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cf1dayGrace - Aswath Damodaran Corporate Finance in a Day...

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Unformatted text preview: Aswath Damodaran Corporate Finance in a Day An Analysis of Grace Kennedy Aswath Damodaran Home Page : www.stern.nyu.edu/~adamodar www.stern.nyu.edu/~adamodar/New_Home_Page/cfshdesc.html E-Mail : [email protected] Stern School of Business Aswath Damodaran A Financial View of the Firm… Assets Liabilities Investments already made Debt Equity Borrowed money OwnerÕs funds Investments yet to be made Existing Investments Generate cashflows today Expected Value that will be created by future investments Figure 1.1: A Simple View of a Business (Firm) Aswath Damodaran First Principles ■ Invest in projects that yield a return greater than the minimum acceptable hurdle rate . • The hurdle rate should be higher for riskier projects and reflect the financing mix used - owners’ funds (equity) or borrowed money (debt) • Returns on projects should be measured based on cash flows generated and the timing of these cash flows; they should also consider both positive and negative side effects of these projects. ■ Choose a financing mix that minimizes the hurdle rate and matches the assets being financed. ■ If there are not enough investments that earn the hurdle rate, return the cash to stockholders. • The form of returns - dividends and stock buybacks - will depend upon the stockholders’ characteristics . Objective: Maximize the Value of the Firm Aswath Damodaran The Objective in Decision Making ■ In traditional corporate finance, the objective in decision making is to maximize the value of the business you run (firm) . ■ A narrower objective is to maximize stockholder wealth . When the stock is traded and markets are viewed to be efficient, the objective is to maximize the stock price . ■ All other goals of the firm are intermediate ones leading to firm value maximization, or operate as constraints on firm value maximization. Aswath Damodaran The Classical Objective Function STOCKHOLDERS Maximize stockholder wealth Hire & fire managers- Board- Annual Meeting BONDHOLDERS Lend Money Protect bondholder Interests FINANCIAL MARKETS SOCIETY Managers Reveal information honestly and on time Markets are efficient and assess effect on value No Social Costs Costs can be traced to firm Aswath Damodaran What can go wrong? STOCKHOLDERS Managers put their interests above stockholders Have little control over managers BONDHOLDERS Lend Money Bondholders can get ripped off FINANCIAL MARKETS SOCIETY Managers Delay bad news or provide misleading information Markets make mistakes and can over react Significant Social Costs Some costs cannot be traced to firm Aswath Damodaran When traditional corporate financial theory breaks down, the solution is: ■ To choose a different mechanism for corporate governance. Japan and Germany have corporate governance systems which are not centered around stockholders....
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This note was uploaded on 12/01/2011 for the course FINANCE 350 taught by Professor Aswath during the Summer '10 term at NYU.

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cf1dayGrace - Aswath Damodaran Corporate Finance in a Day...

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