Instagram: ECOsummaries DM me for 20% discount!
Summary for the course 'Advanced Corporate Finance'. This summary was written in order to study for the final. Everything you need to know is available in this summary.
Instagram: ECOsummaries DM me for 20% discount!
,Lecture 1 – Revision and introduction
Financial sources:
1. Internal capital:
- Retained earnings: profits that are kept within the company to invest back into the
company.
2. External capital:
- Debt: borrowed money to be paid back with interest.
→ Debt holders usually have no voting rights.
→ Debt is senior to equity (receive money before equity holders).
- Capital: compensated with dividend, which is dependent on company performance.
→ Equity holders have voting rights.
Leverage definitions:
Academic leverage:
Industry leverage:
➔ Indicated with 3X or 4X etc.
Meaning: X years of earnings to pay back entire debt.
Modigliani-Miller irrelevance theorem:
Perfect world:
Assumptions:
1. Perfect financial markets:
- Competitive (price takers)
- Frictionless (no transaction costs)
- Rational agents
2. Equal information among agents:
- No inside information, no information asymmetry, etc.
3. No bankruptcy costs
4. No taxes
MM-Proposition I:
- Firm value = PV(FCF) (future cash flows)
- Firm value is independent of capital structure.
- Firm value = real assets (cash flow equity + cash flow debt)
- ‘’The size of the pie is what matters, not HOW we slice it’’
Notation:
VU = VE = (EBIT) / rU (rU = required return on unlevered equity)
VL = D + E = ((interest + (EBIT – interest)) / rU (same as above just added CF of interest)
VE = VL – value of debt (of a levered company)
3
, MM-Proposition II:
- Cost of equity increases with its D/E ratio.
- WACC: rate that a company is expected to pay on average to all its security holders
- RWACC = RU (cause then D = 0) = RA
-
- If WACC > rD, then rE is
increasing with D/E
- Higher debt makes equity
riskier → higher rE
Business risk: firm risk, which is not related to debt
Financial risk: risk of the equity investment
➔ Unlevered firm: business risk = financial risk, because assets = equity (intertwined)
➔ Levered firm: higher financial risk, because equity has become riskier
→ Equity has to absorb everything instead of debt.
→ Debt is senior to equity
→ Absorb 10% vs 20% of initial investment
→ Higher rE = higher compensation
4
The benefits of buying summaries with Stuvia:
Guaranteed quality through customer reviews
Stuvia customers have reviewed more than 700,000 summaries. This how you know that you are buying the best documents.
Quick and easy check-out
You can quickly pay through credit card or Stuvia-credit for the summaries. There is no membership needed.
Focus on what matters
Your fellow students write the study notes themselves, which is why the documents are always reliable and up-to-date. This ensures you quickly get to the core!
Frequently asked questions
What do I get when I buy this document?
You get a PDF, available immediately after your purchase. The purchased document is accessible anytime, anywhere and indefinitely through your profile.
Satisfaction guarantee: how does it work?
Our satisfaction guarantee ensures that you always find a study document that suits you well. You fill out a form, and our customer service team takes care of the rest.
Who am I buying these notes from?
Stuvia is a marketplace, so you are not buying this document from us, but from seller ecosummaries. Stuvia facilitates payment to the seller.
Will I be stuck with a subscription?
No, you only buy these notes for $7.22. You're not tied to anything after your purchase.
