Advanced Corporate Finance
Master Finance (period 1)
Lectures week 1
Topics A1, A2, B1 and B2
1 + 3 September 2025
Author / Copyright: H.A. Rijken
1
Topics week 1
Introduction to the course Corporate Finance
- Introduction Course outline
- topic A1 Overall Framework
- topic A2 Market Balance sheet versus Book Balance sheet
Topic 1 Business Model Analysis
- topic B1 Profitability Analysis
- topic B2 Analysis Working Capital Management
Introduction to case studies
Literature
•
EXAM – Standard text books on Corporate Finance. Basics on short term finance and working capital
management (for example Berk and DeMarzo chapter 26 – 27).
•
EXAM – Chapter 3 “Fundamental Principles of Value Creation”, in McKinsey Valuation
•
EXAM – Chapter 11 + 12, “Reorganizing the Financial Statements”, “Analyzing Performance”, in McKinsey
Valuation (exclude tax issues and advanced issues, page 239 – 244).
•
EXAM - Supply Chain Fundamentals. This brochure from PrimeRevenue (consultant and service provider)
gives an overview on Supply Chain Finance. Study this brochure with the SCF case (Procter & Gamble) in
the back of your mind.
2
McKinsey Book “Valuation”: ​a must to have (read)​
Very Strong in
- Concept of DCF
- Linking business model with DCF
- Teaching professional language
A little weaker / less complete in
- Cost of Capital
- Multiple Valuation
- Link with Corporate Finance
3
Topic A1
Overall Framework
4
Corporate Finance & Valuation in practice:
It all starts with understanding the business model
Free cash Flow
ROIC
Business
Assets
FCF engine
Equity
Investors
Debt
Asset/Business Risk + Financing Risk
- Solvency
- Liquidity
Value creation: ROIC > WACC
Objective: maximize value: V = Σ CF/(1+k)t
Discount rate (pricing risk)
- Cost of equity (pricing volatility)
- Cost of debt (pricing PD, LGD)
WACC
5
Corporate Finance at different levels
•
Long term finance
(LT investments, capital structure, equity versus debt)
•
Short term finance
- working capital management (total funding need for WC assets)
- liquidity management (liquidity assets, maturity funding)
•
Cash management
- organization of all transactions / payments in a company
6
topic A2:
Market Balance sheet versus
Book Balance sheet
7
Corporate finance:
- managing the balance sheet, matching assets with funding
Book balance sheet
Cash + Liquid assets
Accounts receivable
Short term liabilities
- short term debt
- accounts payable
Inventory
Long term liabilities
LT assets
- fixed
- non-fixed
- financial
Equity
8
Market balance sheet
asset
Company Value
liability
Market Value
Equity
= Present value
expected future FCF
Market Value Debt
9
COMPANY free cash flows (FCF)
are available to all investors after tax
I
Operational cash flows
= EBITDA – (‘other costs’) – tax (if 100% E) – Δ working capital
II
Investment cash flows (investments in fixed assets)
FCF = Operational cash flows (I) minus investment cash flows (II)
III
Financing cash flows (dividend, loan payback at maturity, rollovers, issue of new
shares etc.)
Δ working capital = increase account receivable and inventories + decrease in accounts
payable
I+II+III = Δ (cash + liquid assets)
Proxy for FCF = NOPAT
EXAM: McKinsey “Valuation” 7th edition , chapter 11
Sales
- Costs
EBITDA
- Depreciation
EBIT
- Tax (100% equity financed)
NOPAT (= proxy for FCF)
10
NOPAT calculations
EXAM: McKinsey “Valuation” 7th edition , chapter 11
11
How to account for investment cash flows?
• Maintenance investment (maintaining the current business level)
- Included in NOPAT
- replacement of assets
- proxy: depreciation costs (for assets related to EBIT figure)
- assumption: depreciation costs = costs replacement of assets (timing? --> inflation?)
- included in NOPAT
• Investment for growth
- from reinvestment of (part of) NOPAT
- determined by IR x NOPAT (IR = reinvestment rate)
- investments in extra assets AND/OR extra working capital
12
Invested Capital Calculations (BOOK value)
EXAM: McKinsey “Valuation” 7th edition , chapter 11
13
How should we measure invested capital?
McKinsey says: invested capital represents the cumulative amount the business has invested
in its core operations - primarily property, plant and equipment and working capital **
1 Book value
= fixed assets + non-fixed assets+ financial assets + inventory + accounts receivable + cash –
non interest rate bearing liabilities (sometimes cash is deducted)
(1) book value is based on historic invested capital and depend on depreciation policies
 book value representative for current situation (if invest from scratch)?
(2) Are all investment costs capitalized? (HR investment, brand investment etc)
 book value works best for companies with a lot of tangible assets
2 Replacement value is maybe a good alternative for book value
= often determined as historic invested capital with inflation correction
- but real investment from scratch is still difficult to determine “(investments in brand value,
development business network etc. are often not registered and labeled as costs in annual
statements).
3 Market value is for a proxy for invested capital, including intangibles
- BUT market prices adjusts by definition to ROIC = WACC (so, how to measure value creation?)
14
Basis formula for
company valuation
Distribution policy of FCF
Note: NOPAT = NOPLAT
= rough proxy for
free cash flow
NOPAT
growth g
-> time
EXAM: McKinsey “Valuation” 7th edition , chapter 3
15
If required return = expected return (no value creation),
growth by reinvestment has no impact on value, dividend is irrelevant
Company perspective
Value company = NOPAT1 (1 – IR)/(WACC-g)
Analogy for equity perspective
Value equity = NI1 (1 – IR)/(rE-g)
with g = ROICxIR
with g = ROEx(1-p) = ROExIR
NOPAT1 = EBIT*(1 – T) year 1
T = corporate tax rate
g = growth by reinvestment
IR = reinvestment rate
WACC = required rate of return equity
NI1 = net income year 1
g = growth by reinvestment
p = payout ratio
IR = reinvestment rate
rE = required rate of return equity
If ROIC = WACC
 Value company = NOPAT1 / WACC
If ROE = rE
 Value equity = NI1 /rE
Proof: if ROE = rE
Value equity = NI1*(1 – g/ROE)/(rE-g) = NI1*(1 – g/rE)/(rE-g) = (NI1/rE)*{(rE-g)/(rE-g)} = (NI1/rE)
Similar proof can be given for company perspective
16
BUT, how to deal with inflation?
If inflation exists NOPAT may grow with inflation, even without reinvestments
NOPAT grows with inflation IF
All items in NOPAT calculation
Growth by inflation
Sales
- Costs
EBITDA
- Depreciation
EBIT
- Tax (100% equity financed)
NOPAT (= proxy for FCF)
(+ inflation)
(+ inflation)
(+ inflation?)
(+ inflation)
IF NOPAT is expected to grow by long term inflation expectations as well, than
g = ROICxIR + inflation
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If required return = expected return (no value creation),
and growth g by reinvestment AND inflation gives
Company perspective
Value company = NOPAT1 (1 – IR)/(WACC-g)
WACC = ROIC
Value company = NOPAT1 / WACC
plus inflation*
Value company = NOPAT1 / (WACC – infl)
= NOPAT1 / (real WACC)
* = expected long term inflation
Analogy for equity perspective
Value equity = NI1 (1 – IR)/(rE-g)
ROE = rE
Value equity = NI1 /rE
plus inflation*
Value equity = NI1 /(rE – infl)
= NI1 /(real rE)
18
Illustration
Market balance sheet
HEMA (just before default in 2000)
19
HEMA case: Income statement Q3 2019
EBITDA = (4/3)x(30+36) = 88 mio
Interest expense = (4/3)x39 = 52 mio
20
HEMA case: BOOK balance sheet Q3 2019: asset side
(see the impact of IFRS-16)
21
HEMA case: BOOK balance sheet Q3 2019: liability side
(see the impact of IFRS-16)
22
HEMA case: invested debt capital (by contract, nominal value)
Question: can book equity be considered as invested capital?
23
HEMA case: Market balance sheet
(given the market value of debt  implied company value / WACC)
implied company value = 268 mio
total nominal value of debt = 774 mln
= FCF/WACC(real)
= (EBITDA – dep)x(1-T) / WACC(real)
= (88* – 48)x(1 – 0.3)/ WACC(real)
implied WACC(real) = 28/268 ≈ 10% *
implied EBITDA factor = 268/EBITDA ≈ 4 *
Market value debt:
- 10.75%x150 = 16 mio
- 38%x600 = 228 mio
- revolving = 24 mio
Total market value debt = 268 mio
Equity value = out of the money option
* Note: for EBITDA = 88 mln before the start of the COVID epidemy
Potential after restructuring:
reducing the claim to a “normal” 300
restructuring
Cash flow engine
For a healthy business
 WACC(real) should be
about 6.7% minus 2% inflation*
Going concern value
≈ (88 – dep)*(1-T)/WACC(real)
= (88 – 48)*(1 – 0.25)/0.047
= 650
300
0
Used credit facilities (assume)
40
340
Implied Equity Value = 650 – 340 ≈ 300
Debt = 340 ≈ 3.5*88 (factor close to 4)
(listed companies inv grade D/EBITDA ≈ 2.5)
D/650 = 340/650 ≈ 50%
(listed companies inv grade D/V ≈ 25%)
*WACC = 0.75*(1.5+1*6.5) + 0.25*4*(1 – 0.25) ≈ 6.7%,
= cost of equity (CAPM, no size premium) + cost of debt (after tax)
25
Topic B
Business Model Analysis
26
Corporate Finance & Valuation in practice:
It all starts with understanding the business model behind the FCF engine
Free cash Flow
ROIC
Business
Assets
FCF engine
Equity
Investors
Debt
Asset/Business Risk + Financing Risk
- Solvency
- Liquidity
Value creation: ROIC > WACC
Objective: maximize value: V = Σ CF/(1+k)t
Discount rate (pricing risk)
- Cost of equity (pricing volatility)
- Cost of debt (pricing PD, LGD)
WACC
27
Get started with business model analysis
by looking at financial ratio’s
1.
2.
3.
4.
5.
6.
7.
Profitability ratio’s (can be anything, but typical for the business model)
Efficiency ratio’s (efficient use of assets)
Leverage ratio’s (financing/funding risk)
Liquidity ratio’s (“probability running out of cash”)
Coverage ratio’s (“interest payments relative to earnings level”)
Growth %
Ratio’s with market value information
Business performance (FCF level and FCF business risk profile)
- Find key business drivers (ratio’s): in sales, cost structure and thus profitability
- Find trends in key drivers  time series
- Compare key drivers with peers cross section, relative to peers
Financing (funding) performance (financial risk)
- solvency, liquidity, coverage ratio’s, collateral quality
28
Ratio analysis is
a first quick and dirty analysis of a company
• Find ratio’s relevant for the business model
• Ratio’s only tell a story IF
- benchmarked with sector peers
- compared with historical time series
• Separate out structural and incidental developments
• Be aware of accounting differences / changes in accounting practice
• Risk is (mostly) measured by deviations from sector averages
• Detect inconsistencies !
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Topic B1
Profitability analysis
- Dupont Analysis
30
Profitability analysis: look at
(1) Dupont formula, (2) added value, and (3) breakeven calculations
1 Dupont formula
ROE
(1 - debt/total assets)
ROA
Net profit margin
= net income / turnover
Asset turnover
= turnover / assets
2 Added value
Gross margin ratio = (net sales – COGS) / net sales
3 Fixed versus variable costs
- Breakeven analysis
- Cash breakeven analysis (also includes cash investments in fixed assets and
working capital for additional turnover)
31
Profitability by total assets (TA)
does not differ that much between industries
NI / TA
excl.
extraordinary EBITDA/TA
items
EBIT/TA
NI/TA
agricultural
6,8%
4,1%
3,7%
9,9%
mining construction
11,3%
7,5%
7,1%
17,3%
heavy industry
10,4%
5,3%
5,2%
14,4%
industry
10,0%
6,1%
5,9%
13,7%
transport en utility
7,5%
3,9%
3,8%
11,7%
retail and wholesale
10,7%
6,3%
6,1%
14,6%
service
9,0%
5,8%
5,3%
12,7%
Data: US listed companies
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A variant to the Dupont formula
EXAM: McKinsey “Valuation” 7th edition , chapter 12
33
Topic B2
Working Capital Management
- Cash Conversion cycle
- CCC in the (business) supply chain
- Financing working capital
- Cash on the balance sheet
34
The cash conversion cycle provides insight
in the financing need for working capital
Supplier delivers
Delivery to client
Inventory, WIP cycle
Accounts Payable cycle
Accounts Receivable cycle
Cash conversion cycle
CCC needs to be financed
Payment to supplier
Client pays
35
Ernst & Young 2019 survey:
typical cycle statistics for the larger companies
Support lectures - All tied up working capital management 2019
36
Ernst & Young 2019 survey
Large differences in cycles among countries and sector
Support lectures - All tied up working capital management 2019
37
Trends in net working capital (no ST debt, no cash)
show that CCC is close to a “bottom level” since 2003
0.3
0.25
non sp500
0.2
sp500
0.15
0.1
0.05
0
1983
Author’s calculations
1988
1993
1998
2003
2008
2013
2018
2023
38
Working Capital usage is much lower for Private Equity
companies than for listed companies. Why?
PWC, 2017
Note that small improvements add up !!
39
Position in the supply chain, market power, business model
determines largely CCC
40
Objective is to “optimize” working capital
supply chain flexibility versus financing costs of WC
Inventory related
Receivable/payables
related
41
Management working capital
Business (FIRST, lower the need for financing as much as possible)
• Working Capital Management
- inventory management
- receivable/payables management
Finance
•
•
•
•
Company loan
(loan to a company)
Asset based loan financing (loan one-to-one linked to assets: > 100% collateral)
“Factoring”
(sell receivables)
Supply chain financing
(invoice financing by financial service provider)
42
Supply chain finance (= financing working capital)
Note: Demica is a financial service provider
EXAM - Supply Chain Fundamentals
43
Cash holding and net working capital
differences between sectors
Cash / TA
Net WC / TA
Net WC / TA
(no inventories)
agricultural
8,6%
17,8%
4,1%
mining construction
10,7%
9,2%
4,6%
heavy industry
12,5%
23,8%
5,3%
industry
18,0%
35,2%
14,0%
transport en utility
6,3%
5,1%
-0,6%
retail and wholesale
10,7%
24,1%
-4,8%
service
23,2%
24,0%
17,6%
Author’s calculations
44
Since the internet bubble the companies have more cash on the
balance sheet (more aware of liquidity risk or selection bias?)
cash / total assets
0.15
0.12
non sp500
sp500
0.09
0.06
0.03
0
1983
Author’s calculations
1988
1993
1998
2003
2008
2013
2018
2023
45
Motives to hold cash
(or cash equivalents, very liquid assets)
Motives to hold operational cash (= requirement to run the main business, ≈ 2% sales)
•
Transaction motive (to facilitate a mismatch in cash-in and cash-out, could be partly solved
by a credit facility)
Motives to hold operational/ non-operational cash
•
Precaution motive (business risk buffer, in case of no immediate access to capital market)
Motives to hold non-operational cash
•
Financing motive (finance risk buffer, in case access to capital market is difficult)
•
Strategic motive (ability to respond quickly to acquisition opportunities, without being
delayed by a required equity or debt issue, which takes time)
•
Self interest motive (rely in internal funding, to escape the market discipline of the capital
market. This is costly  agency costs)
46