CFA 2018 Level 2 Corporate finance

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  Introduction of the course Study Session 1-2 Ethics & Professional Standards 10 -15% Study Session 3 Quantitative Analysis 5 -10% Study Session 4 Economics 5 -10%
  Corporate Finance Study Session 5-6 Financial Reporting and Analysis 15 -20% Study Session 7-8 Corporate Finance 5 -15% Study Session 9-11 Equity Investment 15 -25%
  Weight: 5%~15% Study Session 12-13 Fixed Income 10 -20% Study Session 14 Derivatives 5 -15% Study Session 15 Alternative Investments 5 -10%
  SS7: Corporate Finance Study Session 16-17 Portfolio Management and Wealth Plan 5 -10%
  SS8: Financing and Control Issues Weights: 100%
  Summary ØExam tips:
  Evaluate Expansion & Replacement Projects •
  17年公司金融的考纲相较16年没有发生任何变化,仍然可 以沿用之前的准备思路。Tasks:
根据统计,二级的公司金融科目是考生得分率最低的科目
  Ø Calculate the yearly cash flows of expansion and replacement 之一,条件繁多,计算繁琐且环环相扣是二级公司金融考 capital projects and evaluate how the choice of depreciation 题的特点。因此,在学习和复习时需要一定要结合大量的 操练来熟悉计算的流程。 method affects those cash flows.
从考试内容来看,Session 7中包含大量公司金融的核心知
  识点以及计算考点,是考试主要涉及的部分。需要大家重 点关注。
  咨询电话: Preface Evaluate Capital ProjectsCapital budgeting decisionsBasic Capital Budgeting Approach
  Ø Often use NPV or IRR n n
  n C F C F t T N O
  C F C F t t    
  N P V C F  t n
   
  N P V  t  t  t 1   t     t    
   1 r   1 r 
  1 r
  1 IR R
  Ø CF: based on incremental , after-tax cash flows
  |CF | is Initial outlay r: discounted at the opportunity cost of funds Ø
  CF t is annual after-tax operating cash flow
  Financing costs are ignored because both the cost of debt •
  Ø CF TNO is terminal year after-tax non-operating cash flow
  and the cost of other capital are captured in the discount rate.
  Evaluate Capital Projects Evaluate Capital Projects
  Initial Outlay in DetailAnnual After-tax Operating Cash Flow in Detail
  Ø Ø
  Outlay = FCINv + NWCInv – Sal + T(Sal – B ) CF = (S− C − D)( 1−T ) + D, or CF = ( S−C )( 1−T ) + TD FCInv: investment in new fixed capital S: sales •
NWCInv: investment in net working capital •Sal • : salvage value from sale of old fixed capital
  C: cash operating expenses
  D: depreciation T: marginal tax rate • T: marginal tax rate •
B : book value of old fixed capital
  咨询电话:
  Example 1: Evaluate Expansion Project Ø
  Evaluate Capital Projects ØTerminal Year After-tax Non-operating Cash Flow in Detail
  Ø TNOCF = Sal
  Equipment to expand production will cost $450 million, depreciated straight-line to zero over three years for tax purposes.
NWCInv − T(Sal
SalNWCInv: recovery of investment in net working capital T: marginal tax rateB T : book value of fixed capital on termination date
  − B
  T
  )
  T
  : sal. value from sale of fixed capital on termination date
  T
  T
  Ø Salvage value for financial statement purposes is $30 million.
  Ø Paid outside consultant $2 million for detailed market share and cost analysis.
  Ø Expected to generate incremental revenue of $350 million in each year for three years.
  Example 1: Evaluate Expansion Project
  Additional annual cash operating expenses associated with project are $150 million ØSolution Step 1: Calculate Incremental Cash Flows
  Investment in net working capital of $25 million will be recovered in three years Ø
  Project cost of capital is 20% and marginal tax rate is 40% Calculate NPV&IRR, determine appropriate investment decision.
  Ø Outlay = FCINv + NWCInv – Sal + T(Sal – B )
  =$450 + $25 – 0 + 0 = $475 Ø
  Depreciation: depends on method for tax purpose =$450 / 3 = $150
  Ø CF = ( S−C )( 1−T ) + TD
  =($350 – $150)(1 – 0.4) + (0.4)($150) = $180 Ø
  TNOCF = Sal T
NWCInv − T(Sal
  T − B
  T )
  =$50 + $25 – 0.4($50 – $0) = $55 Example 1: Evaluate Expansion Project
  咨询电话: Example 1: Evaluate Expansion Project Example 2: Evaluate Replacement Project
  Expect to sell equipment in three years for $50 million ØSolution Step 2: Calculate NPV and IRR
  1
  2
  3 Incremental CF(step 1) – $475 $180 $180 $180+$55 PV of CF at 20% – $475 $150 $125 $136 n
  C F C F t T N O N P V   C F  
   NPV – $64 t n   t
1   Ø If the new equipment replaces the old equipment, an 1 r   1 r  additional investment of $80,000 in net working capital will be
  IRR 11.6%
  IRR: computed r when NPV = 0
  required. The tax rate is 30 percent, and the required rate of
  Decision: Reject Reason: NPV < 0 and IRR < 20%
  return is 8 percent. Whether to replace or not?
  Example 2: Evaluate Replacement Project Example 2: Evaluate Replacement ProjectSolution Step 1: Calculate Incremental Cash Flows Solution Step 2: Calculate NPV and IRR
  1 0
  Ø Outlay = FCInv + NWCInv – Sal + T(Sal – B )
  1 0 2 , 0 0 0 1 5 0 , 0 0 0 Ø     
  N P V 5 4 0 , 0 0 0 $ 2 1 3, 9 0 7 t 1 0  t  1
  1 .0 8 1 .0 8
  = 1,000,000 + 80,000 – 600,000 + 0.3(600,000 – 400,000)
  Ø
  IR R  1 5 .4 0 % = $540,000
  Ø
  Ø CF = (S – C – D)(1 – T) + D
  Decision: Accept the replacement project
  =[(450,000 – 300,000) – (150,000 – 120,000) – (100,000 –
  Ø Reason: NPV>0, IRR>8%
  40,000)](1 – 0.30) + (100,000 – 40,000) = $102,000 Ø TNOCF = Sal T + NWCInv – T(Sal T – B T )
  = (200,000 – 100,000) + 80,000 – 0.30[(200,000 – 100,000) – (0 – 0)] = $150,000
  咨询电话:Content:
主要掌握扩张项目和替代项目Tasks:
  Evaluate Capital Projects
  NPV以及IRR的计算 ü
  正确理解增量现金流的概念 ü
  能计算不同 Stages的增量现金流
  Ø
  Summary Evaluate Capital Projects
  Ø Evaluate capital projects and determine the optimal capital project in situations of 1) mutually exclusive projects with unequal lives, using either the least com- mon multiple of lives approach or the equivalent annual annuity approach, and2) capital rationing.Exam tips:
这部分知识是考查重点,且多考计算题,需要通过大量 操练提高正确率。
  Ø Calculate and interpret accounting income and economic income in the context of capital budgeting
  Evaluate Capital ProjectsEvaluate Mutually Exclusive Projects with Unequal LivesEvaluate Projects Under Capital Rationing
  等效年金法
  )
  Ø Equivalent Annual Annuity Approach (
  Ø Capital rationing is the case in which the company’s capital budget has a size constraint, i.e. fixed money amount.
  Ø Use profitability index (PI) since it shows the profitability of each investment per currency unit invested:
  1 N P V
  P I I n i t i a l I n v e s t m e n t
   
  最小公倍数法
  Ø Least Common Multiple of Lives Approach (
e.g. For 2-year project S and 3-year project L, replicate their CFs in a 6-year horizon.A simple two-step procedure: 1) find NPV; 2) find PMT
  咨询电话: Ø Importance: ☆ ☆ ☆ Ø
  )Evaluate Projects with Real Options
Timing Options • Sizing Options • Flexibility Options •Simple add: NPV(no option) + Net value of options More complicated: decision trees or option pricing models
  Risk Analysis of Capital Investments
    
  r R E R R 
  publicly traded stocks in the same business as the project [ ( ) ] i F i M F
  discount rate (NOT company WACC)
  β (“beta”) Ø Discount rate = required rate of return Ø Use CAPM and SML to find required rate of return:
  Ø Consider only market risk for a diversified investor:
  Risk Analysis of Capital Investments
  “pessimistic”, “most likely”(base), and “optimistic” Ø Monte Carlo Simulation Analysis
  Ø Sensitivity Analysis
  Fundamental Options Ø Evaluate approaches
  Ø Types of real options
  Total Outlay = 1,400 + 1,100 + 300 = $2,800 < $3,000 budget Evaluate Capital Projects
  1.33 Project E 300 $60
  1.36 Project D 600 $200
  1.48 Project C 1,100 $400
  1.42 Project B 1,400 $670
  Project A 1,650 $700
  Index
  Investment Outlay NPV Profitability
  Ø Omni Corporation has a $3,000 capital budgetStand-Alone Methods (Assume Total Risk)Market Risk Methods (Assume Only Systematic Risk)
change one input variable at a time in base case more resultant change in NPV -> more sensitive -> riskier Ø Scenario Analysis • change several input variables for each scenario --Notice: we use PROJECT beta here to get the PROJECTemploy "pure-play" method to get beta: identify otherstochastic variables -> probability distribution of NPV
  咨询电话: Example 3: Evaluate Projects Under Capital Rationing Factors That Affect Evaluation Factors That Affect EvaluationEffects of Depreciation Method on Analysis : Effects of Inflation on Analysis
  Ø NPV with Accelerated depreciation is larger than calculated
  Ø The cash flows and discount rate used should both be with Straight-line depreciation. nominal or both be real.
CF = ( S−C )( 1−T ) + TD
  Ø Higher than expected inflation:Why? Larger depreciation in early years are assigned Reduces value of depreciation tax shelter if tax
  bigger weight, and so does the tax shield TD, and
  system doesn’t adjust therefore CF&NPV.
Decreases value of fixed payments to bondholders
  Ø As a result, many countries specify the depreciation methods
that are acceptable for tax purposes in their jurisdictions. Revenues and costs not affected uniformly
  Factors That Affect Evaluation Factors That Affect Evaluation
  Common Capital Budgeting PitfallsCommon Capital Budgeting Pitfalls
  Ø Ø
  Not incorporating economic responses into the investment analysis Overhead costs Ø Misusing capital budgeting templates
  Ø Not using the appropriate risk-adjusted discount rate Ø Pet projects
  Ø Spending all of the investment budget just because it is available Ø Basing investment decisions on EPS, net income, or return on equity Ø Failure to consider investment alternatives Ø Using IRR to make investment decisions
  Ø Handling sunk costs and opportunity costs incorrectly Ø
  Bad accounting for cash flows
  咨询电话: Other Income Measures Example 4 : Compute Economic IncomeEconomic Income V.S. Accounting Income
  Ø Omni Corporation project costs $25,000
  Ø Accounting income: net income on financial statements
  Ø Cost of capital = 12%
  Ø Economic Income = Cash flow + Change in market value
  Ø After-Tax Cash flows:
  or Economic income = Cash flow – Economic depreciation
Year 1: $10,000
  NPV = $4,172 Economic Income Accounting Income
  Difference
Year 2: $12,000
  Depreciation Beginning Market Value Beginning Book Value
- Ending Market Value - Ending Book Value
  Year 3: $15,000 • Interest already deducted
  ignored
  1 0 ,0 0 0 1 2 ,0 0 0 1 5 ,0 0 0 Expense interest expense to
     B e g in n in g M V = $ 2 9,1 7 2 2 3
  debt holders
    1 .1 2     1 .1 2 1 .1 2
  Example 4 : Compute Economic Income Other Valuation ModelsEconomic Profit
  PV of remaining CFs
  Year 1 Year 2 Year 3 Ø Used in asset valuation, performance measurement and Beginning MV $29,172 $22,672 $13,393 management compensation. Focus on return to all investors . Ending MV 22,672 13,393
  Ø EP = NOPAT – $WACC Change in MV – 6,500 – 9,279 – 13,393
  NOPAT = net operating profit after tax = EBIT(1 – tax rate) • After-tax CF 10,000 12,000 15,000
  $WACC = WACC • × Capital
  Economic Income $3,500 $2,721 $1,607
  Ø Market value added (MVA) is NPV based on economic profit Economic ROR = 12% 12% 12% 
  E P
  Econ Inc./Beg MV t
  M V A   t t 1 
  1 W A C C   
  Not accounting income Must equal to project cost of capital 咨询电话:
  Other Valuation Models Other Valuation ModelsClaims Valuation Residual income
  Ø Focus on return to debt holders and equity holders separately
  Ø Focus on return to equity holders
  Balance Sheet Ø
  RI = NI – r B t t e t–1
  Assets Liabilities
NI = net income during period t
  t
  Equity
  B • r = equity charge for period t e t–1
CFs to debt holders = interest and principal, discounted at
  × beginning book value of equity = required return on equity 
  cost of debt
  R I t N P V 
   t 1 1 r
 t
  CFs to equity holders = dividends and share repurchases,
    e 
  discounted at cost of equity
  Summary of Capital Budgeting Summary Ø ☆Importance: ☆ Who Likes to Use Which Model
  Ø
  Ø Corporate managers often focus on total after-tax cash flows Content:
Mutually exclusive projects with unequal lives
  e.g. Basic capital budgeting approach • ü 最小公倍数法
  Ø Security analysts use cash flows to stockholders 等效年金法
  ü
e.g. Free cash flow to equity
  Factors affect evaluation • Ø Real estate investors use cash flows to the equity investor after
  Other valuation models • payments to creditors, which is like the claims valuation
  Ø Exam tips: approach.
这部分知识仍然是考查重点,概念和计算都有可能会考 到,需要考生定量和定性的去理解相关知识点。
  咨询电话:
  PrefaceCapital Structure Decision Objective
  Ø Optimal capital structure maximizes the firm’s value by minimizing the weighted average cost of capital:Tasks:
  Ø Explain the Modigliani–Miller propositions regarding capital structure. Ø Explain factors an analyst should consider in evaluating the effect of capital structure policy on valuation. Ø Describe the role of debt ratings in capital structure policy.
D = market value of debt, E = market value of equityV = D + E = market value of the firm r
  d
  = before-tax marginal cost of debt, t = marginal tax rate
r
  e
  = marginal cost of equity
  ( 1 ) ( ) w a c c d e D E r r t r
  V V          marginal cost (raise additional capital) current cost (the past is irrelevant)
  Theory
  TheoryModigliani and Miller AssumptionModigliani and Miller Theory
  Ø Investors can borrow and lend at the risk-free rate
  Ø No agency costs
  Ø Independent financing decision & investment decision
  Ø Homogeneous expected cash flows
  Ø MM Proposition I ( without taxes):
V
  Levered = V
  Unlevered The market value of a company is not affected by the capital structure of the company.
  Ø MM Proposition II ( without taxes):
  ( ) ( ) e d
  D r r r r E
    
The cost of equity is a linear function of the company’s debt/equity ratio.
  咨询电话: Capital Structure
  Ø Perfect capital markets (no transactions costs, no taxes, no bankruptcy costs, and symmetric information)Impact from Various CostsModigliani and Miller Theory
  Ø MM Proposition I ( with taxes):
Direct & indirect costs Leverage increases -> Probability of bankruptcy increases Ø Agency costsV
tDMonitoring costs, bonding costs, and residual loss Michael Jensen: higher debt level gives less free cash flow torPecking order theory: internal capital > debt > external equity
  Levered = V
  Unlevered
  t = marginal tax rate, D = debt value Ø
  MM Proposition II ( with taxes):
  wacc < r WACC for the company with debt must be lower than that for the all-equity company ( )(1 )( ) e d
  D r r r r t E
      Theory
  Ø Costs of Financial Distress
  managers to misuse -> lower agency costs Ø Costs of Asymmetric Information
  TheoryOptimal Capital StructureOptimal Capital Structure
Vr
  L
  = V
  U
  dynamic target Theory
  Ø Static trade-off theory of capital structure
tD – PV(Costs of financial distress)
  WACC
  = (D/V)r
  d
  (1-t)+(E/V)r
  e dynamic target
  咨询电话: Theory Practical Issues Practical Issues
  Ø Static trade-off theory of capital structure
  Debt RatingsEvaluating Capital Structure Policy
  Ø leverage rises->rating lowered->higher demanded costs
  Ø Changes in its own capital structure over time
  Ø with status as “Nationally Recognized Statistical Rating Organizations”
  Ø Capital structure of competitors with similar business risk
  from (SEC), the 3 largest are Moody’s, Standard & Poor’s, and Fitch
  Ø Industry-specific factors
volatility of opearating cash flows need for financial flexibility regulatory aspects
  Ø Company-specific factors
quality of corporate governance (affects agency costs)
  Practical Issues – international differences Summary of Capital StructureTheory V.S. Practice
  Ø MM theory and various costs
  Ø Static trade-off theory
Pursue optimal (target) capital structure Ø
  Practical issues: influences from external environment 咨询电话:Content:
Modigliani and Miller Theory (Proposition 1 & 2)Tasks:
Optimal capital structure Debt ratingsExam tips:
MM理论以及相关推论是二级公司金融常考的知识点,结Why do we study this?Theories
  Ø Dividends&share repurchases : how to distribute money wisely
  Ø
  Ø It does matter: bird-in-hand argument & tax argument
  Ø Dividend policy does not matter (MM)
  Effects of Dividend Policy
  Ø Capital budgeting: how to spend money efficiently
  Ø Capital structure: how to get money effectively
  Preface
  Ø Explain factors that affect dividend policy.
  Ø Compare theories of dividend policy and explain implications of each for share value given a description of a corporate dividend action.
  Summary Dividend and Share Repurchases
  合图像来记忆相关要点会起到事半功倍的效果。
  Ø
  ü Without tax ü With taxOther theoretical issuesinformation signaling

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