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Summary MFD LU5-8
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Summary of LUs 5-8 from powerpoints and notes from lecturers
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LU 5 – Valuing an InvestmentInvesting: Any investment (asset) with economic benefits lasting more than a year
(otherwise it is an expense)
It is wise to invest money because leaving it in a bank will make you lose money due to
inflation.
Purpose of investing: Good investment?
Creating value More sales
Increase sales Less costs
Decrease costs More profits
Conform to regulations More customer satisfaction
Replace obsolete asset Better corporate image
Or combination = all increase VALUE of investing
company
Managers need to protect interest of both parties (owners and creditors)
Optimal asset structure
Different forms of debt & equity
Ensuring tradability of stocks & bonds
Goal of hospitality financial management
''To make decisions that maximize the present value of the company or the wealth of
the hospitality company's owners''.
Creating and Maximizing Value
Present value
W 0 =¿0 +V 0 (¿)t
W0 owners present value in the firm at present time
¿0 any immediate cash dividends to be paid at present time
V 0 (¿)t the value of all future cash dividends at the present time
Using this model, an investor would require the sum of all current dividends + future
dividends to be bigger than the investment made at present time.
HOWEVER:
Not all companies pay dividends (eg. Facebook or AirBNB)
o Using this model, your investment would be worthless, which is incorrect
,Reinvestment Decision:
When the benefits (the current value of future dividends (V0[DIVt]))
are larger than the costs (money invested at present time INV0), then owners
value (W0) will increase.
When the costs of the investments are higher than the expected benefits,
owners value will decrease.
When the costs equal the benefits, owners value remains unchanged.
Major factors determining owner’s value:
of future dividends:
Timing When will they be paid? (the sooner the better)
Magnitude How much will be paid?
Riskiness How likely is it that these dividends will actually be paid? (certainty)
Risk of New Investments
Profit and value are not the same
Profit Revenues – all expenses
Value Risk adjusted profit
Road to Value
1. Determine proper required return (target)
Ke, Kd, Interest rate, Inflation, WACC
2. Determine if discounting (PV) or compounding (FV) is needed (how to calculate)
3. Determine relevant CFs (what to include in calculation)
Payback: simple CF, WACC based methods: adjusted CF
Step 1: Determine proper required return target
Investment Target Measure
Bank saving Interest rate
Pension scheme Expected return
Real income Inflation rate
Equity investment Ke (aka Re) required return on equity
Lending money Kd (aka Rd) required return on debt
Company project WACC weighted average of L and E
= every investment will lead to different required target returns for each type of investor
Equity normally requires higher return on debt
Due to difference in risks, the higher the risk the higher the required (DEMANDED) rate
of return (links to financial risk)
2
, Discount Rate Selection: RISK
Operating Risk (Business Risk) Financial Risk
The actual cash flow is not the same as Increased variability of cash flows to equity
the one that you projected due to the use of debt financing
Interest payment stays the same if
Factors that might jeopardize operating EBIT goes down
cash flow:
Seasonality The uncertainty of net income and cash flows
Fraud attributed to fixed costs financing
Strike
Conflicts In simple terms: As a result of the way we
Adverse market conditions fund our assets there may be situations
Sales where this structure might have a negative
Uncertainty of how much we will sell and impact on the outcome of the operation
at what price
Factors affecting: General Statements
Elasticity of product demand For the company, E is more expensive
Industry competition Debt may increase ROE
Revenues cyclicality = Shareholders prefer higher debt
100% debt financing unlikely (financial
Considerations when analysing: risk)
3
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