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Lecture03c - FINM2401 Financial Management FINM2401...

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FINM2401 Financial Management Valuation Lecture 3 Valuation Basics Working Capital Bonds FINM2401 Financial Management Valuation Basics 3 Key Concept The value of any asset is the present value of all the cash flows that asset generates 4 Free cash flows to the firm The Role of the Firm Real Assets Net Cash Flow Re-investment Div idend s Interest Shareholders Debtholders V V E D
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5 Debt versus Equity Fixed return Contractual interest rate Fixed life Redeemed on maturity date Security Paid before shareholders Variable return Dividends only when declared Indefinite life No maturity date Security Residual claim on assets 6 Valuing the Firm Free cash flows to the firm are Net cash flow from operations Less capital expenditures required to keep the firm in business These are distributed to Debtholders as interest Shareholders as dividends 7 Valuing the Firm Value of firm is present value of all future free cash flows to the firm square6 Value of firm is market value of debt plus equity ( ) = + = 1 1 t t t r F V E D V + = FINM2401 Financial Management Working Capital Management
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9 Short Term Debt Sources of short term debt Trade credit Borrowing from banks and other financial institutions Money market sources Issuing short term marketable debt securities such as promissory notes and bills of exchange 10 Trade Credit Generally no explicit interest charge May be a discount for early payment 2/10 net 30 means: 2% discount if paid within 10 days Otherwise full payment within 30 days Not taking the discount is effectively an interest cost 11 How many 15 day periods in one year? For each dollar you don’t pay on day 10, how much must you pay on day 25? Cost of Trade Credit BuyRite acquires $10,000 of merchandise on terms of 1.5/10 net 25 What is the effective cost of not taking the discount? BuyRite can pay (.985)$10,000=$9,850 in 10 days or $10,000 in 25 days = + = 10000 9850 1 1.5228% r r ( ) - = 365 15 1.015228 1 44.45% 12 Try it out… pentasterisk6 BigCorp offers goods on the following terms: pentasterisk5 2/7 net 28 pentasterisk6 What is the effective cost of not taking the discount?
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13 Solution 2.0408% per r = 42.0689% = 1.00 0.98 1 per r = + ( ) 365 21 1.020408 1 EAR = - Hint: If a dollar amount is not given, use $1 or $100 Time period : 28 7 21 days - = Time periods per year : 365 21 m = 14 Borrowing From Financial Institutions Bank overdraft Factoring, invoice discounting and accounts receivable financing Inventory loans Bridging finance 15 Money Markets Market for very large sums for relatively short time periods Overnight loan (11 a.m. money) 24-hour loans 16 Short Term Marketable Debt Companies can obtain short term debt funding by issuing (selling) securities
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