Financial Management
Professor Jung-Wook Kim
CBA
SNU
Fall, 2023
Fall 2023
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 You should not share, post, nor distribute any
course related materials.
Fall 2023
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Finance
Investment
Fall 2023
Corporate
Finance
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Finance
 Investment:


a.k.a Asset Pricing, Portfolio Management
Optimal portfolio mix, investment strategy
 Corporate Finance: How to make optimal corporate
financial decisions?
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Corporate finance related decisions
 Time value of money related questions (lecture notes 3 & 4)
 How to justify spending huge amount of money to build a
factory (or not)? (lecture note 5 & 6)
 What is the cost of raising external funds? How to raise
them? Issuing bond (borrowing money) or issuing stocks?
 How to distribute the money a company earned to
shareholders? (dividend or share repurchases?)
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Example (Lecture Notes 3 & 4)
 A large coffee costs $1.65. If the bank’s quoted interest
rate is 6% APR with daily compounding, and if the
coffee price never changed, what would a lifetime free
subscription to Tim Horton coffee (a cup a day) be
worth today, assuming you will live for 50 more years?
What is the additional value of the subscription today
that allows you to bequeath or sell it after 50 years
(assuming that it gives a cup a day infinitely)?
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Personal financial problem
 Assume that you are 30 years old today, and that you are
planning on retirement at age 65. Your current salary is
$45,000 and you expect your salary to increase at a rate of
5% per year as long as you work. To save for your
retirement, you plan on making annual contributions to a
retirement account. Your first contribution will be made
on your 31st birthday and will be 8% of this year's salary of
$45,000. Likewise, you expect to deposit 8% of your salary
each year until you reach age 65. Assume that the rate of
interest is 7%.
 In this case, how much money you would have at age 65?
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Capital Budgeting of HomeNet
 Linksys is considering developing a wireless home networking
appliance, called HomeNet
 Linksys has already conducted an intensive, $300,000 feasibility study
to assess the attractiveness of the new product. Based on survey,
- sales forecast for HomeNet is 100,000 units per year with 4 year life
- retail price of $375,with an expected whole sale price of $260
- engineering and design costs: $5 mil
- production cost (outsourced. Including package): $110 per unit. Thus,
$11 million
- cost of software engineer: $0.2 million*50 engineer=$10 million
- new equipment for testing purpose: $7.5 million
- selling and marketing related cost (annual overhead): $2.8 million per
year
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Finance answers these questions
using
 Economics (underlying tools)
 Statistics or econometrics(data analysis)
 Accounting (language)
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Relevant building blocks (syllabus
topics) for the analyses
 NPV: net present value
 ‘present value’?-Time value of money
 Discount rate? Depending on risk
 ‘NPV rules’?-capital budgeting
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Example: Do these two firms have
the same level of risk?
 Cashflow in one year.
 Firm A:
0 in weak economy & 600 in strong economy
 Firm B: 600 in weak economy & 0 in strong economy
 Probability of weak (strong) economy is 0.5
 What are expected values of cashflows of Firm A and
Firm B respectively?
 What are variances?
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Stat facts: Expected value and
variance
~
Stat Fact 1: If X takes the value of X i with probability p i
n
~
Expected value=
E ( X ) =  pi X i
i =1
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Stat Fact 2: Variance is a measure of the dispersion of a random variable f
n
~
~
~
~
Variance= V (X ) =  pi (X i − E (X ))2 =p1(X 1 − E (X ))2 + p2(X 2 − E (X ))2
i =1
~
~
Standard Deviation= Std ( X ) = V ( X )
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 In terms of expected value and variance, both are the
same. Do they have same risk?
 Answer is….
Underlying concept to be discussed to answer this
question: Marginal utility of money and covariance
risk
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What is risk?
 Such an important
question in finance.
 Two economists, Hary
Markowitz and William
Sharpe received Nobel
prize for their
contribution in 1990.
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Uncertainty and Investment
Decision: Real Option Approach
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Example: Honey Butter Chip
 Was a huge success
 Looks very profitable.
Future discounted cashflow
may be greater than cost of
increasing production
capacity. But the
manufacturer did not
increase the capacity for a
sustained period of time.
Why?
 NPV vs real option approach
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Uncertainty and Investment
Decision: Real Option Approach
 Merton and Scholes received Nobel prize in 1997 for
their contribution in option pricing
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Relevant building blocks (syllabus
topics) for the analyses
 NPV: net present value
 ‘present value’?-Time value of money
 ‘NPV rules’?-capital budgeting
 ‘Options’?
 ‘Real options’?
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Capital Structure: two firms with
the asset of $1000
 Firm A borrowed $500
 Firm B has no borrowing at all (100% of money is from
the owner of the company, i.e., shareholders)
 Two firms have identical cashflow outlooks
 Which firm’s value will be higher?
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A theorem that started corporate
finance as a separate field
 Modigliani and Miller
theorem: Under the
assumption of ‘perfect
market’, financing
decision does not matter
 Modigliani received
Nobel prize in
Economics in 1985 and
Miller received Nobel
prize in 1990
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Market Efficiency in Economics and
in Finance
 Market efficiency in
economics: Wealth of Nation
(1776) describes a market
governed by ‘an invisible
hand’
 Allocative efficiency: “What
to produce, who will produce
and who will consume” can
be done best if left to
market. Central planning is
not necessary.
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Market Efficiency in Finance
 Most modern financial theories
assume that the stock market is
informationally efficient: New
information is quickly and
correctly incorporated into
stock prices
 Recently, there is a challenge to
this conventional view
 What if market is not ‘efficient?’
What is the implication on
corporate finance?
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‘Bubble’: Investors could be
irrational
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As of Aug 25, 2022
Robert Shiller (Yale,
Nobel Prize in
Economics, 2013)
1996
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Initial Public Offering
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Uber IPO Related (as of 2019-04-29)
2018 estimate was $120B
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Corporate ownership
 Ownership structure around the world; widely held
firm vs pyramidal structures
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Corporate ownership
A Typical Large US Firm
1.
2.
Widely held. No controlling shareholder
Freestanding. US listed firms usually don’t
control other listed firms
Minnesota Mining and Manufacturing
Almost 100% owned
by small shareholders
100% owned
Domestic subsidiaries
Public Shareholders
 Principal (owner of the company)-Agent (professional managers)
Problem: Principal wants profit maximization but agent may want
sales maximization.
 How to make professional managers faithful to small shareholders?
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Corporate Governance Elsewhere
Who Controls the top 20 listed firms in each country?
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Outside of US and UK, pyramid is quite common. Why?
Family Firm
Governance Problems in a Pyramid
>50%
>50%
A1
A2
>50%
>50%
B1
B2
>50%
>50%
C1
D1
D2
<50% in
each
>50%
D3
<50% in
each
>50%
C3
>50%
D4
<50% in
each
>50%
D5
<50% in
each
D6
<50% in
each
>50%
<50% in
each
>50%
C5
>50%
D7
B4
>50%
C4
>50%
>50%
B3
>50%
C2
>50%
>50%
D8
<50% in
each
>50%
D9
<50% in
each
>50%
C6
>50%
D10
<50% in
each
>50%
D11
<50% in
each
>50%
C7
>50%
D12
<50% in
each
>50%
D13
<50% in
each
C8
>50%
>50%
D14
<50% in
each
>50%
D15
<50% in
each
D16
<50% in
each
Public Shareholders
1. Family has little real stake in most firms
2. Family is entrenched (votes > 51% in each firm)
3. Family can “tunnel” funds from one firm to another to
concentrate wealth in the ones it owns directly
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