BADM 7090 IVA 2011 - Corporate Financing Policy (Market Efficiency & Financing Decs)

BADM 7090 IVA 2011 - Corporate Financing Policy (Market Efficiency & Financing Decs)

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BADM 7090 Financial Management Unit IV.A Corporate Financing Policy: Text material: GSM, Ch. 10 D. Chance
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Version: 1/3/11 D. Chance – BADM 7090 – Unit IVA p. 2 of 32 Questions What do we mean by an efficient market? What does the notion of market efficiency mean for financial managers? Can financial managers expect to generate abnormal performance in making capital investment decisions? Can how a firm is financed make a difference in contributing to shareholder wealth in an efficient market? Note: This material is largely qualitative.
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Version: 1/3/11 D. Chance – BADM 7090 – Unit IVA p. 3 of 32 Capital Investment, NPV, and Financing Decisions Until now we have said nothing about how the firm obtains its funds. We simply used a weighted-average cost of funds. Does how the firm finance a project matter? Can value be generated by financing at an especially attractive rate?
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Version: 1/3/11 D. Chance – BADM 7090 – Unit IVA p. 4 of 32 Capital Investment, NPV, and Financing Decisions (cont.) Remember the notion of positive NPVs (AKA economic rents). How do these arise? By finding projects that generate cash flows with value greater than the cost of funds required to finance the projects By beating the competition to these projects
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Version: 1/3/11 D. Chance – BADM 7090 – Unit IVA p. 5 of 32 Capital Investment, NPV, and Financing Decisions (cont.) But what happens when the competition is much tougher? The positive NPVs go away The firm earns only its cost of capital Positive NPVs can be earned at least for awhile by innovation, creativity, headstrong competitiveness, and occasionally monopolies or legally mandated advantages. In other words, there are gains, however temporary, from the firm’s decision to invest in assets, the left-hand side of the balance sheet.
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Version: 1/3/11 D. Chance – BADM 7090 – Unit IVA p. 6 of 32 Capital Investment, NPV, and Financing Decisions (cont.) Can positive NPVs be earned by the firm’s decision on how to finance, i.e., how much to borrow versus how much the owners invest, i.e., the right-hand side of the balance sheet? In this unit we establish one good reason why the answer is no . The financial markets are too competitive to permit such opportunities. In the next several units, we further explore this issue.
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1/3/11 D. Chance – BADM 7090 – Unit IVA p. 7 of 32 An Efficient Market Definition: A market in which it is impossible for anyone to earn consistent returns in the long run beyond those that provide adequate compensation for the risk assumed. How would one generate such returns, at least in theory? By being able to predict the future.
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BADM 7090 IVA 2011 - Corporate Financing Policy (Market Efficiency & Financing Decs)

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