Professional Documents
Culture Documents
Corporation Finance
Course Material
Text: Berk and DeMarzo
(1st, 2nd, 3rd, 4th editions ALL ARE OKAY TO USE!)
Lecture notes refer to 2nd edition, readings for other editions
are in the class schedule posted online
Course packet: notes and cases
Chalk site: http://chalk.uchicago.edu
Lecture notes
Case questions
Problem sets & solutions
Announcements
Sample midterms and finals
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Course Requirements
Final grade based on
1. Final Exam (40% or 70%)
Cases
Case write-ups
All cases weighted equally
3 cases (of my choosing) graded on a 10 point scale
Other cases (including first case) graded on a credit/no credit basis
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Problem Sets
Problem sets are optional and not to be handed in
Discussed in review sessions
Most similar to midterm and final exam
Exams
You MUST take the midterm and final exam in the
section you are registered for
Allowed materials
Calculator (no cell phones)
One 8.5 X 11 in, double sided page of notes for midterm
Two 8.5 X 11 in, double sided pages of notes for final
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Make-up Exams
Exams cannot be rescheduled unless you
have a documented medical emergency,
documented conflict with your personal Booth
graduation ceremony, or a documented
conflict with an internship start date
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Administrative Information
Office Hours: by appointment
Email: kelly.shue@chicagobooth.edu
Teaching Assistant:
Ariel Almeida
Content or case questions, first email
ariel.almeida@chicagobooth.edu
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Overview of the Course
Part I: Capital Budgeting
What real assets should the firm invest in?
Project valuation will give us an answer to this question
PV, discount rates, valuation in practice (WACC and APV)
Who Am I?
Education
A.B, Harvard University, Applied Mathematics
Ph.D., Harvard University, Economics
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Executive Social Networks
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Percent
10
0
-1 0 1 2
Proportionate Change
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The Peter Principle
Firms promote based upon current job performance, at the expense of promoting
the best potential managers
Every employee tends to rise to his level of incompetence
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Overview
Cash Flows (CF) and Present
Value (PV)
These are two fundamental concepts
in Corporate Finance
This is partly a review
Readings: BD 4.1-4.5; 7.1-7.4
May want to brush up on Ch. 1-3
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Present Value
Cash received in the future is worth less
(time value of money)
Suppose you have a cash flow that
continues to time T
C1 C2 CT
PV0 = C0 + + + ... +
(1 + r ) (1 + r )2
(1 + r )T
PV formulas: Perpetuity
C C C
PV = + + + ...
(1 + r ) (1 + r )2 (1 + r )3
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PV formulas: Perpetuity and Annuity
PV today of perpetuity starting tomorrow:
PV = C/r
PV today of perpetuity that starts paying C
tomorrow which grows at rate g:
PV = C/(r-g)
PV today of annuity that pays a fixed sum (C)
each year for a given number of years (T)
C 1 C 1 1
PV = =C T
r (1 + r )T
r r r (1 + r )
NPV Rule
Take all projects with NPV > 0 and
Reject all projects with NPV < 0
Equivalent Statement
Buy the security if the PV of its future cash flows is
greater than the purchase price
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A DCF Example
You are the CEO of a microchip
manufacturing company
You know the cash flows of an investment in
a new technology will be:
$35M from investment today (year 0)
$20M annual after-tax cash flow starting in year 1
and growing at a 5% rate
Final cash flow comes at the end of the 7th year
No salvage value of new technology at the end
Investing in an alternative project with
equivalent risk has an expected return of 9%
9% is therefore the opportunity cost of capital in
this example
Kelly Shue Corporation Finance 35200
Cash Flow*
*in millions
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Cash Flows from the New Technology
Microchip Project
time 0 1 2 3 4 5 6 7
date Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Jan-12 Jan-13
Cash Flow* $(35.00) $ 20.00 $ 21.00 $ 22.05 $ 23.15 $ 24.31 $ 25.53 $ 26.80
*in millions
Cash Flow* $(35.00) $ 20.00 $ 21.00 $ 22.05 $ 23.15 $ 24.31 $ 25.53 $ 26.80
*in millions
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Questions
What does the NPV rule tell us about whether
we should build the microchip factory?
What if the project had a negative NPV at the
9% opportunity cost of capital?
Suppose the project had a negative NPV at
9% but a positive NPV at 8%, and a banker
approaches us who is willing to loan us
money at 8%?
What if the best loan rate we can get from a
bank is 10%?
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Some Cash Flow Rules
Four basic ingredients in cash flows are:
Revenues, costs, investments, taxes
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Income Statement to Cash Flows
Projected Income Statement for the Project ($ thousands)
0 1 2 3 4 5 6
Sales 0 523 12,887 32,610 48,901 35,834 19,717
Cost of goods sold 0 837 7,729 19,552 29,345 21,492 11,830
Startup and SG&A costs 4,000 2,200 1,210 1,331 1,464 1,611 1,772
Depreciation 0 1,583 1,583 1,583 1,583 1,583 1,583
Pretax profit (EBIT) -4,000 -4,097 2,365 10,144 16,509 11,148 4,532
Interest 0 0 0 0 0 0 0
Tax -1,400 -1,434 828 3,550 5,778 3,902 1,586
Profit after tax -2,600 -2,663 1,537 6,593 10,731 7,246 2,946
Answer: No.
Kelly Shue Corporation Finance 35200
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Components of Investments
Four main investment cash flows:
1. Initial capital expenditures
2. Required ongoing capital expenditures
3. Change in net working capital (NWC)
Generally, NWC = CA - CL
In this class, NWC = Inventories +
Accounts receivable Accounts payable
Why is change in NWC an Investment?
4. Terminal value
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Method 1: Salvage Value (Liquidation)
Appropriate method if machine or project will be
sold off at the end of the horizon
Best for slow growing companies
Start with estimate of sale price of machine in
the year after the final forecasted cash flow
Consider tax implications
Salvage Value
= SALEPRICE TAX LIABILITY
= SALEPRICE
taxrate*(Saleprice Depreciated Book Value)
Note: In the cases that we will do in this course, the terminal value is
usually recognized during the final year of the operating cash flows.
Note: All NWC is recovered in the final year of operating cash flows
Kelly Shue Corporation Finance 35200
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Method 2: Continuation Value (Perpetuity)
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Takeaways
Make valuation decisions based on the NPV rule:
Take all projects with NPV > 0 and Reject if NPV<0
Cash flow are DIFFERENT from accounting earnings
CF = EBIAT + Depreciation Investments
Investments = Initial CAPX + Ongoing CAPX + NWC +
Terminal Value
Terminal Value:
Salvage value (liquidation method) or
Continuation value (perpetuity method)
Only count cash flows that are additions or subtractions
to what the firm is already doing
Ignore sunk costs
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