Dr. Andrew L. H. Parkes
“A practical and hands on course on the valuation and financial management of corporations”
The syllabus provides an outline of what we will do this semester: Chapters 1 - 4 as well as Chapters 12, 13 and
14 of the textbook.
This week we will talk about
Chapter 1 and some of 2;
The role of financial management and the business environment
The required textbook
Lectures: 2 hours per week I will introduce the new material to you
Practice Problems: 2 hours we will do assignments (@)from my slides and from the textbook
You will have to prepare assignments for every class; there is NO class without homework
You will work on a group project during the course and select a
S&P500 company that you would like to work on with your team.
You will simulate your own investments and learn about financial markets (e.g. investopedia.com -
Keep up to date with
Finance related issues
Mid-term test - 20%
Final Exam - 40%
Homework - 30%
Quizzes - 10%
Total - 100%
What are the most admired companies in the world?
High management quality companies
High employee talent companies
High product quality companies
High return on investment value companies
Financial sound companies
Social responsible (ethical) companies
Efficient use of assets companies
Money and capital markets
Warren Buffett – The Oracle of Omaha - #2 Forbes
World’s Billionaires - $52 Billion
Maximize stock value by:
– Forecasting and planning
– Investment and financing decisions
– Coordination and control
– Transactions in the financial markets
– Managing risk
Who owns GEICO?
Board of Directors
Capital Budgeting Director
Ease of formation
(to start-up the company)
Subject to few regulations
– No corporate income taxes
Difficult to raise capital
– Limited life
Stores along the Street
– Unlimited life
Easy transfer of ownership
Ease of raising capital
– Double taxation
– Cost of set-up and report filing
The incorporators of the corporation have to:
Create a charter of the company
– Name of the company
– Types of activities of the company
– Amount of capital stock
– Number and names/addresses of directors
Define a set of so called bylaws for the company
– How directors are elected
– Will shareholders have the first right on newly issued shares (right of first refusal)
– The conditions for changing the bylaws of the company
Investment decision: what assets does the firm need to hold and in what quantities?
Financing decision: how should these assets be financed? (debt or equity/ short or long?)
Asset management decision: how should assets develop over time with the growth/change of the business?
The primary financial goal is shareholder wealth maximization, which translates to maximizing stock price.
Do firms have any responsibilities to society at large?
Is stock price maximization good or bad for society?
Should firms behave ethically?
No, despite a generally high correlation amongst stock price, EPS, and cash flow.
Current stock price relies upon current earnings, as well as future earnings and cash flow.
Some actions may cause an increase in earnings, yet cause the stock price to decrease (and vice versa).
For stakeholders of the company like:
Customers (sustainable flow of products and services)
Suppliers (sustainable flow of raw material orders)
Employees (sustainable jobs with career perspectives)
Shareholders (growing share value and dividends)
Banks and Financial Institutions
(sustainable pay back of loans and interest)
The Government … (more profit is more tax income)
The Textbook approach…
Increasing FCF or lowering WACC%
The Company Value =
Long Term FCF/ WACC%
NOPAT ( N et O perating
P rofit [Earnings before
Interest] A fter T ax)
The increase in Net
Working Capital (NWC)
NOPAT you will find in the income statement of your company
Depreciation you will find in the income statement and cash flow statement of your company
NWC = Accounts Receivables plus Inventories minus Accounts Payables; the change from your to year you can calculate (a decrease in
NWC from one year to another is a Cash In
Flow so this adds to FCF)
CAPEX you will find in the cash flow statement it’s the amount spend on investments…
So if Google Inc. in the Long Term can generate a FCF of $ 3 b. And the WACC of Google Inc. is 10% then the value of
Google Inc. is (follow the formula)
Company Value (Google Inc.) =
$ 3 b/0.10 = $ 30 billion
Of course this is an example and I just made up the estimated FCF and WACC.
We will learn during the course how to estimate FCF and WACC to enable us to calculate the value of any company … under certain assumptions
This in fact is the core capability of finance
Once we can calculate the value of a company periodically, we can calculate if the company is in fact creating value for its stakeholders or destroying value
You have picked a S&P500 company to work on during the course:
Try to figure out what the Long Term Free Cash Flow is of your company by reading its annual reports (1999-2005) Limit yourself to the financial paragraph (5 years is fine).
Assume your companies’ WACC is anywhere in between 5% and
25%; 5% if your company is extremely financially solid and rather low risk, 25% if your company has a very volatile performance over the last 5 years and a bumpy road ahead and is an extremely high risk business (you may pick any WACC in between).
Step 1: Calculate the Company Value of your company under these assumptions.
Now look up the Long Term debt from the latest available Balance Sheet (sure you will find it under liabilities)
Subtract this figure from the Company Value you found in 1a)
Now you have the companies’ equity value
Divide that number by the number of common shares outstanding
Now you find the equity value per share outstanding or the calculated share price of your company
Compare this share price with the current share price of your company (take the latest closing price for comparison)
Does the market value the share of your company higher (over priced) or lower
(under priced) then what you calculated?
Why do you think there is a difference?
You can find your company’s figures at www.sec.gov
– Go to Filings and Forms (EDGAR)
– Search for company filings
– Look up the ticker symbol of your
company at Yahoo Finance
– Plug in the found ticker symbol
– Try GOOG and you will find all
the filings of Google Inc.
– Now search for the latest 8 and
10-K (annual reports) filings or
10-Q (quarterly reports)
Go to Yahoo Finance
Plug in the ticker of your company
See the left hand buttons “More on…”
For a quick scan of your company
Click Profile, Key Statistics
For Historical Share Prices click…
Professional research on your company…
Company events, news on your company…
Everything is here…Use it!
Your Homework is:
1) form a team 4-5 members max.
2) pick a S&P 500 company
3) download FY 2006 annual report of the company you have chosen
4) Try to calculate Free Cash Flow
5) Assume that the Cost of Capital is 10% (WACC%)
6) Calculate The Value of the company by: Value= Free Cash
Flow/Cost of Capital
Who is this man?
Did he create value in his companies?