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Corporate-Finance-Siegal-Sp04 - CORPORATE FINANCE OUTLINE...

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CORPORATE FINANCE OUTLINE Professor Stanley Siegal Fall 2004 I. VALUE AND CAPITAL BUDGETING (Micro-economic theories) A. Cash Flows (1) Money in/ money out (2) Components of cash flow to be studied: (a) Amount (need a sign) If you pay money out to someone else or put money in the bank, then that cash flow sign is negative (cash flow out from me- e.g. a periodic loan or investment into a savings account) If you receive money as a payment or loan or interest, that is a positive cash flow sign (cash flow from bank to me- e.g. interest payments or a bond)) (b) Timing (c) Risk (3) Examples: + $1001.50 (a) Time -------------------------------------------------------------------------- T0(put money into savings account) T1 (principle + interest) -$1,000 (b) Ten year bond at 6% interest- $1,000 + $60(coupon) +$1060 Time ------------------------------------------------------------------------------ T0(buy bond) T1………. T10 -$1,000 (4) Cash flow vs. income: (a) Both are important but distinguished components of an institution/ enterprise. (b) Cash flow is a function of the ability to pay bills, not income (c) Cash flow is used to show the owners of a business what they can take out/ buy (d) Example: Company A bills a firm $50,000 in 2004 and is paid the bill in full in 2005. 1
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The $50,000 would show up on a schedule C for 2004 but not for 2005 (e) Cash flow is certain/ black and white (f) Cash flow can be saved/ invested whereas income cannot be (5) A treasury bill is one of the easiest types of cash flow to measure (a) Pure discount (i.e. zero coupon) (b) Risk free (c) Government obligation (d) The market determines the interest rate through the buying and selling of bonds (e) Illustration: + $1,000 Time ------------------------------------------------------- X Whatever “X” is, you get $1,000 in six months with the T-Bill interest rate APR on X E.g. if the interest rate is 1.75%, X = $991.25 (interest for first month is $1.45; the interest is then compounded. Don’t forget to divide 1.75% by two before calculating because period is only six months (6) Assumptions: (a) We will assume in this class that interest payments are made in arrears at the end of the period. Sometimes this makes a difference of a few pennies; sometimes it makes a much bigger difference. (b) We will also assume that any interest payments/ income is reinvested at the same rate as the original investment was paid out (see compounding section under chapter four) (7) Cash flows from stocks: (a) Dividends These are technically discretionary However, boards are very reluctant to reduce dividends because they are worried that people will think the company is doing poorly Board will tend to raise dividends to signal to the market that the company is able to sustain it (the dividend payment) and thus expects to do well (8) Object of making calculations is to determined to us now the value of a cash flow in the future
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Corporate-Finance-Siegal-Sp04 - CORPORATE FINANCE OUTLINE...

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