Notes - Intermediate Corporate Finance Spring Semester 2011...

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Intermediate Corporate Finance Spring Semester, 2011 REVIEW Goal of the Manager of the Firm: a) Maximize shareholder wealth—Weighs the risk/return tradeoff Are these valid objectives? Minimize Risk: Maximize Profits: Need a performance measure that weighs the risk/return trade-offs. What is S/H wealth and why does it measure the risk/return trade-off ? S-T: Can be measured by ___________ x # shares L-T: Must consider __________________ in addition to above 1
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How does “stock price” weigh the risk/return tradeoff? To answer this, we need to examine stock price formulas.Stock Price = PV of future expected dividends. Why not include stock price appreciation when we value of stock price? (I.e., Wouldn’t you be willing to pay more for a stock that is expected to appreciate, compared to one that is not?) *Firms must pay divs eventually—Positive NPV projects will be competed away. Today’s price apprec=PV of tomorrows dividends. *Risk of stock (req rate of return) (also cost of equity for a firm, excluding floatation costs) reflects RISK STOCK PRICE FORMULAS : T P 0 = ∑[D t /(1+r) t ] + P T /(1+r) T (1) t=1 P 0 = D 1 / (r –g) (2) r = required rate of return on a stock g = growth rate of dividends Dividends reflect return (in dollar metric) Discount rate of divs, r, reflects risk of stock (equity). P 0 = EPS 1 / r + PVGO (3) EPS 1 /r = capitalized value of future earnings per share, with a no-growth policy (i.e., assuming 0 NPV investment opportunities) PVGO = NPV of future growth opportunities (earnings not reflected in EPS) on a per- share basis Example: Prior stock price = $50 1-million shares outstanding Managers accept a project with an NPV of $10 million. 2
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When will the stock price reflect a project’s value?(May be more than one correct answer.) a) When rumors circulate about a positive NPV project available to the firm b) When the S/H’s learn of management’s decision to accept the project c) When the project is “officially” accepted (done deal: contracts signed, etc) d) When the cash inflows from the project occur Recall that P 0 = EPS 1 / r + PVGO. Can stock price ever be less than EPS 1 /r? Such firms often become takeover targets. Why? Note: Sometimes a project is negative NPV for one firm, but + NPV to another. Investing in positive NPV projects is one way that managers maximize shareholder wealth . Are +NPV projects easy to find? STAKEHOLDERS VS. STOCKHOLDERS What about the interests of other stakeholders of the firm. Other than stockholders, who has an interest in the firm’s continued success? What is the best goal for the manager if maximizing shareholder wealth conflicts other stakeholder interests? (Do conflicts between shareholders & stakeholders occur? Explain.)
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This document was uploaded on 10/26/2011 for the course FIN 302 at Miami University.

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Notes - Intermediate Corporate Finance Spring Semester 2011...

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