The 6 lessons of corporate finance

Question 1

What is the difference between accounting and financial logic with reference to the “theory of value”?

Answer 1

the accounting logic uses a “historical” perspective of capital accumulation, financial logic uses a “forward looking” approach.

While the former relies on historical cost, the latter values assets as a function of the cash flows they will generate in favout of the owner, discounted at a specific point in time.

Question 2

What are the three fundamental parameters of discounted cash flow valuation?

Answer 2

1. the amount of cash inflows and cash outflows
2. the time distribution of financial flows
3. the value of time and the risk of financial flows

Question 3

What is Net Invested Capital (NIC)?

Answer 3

NIC = Financial Debt (acc) + Equity (acc)

the capital a company has invested in its operations

Question 4

What role does risk play in estimating future cash flows?

Answer 4

Future flows are by definition an estimation, and the degree of risk depends on the difficulty in predicting them

Question 5

Valore contabile “asset side” vs. valore di mercato “enterprise value”: the process of creation of value.

Answer 5

Collection of capital [in the form of debt or equity] available to the enterprise to be
invested in operational projects [book value of equity and debt].

Through a selection of projects based on economic attractiveness, Net Invested Capital (or net assets) is employed and will generate operating cash flows associated with the investments.

The evaluation of future cash flows, discounted with appropriate risk, will determine market asset value.

Goodwill (Badwill if negative) is the difference between EV and NIC.

Question 6

Goodwill Formula

Answer 6

GW = EV - NIC = Equity(mkt) - Equity(acc)

Any change in EV is transfereed to the shareholders in the form of GW, and is not transferred to the market value of debt. This is why equity is defined as “risk capital”.

Question 7

What is the cost of capital?

Answer 7

The alternative return offered by the market for an investment with the same characteristics

Question 8

What is the internal rate of return (IRR)?

Answer 8

The cost of capital / discount rate that, applied to all cashflows, obtains an NPV of 0.

Note: the IRR solely depens on amount and timing of cashflows, NOT on market parameters (like the cost of capital)

Question 9

Price VS Value

Answer 9

Price is realized at a precise moment, value is an expression of uncertain future (discounted) cashflows.

Question 10

3 examples of corporate finance as a maturity transformation mechanism:

Answer 10

1. instant equity against furture income (dividends)
2. subscription of a loan (now) in exchange of future reimbursement
3. Operational investments against operating cash flows over a long horizon

Question 11

why is equity defined as risk capital?

Answer 11

because changes in EV are transferred to shareholders in the form of goodwill, and not to debtholders

Question 12

which are the most used measures to determine value creation?

Answer 12

Price/Book Value

Tobin’sQ=EV/NIC at replacement cost