Generally found by
-Does not accept negative estimated NPV investments trial and error.A project is accepted if its IRR is > the
-Biased towards liquidity required rate of return.The IRR on an investment is the
required return that results in a zero NPV when it is used as
Disadvantages the discount rate.
-May reject positive NPV investments
-Arbitrary determination of acceptable payback period Example—IRR
-Ignores cash flows beyond the cutoff date
-Biased against long-term and new products
Accounting Rate of Return (ARR)
Measure of an investment’s profitability.
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at 33.33%:NPV =0
at 42.86%:NPV =0
at 66.67%:NPV =0
Two questions:
1.What’s going on here?
2.How many IRRs can there be?
Multiple Rates of Return
IRR and Non-conventional Cash Flows

When the cash flows change sign more than once, there is
more than one IRR.When you solve for IRR you are solving
for the root of an equation and when you cross the xaxis
more than once, there will be more than one return that
solves the equation.If you have more than one IRR, you
cannot use any of them to make your decision.
Problems with IRR
More than one negative cash flow multiple rates of return. IRR, NPV and Mutually-exclusive Projects
Project is not independent mutually exclusive
investments.Highest IRR does not indicate the best project.
Advantages of IRR
Popular in practice
Does not require a discount rate
Multiple Rates of Return
Assume you are considering a project forwhich the cash
flows are as follows:
What’s the IRR? Find the rate at whichthe computed NPV =

0:
at 25.00%:NPV =0 Present Value Index (PVI)
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Expresses a project’s benefits relative to its initial cost. Stand-aloneprinciple:wecanevaluatetheprojectonitsown.

Types of Cash Flows
Sunk costs  a cost that has already been incurred and
cannot be removed  incremental cash flow
Accept a project with a PVI > 1.0.
Example—PVI Opportunity costs  the most valuable alternative that is
given up by the investment = incremental cash flow
Assume you have the following information on Project X:
Initial investment = –$1100 . Required return = 10%. Annual
cash revenues and expenses are as follows: Side effects  erosion = incremental cash flow
Financing costs  incorporated in discount rate 
incremental cash flow
Always use after-tax incremental cash flow
Investment Evaluation
Step1Calculatethetaxableincome.
Step2Calculatethecashflows.
Step3Discountthecashflows.
Step4Decision.
Example—Investment Evaluation
Purchase price $42 000
Salvage value $1000 at end of Year 3
Net cash flows
Year 1 $31 000
Year 2 $25 000
Year 3 $20 000
Tax rate is 30%
Is this a good project? If so, why? Depreciation 20% reducing balance
This is a good project because the present value of the Required rate of return 12%
inflows exceeds the outlay.
Each dollar invested generates $1.1645 in value or $0.1645
in NPV.
Advantages and Disadvantages of PVI (and NPVI)
Advantages
-Closely related to NPV, generally leading to identical
decisions.
-Easy to understand.
-May be useful when available investment funds are limited.
Disadvantages
-May lead to incorrect decisions in comparisons of mutually
exclusive investments. Solution—Taxable Income
Capital Budgeting in Practice

We should consider several investment criteria when
making decisions.NPV and IRR are the most commonly used
primary investment criteria.Payback is a commonly used
secondary investment criteria.
CHAPTER 8 Solution—Cash Flows

MAKING CAPITAL INVESTMENTS DECISIONS
BASED ON CASHFLOW
Incremental Cash Flows
Solution—NPV and Decision

Theonlyrelevantcashflowsincapitalprojectevaluation.
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Interest
As the project’s NPV is positive, the cash flows from the
investment will cover interest costs (as long as the interest Solution—NPV and Decision
cost is less than the required rate of return).Interest costs
should not therefore be included as an explicit cash
flow.Interest costs are included in the required rate of
return (discount rate) used to evaluate the project
Depreciation
The depreciation expense used for capital budgeting should Decision: NPV < 0, therefore REJECT.
be the depreciation schedule required for tax
purposes.Depreciation itself is a non-cash expense; Setting the Bid Price
consequently, it is only relevant because it affects How to set the lowest price that can be profitably
taxes.Prime cost vs diminishing value methods charged.Cash outflows are given.Determine cash inflows
Depreciation tax shield = DT that result in zero NPV at the required rate of return.From
-D = depreciation expense cash inflows, calculate sales revenue and price per unit.
-T = marginal tax rate
Setting the Option Value
Disposal of Assets Option value =Asset value ×Probability of the Value–Present
 If the salvage value > book value, a profit/gain is value of the exercise price ×Probability the exercise price
made on disposal. This profit/gain is subject to tax will be paid.
(excess depreciation in previous periods).
 If the salvage value < book value, the ensuing loss Annual Equivalent Cost (AEC)
on disposal is a tax deduction (insufficient When comparing two mutually-exclusive projects with
depreciation in previous periods). different lives, it is necessary to make comparisons over the
same time period.AEC is the present value of each project’s
Capital Gains costs to infinity calculated on an annual basis.Select the
Capital gains made on the sale of assets such as rental project with the lowest AEC.
property are subject to taxation.Capital losses are not a tax
deduction but can be offset against future capital gains Example—AEC
Project A costs $3000 and then $1000 per annum for the
Example—Incremental Cash Flows next four years.Project B costs $6000 and then $1200 for
A firm is currently considering replacing a machine the next eight years.Required rate of return for both
purchased two years ago with an original estimated useful projects is 10 per cent.Which is the better project?
life of five years. The replacement machine has an economic
life of three years. Other relevant data is summarised Solution—Project A
below:
Solution—Taxable Income
Solution—Project B
Solution—Cash Flows
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The base case NPV is then:

NPV = – $20 000 + ($11 000 × 3.3522) = $16 874
Fairways Example—Scenario Analysis

Inputs for scenario analysis:
Base case: Rentals are 20 000 buckets p.a., variable costs
are 10 per cent of rental income, fixed costs are $40 000,
depreciation is $4000 p.a.
Solution—Interpretation Best case: Rentals are 25 000 buckets p.a., variable costs are
Project A is better because it costs $1946 per year compared 8 per cent of rental income, fixed costs are $40 000,
to Project B’s $2325 per year. depreciation is $4000 p.a.
CHAPTER 9 Worst case: Rentals are 18 000 buckets p.a., variable costs
are 12 per cent of rental income, fixed costs are
PROJECT ANALYSIS AND EVALUATION $40 000, depreciation is $4000 p.a.
Evaluating NPV Estimates

The basic problem: How reliable is our NPV estimate?
Projected cash flows are based on a distribution of possible Fairways Example—Scenario Analysis
outcomes each period: resulting in an ‘average’ cash Inputs for sensitivity analysis:
flow.Forecasting risk: the possibility of an incorrect decision Base case: Rentals are 20 000 buckets p.a., variable costs
due to errors in cash flow projections (GIGO system). are 10 per cent of rental income, fixed costs are $40 000,
Ask: What sources of value create the estimated NPV? depreciation is $4000 p.a.
Scenario and Other ‘What If’ Analysis Best case: Rentals are 25 000 buckets p.a. All other variables
Base case estimation are unchanged.
Estimated NPV based on initial cash flow projections.
Worst case: Rentals are 18 000 buckets p.a. All other
Scenario analysis variables are unchanged.
Examine effect on NPV of best-case and worst-case
scenarios. Fairways Example—Sensitivity Analysis
Sensitivity analysis
Examine effect on NPV by changing only one input variable.
Simulation analysis
Vary several input variables simultaneously to construct a
distribution of possible NPV estimates.
Fairways Driving Range Example
Fairways Driving Range expects annual rentals to be 20 000
buckets at $3 per bucket. Equipment costs $20 000 and is
depreciated using the straight-line method over five years
to a zero salvage value. Variable costs are 10 per cent of
rentals income and fixed costs are $40 000 per year.
Assume no increase in working capital and no additional
capital outlays. The required rate of return is 15 per cent
and the tax rate is 30 per cent.
Fairways Example—Net Profit
Break-even Analysis
Useful for analysing the relationship between sales volume
and profitability.Break-even point is the sales volume at
Estimated annual cash flow: which the present value of the project’s cash inflows and
$10 000 + $4000 – $3000 = $11 000 outflows are equal  NPV = 0.
At 15%, the 5-year annuity factor is 3.3522.
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Important distinction between variable costs and fixed Solve algebraically for break-even quantity (Q):
costs.Accounting break-even is the sales volume that results
in a zero net profit.
Fixed and Variable Costs
There are two types of costs that are important in break-
even analysis: variable and fixed.
-Variable costs change when the quantity of output changes
-Total variable costs= quantity ×cost per unit If sales do not reach 16 296 buckets, Fairways willincur
-Fixed costs are constant, regardless of output, over some losses in both the accounting sense and thefinancial sense.
time period
-Total Costs = fixed + variable = FC + Vq Accounting of Break-even Point
Example: Generalexpression
Your firm pays $3000 per month in fixed costs. You also pay Q= (FC + D)/(P–v)
where:
$15per unit to produce your product. Q=totalunitssold
(Total cost if you produce 1000 units = 3000 + 15(1000) = 18 FC=totalfixedcosts
000) D=depreciation
(Total cost if you produce 5000 units = 3000 + 15(5000) = 78 P=priceperunit
000) V=variablecostperunit
Average versus Marginal Cost Using Accounting Break-even
Average Cost Accounting break-even is often used as an early-stage
-TC/number of units screening number.If a project cannot break even on an
-Will decrease as number of units increases accounting basis, then it is not going to be a worthwhile
Marginal Cost project.Accounting break-even gives managers an indication
-The cost to produce one more unit of how a project will impact accounting profit.
-Same as variable cost per unit
Example: What is the average cost and marginal cost under Summary of Break-even Measures
each situation in the previous example?
-Produce 1000 units: Average = 18 000/1000 = $18
-Produce 5000 units: Average = 78 000/5000 = $15.60
Fairways Example—Accounting Break-even Analysis
Fairways Example—Break-even Measures
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Operating Leverage
The degree to which a firm is committed to its fixed costs.
The higher the degree of operating leverage, the greater the
danger from forecasting risk.The lower the degree of
operating leverage, the lower the break-even point.DOL
depends on the current sales level.
Percentage Return Example
Fairways Example—DOL
Let Q = 20 000 buckets and, ignoring taxes, OCF = $14 000
and FC = $40 000. Per dollar invested we get 5 cents in dividends and 9
cents in capital gains—a total of 14 cents or a return of
14 per cent.
A 10 per cent increase (decrease) in quantity sold will result Percentage Returns
in a 38.57 per cent increase (decrease) in OCF.
Note: Higher DOL equals greater volatility (risk) in OCF and
leverage is a two-edged sword—sales decreases will be
magnified as much as increases.
Managerial Options and Capital Budgeting
A static DCF analysis ignores management’s ability to
modify the project as events occur.
Contingency planning
 The option to expand.
 The option to abandon.
 The option to wait.
Strategic options
1. ‘Toe hold’ investments.
2. Research and development.
Capital Rationing
A condition which prevents management from undertaking
all acceptable projects because of a shortage of funds.
1. Soft rationing occurs when management limits the
amount that can be invested in new projects during Inflation and Returns
some specified time period. Real return is the return after taking out the effects
2. Hard rationing occurs when the firm is unable to ofinflation. Real return shows the percentage change in
raise the financing for a project. buying power. Nominal return is the return before taking
out the effects ofinflation. The Fisher effect explores the
CHAPTER 10 relationship between real
SOME LESSONS FROM CAPITAL MARKET HISTORY
Dollar Returns Average Equivalent Returns & Risk Premiums 1978–2002

The gain (or loss) from an investment.Made up of two
components:
1. income (e.g. dividends, interest payments)
2. capital gain (or loss).
Not necessary to sell investment to include capital gain or
loss in return.
Percentage Returns
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Average Returns: The First Lesson

Risky assets on average earn a risk premium (i.e. there is a
reward for bearing risk).
Frequency of Returns on Ordinary Shares 1978–2002
The Normal Distribution
Variance
 Measure of variability.
 The mean of the squared deviations from the
average return. Variability: The Second Lesson
The greater the risk, the greater the potential reward.This
lesson holds over the long term but may not be valid for the
short term.
Capital Market Efficiency
Example—Variance The efficient market hypothesis (EMH) asserts that the price
ABC Co. have experienced the following returns in the last of a security accurately reflects all available
five years: information.Implies that all investments have a zero
NPV.Implies also that all securities are fairly priced.If this is
true then investors cannot earn ‘abnormal’ or ‘excess’
returns.
Price Behaviour in Efficient andInefficient Markets
Calculate the average return and the standard deviation.
What Makes Markets Efficient?

There are many investors out there doing research:As new
information comes into the market, this information is
analysed and trades are made based on this
information.Therefore, prices should reflect all available
The Historical Record public information.If investors stop researching stocks, then
Conclusion: Historically, the riskier the asset, thegreater the the market will not be efficient.
return.
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Common misconceptions about EMH

Efficient markets do not mean that you can’t make
money.They do mean that, on average, you will earn a
return that is appropriate for the risk undertaken and that
there is not a bias in prices that can be exploited to earn
excess returns.Market efficiency will not protect you from
making the wrong choices if you do not diversify—you still
don’t want to put all your eggs in one basket
Price Behaviour in Efficient and Inefficient Markets
Efficient market reaction: The price instantaneously adjusts Example—Calculating Variance
to and fully reflects new information. There is no tendency
for subsequent increases and decreases.
Delayed reaction: The price partially adjusts to the new
information. Several days elapse before the price
completely reflects the new information.
Example—Expected Return and Variance
Overreaction: The price over-adjusts to the new
information. It ‘overshoots’ the new price and
subsequently corrects itself.
Forms of Market Efficiency
Weak form efficiency: Current prices reflect information
contained in the past series of prices.
Semi-strong form efficiency: Current prices reflect all
publicly available information.
Strong form efficiency: Current prices reflect all information
of every kind.
CHAPTER 11
RISK AND RETURN TRADE OFF
Portfolios
Expected Return and Variance A portfolio is a collection of assets.An asset’s risk and return
1. Expected return—the weighted average of the is important in how it affects the risk and return of the
distribution of possible returns in the future. portfolio.The risk–return trade-off for a portfolio is
2. Variance of returns—a measure of the dispersion of measured by the portfolio’s expected return and standard
the distribution of possible returns. deviation, just as with individual assets.
3. Rational investors like return and dislike risk.
Portfolio Expected Returns
Example—Calculating Expected Return The expected return of a portfolio is the weighted average
of the expected returns for each asset in the portfolio.
You can also find the expected return by finding the

portfolio return in each possible state and computing the
expected value as we did with individual securities.
Example—Portfolio Return andVariance
Assume 50 per cent of portfolio in asset A and50 per cent in
asset B.
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Example—Portfolio Return and Variance
Diversification
The process of spreading investments across different
assets, industries and countries to reduce risk.
The Effect of Diversification onPortfolio Variance
Total risk = systematic risk + non-systematic risk
Non-systematic risk can be eliminated by diversification;
systematic risk affects all assets and cannot be diversified
away.
The Principle of Diversification
Diversification can substantially reduce the variability of
returns without an equivalent reduction in expected
returns.This reduction in risk arises because worse than
expected returns from one asset are offset by better than
expected returns from another.However, there is a
minimum level of risk that cannot be diversified away and
that is the systematic portion.
Portfolio Diversification
Announcements, Surprises and Expected Returns
Key Issues
What are the components of the total return?
What are the different types of risk?
Expected and Unexpected Returns
Total return (R) = expected return (E(R))+ unexpected return
(U)
Announcements and News
Announcement = expected part + surprise
It is the surprise component that affects a stock’s price and,
therefore, its return.
Risk
Systematic risk: that component of total risk which is due to
economy-wide factors.
Non-systematic risk: that component of total risk which is
unique to an asset or firm.
Standard Deviations of Monthly Portfolio Returns Systematic Risk

The systematic risk principle states that the expected return
on a risky asset depends only on the asset’s systematic risk.
The amount of systematic risk in an asset relative to an
average risky asset is measured by the beta coefficient.
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Std Deviation Return, Risk and Equilibrium

Beta Key issues:
Security A 30% 0.60 What is the relationship between risk and return?
Security B 10% 1.20 What does security market equilibrium look like?
Security A has greater total risk but less systematic risk The ratio of the risk premium to beta is the same for every
(more non-systematic risk) than Security B. asset. In other words, the reward-to-risk ratio for the
market is constant and equal to:
Measuring Systemic Risk
What does beta tell us?
-A beta of 1 implies the asset has the same systematic risk
as the overall market.
-A beta < 1 implies the asset has less systematic risk than
the overall market.
-A beta > 1 implies the asset has more systematic risk than Example—Asset Pricing
the overall market. Asset A has an expected return of 12 per cent and a beta of
1.40. Asset B has an expected return of 8 per cent and a
Beta Coefficients for Selected Companies beta of 0.80. Are these two assets valued correctly relative
to each other if the risk-free rate is 5 per cent?
Asset B offers insufficient return for its level of risk, relative

to A. B’s price is too high; therefore, it is overvalued (or A is
undervalued).
Example—Portfolio Beta Calculations Security Market Line
The security market line (SML) is the representation of
market equilibrium.The slope of the SML is the reward-to-
risk ratio:
(E(RM) –Rf)/ßM
But since the beta for the market is ALWAYS equal to one,
the slope can be rewritten.Slope = E(RM) –Rf = market risk
premium
Example—Portfolio Expected Returns and Betas

Assume you wish to hold a portfolio consisting of asset A
and a riskless asset. Given the following information,
calculate portfolio expected returns and portfolio betas,
letting the proportion of funds invested in asset A range
from 0 to 125 per cent.Asset A has a beta of 1.2 and an
expected return of 18 per cent.The risk-free rate is 7 per
cent.Asset A weights: 0 per cent, 25 per cent, 50 per cent,
75 per cent, 100 per cent and 125 per cent.
The Capital Asset Pricing Model (CAPM)

An equilibrium model of the relationship between risk and
return.
What determines an asset’s expected return?
–The risk-free rate—the pure time value of money.
–The market risk premium—the reward for bearing
systematic risk.
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–The beta coefficient—a measure of the amount of

systematic risk present in a particular asset.
CHAPTER 12
CURRENT INVESTMENTS DECISIONS

Calculation of Systematic Risk
Current Investment Decisions

Where: Involve the administration of the company’s current assets
Cov = covariance (cash and marketable securities, receivables and inventory),
i = random distribution of return for asset i and the financing needed to support these assets. Problems
M = random distribution of return for the in using discounted cash flow techniques to evaluate these
market decisions:
1. identification of all relevant cash inflows and
R outflows
Covariance and Correlation 2. determining the size and timing of these cash flows
The covariance term measures how returns change 3. determining the correct discount rate.
together—measured in absolute terms.The correlation
coefficient measures how returns change together— Operating Cycle versus Cash Cycle
measured in relative terms. Operating cycle—the time period between the acquisition
of inventory and the collection of cash from receivables.
Operating cycle = Inventory period + A/cs receivable period
Cash cycle—the time period between the outlay of cash for
purchases and the collection of cash from receivables.
Security Market Line versus Capital
Cash cycle = Operating cycle – A/cs payable period
Cash Flow Time Line
SML explains the expected return for all assets.
CML explains the expected return for efficient portfolios.
Risk of a Portfolio
Variance of a two-asset portfolio is calculated as:
weighted variance of the expected return foreach asset in
the portfolio+twice the weighted covariance of the
expectedreturn on the first asset with the expectedreturn on
the second
Example—Risk of a Portfolio
Example—Operating Cycle
The following information has been provided for Overcredit
Co.:
Sales for the year were $510 000 (assume all credit) and
the cost of goods sold was $350 000.Calculate the operating
Problems with CAPM cycle and cash cycle.
Difficulties in estimating beta
-thin trading
-non-constant beta
Using CAPM
-adding explanatory variables
-measure of market return
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Financing of current assets

-Flexible policy—less short-term debt and more long-term
debt
-Restrictive policy—more short-term debt and less long-
term debt
The size of the firm’s investment in current assets is
determined by its short-term financial policies.
Flexible policy actions include:
1. keeping large cash and securities balances
2. keeping large amounts of inventory
3. granting liberal credit terms.
Restrictive policy actions include:
 keeping low cash and securities balances
 keeping small amounts of inventory
 allowing few or no credit sales.
Costs of Investments
Need to manage the trade-off between carrying costs and
shortage costs.
Carrying costs increase with the level of investment in
current assets, and include the costs of maintaining
economic value and opportunity costs.
Shortage costs decrease with increases in the level of
investment in current assets, and include trading costs and
the costs related to being short of the current asset. For
example, sales lost as a result of a shortage of finished
goods inventory.
Carrying Costs and Shortage Costs
Example—cash cycle
Short-term Financial Policy

Size of investments in current assets
-Flexible policy—maintain a high ratio of current assets to
sales
-Restrictive policy—maintain a low ratio of current assets to
sales
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EOQ Example With Quantity Discounts

Smile Camera Shop is offered a 2-cent-per-roll discount if
2000–3500 rolls of film are ordered, and a 3-cent-per-roll
discount if more than 3500 rolls are ordered at a time.
Determine the optimal order quantity.
Calculate the total cost for each quantity:
Smile Camera Shop would be better off purchasing in lots of

2000
Inventory Management Under Uncertainty
Inventory management requires two decisions:
1. quantity to be ordered
2. reorder point
Safety stock is the additional inventory held when demand
is uncertain so as to reduce the probability of a stock
out.Reorder point takes into account the lead time from
placement of an order to receipt of the goods.
EOQ Example Under Uncertainty
Smile Camera Shop’s EOQ (with quantity discounts)is 2000
rolls of film and five orders are placed eachyear. Determine
the reorder point if it takes 30 daysto fill an order, a safety
stock of 100 is desired anddaily usage is 30 rolls.
The Inventory Model

The economic quantity (EOQ) is the optimal quantity of
inventory ordered that minimises the costs of purchasing
and holding the inventory.
Where
TC = total cost
X = order size
EOQ = economic order qty
A = acquisition costs
Y = total demand
C = carrying costs
P = price per unit
Cash Budget
Example—EOQ Forecast of cash receipts and disbursements over the next
Smile Camera Shop sells 10 000 rolls of film per year, each short-term planning period.Primary tool in short-term
with a wholesale price of $3.20. The cost of processing each financial planning. ItsHelps determine when the firm should
order placed is $10.00 and carrying costs are 20 cents per experience cash surpluses and when it will need to borrow
roll per year. Calculate the EOQ. to cover working-capital costs.Allows a company to plan
ahead and begin the search for financing before the money
is actually needed.
Example—Cash Budget
Projected sales for the first six months of 2004:
Jan. $130 000 Apr. $140 000
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Feb. $125 000 May $155 000

Mar. $145 000 Jun. $145 000
Analysis of collection of accounts receivable:
collected in month of sale 20%
collected in month following sale 60%
collected in second month following sale 20%
Actual sales for November and December were $125 000
and $120 000 respectively.
Wages and other expenses are 30 per cent of total monthly
sales.Purchases are 50 per cent of the month’s estimated
sales, all paid for in the month of purchase.Monthly interest
payments are $15 000 (interest rate is 1.5 per cent per
month).An annual dividend of $60 000 is payable in
March.The beginning cash balance is $30 000.The minimum
cash balance is $20 000.
Cash Collections
CHAPTER 13
CASH AND LIQUIDITY MANAGEMENT
Cash Disbursements
Reasons for Holding Cash
Speculative motive—the need to hold cash to take
advantage of additional investment opportunities, such as
bargain purchases.
Precautionary motive—the need to hold cash as a safety
margin to act as a financial reserve.
Transaction motive—the need to hold cash to satisfy normal
disbursement and collection activities associated with a
Cash Budget firm’s ongoing operations.
Compensating balance requirements—cash balances kept at
commercial banks to compensate for banking services the
firm receives.
Target Cash Balance
Key Issues:
What is the trade-off between carrying a large cash balance
versus a small cash balance? That is, carrying costs versus
shortage costs.
What is the proper management of the cash balance? BAT
Short-term Financial Planning model versus Miller–Orr model
The BAT Model
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Example—Miller–Orr Model
Assume L = $0, F = $10, i = 0.5 per cent per month andthe
standard deviation of monthly cash flows is $2000.
Assumptions
-Cash is spent at the same rate every day
-Cash expenditures are known with certainty
Optimal cash balance is where opportunity cost of holding Miller–Orr Model Implications
cash ([C/2]*R) = trading cost ([T/C]*F): Considers the effect of uncertainty (through 2 in net cash
flows). The higher the 2, the greater the difference
between C* and L.The higher the 2, the higher is the upper
F = fixed cost of making a securities trade to replenish cash limit and the average cash balance.
T = total amount of new cash needed for transactions All things being equal:
purposes over the relevant planning period 1. the greater the interest rate, the lower is the C*
R = the opportunity cost of holding cash (the interest rate 2. the greater the order costs, the higher is the C*.
on marketable securities)
Miller–Orr Model Miller–Orr Model With Overdraft
Assumes that, if left unmanaged, a company’s cash balance Yield on short-term investments < cost of bank overdraft <
yield on long-term investments.A dollar invested in short-
would follow a random walk with zero drift.Cash balance is term assets earns less than the costs saved by applying that
allowed to wander freely between an upper limit (U*) and a dollar to reduce overdraft usage.The company invests
lower limit (L).If cash holdings reach U*, management nothing in short-term assets and as much as possible in
intervenes by withdrawing U* – C* dollars to return the long-term assets, while meeting its liquidity needs through
cash balance to the target level C*.If cash balance reaches using the overdraft facility.
L,management intervenes by injecting C* – L dollars to
return the cash balance to the target level C*.
Understanding Float
What is float?
The difference between book cash and bank cash,
representing the net effect of cheques in the process of
being cleared.
Types of float:
U* is the upper control limit. L is the lower control limit. The Disbursement float—the result of cheques written;
targetcash balance is C*. As long as cash is between L and decreases book balance but does not immediately change
U*, notransaction is made. available balance.
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Collection float—the result of cheques received; increases

book balance but does not immediately change available Short-term Securities
balance. Characteristics of short-term securities include:
1. Maturity maturities usually less than 90 days.
Net float—the overall difference between the firm’s Investments then avoid interest rate risk but have
available balance and its book balance. low returns.
2. Default risk idle cash generally invested in less
Float Management risky securities (e.g. government issues).
Objectives: 3. Marketability idle funds usually invested in highly
1. In cash collection—speed up cheque collections liquid securities.
(reduce float components).
2. In cash disbursement—control payments and Investing Cash
minimise costs (increase float components). Temporary Cash Surpluses
-Seasonal or cyclical activities—buy marketable securities
Components of float: with seasonal surpluses, convert securities back to cash
1. Mail float—cheques trapped in postal system. when deficits occur.
2. Processing float—until receiver of cheque deposits
cheque. -Planned or possible expenditures—accumulate marketable
3. Availability float—until cheque clears in the banking securities in anticipation of upcoming expenses.
system.
Financing Seasonal or Cyclical Activities
Mail float + processing float + availability float = total time
delay.
Measuring and Costing the Float
The cost of collection float to the firm is theopportunity cost

from not being able to use thatcash.
Managing the Float
Factoring—the selling of receivables to a financial
institution (the factor), usually ‘without recourse’.Credit
insurance—protection against the risk of bad debt
losses.Delaying disbursements—increases the disbursement
float.
Investing Idle Cash
Temporary cash surpluses can be invested in marketable
securities.Temporary cash deficits—sell marketable
securities or use short-term bank financing.The temporary
surpluses/deficits are a result of: Regulation of Financial Intermediaries
–seasonal or cyclical activities
–planned or possible expenditures.
The Securities Markets
Regulation of Financial Intermediaries
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Terminology to know:
Cost of the Credit
2/10, net 30 = buyer pays in 10 days to get a 2 per cent
discount, or within 30 days for no discount.Buyer has an
order for $1500 and ignores the credit period  gives up
$30 discount.
The benefit obviously lies in paying early

CHAPTER 14 Credit Policy Effects
Revenue effects—Payment is received later, but price and
CREDIT MANAGEMENT quantity sold may increase
.
Cost effects—Cost of sale is still incurred even though the
cash from the sale has not been received.
Components of Credit Policy
Terms of sale : The conditions on which a firm sells its The cost of debt—The firm must finance receivables and,
goods and services for cash or credit. therefore, incur financing costs.
Credit analysis : The process of determining the probability The probability of non-payment—The firm always gets paid
that customers will not pay. if it sells for cash, but risks losses due to customer default if
it sells on credit.
Collection policy : Procedures that are followed by a firm in
collecting accounts receivable. The cash discount—Discounts induce buyers to pay early;
the size of the discount affects payment patterns and
Accounts receivable = Average daily sales × average amounts.
collection period
Evaluating a Proposed Credit Policy
P= price per unit
Q’= new quantity expected to be sold
v= variable cost per unit
Q = current quantity sold per period
R= periodic required return
The benefitof switching is the changein cash flow:
Terms of the Sale

Credit period : The length of time that credit is granted,
usually between 30 and 120 days. Evaluating a Proposed Credit Policy
Cash discount : A discount that is given for a cash purchase The present value of switching is:
to speed up the collection of receivables. PV = [(P – v) × (Q’ – Q)]/R
The cost of switching is the amount uncollected for the
Credit instrument : Evidence of indebtedness such as an period plus the additional variable costs of production:
invoice or promissory note.
Length of the Credit Period Cost = PQ + v(Q’ – Q)
And the NPV of the switch is:
Factors that influence the length of the credit period
include: NPV = –[PQ + v(Q’ – Q)] + [(P – v)(Q’ – Q)]/R
o buyer’s inventory period and operating
cycle Example—Evaluating a Proposed Credit Policy
o perishability and collateral value of goods ABC Co. is thinking of changing from a cash-only policy to a
o consumer demand for the product ‘net 30 days on sales’ policy. The company has estimated
o cost, profitability and standardisation the following:
o credit risk of the buyer P = $55 v = $32 Q = 160
o the size of the account Q’ = 175 R = 2%
o competition in the product market
o customer type. Solution
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As the NPV of the change is negative, ABC Co.should not

switch.
The Costs of Granting Credit
Opportunity costs are lost sales from refusing credit. These
costs go down when credit is granted.Carrying costs are the
cash flows that must be incurred when credit is granted.
They are positively related to the amount of credit
extended.
1. The required return on receivables.
2. The losses from bad debts.
3. The costs of managing credit and credit collections.
Optimal Credit Policy
Credit Analysis
Break-even Point Process of deciding which customers receive credit.
One-time sale—risk is variable cost only.
Repeat customers—benefit is gained from one-time sale in
perpetuity.
Grant credit to almost all customers onceas long as variable
cost is low relative to price (high markup).
The Five Cs of Credit
The switch is a good idea as long as thecompany can sell an Character : Customer’s willingness to pay.
additional 7.87 units. Capacity : Customer’s ability to pay.
Capital : Financial reserves/borrowing capacity.
Discounts and Default Risk Collateral : Pledged assets.
ABC Co. currently has a cash price of $55 per unit. If the Conditions : Relevant economic conditions.
company extends the 30 day credit policy, the price will
increase to $56 per unit on credit sales. ABC Co. expects 0.5 Collection Policy
per cent of credit to go uncollected (). All other Monitoring receivables:
information remains unchanged. Should the company - Keep an eye on average collection period relative to your
switch to the credit policy? credit terms.
Ageing schedule—compilation of accounts receivable by the
age of each account; used to determine the percentage of
payments that are being made late.
Collection procedures include:
Discounts and Default Risk  delinquency letters
NPV of changing credit terms:  telephone calls
 employment of collection agency
 legal action.
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CHAPTER 15
SHORT-TERM FINANCING
The Financial System
Banks
Trading banks includes activities such as deposits, loans,
insurance, superannuation and stockbroking, usually
through subsidiaries and affiliated companies.
Retail banking involves transactions with the general

public.
Wholesale banking involves transactions with companies

Financial Markets or businesses.
Hold approximately 44 per cent of market share.
Merchant Banks
Primarily concerned with wholesale finance.Responsible for
the development of CMTs, rebatable preference shares, the
commercial bills market, the promissory note market, the
currency hedge market and the unofficial deposit
market.Activities now include ‘investment banking’.Market
share has decreased dramatically since the 1980s, now
approximately 5 per cent
Superannuation and Life Insurance Companies
Crucial for the saving and provision of funds for retirement
(superannuation) or ‘one-off’ events such as death,
The Listed Market disability or trauma (insurance).Diversified operations to
include general insurance, short-term money market
dealing and merchant banking.Hold approximately 30 per
cent of market share.
Finance Companies
Initially responsible for the provision of hire purchase and
instalment credit, financing of vehicles and home loans,
lease financing and factoring.Funds obtained mainly
Through the issue of debentures.Deregulation in 1980s led
to many finance companies’ activities being absorbed by
their large parent banks.Market share now only
approximately 6 per cent.
Building Societies and Credit Unions
Building societies :
1. Traditionally provide housing finance to small
savers.
Financial Intermediaries 2. Diversified activities to include lending for other
purposes.
Credit unions
Pool the funds of people with common interests to provide
consumer-type financing and lending to ‘members’.
Both have very small market share, totalling approximately
2 per cent.
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Unit Trusts
Pool funds of small investors with the aim of earning a
greater return collectively than that achieved
individually.Cash management trusts, equity trusts,
property trusts, mortgage trusts
Other Intermediaries
Authorised foreign exchange dealers  perform a full range
of foreign exchange transactions.
Australian Stock Exchange (ASX) and share brokers 
provide the medium for buying and selling shares and other
listed securities.
Friendly societies  non-profit, state-controlled
intermediaries for small groups to pool funds to be used for
funerals, sickness or, simply, savings.
Financing Policy for an ‘Ideal’ Economy
CompromiseFinancing Policy
Optimal Amount of Short-term Borrowing

Factors to consider: With a compromise policy, the firm keeps a reserve of
Cash reserves—reducing the probability of financial distress iquidity which it uses to initially finance seasonal ariations in
vs investments in zero NPV securities. current asset needs. Short-term borrowing is used when the
reserve is exhausted.
Maturity hedging—match maturity of asset with maturity of
liability. Short-term Financing
Used for:
Relative interest rates—cheaper to have short-term 1. Working capital requirements in the day-to-day
borrowing than long-term borrowing. operations of the business.
2. Transactions that are self-financing over short
Alternative Asset Financing Policies periods.
Main providers are trading banks, merchant banks and
finance companies.
Short-term Financing Sources
Overdrafts
A credit arrangement where the bank permits the customer
to draw more money from the bank account than has been
put in it, up to an agreed limit.Repayable on demand
although this is rarely required. Interest rate is variable and
account balance fluctuates between positive (deposit) and
negative (loan) over the business cycle.
Short-term loans
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An advance of funds made by a financial institution for a Transferable loan certificates

specific purpose, repayable over a fixed period. Derivative debt products
Short-term Financing Sources Sources of Long-term Financing
Bills of exchange 1. Debentures—secure, fixed-term loan instruments
1. A negotiable instrument requiring the payment of a issued by companies.
specific sum of money, either on demand or at a 2. Secured notes—same as debentures with lower
specified time. security.
2. Trade bills versus accommodation bills. 3. Unsecured notes—shorter-term loans to a company
3. Three parties to a bill: drawer (borrower), acceptor offering no assets as security.
(endorser) and payee (owner). 4. Convertible notes—debt that provides an option to
4. Discounted value (price) of a bill: convert to equity at maturity.
5. Fixed deposits—unsecured loans at fixed rates for
definite terms.
6. Mortgages—the conveyance of property for the
security of debt.
7. Eurobonds—unsecured fixed-interest borrowings
Short-term Financing Sources denominated in a currency of a country other than
Promissory notes its country of issue.
A negotiable instrument whereby the borrower promises to 8. Eurocurrency FRNs—a foreign currency borrowing
repay the face value to the holder at maturity. .Different to whose rates adjust to reflect market interest rates.
bills of exchange because they are unsecured (no acceptor). 9. Leasing—purchaser of equipment leases the asset
Most borrowers are well-known large organisations. There to another party.
is an active secondary market. 10. Project financing—syndicate financing of very large
(and expensive) projects.
Inventory loans 11. Transferable loan certificates—marketable evidence
A short-term loan used specifically to purchase inventory, of the existence of a debt.
including a blanket inventory lien, a trust receipt and field 12. Derivative debt products—instruments used to
warehouse financing. manage interest rate risk:
1. interest rate swaps
Letters of credit 2. forward rate agreements (FRAs)
Irrevocable and unconditional undertaking by a bank to 3. interest rate futures
repay a loan if the borrower defaults. 4. options on futures contracts.
Short-term eurocurrency funding Debt versus Equity
Financing in a currency outside the country of issue. Corporations try to create debt securities that are really
equity to get the tax benefits of debt and the bankruptcy
Factoring benefits of equity.Interest on debt is fully tax deductible, so
Selling of accounts receivables to a factor. the distinction is important for tax purposes.Hybrid
securities have characteristics of both debt and equity:
CHAPTER 16  convertible notes
 subordinated debt
LONG-TERM FINANCING : AN INTRODUCTION  preference shares.
The Debenture Trust Deed
Legal document binding the corporation and its creditors.
What is Debt? Provisions in a trust deed include:
An obligation to pay a specific amount of money to another 1. the basic terms of the issue
party. 2. the amount of the debentures issued
3. property used as security
Characteristics of debt: 4. repayment arrangements
 short-term vs long-term 5. call provisions
 fixed vs floating interest rate loans 6. any protective covenants.
 secured vs unsecured Debt Ratings
 domestic vs foreign Letter grades that designate investment quality.Assigned to
a debt issue by independent rating agencies such as
Types of Long-term Debt Moody’s and Standard & Poor’s.Long-term ratings range
Debentures from Aaa to C; short-term ratings range from Prime-1 to
Secured and unsecured notes Prime-3.Ratings relieve individual investors of the task of
Convertible notes evaluating the investment quality of an issue.
Fixed deposit loans
Mortgages Different Types of Debentures
Eurobonds 1. Zero coupon debentures—initially priced at a deep
Eurocurrency term loans discount as they make no coupon payments.
Leasing
Project finance
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2. Floating-rate debentures—coupon payments are

tied to an interest rate index and are therefore
adjustable. Usually contain a put provision,
together with coupon ceilings and floors.
3. Income debentures—coupons dependent on
company income.
4. Put debentures—holder can force the buy back of
debt at a stated price.
The call provision effectively costs $50.
Securitisation
The process of transforming financial institutions’ assets Solution—Debentures
such as mortgages, into marketable securities, by pooling What is the NPV per debenture of the refunding if
and selling the rights to the income streams. interest rates fall to 5 per cent?
Advantages:
Investor—negotiable security provides both regular income
and final payout.
Mortgage agency—conversion of an illiquid asset into a
marketable security.
As NPV is positive, refunding should commence.
Debenture Refunding Reasons for Issuing Callable Debentures

Process of replacing all or part of an issue of outstanding Superior interest rate forecasting—company insiders may
debentures.Used to refinance a higher-interest loan with a think they know more about interest rate decreases than
lower-interest one.Call provision allows a company to debtholders.
repurchase or ‘call’ part or all of the debt issue at stated
prices over a specified period.Debtholders demand a Taxes—call provisions provide tax advantages to both
coupon that exactly compensates them for the possibility of debtholders and the company.
a call.
Future investment opportunities—allows the company to
Cost of call provision = Value of call position buy back debentures to take advantage of superior
investment opportunities.
Example—Debentures
Assume: Preference Shares
Current interest rate on debentures is 10 per cent 1. Shares with dividend priority over ordinary shares,
Probability of interest rate changes by the end of normally with a fixed dividend rate, sometimes
the year: without voting rights.
— fall to 5 per cent (50 per cent probability) 2. Cumulative vs non-cumulative dividends.
— rise to 15 per cent (50 per cent probability) 3. Irredeemable vs redeemable shares.
Call premium = $20 4. Non-participating vs participating shares.
Call period = by the end of the year
Face value of debenture = $100 Most preference shares issued are cumulative, irredeemable
Debentures are perpetual and non-participating.
Solution—Debentures Reasons for Issuing Preference Shares
Market price of debenture (if not callable): Redeemable preference shares can be used to enhance the
balance sheet by increasing the equity base.As subordinate
debt, they can be included in a bank’s capital base.They can
be used to avoid the threat of bankruptcy that exists for
debt.Companies unable to take advantage of the tax
deductibility of debt favour preference shares.A means of
raising equity without surrendering control.
If issue is callable, what coupon (C) must beoffered? Ordinary Shares

Equity without priority for dividends or in bankruptcy.
Types of companies:
1. companies limited by shares
2. companies limited by guarantee
3. companies limited by both shares and guarantee
4. unlimited companies
5. no liability companies.
This is higher than the non-callable coupon.
Shareholders’ Rights
What is the cost of the call provision?
 The right to share proportionally in dividends paid.
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 The right to share proportionally in assets remaining

after liabilities have been paid in liquidation. CHAPTER 17
 The right to elect the directors and to vote on
important shareholder matters (one share = one ISSUING SECURITIES TO THE PUBLIC
vote).
 The right to share proportionally in any new shares
sold (pre-emptive right).
Issuing Securities to the Public
Dividends Analyse funding needs and how they can be met.
1. Payment by a corporation to shareholders; made in Approval from board of directors for a public issue.
either cash or shares. Outside expert opinions sought for support of issue.
2. The return on capital to shareholders. Pricing, time-tabling, prospectus prepared, marketing.
3. They are not a liability of the company unless Prospectus filed with ASIC and ASX.
declared by the board of directors. Underwriting agreement executed.
4. They are not a business expense and are therefore Prospectus registered.
not tax deductible. Public announcement of offering.
5. They are fully taxable in the hands of the Funds received.
shareholder. However, an imputation credit may be Shares allotted, holdings registered.
allowed. Shares listed for trading on ASX.
New Issues
Flotation is the initial offering of securities to the public.
Classes of Ordinary Shares Primary issues used to:
Different classes of ordinary shares may be distinguished  convert from a private company to a public
by: company
1. voting rights  spin-off a portion of the business of a listed
2. dividend entitlement company
3. priority to dividend payment  form a new public company
4. priority to capital repayment and surplus asset  privatise a public organisation, or demutualise a
distribution in the event of liquidation. mutual society.
Reasons for different classes: Advantages of Public Company Listing

 debt characteristics for some shares 1. Access to additional capital.Increased negotiability
 retain control in small/newly listed firms of capital.
 taxation issues 2. Growth not limited by cash resources.
 nature of company (e.g. home units). 3. Enhancement of corporate image.
4. Can attract and retain key personnel.
Size of the Capital Market 5. Gain independence from a spin-off.
Disadvantages of Public Company Listing
 Dilution of control of existing owners.
 Additional responsibilities of directors.
 Greater disclosure of information.
 Explicit costs.
 Insider trading implications.
Secondary Issues
Private placements—securities are offered and sold to a
limited number of investors who are often the current
major investors in the business.
Rights issues—issue of shares made to all existing
shareholders, who are entitled to take up the new shares in
proportion to their present holdings.
Terms are determined by:
Financial Distress 1. amount of funds required by the company
The disadvantage of using debt is the possibility of financial 2. the market price of the company’s securities
distress, which can be defined as: 3. general economic conditions
o business failure 4. desire to benefit shareholders
o legal bankruptcy 5. nature of the company’s shareholders
o technical insolvency
-- accounting insolvency.. Underwriting
.Firm underwriting : A guarantee that funds will be
made available to a company at a specific time on agreed
terms and conditions.
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Standby underwriting : Where the bidding company has

insufficient cash in a successful bid or if cash is offered as an
alternative to a share bid.
Best efforts underwriting : Underwriter must use ‘best
efforts’ to sell the securities at the agreed offering rate.
Role of underwriter
–pricing the issue
–marketing the issue
–engaging sub-underwriters
–placing the shortfall
Sub-underwriter
–A group of underwriters formed to reduce the risk and to
help to sell an issue.
Underwriting Fees Rights Offerings—Basic Concepts
The underwriter’s fee is a reflection of the: Rights offering : Issue of ordinary shares to existing
1. size of the issue shareholders.
2. issue price
3. general market conditions Allows current shareholders to avoid the dilution that can
4. market attitude towards shares occur with a new share issue.
5. time period required for underwriting.
Fees also include brokerage and management feesAverage ‘Rights’ are given to the shareholders specifying:
1. number of shares that can be purchased
Averageinitial return 2. purchase price
3. time frame.
Shareholders can either exercise their rights or sell them.
They neither win nor lose either way.
Subscription price : The dollar cost of one of the shares to
be issued, generally less than the current market price.
Ex-rights date : Beginning of the period when shares are
sold without a recently declared right, normally four trading
days before the holder-of-record date. The share price will
New Equity Sales—Research Findings drop by the value of the right.
Shares prices tend to decline after a new equity issue Holder-of-record date : Date on which existing shareholders
announcement, but rise following a debt announcement. are designated as the recipients of share rights.
Why? Ex-rights Share Prices

1. Management has superior information about firm
value and knows when the firm is overvalued →
sell equity.
2. Excessive debt usage.
3. Substantial issue costs.
4. Management needs to understand the signals that
an equity issue sends.
The Cost of Issuing Securities
Theoretical Rights Price
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due to less-than-proportionate purchase of new

shares.
2. Dilution of market value—loss in share value due to
use of proceeds to invest in negative NPV projects.
3. Dilution of book value and earnings per share (EPS)
—reduction in EPS due to sale of additional shares.
This has no economic consequences.
Example—Rights Issue Corporate Debt
Lemon Co. currently has 5 million shares on issue with a The late 1980s saw a major growth in the Australian
market price of $8 each. To finance new projects, the corporate debt market due to:
company needs to raise an additional $6 million. To raise a. the substantial cutback in the level of
the finance, the company makes a rights issue at a government borrowing
subscription price of $6 per share. b. the fall in interest rates from extremely high
levels
The number of new shares to be sold: c. the flight to quality
d. the shortage of government bonds
e. the attractiveness of raising funds in the
domestic market relative to that of the
euromarket.
Long-term Debt
Differences between direct, private long-term financing and
public issues of debt include:
The holder of one right is entitled to subscribe to one new o direct loans avoid ASIC registration costs
share at $6 per share.To issue 1 million shares, the company o direct loans have more restrictive
would have to issue 1 million rights.The company has 5 covenants
million shares on issue, which means that for every 5 shares o term loans and private placements are
held, a shareholder is entitled to receive one right (1-for-5 easier to renegotiate than public issues
rights issue). o private placements are dominated by life
insurance companies and pension funds,
Calculate the theoretical rights price: whereas commercial banks dominate the
term-loan market.
CHAPTER 18
COST OF CAPITAL AND CAPITAL STRUCTURES

If an outsider buys a right, it will cost $1.67.The right can be
exercised at a subscription price of $6.Total cost of a new
share = $1.67 + $6 = $7.67.
The Cost of Capital: Preliminaries
The Value of Rights Vocabulary—the following all mean the same thing:
1. required return
2. appropriate discount rate
3. cost of capital.
The cost of capital is an opportunity cost—it depends on
where the money goes, not where it comes from.The
assumption is made that a firm’s capital structure is fixed—
a firm’s cost of capital then reflects both the cost of debt
and the cost of equity.
Cost of Equity
*$8.00 – 7.67 = 0.33 The cost of equity is the return required by equity investors
**$0.33 × 5 = $1.65 given the risk of the cash flows from the firm.There are two
major methods for determining the cost of equity:
New Issues and Dilution –Dividend growth model
Dilution –SML or CAPM.
Loss in existing shareholders’ value in terms of either
ownership, market value, book value or EPS. The Dividend Growth Model Approach
According to the constant growth model:
Types of dilution
1. Dilution of proportionate ownership—a
shareholder’s reduction in proportionate ownership
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Rearranging: Advantages
 Adjusts for risk.
 Accounts for companies that don’t have a constant
dividend.
Disadvantages
Example—Cost of Equity Capital: Dividend Approach 1. Requires two factors to be estimated: the market
Reno Co. recently paid a dividend of 15 cents per share. risk premium and the beta co-efficient.
This dividend is expected to grow at a rate of 3 per cent per 2. Uses the past to predict the future, which may not
year into perpetuity. The current market price of Reno’s be appropriate.
shares is $3.20 per share. Determine the cost of equity
capital for Reno Co The Cost of Debt
The cost of debt, RD, is the interest rate on new borrowing.
RD is observable:
yields on currently outstanding debt
yields on newly-issued similarly-rated bonds.
Estimating g The historic cost of debt is irrelevant
One method for estimating the growth rate is to use the
historicalaverage. Example—Cost of Debt
Ishta Co. sold a 20-year, 12 per cent bond 10 yearsago at
par. The bond is currently priced at $86.What is our cost of
debt?
The Dividend Growth Model Approach The yield to maturity is 14.4 per cent, so this is used
Advantages as the cost of debt, not 12 per cent.
1. Easy to use and understand.
Disadvantages The Cost of Preference Shares
 Only applicable to companies paying dividends. Preference shares pay a constant dividend every period.
 Assumes dividend growth is constant. Preference shares are a perpetuity, so the cost is:
 Cost of equity is very sensitive to growth estimate.
 Ignores risk.
The SML Approach Notice that the cost is simply the dividend yield.
Required return on a risky investment is dependent on
three factors: Example—Cost of Preference Shares
o the risk-free rate, Rf An $8 preference share issue was sold 10 years ago. It sells
o the market risk premium, E(RM) – Rf for $120 per share today.
o the systematic risk of the asset relative to
the average,  The dividend yield today is $8.00/$120 = 6.67 per cent, so
this is the cost of the preference share issue.
The Weighted Average Cost of Capital
Example—Cost of Equity Capital: SML Approach

Obtain the risk-free rate (Rf) from financial press—
many use the 1-year Treasury note rate, say, 6 per
cent.Obtain estimates of market risk premium and security
beta:
historical risk premium = 7.94 per cent (Officer, 1989)
beta—historical
investment information services
estimate from historical data
Assume the beta is 1.40.
The SML Approach

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Interest payments on debt are tax deductible, so the after-  WACC is the return that the firm must earn on its
tax cost of debt is: existing assets to maintain the value of its shares.
 WACC is the appropriate discount rate to use for
Dividends on preference shares and ordinary shares are cash flows that are similar in risk to the firm.
nottax-deductible so tax does not affect their costs.
The weighted average cost of capital is therefore: Divisional and Project Costs of Capital
When is the WACC the appropriate discount rate?
When the project’s risk is about the same as the firm’s risk.
Other approaches to estimating a discount rate:
Example—Weighted Average Cost of Capital  divisional cost of capital—used if a company has
Zeus Ltd has 78.26 million ordinary shares on issue with a more than one division with different levels of risk
book value of $22.40 per share and a current market price  pure play approach—a WACC that is unique to a
of $58 per share. The market value of equity is therefore particular project is used
$4.54 billion. Zeus has an estimated beta of 0.90. Treasury
bills currently yield 4.5 per cent and the market risk  subjective approach—projects are allocated to
premium is assumed to be 7.94 per cent. Company tax is 30 specific risk classes which, in turn, have specified
per cent. WACCs.
The firm has four debt issues outstanding: The SML and the WACC
Example—Cost of Equity(SML Approach
Example—Cost of Debt
If a firm uses its WACC to make accept/reject decisions for
all types of projects, it will have atendency towards
incorrectly accepting risky projects and incorrectly rejecting
less riskyprojects.
Example—Using WACC for all Projects
What would happen if we use the WACC for all projects
The weighted average cost of debt is 7.15 per cent. regardless of risk?
Example—Capital Structure Weights Assume the WACC = 15 per cent

Market value of equity = 78.26 million × $58 = $4.539
billion.
Market value of debt = $1.474 billion.
Project A should be accepted because its risk is low (Beta =
0.60), whereas Project B should be rejected because its risk
is high (Beta = 1.2).
The SML and the SubjectiveApproach
WACC
 The WACC for a firm reflects the risk and the target
capital structure to finance the firm’s existing assets
as a whole.
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Assume a corporate tax rate of 30 per cent.
Example—NPV (No Flotation Costs)
With the subjective approach, the firm places projects into

one of several risk classes. The discountrate used to value
the project is then determined by adding (for high risk) or
subtracting (for low risk)an adjustment factor to or from the
firm’s WACC. Flotation costs decrease a project’s NPV and
could alter an investment decision.
Flotation Costs
The issue of debt or equity may incur flotation costs such as
underwriting fees, commissions, listing fees.Flotation costs CHAPTER 19
are relevant expenses and need to be reflected in any
analysis. DIVIDENS AND DIVIDEND POLICY
Types of Dividends
Example—Project Cost includingFlotation Costs A dividend is a payment made out of a firm’s earnings to its
Saddle Co. Ltd has a target capital structure of 70per cent owners (shareholders).Dividends are usually paid in the
equity and 30 per cent debt. Theflotation costs for equity form of cash.
issues are 15 per cent ofthe amount raised and the flotation
costs for debtissues are 7 per cent. If Saddle Co. Ltd Types of cash dividends include:
needs$30 million for a new project, what is the ‘true 1. regular cash dividends
cost’ of this project? 2. extra dividends
3. special dividends
4. liquidating dividends.
The weighted average flotation cost is 12.6 percent. Share dividends are also paid, and share repurchases are a
dividend alternative.
Procedure for Dividend Payment
Example—Flotation Costs and NPV

Apollo Co. Ltd needs $1.5 million to finance a new project
expected to generate annual after-tax cash flows of $195
800 forever. The company has a target capital structure of
60 per cent equity and 40 per cent debt. The financing
options available are: 1. Declaration date: the board of directors declares a
payment of dividends.
An issue of new ordinary shares. Flotation costs of equity 2. Ex-dividend date: if you buy the share on or after
are 12 per cent of capital raised. The return on new equity this date the seller is entitled to keep the dividend.
is 15 per cent. Under ASX rules, shares are traded ex-dividend on
and after the seventh business day before the
An issue of long-term debentures. Flotation costs of debt record date.
are 5 per cent of the capital raised. The return on new debt 3. Record date: declared dividends are distributable to
is 10 per cent. shareholders of record on a specific date.
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4. Payment date: the dividend cheques are mailed to  Flotation costs: Higher dividend payouts may
shareholders of record. require a new share issue, which could be expensive
and decrease the value of the firm.
The Ex-date Price DropEx date  Dividend restrictions: Debt contracts might limit the
percentage of income that can be paid out as
dividends.
A high payout is better if one considers:
 Desire for current income instead of capital gain.
 Uncertainty resolution: ‘bird-in-hand’ story.
 Tax benefits: There are some investors who do
The share price will fall by the amount of the dividend on receive favourable tax treatment from holding high
the exdate (Time 0). If the dividend is $1 per share, the price dividends (e.g. corporate investors).
will beequal to $10 –1 = $9 on the ex date.  Legal benefits.
Before ex date (Time –1)Dividend = $0Price = $10
On ex date (Time 0)Dividend = $1Price = $9 Examples of Imputed Tax Credits
Do Dividends Matter?
Yes: the value of a share is based on the present value of
expected future dividends.
No: the value of a share is not affected by a switch in
dividend policy.
Does Dividend Policy Matter?
Dividend policy versus cash dividends
An illustration of dividend irrelevance : Original dividends
To Date …
Based on the home-made dividend argument, dividend
policy is irrelevant.Because of high taxation of some
individual investors, a high-dividend policy may be
Assume an additional $200 of dividends is offered, financed best.Because of new issue costs, a low-dividend policy is
by an issue of debt or shares. New dividend plan: best.
Dividends and Signals
Changes in dividends convey information
Dividend increases:
 Management believes it can be sustained.
 Expectation of higher future dividends, increasing
P0= $1200/1.2 + $760/1.22= $1 527.78 present value.
 Signal of a healthy, growing firm.
Dividend Policy Irrelevance
Any increase in dividends at one point is offset exactly by a
decrease somewhere else.An alternative explanation is Dividend decreases:
home-made dividends. Individual investors can undo  Management believes it can no longer sustain the
corporate dividend policy by reinvesting dividends or selling current level of dividends.
shares.Companies may help with creating home-made  Expectation of lower dividends indefinitely;
dividends by offering shareholders automatic dividend decreasing present value.
reinvestment plans (DRIPs).  Signal of a firm that is having financial difficulties.
The information content makes it difficult to interpret the
Dividends and the Real World effect of the dividend policy of the firm.
A low payout is better if one considers:
Clientele Effect
 Taxes: Optimal dividend policy is determined by Shares attract particular groups based on dividend yield and
various shareholder situations. Some shareholders the resulting tax effects.Some investors prefer low dividend
prefer high franked dividends, others prefer the payouts and will buy shares in those companies that offer
company to pay no dividend and retain the funds low dividend payouts.Some investors prefer high dividend
for reinvestment (tax on dividend income vs capital payouts and will buy shares in those companies that offer
gains tax). high dividend payouts.
Residual Dividend Policy
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Issue costs eliminate any indifference between financing by

internal capital and new shares.Dividends are paid only if
profits are not completely used for investment
purposes.Desired debt-to-equity ratio is maintained.
Relationship Between Dividends andInvestment
Share Repurchases
Company buys back its own shares.Similar to a cash
dividend in that it returns cash from the firm to the
shareholders.This is another argument for dividend policy
irrelevance in the absence of taxes or other imperfections.
Equal access purchase: Offer made by company to all
shareholders to purchase shares in the same proportion as
their holdings.
On-market purchase: Purchase by a company of its own
shares on the open market.
Employee share purchase: Repurchase shares from
employees that were issued under employee incentive
scheme.
Key Concepts in Dividend Policy Selective purchase: Repurchase of shares from specific
Dividend stability—dividends are only increased if the shareholders.
increase is sustainable.
Odd-lot purchase: Repurchase of small parcels of
Dividend streaming—shareholders can choose different shares.
dividend schemes to suit their tax position (franked vs
unfranked dividends) Cash Dividend versus ShareRepurchase
Assume no taxes, commissions or other market
Special dividends—‘one-off’’ extra dividends. imperfections.Consider a firm with 50 000 shares
outstanding, netprofit of $100 000 and the following
Dividend reinvestment schemes—company reinvests balance sheet.
individuals’ dividends into fully paid shares of the company.
Avoids transactions costs and need for prospectus, and
shares are usually offered at a discount.
Australian Equity Raisings 2001
Price per share is $20 ($1 000 000/50 000).
EPS = $2.00 ($100 000/50 000).
PE ratio = 10.
The firm is considering either:
Paying a $1 per share cash dividend.
OR
Repurchasing 2500 shares at $20 a share.
Cash Dividend Option
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restructure, what is the minimum level of EBIT the company

needs to maintain EPS (the break-even EBIT)? Ignore taxes.
With no debt:
EPS = EBIT/500 000
Price per share is $19.00 ($950 000/50 000). With $2.5 million in debt @ 10%:
EPS = $2.00 ($100 000/50 000). EPS = (EBIT – $250 0001)/250 0002
PE ratio = 10.
1
Interest expense = $2.5 million × 10% = $250 000
Share repurchase option 2
Debt raised will refund 250 000 ($2.5 million/$10)shares,
Price per share is $20.00 ($950 000/47 500). leaving 250 000 shares outstanding
EPS = $2.10 ($100 000/47 500).
PE ratio = 9.5. These are then equal:
EPS = EBIT/500 000 = (EBIT – $250 000)/250 000
Share Dividends and Share Splits
Bonus shares and share splits: With a little algebra:
 involve issuing new shares on a pro-rata basis to the EBIT = $500 000
current shareholders EPSBE = $1.00 per share
 do not change the firm’s assets, earnings, risk
assumed and investors’ percentage of ownership in
the company Financial Leverage, EPS and EBITEBIT ($ millions, no taxes)
 increase the number of shares outstanding EPS ($)
 reduce the value per share
A common explanation is to adjust the share price to a
‘more desirable trading range’.
Reverse Splits
The firm reduces the number of shares outstanding.
Reasoning:
1. reduction in transaction costs
2. increase in share marketability (trading range)
3. regain respectability.
Share Ownership Plans
Encourage the financial participation of employees in the
company, including:
 fully paid shares
 partly paid shares
 special classes of shares
 options Example—Home-made Leverage and ROE
 phantom or shadow shares Home-made leverage is the use of personal borrowing to
 employee share trusts. alter the degree of financial leverage. Investors can
replicate the financing decisions of the firm in a costless
CHAPTER 20 manner.
Example :
FINANCIAL LEVERAGE AND CAPITAL STRUCTURE Original capital structure and home-made leverage
POLICY investor uses $500 of their own and borrows $500 to
purchase 100 shares.
Proposed capital structure investor uses $500 of their own,
Key issues together with $250 in shares and $250 in bonds.
What is the relationship between capital structure and firm
value? Original Capital Structure and Home-made Leverage
What is the optimal capital structure?
Cost of capital
A firm’s capital structure is chosen if WACC is
minimised.This is known as the optimal capital structure or
target capital structure.
Example—Computing Break-even EBIT
ABC Company currently has no debt in its capital structure.
The company has decided to restructure, raising $2.5
million debt at 10 per cent. ABC currently has 500 000 Proposed Capital Structure
shares on issue at a price of $10 per share. As a result of the
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By M&M Proposition II, the required rate of return on

equity arises from sources of firm risk. Proposition II is:
RE= RA+ [RA–RD] ×[D/E]
Business risk—equity risk arising from the nature of the
firm’s operating activities (measured byRA).
Financial risk—equity risk that comes from the financial
policy (i.e. capital structure) of the firm (measured by [RA–
RD] ×[D/E]).
The SML and M&M Proposition II
Capital Structure Theory How do financing decisions affect firm risk in both M&M’s
Modigliani and Miller Theory of Capital Structure Proposition II and the CAPM?
–Proposition I—firm value
–Proposition II—WACC Consider Proposition II: All else equal, a higher debt/equity
ratio will increase the required return on equity, RE.
The value of the firm is determined by the cash flows to the RE= RA+ (RA–RD) ×(D/E)
firm and the risk of the assets
Substitute RA= Rf+ (RM-Rf)Βa
Changing firm value: and by replacement RE= Rf+ (RM-Rf)βE
–Change the risk of the cash flows
–Change the cash flows The effect of financing decisions is reflected in the equity
beta, and, by the CAPM, increases the required return on
M&M Proposition I equity.
βE= βA(1 + D/E)
Debt increases systematic risk (and moves the firm along
the SML).
Corporate Taxes
The interest tax shield is the tax saving attained by a firm
from interest expense.
Assumptions:
(The size of the pie does not depend on how it is sliced.)  perpetual cash flows
The value of the firm is independent of its capital structure.  no depreciation
Value of firm Value of firm  no fixed asset or NWC spending.
M&M Proposition II For example, a firm is considering going from $0 debt to
Because of Proposition I, the WACC must be constant, with $400 debt at 10 per cent.
no taxes:
WACC = RA= (E/V) ×RE+ (D/V) ×RD
where RAis the required return on the firm’s assets
Solve for REto get M&M Proposition II:
RE= RA+ (RA–RD) ×(D/E)
The Cost of Equity and the WACC
Tax saving = $16 = 0.40 x $40 = TC × RD × D

What is the link between debt and firm value?
Since interest creates a tax deduction, borrowing creates a
tax shield. The value added to the firm is the present value
of the annual interest tax shield in perpetuity.
M&M Proposition I (with taxes):
The firm’s overall cost of capital is unaffected by its capital

structure. Key result VL = VU + TCD
Business and Financial Risk M&M Proposition I with Taxes
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–The bad news:all else equal, borrowing more money

increases the probability (and therefore the expected value)
of direct and indirect bankruptcy costs.
Key issue: The impact of financial distress on firm value.
Direct versus Indirect Bankruptcy Costs
Directcosts : Those costs directly associated with
bankruptcy, (e.g. legal and administrative expenses).
Indirect costs : Those costs associated with spending
resources to avoid bankruptcy.
Financial distress:
–significant problems in meeting debt obligations
–most firms that experience financial distress do recover.
The static theory of capital structure:
A firm borrows up to the point where the tax benefit from
Taxes, the WACC and Proposition II an extra dollar in debt is exactly equal to the cost that
Taxes and firm value: an example comes from the increased probability of financial distress.
EBIT = $100 This is the point at which WACC is minimised and the value
TC = 30% of the firm is maximised.
RU = 12.5%
Suppose debt goes from $0 to $100 at 10 per cent. What The Optimal Capital Structure and theValue of the Firm
happens to equity value, E?
VU = $100 × (1 – 0.30)/0.125 = $560
VL = $560 + (0.30 × $100) = $590
E = $490
WACC and the cost of equity (M&M Proposition II with
taxes):
RE=RU+(RU–RD)×(D/E)×(1–TC)
Conclusions
The WACC decreases as more debt financing is used.
Optimal capital structure is all debt. The Optimal Capital Structure and theCost of Capital
Bankruptcy Costs
Borrowing money is a good news/bad news proposition.
–The good news:interest payments are deductible and
create a debt tax shield (TCD).
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The Capital Structure Question With corporate and personal tax, and dividend imputation,
shareholders are again indifferent between corporate and
personal borrowing.
Dynamic Capital Structure Theories
 Pecking order theory : Investment is financed first
with internal funds, then debt, and finally with
equity.
 Information asymmetry cost : Management has
superior information on the prospects of the firm.
 Agency costs of debt : These occur when equity
holders act in their own best interests rather than
the interests of the firm
CHAPTER 21
OPTION, CORPORATE SECURITIES AND FUTURES
Managerial Recommendations
The tax benefit is only important if the firm has a large tax Option Terminology
liability. 1. Call option : Right to buy a specified asset at a
specified price on or before a specified date.
Risk of financial distress: 2. Put option : Right to sell a specified asset at a
–The greater the risk of financial distress, the less debt will specified price on or before a specified date.
be optimal for the firm. 3. European option : An option that can only be
–The cost of financial distress varies across firms and exercised on a particular date (on expiry).
industries. 4. American option : An option that can be exercised
at any time up to its expiry date.
The Extended Pie Model 5. Striking price : The contracted price at which the
underlying asset can be bought (call) or sold (put).
6. Expiration date : The date at which an option
expires.
7. Option premium : The price paid by the buyer for
the right to buy or sell an asset.
8. Exercising the option : The act of buying or selling
the underlying asset via the option contract.
Option Contract Characteristics
Expirationmonth
Optiontype
Contractsize
Expiry
Exerciseprice
Option Valuation
S1 = share price at expiration S0 = share price today
The Value of the Firm C1 = value of call option on expiration
Value of the firm = marketed claims + non-marketed claims: C0 = value of call option today
–Marketed claims are the claims of shareholders and E = exercise price on the option
bondholders.
–Non-marketed claims are the claims of the government Value of Call Option at Expiration
and other potential stakeholders.
The overall value of the firm is unaffected by changes in the
capital structure.The division of value between marketed
claims and non-marketed claims may be impacted by capital
structure decisions.
Corporate Borrowing and Personal Borrowing
Without tax, corporate and personal borrowing are
interchangeable.
With corporate and personal tax, there is an advantage to
corporate borrowing because of the interest tax shield.
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Value of a Call Option Before Expiration Black–Scholes Option Pricing Model
Note: The risk-free rate, the standard deviation and the

time to maturity must all be quoted using the same time
units.
Call Option Boundaries Example—Black–Scholes Option Pricing Model

Upper bound—a call option will never be worth more than
the share itself:
C0S0
Lower bound—share price cannot fall below 0 and to
prevent arbitrage, the call value must be (S0 – E):
The larger of 0 or (S0 – E)
Intrinsic value—option’s value if it was about to expire =
lower bound.
Factors Determining Option Values
Call option value = Share price - PV of exercise price
The value of a call option depends on four factors:
share price
exercise price
time to expiration
risk-free rate.
Another Factor to Consider?
The above four factors are relevant if the option is to finish
in the money.If the option can finish out of the money, From the cumulative normal distribution table:
another factor to consider is volatility.The greater the N(d1) = N(1.34) = 0.9099
volatility in the underlying share price, the greater the N(d2) = N(1.13) = 0.8708
chance the option has of expiring in the money. Therefore, the value of the call option is:
The Factors that Determine Option Value
Equity: A Call Option

Equity can be viewed as a call option on the company’s
assets when the firm is leveraged.The exercise price is the
value of the debt.If the assets are worth more than the debt
when it becomes due, the option will be exercised and the
shareholders retain ownership.If the assets are worth less
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than the debt, the shareholders will let the option expire
and the assets will belong to the bondholders.
Equity Option Contracts
Types of equity option contracts offered in Australia:
–Exchange traded put and call options on company shares
–Exchange traded long dated contracts issued by a financial
institution that can then trade them (warrants)
–Over-the-counter options on company shares
–Convertible notes issued by companies, comprising both a
debt and an equity component.
Warrants
A long-lived option that gives the holder the right to buy
shares in a company at a specified price.
Types of warrants available:
equity warrants low exercise price warrants
fractional warrants endowment warrants Futures Contracts
basket warrants currency warrants An agreement between two parties to exchange a specified
fully covered warrants asset at a specified price at a specified time in the future.
index warrants Do not need to own an asset to sell a future contract.
instalment warrants Either buy before delivery or close out position with an
opposite market position.
Company Options
A holder is given the right to purchase shares in a company Futures Markets
at a specified price over a given period of time.Usually Enable buyers and sellers to avoid risk in commodities (and
offered as a ‘sweetener’ to a debt issue.These options are other) markets with high price variability → hedging.
often detached and sold separately. Involves standardised contracts.
Deposit required by all traders to guarantee performance.
Company Options versus Exchange-traded Options Adverse price movements must be covered daily by further
Company options have longer maturity periods and are deposits called margins (‘marked to market’).
often European-type options.Company options are issued Futures also available for short-term interest rates, to
as part of a capital-raising program and are therefore protect against interest rate movements.
limited in number.The clearing house has no role in the
trading of company options.Company options are issued by Futures Quotes
firms. Commodity, exchange, size, quote units : The contract size
is important when determining the daily gains and losses for
Earnings Dilution marking-to-market.
Put and call options have no effect on the value of the Delivery month : Open price, daily high, daily low,
firm.Company options do affect the value of the settlement price, change from previous settlement price,
firm.Company options cause the number of shares on issue contract lifetime high and low prices, open interest
to increase when: –The change in settlement price multiplied by the contract
–the options are exercised size determines the gain or loss for the day:
–the debts are converted.  Long—an increase in the settlement price leads to a
gain
This increase does not lower the price per share but EPS will  Short—an increase in the settlement price leads to
fall. a loss
Forward Contracts Open interest is how many contracts are currently

A contract where two parties agree on the price of an asset outstanding.
today to be delivered and paid for at some future
date.Forward contracts are legally binding on both Term Structure of Interest Rates
parties.They can be tailored to meet the needs of both Yield curve shows the different interest rates available for
parties and can be quite large in size.Positions : investments of different maturities, at a point in time.The
–Long—agrees to buy the asset at the future date relationship between interest rates of different maturities is
–Short—agrees to sell the asset at the future date called the term structure.
Because they are negotiated contracts and there is no Factors Determining the Term Structure
exchange of cash initially, they are usually limited to large, Risk preferences : borrowers prefer long-term credit
creditworthy corporations. whereas lenders prefer short-term loans (explains upward-
sloping yield curve only).
Supply : demand conditions—segmented capital markets
can cause supply-demand imbalances (explains all yield
curve shapes).
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Expectations about future interest rates (most favoured  Market bid : An announcement by a stockbroker
explanation) that a broking firm will stand in the market to
purchase the target company’s shares for a
specified price for a specified period.
CHAPTER 22
The Legal Framework
MERGERS, ACQUISITIONS AND TAKEOVERS
Legal Forms of Acquisitions

Merger complete absorption of one company by another.
Consolidation creation of a new firm by combining two
existing firms.
Advantages of mergers and consolidations:
 simplicity (buyer assumes all assets and liabilities)
 inexpensive.
Disadvantages of mergers and consolidations: Taxes and Acquisitions
 shareholders of both firms must approve Generally, assets purchased after 19 September 1985 are
 difficulty in obtaining cooperation of target subject to capital gains tax (CGT) when sold.CGT can be
company’s management. deferred under rollover provisions.CGT still applies when
the consideration is shares, and when more than 50 per
Acquisition of assets transfer of assets and liabilities of cent of pre-19 September 1985 shareholders have changed
the target company to the acquiring company. (regardless of purchase date).
Acquisition of shares (tender offer) acquire sufficient Gains from Acquisition

Voting shares to gain management control via a direct Synergy the value of the combined companies is higher
public offer for the shares. than the sum of the value of the individual companies.
Majority control versus effective control.

Acquisition Classifications
Horizontal acquisition : between two firms in the same Need to determine incremental cash flows.
industry.
Vertical acquisition : the buyer expands backwards by = Revenue – Cost – Tax – Capital requirements
acquiring a firm with the source of raw materials or
forwards by acquiring a firm that is closer in the direction of A. Increased revenues
the ultimate consumer. 1. Gains from better marketing efforts.
2. Strategic benefits—‘beachhead’ into new markets.
Conglomerate acquisition : involves companies in unrelated 3. Increased market power—monopoly.
industries.
B. Decreased costs
A Note on Takeovers 1. Economies of scale.
2. Economies of vertical integration.
3. Complementary resources.
C. Tax gains
1. Use of net operating losses.
2. Use of excess or unused franking credits.
3. Use of unused debt capacity.
4. Asset revaluations.
D. Changing capital requirements
1. Reduced investment needs.
2. More efficient asset management.
3. Sell redundant assets.
Takeover Situations
 Creeping takeover : Holdings in a target company Mistakes to Avoid
can be increased by no more than 3 per cent every Do not ignore market values.
six months. Estimate only incremental cash flows.
 Off market bid : A formal written offer is made to Use the correct discount rate.
acquire the shares of a target company.
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Be aware of transactions costs.

Acquisitions and EPS Growth
Pizza Shack and Checkers Pizza are merging to form Stop ’n’
Go Pizza. The merger is not expected to create any How much does Firm A have to give up?
additional value. Stop ‘n’ Go, valued at $1 875 000, is to
have 125 000 shares outstanding at $15 per share. Example—Cash Acquisition
Cost of acquiring Firm B is $675.
NPV of the cash acquisition is:
The value of Firm A after the merger is:
Price per share after the merger is $18.20.

Example—Share Acquisition
The value of the merged firm:
EPS has increased (and the P/E ratio has decreased) because
the total number of shares is less.The merger has not
‘created’ value.
Diversification Firm A must give up $675/$15 = 45 shares. After the merger
Does not create value in a merger. there will be 165 shares outstanding, valued at $17.33 per
Is not, in itself, a good reason for a merger. share.
Reduces unsystematic risk.
True cost of the acquisition: 45 shares × $17.33 = $779.85
BUT NPV of the merger to Firm A:
Shareholders can do this for themselves more easily and
less expensively.
The Cost of an Acquisition Cash acquisition preferred (higher NPV).
The net incremental gain from a merger of Firms A and B is:
V = VAB – (VA + VB) Defensive Tactics
Managers who believe their firms are likely to become
The total value of Firm B to Firm A is: takeover targets and who wish to fend off unwanted
VB* = VB + V acquirers often implement one or more takeover defences.
The NPV of the merger is: These defensive tactics take several forms:
NPV = VB * – Cost to Firm A of the acquisition –Friendly shareholders offer the best defence.
–Poison pills—designed to ‘repel’ takeover attempts.
The cost of the acquisition to Firm A depends on the –Share rights plans—allow existing shareholders to
Medium of exchange used to acquire Firm B—cash or purchase shares at some fixed price in the event of a
shares. Whether cash or shares are used to finance the takeover bid.
acquisition depends on the following factors: –Going private and leveraged buyouts—the publicly owned
 Sharing gains: If cash is used, the selling firm’s shares in a firm are replaced with complete equity
shareholders will not participate in the potential ownership by a private group (often financed by debt).
gains (or losses) from the merger. Terminology of Defensive Tactics
 Control: Control of the acquiring firm is unaffected 1. Golden parachutes—compensation to top-level
in a cash acquisition. Acquisition with voting shares management.
may have implications for control of the merged 2. Poison puts—purchase securities back at a set price.
firm. 3. Crown jewels—selling off of major assets.
4. White knights—acquisition by a ‘friendly’ firm.
Example—Cash or Shares? 5. Lockups—option for a ‘friendly’ firm to purchase
Pre-merger information for Firm A and Firm B: shares or assets at a fixed price.
6. Shark repellant—designed to discourage unwanted
mergers.
.
Evidence on Acquisitions
Shareholders of target companies involved in successful
Both firms are 100 per cent equity financed. takeovers gainsubstantially.Abnormal gains of around 25
The estimated incremental value of the acquisition is per cent reflect merger premium.
Firm B has agreed to a sale price of $675, payable in cash or
shares. The value of Firm B to Firm A is:
PE1
Shareholders of bidding firms involved in successful Hong Kong Stock Exchange

takeovers only experience gains of 5 per cent. There are a Hong Kong Futures Exchange
variety of explanations for this: Shanghai Securities Exchange
–Overestimated anticipated gains Shenzen Stock Exchange
–Scale effect (bidders usually larger than targets) Osaka Stock Exchange
–Agency problem Tokyo Stock Exchange
–Competitive market for takeovers Tokyo Int’l Financial Futures Exchange
–Gains already reflected in bidder’s price (no new Singapore Stock Exchange
information) Kuala Lumpur Stock Exchange
Americas
CHAPTER 23 New York Stock Exchange
American Stock ExchangeBoston Stock Exchange
INTERNATIONAL CORPORATE FINANCE Cincinnati Stock Exchange
Chicago Stock ExchangePacific Stock Exchange
Philadelphia Stock Exchange
Domestic versus International Financial Management Chicago Board of Trade
Whenever transactions involve more than one currency, the Kansas City Board of Trade
levels of, and possible changes in, exchange rates need to Toronto Stock Exchange
be considered.The risk of loss associated with actions taken
by foreign governments also needs to be considered. This Europe and the UK
political riskcan be difficult to assess and difficult to hedge Frankfurt Stock Exchange
against.Financing opportunities encompass international London Stock Exchange
capital markets and instruments, which can reduce the Paris Bourse
firm’s cost of capital. Swiss Stock Exchange
International Finance Terminology Participants in Foreign Exchange Market

Cross rate Importers
–The implicit exchange rate between two currencies quoted Exporters
in some third currency. Portfoliomanagers
Foreignexchangebrokers
Euro Traders
–The monetary unit for the European Monetary System Speculators
(EMS).
Exchange Rates
Eurobonds Q: If you wish to exchange $100 for British pounds at an
–International bonds issued in multiple countries but exchange rate of $A1/£0.337, how many pounds will you
denominated in the issuer’s currency. receive?
A: $A100 ×(0.337) = £33.7
Eurocurrency
–Money deposited in a financial centre outside the country Q: You paid 20 French francs for a croissant in France. If the
whose currency is involved. exchange rate is $A1/FF4.1184, how much did it cost in
dollars?
Foreign bonds A: FF20 : 4.1184 = $A4.8563
–International bonds issued in a single country usually
denominated in that country’s currency. Exchange Rate Quotations
Foreign exchange market

–The market in which one country’s currency is traded for
another.
Gilts
–British and Irish government securities.
London Interbank Offer Rate (LIBOR)
–The rate most international banks charge one another for Example—Exchange Rates
overnight Eurodollar loans. If you wish to convert $A1000 to $US at the above exchange
rates:
Swaps –you SELL $A; therefore, the dealer BUYS $A
–Agreements to exchange two securities or currencies. –$A1000 ×0.5190 = $US519
Global Capital Markets If you now convert $US519 back to $A:
Asia/Pacific Region –you BUY $A; therefore, the dealer SELLS $A
Australian Stock Exchange –$US519 : 0.5215 = $A995.21
Sydney Futures Exchange
New Zealand Stock Exchange The difference is the dealer fee ($A1000 -995.21 = $A4.79).
PE1
Triangle Arbitrage Relative PPP Equation

You have observed the following exchange rates:
You have just made $A25!

Cross Rates Example—Relative PPP
To prevent triangle arbitrage: The German exchange rate is currently 1.3 DM per dollar.
–the $A can be exchanged for FF10 or DM2.00 The inflation rate in Germany over the next five years is
estimated to be 5 per cent per year, while the Australian
Cross rate must be: inflation rate is estimated to be 3 per cent per year. What
will be the estimated exchange rate in five years?
Solution—Relative PPP
Example—Cross Rates The DM will become less valuable; $A will become more
The exchange rates for the British pound and the Japanese valuable.The exchange rate change will be 5% – 3% = 2%
yen are: per year.
$A1 = £0.3538
$A1 = ¥63.74
¥180.16/£ £0.3538¥63.74 or £0.0056/¥ ¥63.74£0.3538 rate
Example—Covered Interest Arbitrage (CIA)
Types of Transactions
Spot deal an agreement to trade currencies based on the
exchange rate today for settlement within two business
days.
Spot exchange rate the exchange rate on a spot deal.

Forward deal an agreement to exchange currency at
some time in the future.
Forward exchange rate the agreed-upon exchange rate to
be used in a forward deal. Interest Rate Parity (IRP)
The interest rate differential between two countries is equal
Purchasing Power Parity to the percentage difference between the forward
The idea that the exchange rate adjusts to keep purchasing exchange rate and the spot exchange rate.
power constant among currencies.Absolute purchasing
power parity (PPP) is a commodity costs the same
regardless of what currency is used to purchase it or where
it is selling.
For absolute PPP to hold:
–transaction costs must be zero
–there must be no barriers to trade
–the items purchased must be identical in all locations.
Relative Purchasing PowerParity
The idea that the change in the exchange rate between two
currencies is determined by the difference in inflation rates Uncovered Interest Parity (UIP)
between the two countries.Relative PPP, therefore, explains The expected percentage change in the exchange rate is
the changesin exchange rates over time rather than the equal to the difference in interest rates.
absolute levels of exchange rates.
PE1
Translation Exposure
Uncertainty arising from the need to translate the results
from foreign operations (in foreign currency) to home
Combines IRP and UFR. currency for accounting purposes.
International Fisher Effect (IFE) Political Risk
Real interest rates are equal across countries. Changes in value due to political actions in the foreign
country.Investment in countries that have unstable
governments should require higher returns.The extent of
Combines PPP and UFR. political risk depends on the nature of the business:
Ignores risk and barriers to capital movements. –The more dependent the business is on other operations
within the firm, the less valuable it is to others.
Example—International Capital Budgeting –Natural resource development can be very valuable to
Pizza Shack is considering opening a store in Mexico. The others, especially if much of the ground work in developing
store would cost $A500 000 or 3 million pesos (at an the resource has already been done.
exchange rate of $A1/6.000 pesos). They hope to operate -- Local financing can often reduce political risk.
the store for two years and then sell it to a local franchisee.
Assume that the expected cash flows are 250 000 pesos in Types of Political Risk
the first year and 5 million pesos in year 2 (including the
selling price of the store and fixtures). The Australian risk-
free rate is 7 per cent and the Mexican risk-free rate is 10
per cent. The required return in Australia is 12 per cent.
Ignore taxes.
Method 1: Home Currency
Using the interest rate parity relationship:
CHAPTER 24
Example—Method 2: Foreign Currency Approach
Using a 3 per cent inflation premium: (1.12 ×1.03) –1 = LEASING
15.36%
Leasing versus Buying
Exchange Rate Risk

The risk related to having international operations in a
world where currency values vary.
Short-run exposure—uncertainty arising from day-to-day
fluctuations in exchange rates.
Long-run exposure—potential losses due to long-run,
unanticipated changes in the relative economic conditions
in two or more countries.
PE1
Leasing
What is a lease?
–A lessee (user) enters an agreement in which they make
lease payments to the lessor (owner) in return for the use of
the leased property/asset.
Who are the major providers of lease finance in Australia?
–Finance companies and banks.
What assets are leased?
–Any asset including photocopiers, cars, construction
equipment, computers, shop/office fittings and equipment.
24-709
Criteria for a Financial Lease
Types of Leases AAS17 ‘Accounting for Leases’ states that a financial lease
Operating lease occurs where substantially all risks and benefits pass to the
Financial lease lessee.A financial lease must be disclosed on the Statement
–Sale and leaseback agreement of Financial Position if at least oneof the following criteria is
–Leveraged lease met:
–the lease term is 75 per cent or more of the estimated
Operating Leases economic life of the asset
Short-term lease. –the present value of the lease payments is at least 90 per
Cancellable prior to the expiry date at little or no cost. cent of the fair market value of the asset at the start of the
Lessor is responsible for maintenance and upkeep of asset. lease.
The sum of the lease payments does not provide for full
recovery of the asset’s costs. Leasing and Taxation
Includes telephones, televisions, computers, photocopiers, Lease premiums paid under a lease contract are tax
cars. deductible.Any payment relating to the ultimate purchase
of the asset is not deductible.The residual payment does
Financial Leases not qualify as a tax deduction.Any profit made on the asset
Long-term lease. previously leased is subject to capital gains tax.
Non-cancellable (without penalty) prior to expiry date.
Lessee is responsible for the maintenance and upkeep of Example—Lease versus Buy
the asset. Macca Co. has to decide whether to borrow the $15 000
Lease period approximates asset’s economic life. needed to purchase a new gadget machine (with a
The sum of the lease payments exceeds the asset’s borrowing cost of 10 per cent) or to lease the machine for
purchase price. $4000 per annum. If purchased, the asset could be
Includes specialist equipment, heavy industrial equipment. depreciated using the straight-line method over the three-
year life. The company tax rate is 30 per cent.Under the
Residual Value Clause lease agreement, Macca Co. would be responsible for
Lease continues for its full term maintaining the machine?
Lessee can purchase the asset for its residual value, return
the asset to the lessor (paying any shortfall from residual Example—Lease versus Buy: Repayment Schedule
value) or renew the lease.
Lease is cancelled during its initial term
Lessee must pay outstanding premiums (less interest
component) plus residual value of asset.
Sale and leaseback agreements
Companies sell an asset to another firm and immediately
lease it back. Enables the company to receive cash and yet
maintain use of the asset.
Leveraged leases
The lessor arranges for funds to be contributed by one or Example—Lease versus Buy:Tax Subsidises Borrowing
more parties—form of risk-sharing and transferring tax
benefits. Often used to finance large-scale projects.
Leasing and the Statement of Financial Position
PE1
Example—Lease versus Buy:Tax Subsidises Leasing Net Advantage of Leasing
Example—Lease versus Buy:Net Advantage of Leasing

Setting Lease Premiums
Lease premiums are paid in advance in Australia.
Example—Lease Premiums
KAZ Co. has started a four-year lease of a photocopier which
has a $70 000 purchase price. Had the company purchased
the copier, the interest rate quoted on borrowings was 1.5
per cent per month. KAZ has agreed with the lessor to a
residual value of $10 000 at the end of four years.What will
The advantage is greater than zero so Macca Co. be the amount of the lease premiums?
should lease.
Solution—Lease Premiums
Residual Value
The residual valueis the amount for which the asset may be
purchased by the lessee from the lessor at the end of the
lease term.
The salvage valueis the amount the asset can be sold for in
the market place by the lessee (once they have acquired the
asset).
In the previous example, assume a residual value of $2000
and a salvage value of $1500.
Advantages of Financial Leases
Example—Lease the Asset with Residual Value No restrictions on future borrowing.
Can be tailored to suit firm’s needs.
Eliminates the need to raise extra capital.
No unnecessary financial outlay.
May be excluded from the Statement of Financial Position.
Facilitates financing capital additions on a piecemeal basis.
Is an allowable cost under government contracting.
Offers tax advantages.
Advantages of Operating Leases
Example—Borrow to Purchase the Asset with Residual Frees up capital for alternative uses.
Value Increases the company’s working capital.
Provides greater control due to greater certainty in future
outlays.
Assures more competent upkeep of asset.
Avoids the risk of obsolescence.
Avoids the equipment disposal problem.
Future outlays cost less in real terms due to inflation.
Disadvantages of Leasing
Interest cost often higher.
May not offer the right to the residual value of the asset.
Allows the acquisition of assets without submitting formal
capital expenditure procedures.
May cause distortions in the evaluation of interfirm and
interdivision performance.
PE1
Lacks the prestige associated with ownership.

Good Reasons for Leasing
Taxes may be reduced by leasing.
The lease contract may reduce certain types of uncertainty
that might otherwise decrease the value of the firm.
Leasing reduces the impact of obsolescence of an asset on a
firm.
Transaction costs may be lower for a lease contract than for
buying the asset.
Leasing may require fewer (if any) restrictive covenants
than secured borrowing.
Bad Reasons for Leasing
The perception of 100 per cent financing.
The apparent low cost.
Using leasing to artificially enhance accounting income.A
UTS SEMESTER GASAL 2012/2013
MANAJEMEN KEUANGAN
150 menit (Closed Book)
PE1
JAWABAN
1.) a
AR Turnover = Sales /
AR 11.24 kali
Average Collection
Period = 365 / (AR
Turnover) 32.49 hari
Inventory Turnover =
COGS / Inventory 16.09 kali
Fixed Asset Turnover =
Sales / Net Fixed Asset 4.60 kali
Total Asset Turnover =
Sales / Total Asset 2.78 kali
b
Comparing: with peers
& with prior
performance
Efisiensi Penggunaan
aset: AR turnover,
inventory turnover,
fixed asset turnover,
TAT
C.
Du Pont Analysis:
ROE = Net income / Equity = Net Income / Sales x Sales /
Equity = Net Income / Sales x Sales / Asset x Asset / Equity
ROE = Profit Margin x Total
Asset Turnover x Equity
Multiplier
RoE = Profitability,
Operating
PE1
efficiency, Leverage Find YTM of 002 --> Find YTM 001 -->
Find Price 001
Logic: YTM of 002, lower or higher
2013 2012
than its coupon?
Lower
Discount --> YTM
0.98 1.15 Profita
is higher than
Profit Margin % % bility
Answer: coupon
TAT 2.78 2.78 Stable
Higher
Use Trial and error --> Do this last.
Levera
Equity Multiplier 2.22 1.63 ge
6.02 5.21
RoE % %
Just to
prove
higher
leverag
Debt Ratio 55% 50% e Trial and Error 926,399,129.49
YTM 6% x 2 = 12%
d.
2013 2012 Price of 001 5,288,934,649.68
Current Ratio =
Current Asset / b.
Curr. Liab. 0.91 1.2 Year Dividend
Acid test Ratio =
(curr. Asset - 1 750.00
inventory) / Curr.
Liab 0.63 0.89 2 750.00
Debt Ratio 55% 50%
2.) 3 900.00 Up 20%
a
4 1,080.00 Up 20%
JWS001
5% constant
growth
162,500,
Req. Rate of
Par 5,000,000,000.00 000.00
Return 13%
every 3
c 13% months
Market Price 10,000.00
Same YTM as 10
Rekomendasi:
JWS002 years
overvalued or
Price? undervalued?
JWS002
Terminal Value D5/R-g3 14,175.00
Price 926,400,000.00
P0 11,231.00
Par 1,000,000,000.00
Market Price 10,000.00
every 6 50,000,0
So, stock is undervalued, Buy !
c 10% months 00.00
5 years 3. ) a.
PE1
Income Statement % %
Sales 1500 Total
Cost 800 0.5333333 40.00 Current
Inv 750 % Liability 475
Taxable Income 700
Total
Tax 238
Current 80.00
Net Income 462 Asset 1500 % LTD 800 n/a
Dividend 154
Add to R/E 308 Fixed
Asset CS & PIS 800 n/a
Sales up 25% Pro Forma 120.0 1385.000
Sales 1875 Net PPE 2250 0% RE 193 n/a
Cost 1000 2185.000
Taxable Total 193
Income 875
Tax (34%) 297.5
Net Income 577.5 200.0 3460.000
Dividend 192.4998075 Total 3750 0% Total 193
Add to R/E 385.0001925
EFN 290.00
Balance % of % of
Sheet Sales Sales b
Curr. Curr. Maximum Growth
Asset Liab. without External
10.67 Financing
Cash 160 % AP 300 0.2 Internal Growth
29.33 Rate =
AR 440 % NP 100 n/a 11
40.00 Total RoA X b 462/3000 x (1-0.33) 0.1 %
Inv 600 % Curr Liab 400 1 - 462/3000 x (1-
Tot Curr 80.00 1 - RoA x b 0.33) 0.9
Asset 1200 % LTD 800 n/a So, the maximum growth without external financing is
11%
Fixed
Asset CS & PIS 800 n/a Pro Forma
120.0
Net PPE 1800 0% RE 1000 n/a Sales 1,665.00
Total 1800
Cost 888.00
200.0 Taxable Income 777.00

Total 3000 0% Total 3000
Tax 264.18
Pro
Net Income 512.82
Forma % of % of
BS Sales Sales
Dividend 170.94
Current Current
Asset Liability
Add to R/E 341.88
10.67 20.00
Cash 200 % AP 375 % Pro % of % of
AR 550 29.33 NP 100 n/a Forma Sale Sale
PE1
BS s s
Current Current 990,000,000,000 52,900,000,000 544,500,000,00
Asset Liability 3 .00 .00 0.00
10.6 20.0
Cash 177.60 7% AP 333.00 0% Initial Outlay:
29.3 Izin 200,000,000.00
AR 488.40 3% NP 100 n/a Financing Cost 5,000,000,000.00 irrelevant
Total Sunk Cost 50,000,000,000.00 irrelevant
40.0 Current Net working capital 30,000,000,000.00
Inv 666.00 0% Liability 433 3yrs econ.
Total Life, can
Current 80.0 be sold at
Asset 1,332.00 0% LTD 800 n/a Net capital spending 500,000,000,000.00 100Bio.
530,200,000,000.00
Fixed
Asset CS & PIS 800 n/a
Depreciation - mesin 166,666,666,666.67 per year
120. 1,341.8 Year 1 Year 2
Net PPE 1,998.00 00% RE 8 n/a
2141.88 800,000,000,0 943,000,000,
Total 0171 Sales 00.00 Sales 000.00
40,000,000,00 46,000,000,0
200. 3374.88 FC 0.00 FC 00.00
Total 3330 00% Total 0171
440,000,000,0 518,650,000,
Because total Liabilities and Eq. is bigger than Assets, so no VC 00.00 VC 000.00
EFN is needed
Plug Ex: Pay 44.8 in dividends so the B/S is Depreciatio 166,666,666,6 Depreciatio 166,666,666,
Variable? balanced n 66.67 n 666.67
4.) a
Year Unit Price Unit Sales 153,333,333,3 211,683,333,
EBIT 33.33 EBIT 333.33
1 1,000,000,000.00 800
53,666,666,66 74,089,166,6
2 1,150,000,000.00 820 Tax (35%) 6.67 Tax (35%) 66.67
Add: Add:
3 1,200,000,000.00 825 Depreciatio 166,666,666,6 Depreciatio 166,666,666,
n 66.67 n 666.67
VC 55% of Sales
Operating 266,333,333,3 Operating 304,260,833,
FC 40,000,000,000.00 Cash Flow 33.33 Cash Flow 333.33
Up by 15% every year
Ye 0 1 2 3
ar Sales FC VC
Operatin 304,260, 313,523,
800,000,000,000 40,000,000,000 440,000,000,00 g Cash 266,333,33 833,333. 333,333.
1 .00 .00 0.00 Flow 3,333.33 33 33
Changes
943,000,000,000 46,000,000,000 518,650,000,00 in NWC (30,000,0 30,000,0
2 .00 .00 0.00
PE1
00,000.00 00,000.0 b. Menghitung expected return dari portofolio.

) 0 c. menghitung standar deviasi dari saham A dan C
Aset Jumlah Kondisi
(500,200, investasi ekonomi
Capital 000,000.0 6500000 Total 25000000 Boom Normal Recession
Spending 0) 0000 investasi (25%) (50%) (25%)
Saham A 10000000 20% 16% 13%
Total Saham B 8000000 18% 13% 11%
Project (530,200, 304,260, 408,523, Saham C 4000000 16% 11% 8%
Cash 000,000.0 266,333,33 833,333. 333,333. Risk Free 3000000 7% 7% 7%
Flow 0) 3,333.33 33 33 rate
NPV Soal 2 (20%)

Dengan informasi dari AA Power Co. di bawah ini, hitunglah
304,260, 408,523, WACC nya dengan asumsi pajak korporat sebesar 35%.
(530,200,00 + 266,333,33 833,333. 333,333.
Debt: 9,000 jumlah beredar dengan kupon 5 persen, nilai
0,000.00) 3,333.33 + 33 + 33 par : $1,000, dengan jangka waktu 5 tahun, dijual pada 92
(1+.15)^ persen dari par; pembayaran kupon dilakukan tahunan
(1+.15)^1 2 (1+.15)^3 (annually).
jika NPV positif, accept the project
Common Stock: 260,000 jumlah beredar, dijual dengan
Payback harga $57 per share; dengan nilai beta 1.05.
Period
Cover Preferred Stock: 15,000 jumlah saham beredar dengan 5
initial (530,200,00 Initial outlay percent dividen dari preferred stock, dengan harga pasar
$93 perlembar dan par $100 perlembar saham.
outlay of 0,000.00) Cumulative left
Market: dengan market risk premium 8 persen dan risk free
266,333,333 266,333,333,3 (263,866,666 rate sebesar 4.5 persen.
Year 1 ,333.33 33.33 ,666.67)
Soal 3 (20%)
a. Apakah skema pendanaan yang digunakan untuk
304,260,833 570,594,166,6 40,394,166,6 investasi pengembangan Angkasa Pura II?
Year 2 ,333.33 66.67 66.67 b. Jelaskan kekurangan dan kelebihan masing-masing skema
pendanaan yang dipilih oleh Angkasa Pura II.
408,523,333 979,117,500,0 Soal 4 (20%)
Year 3 ,333.33 00.00 PT Maxima mempunyai 10,000 saham yang beredar di
pasaran. Harga pasar saat ini ialah $15 per lembar
dengan EPS sebesar $1. Perusahaan mengumumkan 2:1
stock split. Anda memiliki 100 lembar saham dari PT.
263,866,666 Maxima.
so, 1 year + ,666.67 0.867238362
a. Apa pengaruh kebijakan stock split pada harga saham,
EPS dan kepemilikan (ownership stake) dari
304,260,833 saham anda?
,333.33 b. Jika PT. Maxima lebih memilih untuk menawarkan
Payback Period is 1+0.87 = 1.87 Years kebijakan 10% stock dividend daripada kebijakan
stock split diatas, bagaimana pengaruh kebijakan stock
dividend tersebut pada harga saham, EPS dan
kepemilikan (ownership stake) dari saham anda?
UAS SEMESTER GASAL 2012/2013
Soal 5 (20%)
MANAJEMEN KEUANGAN a. Berikut ini adalah informasi dari beberapa akun yang ada
di neraca PT. ABC:
150 menit (Closed Book)
Soal 1 (20%)
Anda adalah manajer investasi dari perusahaan sekuritas.
Gunakan informasi di bawah ini untuk:
a. Menghitung expected return tiap saham.
PE1
2.) Dengan informasi dari AA Power Co. di bawah ini,

hitunglah WACC nya dengan asumsi pajak korpora sebesar
35%.
Debt: 9,000 jumlah beredar dengan kupon 5 persen, nilai
par : $1,000, dengan jangka waktu 5 tahun,dijual pada 92
persen dari par; pembayaran kupon dilakukan tahunan
(annually).
Common Stock: 260,000 jumlah beredar, dijual dengan
(a.1) Hitunglah operating dan cash cycle dari PT. ABC. harga $57 per share; dengan nilai beta 1.05.
(a.2) Apa yang dapat dilakukan oleh PT. ABC untuk
mengurangi Cash Cycle-nya. Preferred Stock: 15,000 jumlah saham beredar dengan 5
percent dividen dari preferred stock, dengan harga pasar
b. PT. XYZ saat ini menjual seluruh produknya dalam bentuk $93 perlembar dan par $100 perlembar saham.
tunai dan berencana mengubah kebijakan tersebut dengan
menjual secara kredit. Informasi terkait perubahan Market: dengan market risk premium 8 persen dan risk free
kebijakan tersebut per periode dapat dilihat pada tabel rate sebesar 4.5 persen.
berikut ini:
Market
Current New Value: Weight:
Price per unit 100 104
Cost per unit 56 56 Debt 8280000 Debt 33.80%
Unit sales per month 2,750 2,800 C/S 14820000 C/S 60.50%
Jika required return adalah 2.5% per periode, maka hitung P/S 1395000 P/S 5.70%
NPV dari kebijakan tersebut. Apakah kebijakan baru Total 24495000
tersebut layak atau tidak untuk diterapkan?
Cost YTM: 6.90%
JAWABAN Cost of Debt After
(YTM) tax 4.49%
1.)
Re = Rf + β x (Rm-
A. Hitung expected
Cost of C/S Rf)
return tiap saham
Re 0.129
Saham A 16.25%
Cost of P/S D/Po
Saham B 13.75%
Rp 0.05
Saham C 11.50%
Risk Free Rate 0.07
YTM =
B. Hitung expected
return portofolio
Weight:
Saham A 0.4
Saham B 0.32 WACC = Weight Debt x Cost of Debt + Weight C/S x Cost
ofC/S + Weight P/S x Cost of P/S = 9.61%
Saham C 0.16
4)
Risk Free 0.12
Exp. Return Portofolio 13.58% Stock Split:
Sebelum Sesudah
C. Standar deviasi saham Jumlah saham
A dan C beredar 10000 20000
Varians St. Deviasi Harga Pasar 15 7.5
Saham A 0.0006 0.0249 Nilai Saham 150000 150000
Saham C 0.0008 0.0287
Misal: setelah %change
PE1
Earnings 1000000 1000000 Incremental cash flow 13400

Outstanding 10000 11000 PV of Incremental cash flow 536000
EPS 100 90.90909 9% Cost of switching 277800
(Current Price * Current Sales) +
VC(Qnew - Qcurrent)
a.) Harga saham berkurang 1/2x jadi $7.5
EPS berkurang menjadi $0.5 karena jumlah saham beredar naik 2 kali
NPV of switching 258200
Kepemilikan tidak berubah
(PV of incremental cash flow - Cost of
Nilai saham switching)
sebelum Nilai saham setelah
1500 1500Karena NPV kebijakan tersebut positif, maka kebijakan layak
diterapkan
b.) Stock Dividend
Harga saham turun karena kenaikan saham outstanding 10%
EPS turun sebanyak
Kepemilikan Tetap
5.) a.1
$
Avg Inventory 12,750.00
$
Avg A/R 8,375.00
$
Avg A/P 10,680.00
Inventory
Period 54.59 days
A/R Period 26.47 days
A/P Period 45.73 days
Inventory $
Turnover 6.69
$
A/R Turnover 13.79
$
A/P Turnover 7.98
Operating Cycle 81.06 (Inv Period + A/R Period)

(Operating Cycle - A/P
Cash Cycle 35.33 Period)
a.2
1. Meningkatkan efisiensi penggunaan Inventory dan pengumpulan A/R
2. Memperlama durasi
pembayaran A/P
b.
Cash flow with current policy 121000
Cash flow with new policy 134400
PE1

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Ringkasan Manajemen Keuangan

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Disusun oleh : Muhammad Firman (Akuntansi FE UI 2012)

The business is formed by two or more owners.

The Firm’s Objective

Utility curves Optimal Investment Policy

FINANCIAL STATEMENTS, TAXES,AND CASHFLOW

Utility Maximisation The Statement of Financial Position

The Statement of Financial Performance (Income

Debt versus Equity

Tax Rates Statement of Financial Performance or Income statement

WORKING WITH FINANCIAL STATEMENTS

Statement of Financial Performance ('000s)

‘Players’ in Accounting Standards

Capital Structure Ratios

Market Value Ratios

The Du Pont Identity

Uses for Financial Statement Information

Benchmarks for Comparison

LONG-TERM FINANCIAL PLANNING AND CORPORATE

What is Financial Planning? What is the plug?

Calculate the projected addition to retained earnings and

Example—Partial Pro-Forma Financial Position Statement

External Financing and Growth

Example—External Financing Needed

Ratios Calculated Relationship

–dividend policy (dividend payout) –interest earned$33.10

Future value (FV) is the amount an investment is worth

Future Value of a Lump Sum

Given any three factors in the present value or future value

Interpretation The Rule of 72

Future value calculated by compounding forward one

Future value calculated by compounding each cash flow

Solving for the Discount Rate

Present Value of Multiple Cash Flows Example 1

The compounding term is called the future valueinterest

Present value calculated by discounting back one period at a

m = number of times the interest is compounded

–Bank A:15%, compounded daily Bond Yields

Example 1—Bond Value

Example 2—Bond Value

VALUING SHARES AND BONDS

Interest Rate Risk and Time to Maturity

Example—Constant Growth Dividend

Non-constant Growth Dividend

Computing Yield to Maturity Example—Non-constant Growth Dividend

Ordinary Share Valuation

Constant Growth Dividend

Share Price Sensitivity to Required Return, r

An investment should be accepted if the NPV is positive and

CHAPTER 7 Advantages of Payback Period

Assume initial investment = $240

Discounted payback period is just under three years

IRR and Non-conventional Cash Flows

What’s the IRR? Find the rate at whichthe computed NPV =

Expresses a project’s benefits relative to its initial cost. Stand-aloneprinciple:wecanevaluatetheprojectonitsown.

Capital Budgeting in Practice

CHAPTER 8 Solution—Cash Flows

Incremental Cash Flows

Solution—NPV and Decision

The base case NPV is then:

Fairways Example—Scenario Analysis

Evaluating NPV Estimates

Fairways Example—Break-even Measures

SOME LESSONS FROM CAPITAL MARKET HISTORY

Dollar Returns Average Equivalent Returns & Risk Premiums 1978–2002