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1
Lectures so far…Weeks 1 & 2
Firm’s objective = Maximise firm
value
How do we measure
value
?
Type of cash flow
– Type of cash flow
• Amount
• Inflow or outflow
• Single period or multiperiod
– Timing of the cash flow
– Riskiness of the cash flow
1
FINS1613_s2_2010_L3
Lectures so far… Week 2
How do we measure value? (cont.)
– An asset’s value is the present value of the future cash flows that an asset
is expected to produce.
– Single period Cash flows:
– Multiperiod cash flows
• Annuity:
t
r
C
PV
)
1
(
FINS1613_s2_2010_L3
2
r
r
C
PVIFA
C
PV
t
t
r
t
)
1
(
1
)
(
,
Lectures so far… Week 2
Multiperiod cash flows:
– Annuity due:
– Deferred Annuity:
)
1
(
)
1
(
1
)
1
)(
(
,
r
r
r
C
r
PVIFA
C
PV
t
t
r
t
– Perpetuity:
r
C
PV
1
1
,
)
1
(
)
1
(
1
)
1
(
)
(
k
t
k
t
r
t
r
r
r
C
r
PVIFA
C
PV
FINS1613_s2_2010_L3
3
FINS1613
Business Finance
Lecture 3
Lecture 3:
The Valuation of a Firm’s Securities
Readings:
RTBWJ Chapters 6 & 7
Lecture 3: Learning Objectives
Understand the different approaches to valuing a firm.
Recognise the main characteristics of debt and equity
securities
Understand the main features & determinants of bond
and share values.
Use financial mathematics to calculate the value of
bonds and shares.
5
FINS1613_s2_2010_L3
How to value a Firm?
A firm can be valued in two ways:
PV of cash flows generated by the firm’s
real (productive) assets
OR
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FINS1613_s2_2010_L3
Sum of the PV of cash flows generated by
the firm’s individual securities
(debt & equity)
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How to value a Firm? (cont.
.)
Figure 1.2
FINS1613_s1_2010_L3
7
How to value a Firm? (cont.
.)
This basic relationship can be stated as:
where:
E
D
V
V = PV of cash flows generated by the firm
D = PV of cash flows generated by debt securities
E = PV cash flows generated by equity securities
FINS1613_s2_2010_L3
8
Valuing a firm’s real asset cash flows
The
net
cash flows from real assets, after reinvestment
costs, are known as
free cash flows
If the firm is assumed to have an infinite life, the value
of the firm is given by:
where C refers to the free cash flows of the firm
1
1
t
t
t
r
C
V
FINS1613_s2_2010_L3
9
Debt vs Equity: Main Characteristics
Debt (Creditors)
Equity (Shareholders)
No ownership interest
Ownership interest
No voting rights
Voting rights
Interest is a taxdeductible cost
of doing business
Dividends are not a cost of doing
business and are not tax
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FINS1613_s2_2010_L3
business and are not tax
deductible
Legal recourse if interest or
principal payments are missed
No legal recourse if dividends are
not paid
Excess debt can lead to
financial distress & bankruptcy
An all–equity firm cannot go
bankrupt
First claim over assets in the
event of bankruptcy
Residual claim after all others
have been repaid
Bonds: What are they?
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This note was uploaded on 07/25/2011 for the course FINS 1613 taught by Professor Drkhshim during the Two '10 term at University of New South Wales.
 Two '10
 DrKHShim
 Finance

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