Financial Management... 100 Slides Cash
Raw materials inventory
Receivables
Finished goods inventory
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Key Words... Financial Market – Present Value – Perpetuity – Annuity – Compound Interest – Inflation – Bond Yield – Share Value – Free Cash Flow – IRR – Risk Valuation – Markowitz – SML – CAPM – Beta Risk – APT – Portfolio Theory – Economic Profit – Call Option – Straddle – Option Pricing Theory – Leverage Ratio – Liquidity – Du Pont – Private Equity – Volatility – Working Capital – Valuation – Value Drivers – Risk/Return – Diversification – Corporate Finance – Yield – NPV – Cash Transfer – Accounting
The Dual Functions of Financial Markets
The financial markets
The primary market
The secondary market
cash
The firm
cash
Investors newly issued securities
Investors
Investors outstanding securities
Present Value Present Value
Discount Factor
Value today of a future cash flow.
Present value of a $1 future payment.
Discount Rate Interest rate used to compute present values of future cash flows.
Present Value = PV PV = discount factor ´ C 1
PV
= DF ´ C 1 =
DF = C1 1 + r1
1 (1+ r ) t
Net Present Value
NPV = PV - required investment
C1 NPV = C 0 + 1+ r
Perpetuity Perpetuity - Financial concept in which a cash flow is theoretically received forever. cash flow present va lue C = r PV
Return =
PV of Cash Flow =
cash flow discount rate
C PV = 1 r
Annuity
Annuity - An asset that pays a fixed sum each year for a specified number of years.
1 1 PV of annuity = C ´ t r r (1 + r )
Compound Interest 18 16 14
FV of $1
12
10% Simple 10% Compound
10 8
6 4 2 0
Number of Years
Inflation
Inflation - Rate at which prices as a whole are increasing. Nominal Interest Rate - Rate at which money invested grows. Real Interest Rate - Rate at which the purchasing power of an investment increases.
1 + real interest rate
= 1+ nominal interest rate 1+ inflation rate
Bond Prices and Yields 1600 1400 1200
Price
1000 800
600 400
200 0 0
2
4
6
5 Year 9% Bond
8
10
1 Year 9% Bond
12
14
Yield
Valuing Common Stocks I
Expected Return
P - P Div 0 = r = 1+ 1 P P 0 0
Capitalization Rate
Div 1 = P0 = r- g = r = Div 1 + g P0
Valuing Common Stocks II Return Measurements
Dividend Yield =
Div 1 P0
Return on Equity = ROE EPS ROE = Book Equity Per Share
Valuing Common Stocks III If we forecast no growth, and plan to hold out stock indefinitely, we will then value the stock as a PERPETUITY.
Div1 Perpetuity = P0 = r Assumes all earnings are paid to shareholders.
or
EPS1 r
FCF and PV
FCF1 FCF2 FCFH PVH PV = + + ... + + 1 2 H (1 + r ) (1 + r ) (1 + r ) (1 + r ) H
PV (free cash flows)
PV (horizon value)
NPV and Cash Transfers
Cash
Investment opportunity (real asset)
Firm
Invest
Shareholder
Alternative: pay dividend to shareholders
Investment opportunities (financial assets)
Shareholders invest for themselves
Internal Rate of Return
2500 2000 1500
NPV (,000s)
1000 500 0 -500 -1000 -1500
-2000
Discount rate (%)
Rate of Return 1926 - 1997
60
Percentage Return
40 20 0 -20 Common Stocks Long T-Bonds
-40 -60
T-Bills
30
35
40
45
50
55
60
26
Year
65
70
75
80
85
90
95
Portfolio standard deviation
Measuring Risk
Unique risk Market risk 0
5
10
Number of Securities
15
Portfolio Risk I
The variance of a two stock portfolio is the sum of these four boxes: Stock 1 Stock 1 Stock 2
xσ 2 1
2 1
x 1x 2σ 12 =
x 1x 2ρ 12σ 1σ 2
Stock 2
x 1x 2σ 12 = x 1 x 2ρ 12σ 1σ 2 x 22σ 22
Portfolio Risk II
Expected Portfolio Return = (x r ) + ( x r ) 1 1
2 2
Portfolio Variance = x 2 σ 2 + x 2 σ 2 + 2 ( x x ρ 1
1
2
2
σ σ
1 2 12 1
2
)
Portfolio Risk III The shaded boxes contain variance terms; the remainder contain covariance terms. 1 2 3 STOCK
To calculate portfolio variance add up the boxes
4 5 6
N 1
2
3
4
5
6
STOCK
N
Beta and Unique Risk
B
i
=
s
im s2 m
Expected stock return beta
+10%
- 10%
+10% -10%
Expected market return
Markowitz Portfolio Theory Price changes vs. Normal distribution 600
# of Days (frequency)
500 400 300 200 100 0 -10% -8% -6% -4% -2%
0%
2%
Daily % Change
4%
6%
8%
10%
Efficient Frontier I
Return
Expected Return (%)
B A Risk Standard deviation
Efficient Frontier II
Expected Return (%)
T
rf
S Standard deviation
Efficient Frontier III
Return
Low Risk
High Risk
High Return
High Return
Low Risk
High Risk
Low Return
Low Return
Risk
Security Market Line I
Return
Market Return = rm
. Efficient Portfolio
Risk Free Return = rf Risk
Security Market Line II
Return
Market Return = rm
. Efficient Portfolio
Risk Free Return = rf
1.0
BETA
Security Market Line III Return
SML
rf 1.0
SML Equation = rf + B ( rm - rf )
BETA
Capital Asset Pricing Model (CAPM) Expected return
Security market line Market portfolio rate Rm = 13.5%
Rf = 5% Treasury bill rate
0
1
R = r f + B ( r m - rf )
Beta
Beta vs. Average Risk Premium
Avg Risk Premium 30 1966-91
20
SML
Investors 10
Market Portfolio
0
1.0
Portfolio Beta
Consumption Betas vs. Market Betas
Stocks (and other risky assets)
Stocks (and other risky assets) Wealth is uncertain
Market risk makes wealth uncertain.
Standard CAPM
Consumption
Wealth Consumption is uncertain
Wealth = market portfolio
Consumption
CAPM
Arbitrage Pricing Theory Alternative to CAPM Expected Risk Premium = r - rf = Bfactor1(rfactor1 - rf) + Bf2(rf2 - rf) + … Return = a + bfactor1(rfactor1) + bf2(rf2) + …
Portfolio Risk Specific company return (%)
Market return (%)
Capital Structure & COC Expected Returns and Betas prior to refinancing Expected return (%)
20
Requity= 15 Rassets= 12.2 Rdebt= 8
0 0
0.2
0.8
Bdebt
Bassets
1.2
Bequity
Risidual Income & EVA
Residual Income or EVA = Net Dollar return after deducting the cost of capital. EVA = Residual Income = Income earned - Income required = Income earned - [Cost of Capital ´ Investment]
Economic Profit
Economic Profit = capital invested multiplied by the spread between return on investment and the cost of capital. EP = Economic Profit = ( ROI - r ) ´ Capital Invested
Accounting Measurement
INCOME
RETURN
ECONOMIC
ACCOUNTING
Cash flow +
Cash flow +
change in PV =
change in book value =
Cash flow -
Cash flow -
economic depreciation
accounting depreciation
Economic income
Accounting income
PV at start of year
BV at start of year
M&M Proposition
r rE
rA
rD Risk free debt
Risky debt
D E
WACC (traditional and M&M view) r
r
rE rE WACC
rE =WACC rD D V
rD D V
r rE WACC
rD D V
Financial Distress
Maximum value of firm Costs of financial distress PV of interest tax shields
Value of levered firm
Value of unlevered firm
Debt
Optimal amount of debt
Call Option (long)
Call option value
Call option value given a $85 exercise price.
$20
85
Share Price
105
Put Option (long)
Put option value
Put option value given a $85 exercise price.
$5 80 85 Share Price
Call Option (short)
Call option $ payoff
Call option payoff (to seller) given a $85 exercise price.
85 Share Price
Put Option (short)
Put option $ payoff
Put option payoff (to seller) given a $85 exercise price.
85
Share Price
Protective Put Long stock and long put Long Stock
Position Value
Protective Put
Long Put Share Price
Straddle
Position Value
Long call and long put - Strategy for profiting from high volatility
Straddle
Share Price
Black-Scholes Option Pricing Model
Ps
v2 ln + (r + )t S 2
(d1) =
v
t
N(d1)=
32
34
36
38
40
Binomial vs. Black Scholes Expanding the binomial model to allow more possible price changes
1 step
2 steps
4 steps
(2 outcomes)
(3 outcomes)
(5 outcomes)
etc. etc.
Straight Bond vs. Callable Bond
Value of bond
Straight bond
100
Bond Callable at 100
75
50
25 Value of straight bond 25
50
75
100
125
150
Exchange Rate Relationship
1 + rforeign 1 + r$
1 + i foreign equals
equals
1 + i$ equals
f foreign
/$
S foreign
/$
equals
E(sforeign / $) S foreign / $
Leverage Ratios I
Long term debt ratio
Debt equity ratio =
=
long term debt
long term debt + equity
long term debt + value of leases equity
Leverage Ratios II
Total debt ratio
total liabilities
=
total assets
=
Times interest earned
Cash coverage ratio
=
EBIT interest payments
EBIT
+ depreciation
interest payments
Liquidity Ratios I
Net working capital
net working capital =
to total assets ratio
total assets
current assets Current ratio
=
current liabilities
Liquidity Ratios II
Quick ratio
cash
=
+ marketable securities + receivables current liabilities
Cash ratio
=
cash
+ marketable securities current liabilities
Interval measure
=
cash + marketable securities
+ receivables
average daily expenditures from operations
Efficiency Ratios I
Asset turnover ratio
=
sales average total assets
sales NWC turnover
=
average net working capital
Efficiency Ratios II
Inventory turnover ratio
Days' sales in inventory
=
cost of goods sold average inventory
average inventory
=
cost of goods sold / 365
Average collection period
=
average receivables average daily sales
Profitability Ratios I
Net profit margin
Return on assets
=
=
EBIT - tax sales
EBIT
- tax
average total assets
Return on equity
=
earnings available for common stock
average equity
Profitability Ratios II
Payout ratio
Plowback ratio
=
=
dividends earnings
earnings - dividends earnings
=
Growth in equity from plowback
1 - payout ratio
=
earnings - dividends
earnings
Market Value Ratios I
PE Ratio
Forecasted PE ratio
Dividend yield
=
stock price earnings per share
P
0 = aveEPS 1
=
=
Div 1 EPS 1
x
dividend per share stock price
1 r - g
Market Value Ratios II
Price per share
Market to book ratio
Tobins Q
=
=
=
P 0
=
Div
1 r - g
stock price book value per share
market value of assets estimated replcement cost
Du Pont System I
ROA
=
sales
x
EBIT
-
assets
sales
asset turnover
profit margin
taxes
Du Pont System II
ROE =
assets equity
x
sales
x
assets
leverage asset ratio turnover
EBIT - taxes sales
profit margin
x
EBIT - taxes - interest EBIT - taxes
debt burden
Firm‘s Cumulative Capital Requirement Dollars
A B C Cumulative capital requirement
Year 1 Strategy A: Strategy B: Strategy C:
Year 2
Time
A permanent cash surplus Short-term lender for part of year and borrower for remainder A permanent short-term borrower
Working Capital Simple Cycle of operations Cash
Raw materials inventory
Receivables
Finished goods inventory
Inventories & Cash Balances I
Total costs
Carrying costs
Total order costs
Optimal order size
Order size
Inventories & Cash Balances II Cash balance ($000) 25
Average inventory
12.5
0
1
2
3
4
Value of bills sold = Q =
2 x annual cash disbursement x cost per sale interest rate
5
Weeks
Private Equity Partnership Investment Phase
Payout Phase
General Partner put up 1% of capital
General Partner get carried interest in 20% of profits
Mgmt fees Limited partners put in 99% of capital
Partnership
Partnership
Company 1 Company 2 Investment in diversified portfolio of companies
Sale or IPO of companies
Company N
Limited partners get investment back, then 80% of profits
Increase in the Cash Flows from Assets
Debtholders They have fixed claims on these cash flows
Assets
Cash flows form assets Shareholders They have residual claims on these cash flows so that the larger the cash flows, the more value created
A Simplified View of the Financial Accounting Process
The firm
Financial transactions
The rest of the world
Financial accounting process
The income statement The balance sheet Records assets and liabilities at the date of the balance sheet. Their difference is the book value of equity at that date.
Records revenues and expenses over a period of time. Their difference, which represents an increase or a decrease in the book value of equity, is the profit or loss for the period.
Sources of Risk That Increase Profit Volatility
• Economic conditions • Political & social environment
+ 31% + 26% + 10% Less variable Earnings and before interest fixed and taxes expenses
SALES
Less fixed interest expenses and variable tax expenses
Earnings after taxes
- 10% - 26%
• Market structure • Firm‘s competitive position
ECONOMIC RISK
- 31%
OPERATIONAL RISK
BUSINESS RISK
FINANCIAL RISK
The Link Between the Balance Sheets and the Income Statement Balance Sheet December 31, 2001
Assets $170
Income Statement Year 2002
Liabilities $100
Balance Sheet December 31, 2002
Assets $190
Owner‘s equity $70 Revenues $480
Expenses $469.8
Liabilities $113 Owner‘s equity $77
Net Profit $10.2 Retained earnings $7 Dividends $3.2
The Managerial Balance Sheet Versus the Standard Balance Sheet The Managerial Balance Sheet Invested capital or net assets
Capital employed
Cash
The Standard Balance Sheet Total assets Cash
Short-term debt Working capital requirement (WCR) Operating assets less Operating liabilities
Short-term debt Operating assets
Long-term financing
Accounts receivable plus Inventories plus Prepaid expenses
Long-term debt plus Owner‘s equity
Net fixed assets
Liabilities and owner‘s equity
Operating liabilities Accounts payable plus Accrued expenses
Long-term financing
Net fixed assets
Long-term debt plus Owner‘s equity
The Firm‘s Operating Cycle and Its Impact on the Firm‘s Balance Sheet
Cash
Payments for nonoperating activities
Impact on the balance sheet: • Accounts receivable • Finished goods inventory
Impact on the balance sheet:
Sales
Procurement
Production Impact on the balance sheet: • Raw materials inventory • Work in progress inventory • Finished goods inventory
• Accounts payable • Raw material inventory
Sources of cash inflow
Sources of Cash Inflow and Cash Outflow Operating activities • Sale of goods and services
Investing activities • Sale of fixed assets • Sale of long-term financial assets • Collection of interest and dividend income • Collection of loans mad
Financial activities • Issuance of stocks and bonds • Long-term borrowings • Short-term borrowings
$2 $472
$13
CASH $18.2
Sources of cash outflow
$460.8 $12
Operating activities • Purchase of supplies • Selling, general, and administrative expenses • Tax expense
Net cash flow from operating activities $11.2
Investing activities • Capital expenditures and acquisitions • Long-term financial investments
New cash flow from investing activities ($10)
Financial activities • Repurchase of stocks and bonds • Repayment of long-term debt • Repayment of short-term debt • Interest payment • Dividend payment
New cash flow from financing activities ($5.2)
The Drivers of Return on Equity Return on equity ROE =
Earnings after tax Owner‘s equity
Return on invested capital ROIC =
Earnings before interest and tax Invested capital
Financial leverage multiplier
Operating profit margin
Capital turnover
Financial structure ratio
Earnings before interest and tax Sales
Sales Invested capital
Invested capital Owner‘s equity
Invested capital
Owner‘s equity
Sales
Operating costs
Cash
Working Capital requirement Fixed assets
Financial cost ratio
Tax effects
Tax effect ratio
Earnings before tax Earnings after tax Earnings before interest and tax Earnings before tax
Cost of debt
Tax rate
The Financial System Intermediation via institutional investors
S U P P L I E R S
Insurance policies Retirement plans Shares in funds
Insurance companies, pension funds, Investment funds & venture capitalists CASH
CASH SHARES
CASH
CASH
CASH BONDS
PRIVATE PLACEMENT
Money Market Instruments
The equity market
CASH
SHARES
(Trading in shares of common stocks)
SHARES
CASH
The corporate market
CASH
BONDS
(Trading in corporate bonds)
BONDS
OF
CASH
The money market
CASH
F U N D S
Commercial paper
(Trading in money market instruments)
CASH
Commercial paper
Bank certificates of deposit (CD)
BANK DEPOSITS
Intermediation via banks
DEBT OWED TO BANKS
CASH
and other lending institutions
CASH
F I R M S
Alternative Equity Valuation Models Market multiples model
Dividend valuation model
Firm‘s earnings, cash flows, or book value multiplied by the Corresponding market multiple
Discounted cash flow model
Firm‘s earnings, cash flows, or book value discounted at the
Future expected dividends
Equity value
discounted at the Cost of equity
equals
Present value of debt less the
Adjusted present value model Cash flows from assets Unlevered asset value
discounted at the Unlevered cost of equity
Levered asset value
Corresponding market multiple
Tax savings Present value of tax savings
discounted at the Cost of debt
The Drivers of Value Creation EBIT Operating margin = Sales Sales Capital turnover = Invested capital
EBIT Invested capital (pretax ROIC) Expected after tax ROIC
Tax effect = (1 – Taxe rate)
Aftertax cost of debt
Estimated cost of equity
Percent of debt financing
Return spread (ROIC – WACC)
Market Value Added (MVA) Weighted average cost of capital WACC
Percent of equity financing
If the present value of the future stream of expected return spreads is negative, MVA is negative and the higher the growth, the more value destroyed.
Economic, political, and social environments
Market structure Competitive advantages and core competencies EBIT = Earnings before interest and taxes (operating profit before tax); Invested capital = Cash + Working capital requirement + net fixed assets; WACC = (%Debt)(After tax cost of debt) + (%Equity)(Cost of equity).
If the present value of the future stream of expected return spreads is positive, MVA is positive and the higher the growth, the more value created.
Sustainability of growth
Capital-Budgeting Simulation Step 1: Develop probability distributions for key factors.
Probability
Step 2: Randomly select values from these distributions.
Market size
Value range Market growth rate
Share of market
Selling price
Fixed costs
Investment required
Residual value of investment
Operating costs
Useful life of facilities
Step 3: Combine these factors and determine a net present value.
Probability
Step 4: Continue to repeat this process until a clear portrait of the results is obtained.
Net present value
Step 5: Evaluate the resultant probability distribution.
Cash Flow Diagram Supplies and materials purchased using trade credit
Suppliers
Payments for credit purchases
Cash dividends
Saleable product (inventory)
Payment for fixed asset purchases
Payment for wages and salaries
Cash
Proceeds from sale or issuance of stock
Credit sales (accounts receivable)
Bad debts
Payment for heat and power
Cash sales
Collections from credit sales
Payment of taxes
Proceeds from sale or issuance of notes and bonds Interest and principal
Stockholders
Creditors
Government
Aggressive Financing Strategy: Permanent Reliance on Short-Term Financing Permanent dependence on short-term financing
DOLLAR AMOUNT
Temporary (short-term) financing
Permanent current assets Current assets Permanent plus spontaneous financing Fixed assets
TIME
Cash and Marketable Securities Management Irregular cash inflows Bond sales Other debt contracts Preferred stock sales Common stock sales In
Irregular outflows Dividends Interest Principal on debt Share repurchase Taxes
Out
Cash balance Purchase
Fixed assets
Sale
Purchase
Marketable securities
Sale
Labor and material
Depreciation
Inventory
Cash sales
Credit sales
Receivables
Collections
Three Ways to Transfer Financial Capital in the Economy (1)
(2)
(3)
Direct transfer of funds
Indirect transfer using the investment banker
Indirect transfer using the financial intermediary
The business firm (a savings deficit unit)
The business firm (a savings deficit unit)
The business firm (a savings deficit unit)
Securities
Firm‘s securities (stocks, bonds)
Funds (dollars of savings)
Marketable securities
Securities
Savers (savings surplus units)
Funds
Funds
Savers (savings surplus units)
Firm‘s securities
Funds
Marketable securities Intermediary‘s securities
Funds
Savers (savings surplus units)
Key Metrics Required for Different Company Situations High
Growth of net income
Need for long-term view • High probability of significant change of - Technology - Regulation - Competition • Long life of investments • Complexity of business portfolio
Low
Multiyear DCF of economic profit
Operating value drivers Net income, return on sales
ROIC-WACC, economic profit (one year)
Low
High
Capital intensity (need for balance sheet focus) • Working capital • Property, plant, and equipment
Various Levels of Value Driver Identification LEVEL 1
Margin
Margin Invested capital ROIC
LEVEL 2
LEVEL 3
Examples
Examples
• Customer mix • Sales force productivity (expense: revenue)
• Percent accounts revolving • Dollars per visit • Unit revenues
• Fixed cost/ allocations • Capacity management • Operational yield
• Billable hours to total payroll hours • Percent capacity utilized • Cost per delivery
Margin
• Accounts receivable terms & timing • Accounts payable terms & timing
Invested capital Invested capital
Generic
Business-unit specific
Operating value drivers
Customer Servicing – Human Expense Flowchart Call volume
Personal cost
Service Delivery Center expense Total CShuman expense
Number of SDCs
Cost per SDC
Number of people
Percent occupancy
Cost per person
Average work time per call
Number of stations per SDC
Hourly rate
Equipment cost per station Station cost
Headquaters expense
Benefits
Equipment, maintenance experse per station
Annual salary
Other equipment expense
Span of control
Benefits
Number of employees Overhead expense
Regional center expenses
Salary expense Supervisory cost
Area staff center expense Allocated G&A
Overhead cost
Utilities Number of supervisors
Other
Building operating expense
Number of employees
Building maintanance expense
Equipment Materials Other
% time on board % time in training % time on breaks % time on vacation % time paid Absence/other
Six Conditions for Excellent Value-Based Management Performance Driven 5
4 Low cost
3
Value-based
2 Highest level
1
Good Medium Sup par Lowest
Strong self-reinforcement process
Managed bottom up as well as top down Two-way communications
Simple Entity Valuation of a SingleBusiness Company Operating free cash flow
130
90
140
150 160
100
70
Debt value
Cash flow to debtholders
74
69 20
Operating value
85 80
36
43
Cash flow to equity owners Equity value 50
54
57
61
66
70
75
Entity Valuation of a Multibusiness Company 1,750 Excess marketable securities
150
Unit D
200
250
Corporate overhead
Market value: 300
Unit C
300 100
Unit B
400
1,500 1,100 Unit A
700
Total value before subtracting corporate overhead
Total company value
Common equity value
• Of debt • Of preferred stock
Steps in Valuation (1) Analyze historical performance
• Calculate NOPLAT and invested capital • Calculate value drivers • Develop an integrated historical perspective • Analyze financial health
(2) Forecast performance
• Understand strategic position • Develop performance scenarios • Forecast individual line items • Check overall forecast for reasonableness
(3) Estimate cost of capital
• Develop target market value weights • Estimate cost of noequity financing • Estimate cost of equity financing
(4) Estimate continuing value (5) Calculate and interpret results
• Select appropriate technique • Select forecast horizon • Estimate the parameters • Discount continuing value to present • Calculate and test results • Interpret results within decision context
Business System Analysis
Product Design and Development Issues • Product attributes • Quality • Time to market • Proprietary technology
Procurement
• Access to sources • Costs • Outsourcing
Manufacturing
• Costs • Cycle time • Quality
Marketing
• Pricing • Advertising/ promotion • Packaging • Brands
Sales and Distribution • Sales effectiveness • Costs • Channels • Transportation
Structure-Conduct-Performance Model
Industry
External Shocks
Producers
STRUCTURE
CONDUCT
Feedback
PERFORMANCE
Feedback
Cooperation vs. Rivalry
Rates of Return Implied by Alternative Continuing-Value Formulas Average ROIC CV =
NOPLAT WACC - g
CV =
NOPLAT WACC
Aggressive formula
Convergence formula
WACC
Time Forecast period
Continuing-value period
Impact of Continuing-Value Assumptions g = 8%
$3,000
$2,000 g = 6% CONTINUING VALUE ($)
g = 4% g = 2% g = 0%
$1,000
0 10%
12
14
16
18
RETURN ON NET NEW INVESTED CAPITAL
20
Relative Positions of Selected Industries Along Continuing-Value Parameters > Inflation
Growing
Entertainment Sporting goods Not economic
EARNINGS GROWTH
Most Information Soft firms processing drinks = Inflation
CONSUMPTION
Tobacco Not economic Defense Steel < Inflation
Declining = WACC
< WACC
> WACC
RETURN ON NEW CAPITAL Factors affecting returns
Low Many Short High
Entry costs Substitutes Life cycle Price elasticity
High Few Long Low
A Forecast Period that Will Result in a Poor Valuation of a Cyclical Business NOPLAT
Date of valuation TIME
End of forecast period
Risk/Return Trade-Offs of Hedging Programs E (Return)
E (Return)
A
Beta unchanged A
Rf
B Beta decreased Total risk
B
Rf
Beta unchanged
Beta decreased
Beta (undiversifiable risk)
Framework for Evaluating the Value of an Acquisition
Standalone value of acquiror (pre-merger)
Stand-alone value of target (without any takeover premium)
Value Transaction of costs synergies
Combined value
Value of next best alternative
Value of target to acquiror
Price paid including premium
Net value gained from acquisition
Patent Valuation: DCF Method Overview
Value (NPV) of technology/project/product
NPV = Estimation of present value of a business using discounted cash flows Maximal value of technology = NPV x Max Protection Factor
Value of patents = NPV x Pfmax x PPF
Max Protection Factor = Empirical factor indicating maximal impact of patents on NPV
Patent Protection Factor = Measure of the quality of the patent protection
Patent Valuation: Maximal Protection Factor Maximal Protection Factor
30% Empirical curve
5%
Technology under R&D
Mature Technology
Age of Technology
Patent-Value = Maximal-Protection-Factor x Patent-Protection-Factor x NPVtec Pval = Pmax x PPF x NPVtec
Acquisition of Real Options
High
Big bets
Alliance leverage
Low
Entry stakes
Risk pooling
LEVEL OF INVESTMENT (OPTION PRICE)
Internal
External
SOURCE OF OPTIONS
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