Week2 15-16 - 0 Ca Foscari University of Venice MSc on...

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FINANCIAL’ANALYSIS’AND’FINANCIAL’ PLANNING:’HOW’TO’COMPUTE’CASH’ FLOWS’ Show’me’the’money from’Jerry’Maguire’ 0 Ca±’Foscari’ University’of’ Venice MSc’on’ Economics’and’Finance Advanced’Corporate’Finance Lecture’4&5&6’–’BMA29
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1 First’Principles’ Aswath’Damodaran’ 1
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2 How’to’create’value’-’IntroducUon’ Measurement’issues 2 ! How’does’a’frm’decide’whether’to’go’ahead’with’an’ investment’project ?’ ! ±sing’Investment’SelecUon’Criteria’to’pick’valuable’ investments’(‘valuable²’means’Max.’Shareholders’Wealth’=’ Equity’MV’Value)’ ! Efficient’SelecUon’Criteria:’NPV’and’IRR’(see’Week’4).’All’ measures’are’based’upon’project²s’ Expected Free Cash Flows (FCFs)’ ! There³ore,’the’frst’step’o³’Capital’BudgeUng/ValuaUon’is’to’³orecast’ FCFs.’ ! How’to’esUmate’investment’project/business/frm’FCFs?’In’ pracUce,’FCFs’are’not’served’on’a’silver’pla´er!’
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3 FCFs’computaUon’ Rule’1:’Only’Cash’Flow’is’Relevant’ 3 ! FCF’is’the’ diference between cash received (Inflows) and cash paid out (ou<lows) :’we’ use’FCFs’since’we’are’interested’in’the’project’capability’to’generate’cash.’Yet,’many’ people’confuse’FCF’with’(some)’measure’of’accounUng’income.’ ! Cash Flows Vs. [email protected] Income (Earnings’typically)’ Income statements are’intended’to’show’how’well’the’company’is’performing:’they’are’ expressed’in’terms’of’ pro±ts ’earned’(i.e.’they’are’meant’to’show’how’money’are’earned)’ and’not’in’term’of’FCFs’(which’indeed’tell’us’when’money’flows’in’and’bills’are’paid’out)’ As’for’FCF’esUmaUon,’accountants’also’start’with’ “$ in” (Revs) - “$out” (Costs) ’(=EBITDA).’ Yet,’they’adjust’EBITDA’in’a’way’that’distances’their’result’from’Free’Cash’Flow,’which’can’ be’considered’as’the’exact’amount’of’money’that’is’actually’in’the’company.’ ! E.g.:’Accountants’sort’ouJlows’in’ current expenses and capital expenses :’they’deduct’current’expenses’when’ calculaUng’income,’but’do’not’deduct’capital’expenses’which’in’turn’a±ect’income’in’form’of’depreciaUon.’Why’ to’do’that:’if’a’²rm’lays’out’a’large’amount’of’money’on’a’big’capital’project’(e.g.’machine’purchase),’you’cannot’ conclude’that’the’²rm’is’performing’poorly.’Therefore,’the’accountant’does’not’deduct’CAPEX’when’compuUng’ the’income,’but’depreciates’it’over’the’years.’ !
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