Frequently asked questions in corporate finance pierre vernimmen

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The book covers the theory and practice of corporate finance, and demonstrates how to use financial theory to solve practical problems Key topics include: • Valuation • Financial analysis • Financial policy • Financial management By providing a short and a long answer to each question, Frequently Asked Questions in Corporate Finance allows the reader to extract the appropriate information with ease, making it a convenient and useful reference for students of corporate finance and practising corporate financiers alike Pascal Quiry is a Professor of Finance at the leading European business school HEC Paris, and a managing director in the Corporate Finance arm of BNP Paribas, specializing in M&A Maurizio Dallocchio is Bocconi University Nomura Chair of Corporate Finance, and a former Dean of SDA Bocconi School of Management Yann Le Fur is a corporate finance teacher at HEC Paris business school and an investment banker with Mediobanca in Paris Antonio Salvi is a Full Professor of Corporate Finance at Jean Monnet University, Italy He also teaches corporate finance at EMLyon Business School and SDA Bocconi School of Management Frequently Asked Questions in • Cost of capital Corporate Finance • Financial engineering Quiry Dallocchio LE Fur Salvi ed k s A y l t Fr equen in s n o i t s e u Q e t a r o p r o C Finance % In Frequently Asked Question in Corporate Finance the author team behind Pierre Vernimmen’s Corporate Finance: Theory and Practice – now in its third edition – and the vernimmen.com website use their extensive experience in investment banking, corporate finance and academia to address the most frequently asked questions in corporate finance io, a llocch D io iz r u uiry, M a Sa lv i Pa sc a l Q A ntonio , r u F e L Ya nn From the team behind Pierre Vernimmen’s = Corporate Finance + Cover illustration by Dave Thompson Frequently Asked Questions in Corporate Finance Frequently Asked Questions in Corporate Finance Pierre Vernimmen, Pascal Quiry, Antonio Salvi, Maurizio Dallocchio and Yann LeFur A John Wiley & Sons, Ltd., Publication This edition first published in 2011 Copyright  2011 Pierre Vernimmen Registered office John Wiley & Sons Ltd, The Atrium, Southern Gate, Chichester, West Sussex, PO19 8SQ, United Kingdom For details of our global editorial offices, for customer services and for information about how to apply for permission to reuse the copyright material in this book please see our website at www.wiley.com The rights of Pierre Vernimmen, Pascal Quiry, Antonio Salvi, Maurizio Dallocchio and Yann LeFur to be identified as the authors of this work have been asserted in accordance with the Copyright, Designs and Patents Act 1988 All rights reserved No part of this publication may be reproduced, stored in a retrieval system, or transmitted, in any form or by any means, electronic, mechanical, photocopying, recording or otherwise, except as permitted by the UK Copyright, Designs and Patents Act 1988, without the prior permission of the publisher Wiley publishes in a variety of print and electronic formats and by print-on-demand Some material included with standard print versions of this book may not be included in e-books or in print-on-demand If this book refers to media such as a CD or DVD that is not included in the version you purchased, you may download this material at http://booksupport.wiley.com For more information about Wiley products, visit www.wiley.com Designations used by companies to distinguish their products are often claimed as trademarks All brand names and product names used in this book are trade names, service marks, trademarks or registered trademarks of their respective owners The publisher is not associated with any product or vendor mentioned in this book This publication is designed to provide accurate and authoritative information in regard to the subject matter covered It is sold on the understanding that the publisher is not engaged in rendering professional services If professional advice or other expert assistance is required, the services of a competent professional should be sought Library of Congress Cataloging-in-Publication Data Frequently asked questions in corporate finance / Pierre Vernimmen [et al.] p cm ISBN 978-1-119-97755-1 (pbk.) Corporation–Finance I Vernimmen, Pierre HG4026.F747 2011 658.15 – dc23 2011031090 ISBN 978-1-119-97755-1 (pbk), ISBN 978-1-119-96069-0 (ebk), ISBN 978-1-119-96066-9 (ebk), ISBN 978-1-119-96065-2 (ebk) A catalogue record for this book is available from the British Library Typeset in 9/10.5pt Cheltenham-Book by Laserwords Private Limited, Chennai, India Printed in Great Britain by TJ International Ltd, Padstow, Cornwall, UK Contents Frequently Asked Questions Topics 409 50 years of research in finance 410 Ten deadly mistakes in corporate finance Five mistakes in corporate valuation M&A: Six mistakes to be avoided Rating agencies 412 423 429 432 Credit scoring 435 Behavioral finance: are investors really rational? 438 Micro-finance: helping the poor 444 Project finance 449 Corporate finance in Europe: confronting theory with practice 454 Capital markets: some useful definitions Transaction multiples: before and during the crisis The making of an investment banker 457 459 469 Corporate finance books Brainteasers – PART I Brainteasers – PART II Answers True or false: test yourself Answers Crossword 472 475 478 481 482 484 487 Index 493 Frequently Asked Questions What is Corporate Finance? What are cash flows? What alternative formats of the balance sheet may companies use? What is the working capital and how companies manage it? What are the alternative formats of an income statement? How can we perform the financial analysis of a company? What is the operating profit? What is the scissors effect? How does operating leverage work? 10 What is CAPEX? 11 How can the credit risk of a company be assessed? 12 How we measure the profitability of a company? 13 What is the financial leverage effect and how does it work? 14 What are efficient markets? 15 What we mean by discounting a sum? 16 How companies measure value creation? 17 What is the NPV of a project? 18 What is the IRR of a project? 19 How companies deal with uncertainty in capital budgeting? 20 How can real options be used in corporate finance? 21 What is risk in finance? 15 19 26 32 35 38 42 46 50 55 59 66 69 76 81 88 92 98 viii Frequently Asked Questions 22 23 24 25 26 27 28 29 30 31 32 33 34 35 36 37 38 39 40 41 42 43 44 45 Is there any relation between risk and return? How are risk and return measured? What is diversification? What are the efficient frontier and the capital market line? What are the CAPM and the beta coefficients? What is the cost of capital and how can it be estimated? What are the most important debt products for companies’ financing? What we mean by stock market analysis of a company? What are financial options? What are hybrid securities? How are securities sold on capital markets? What are the most important corporate valuation methodologies? What is the DCF method? What are valuation multiples? What does the Modigliani and Miller theorem say? What happens to the Modigliani and Miller theorem if we consider taxes and financial distress costs? What are the other real-world factors that affect the capital structure decision? How companies design their debt funding? Can options be used for the analysis of the capital structure? How can companies distribute their excess cash? What are share buybacks and how they work? What is the dilution of control in a capital increase? How many different types of shareholders we know? Why companies go public? 104 108 111 117 123 129 135 147 156 165 178 189 194 202 209 213 222 241 251 262 272 281 288 296 Index abandonment risk 453 ABB 168 ABCP see asset backed commercial paper Abertis 413 ABN-Amro 292 abnormal returns 63–5 Abu Dhabi 294 accounting 11, 29–33, 69–70, 73–4, 80, 275, 382–3, 416–18, 423–4 acid test ratio see quick ratio additive valuation methods 191–2, 254 see also sum-of-the-parts Adia 294 adjustable rate preference shares 172 Africa 445 agency theory 264–5, 291, 316, 325–36, 360–1, 411, 455–6 AGF 319 agreements in principle 340–3 AIG 408 Air France 254, 422 Air Liquide 421 Alcan 351 Alcatel 115, 117, 310 Alitalia 374 Allianz 156, 272, 319 Altman, Edward 435–6 amortization 4, 6–8, 17, 19–24, 33–4, 149, 167–8, 194–201 annuities 196–201 AOL–Time Warner merger 354 APV method 215 arbitrage pricing theory 162–3, 210–12, 303, 411, 441–3, 488 Arcelor 413 articles of association 305–7, 310 asset backed commercial paper (ABCP) 138 asset turnover ratio 51 assets 5–8, 9–18, 20–4, 27, 29–30, 42–5, 48–9, 194–5, 232, 248–9, 274–5, 394, 408 associated companies 200 AstraZeneca 433 at-the-money options 160, 258–60 auditors’ reports 29–30 audits 29–30, 326, 330–6, 340–3 Autostrade 413 average strike options 405 B&S see Black and Scholes option pricing model bad debts 20–4 balance sheets 9–14, 15–18, 43, 46–9, 143, 145–6, 172–3, 194–5, 201, 274–5, 364–6, 423–4 Bangladesh 444 bank overdrafts 10–14, 139 bankruptcies 191–2, 209, 216–21, 226–7, 236–7, 255–6, 333, 373–81, 433, 455–6 banks 10–14, 138–43, 162–3, 179–82, 229–32, 292, 310–11, 370–80, 382–90, 396–408, 414, 433–7, 444–53, 459–68, 477 see also debt finance; institutional investors; securitization bond offerings 184–6 business loans 138 cash flow management 382–90, 414 commercial loans 139–41 competition 378–9 covenants 141, 145, 229 credit lines 140–1, 143, 230–2, 262–3, 383–90, 406–7 investment banks 170–1, 179–82, 338–53, 415, 431, 458, 469–71 IPOs 179–82 494 Index banks (continued) loans 10–14, 138–43, 162–3, 229–32, 370–1, 373–80, 383–90, 396–403, 414, 444–8, 449–53, 477 Barclays Bank 412–13 Basel II requirements 433 bear markets 113–14, 338 Bear Sterns 293, 321 behavioural finance 62–3, 411, 438–43 Belgium 310, 313 beta coefficient 123–8, 130–2, 148, 151, 225, 410–11, 422, 424–5, 427–8 bid–ask spreads 265–6 bills of exchange 387 BIMBOs 366 binomial models 94–7, 160–3, 166–7 Black and Scholes option pricing model (B&S) 160–3, 166–7, 411 block trades of shares 178, 184 BNP Paribas 272, 292, 322, 441 boards of directors 301–11, 325–36, 337–8, 350–2 bonds 107, 129, 135–8, 146, 160–1, 165–76, 178, 184–6, 198–9, 228–32, 234–9, 246–9, 362, 423–4, 432–7, 451–3 see also convertible ; coupons; debt finance; exchangeable ; hybrid securities banks 184–6 competitive bidding 184–6 credit ratings 129, 132, 136–7, 172, 219–20, 245–7, 432–7 offering techniques on primary markets 178, 184–6, 228–9, 234–9 performance bonds 451–3 prospectuses 185–6 terms 135–6, 362 bonus shares 168, 284–7 Boo.com 374 book values 12–14, 57, 71–3, 74, 148, 150–1, 153–4, 190–2, 199–201, 255–6, 263–71, 279–80, 356–9, 423–5 book-building 179–86, 457 borrowings 7–8, 10–14, 86–7, 138–43, 162–3, 198–9, 229–32, 370–1, 373–80, 383–90, 396–403, 414, 444–8, 449–53, 477 bought deals 184, 186, 457 Bouygues 314, 362 brands 29, 429 breakeven points 29, 38–41 budgeting 88–91, 228–32, 383–90 Buffett, Warren 59, 478, 487 bull markets 113–14 Burberry 52 business angels 288, 290 business models 267, 371, 379–80, 393 call options 93–7, 156–63, 166, 251–61 Cameroon Airlines 309 CAPEX see capital expenditure capital asset pricing model (CAPM) 123–8, 130–2, 151, 225, 410–11, 421–2, 442, 455–6, 488 see also beta coefficient; market portfolios capital budgeting 88–91, 92–7, 228–32 capital decreases 262–71, 272–80, 419 capital employed 10–14, 30, 50–2, 55–8, 69–70, 72–4, 194–5, 197–8, 203–8, 224–7, 251–61, 263–5, 286–7, 416–18, 420, 424–5, 476, 491 capital expenditure (CAPEX) 5–8, 27, 29–30, 42–5, 195, 198–9, 420–1 capital gains tax 225–7, 313, 347 capital increases and secondary offerings 147, 149, 166–7, 172–3, 178, 182–3, 228–32, 234–8, 241–9, 281–7, 351–2, 415 capital market line 117, 119–22 capital markets 2–3, 178–88, 227–32, 296–300, 410–11, 412–22, 444–8, 472–4 capital structures 131, 209–40, 241–9, 251–61, 262–71, 275–80, 369–71, 373–80, 410–11, 414, 415–18, 419–21, 433–7, 455–6 Index see also debt finance; equity finance credit ratings 245–7, 432–7 design issues 238, 241–9, 275–80, 414 lifecycle stages of companies 237–8, 244–5, 247–9, 367–8 managers 233–8, 248–9 options 251–61 taxes 213–21, 222–7, 249, 418, 433–7, 455–6 trade-off model 213–14, 247–9, 455–6 capitalization 67–8, 152 Carrefour 272 CARs see cumulative abnormal returns cascade structures 322–4 cash budgets 382–90 cash certificates 389 cash flow return on investment (CFROI) 69–73 cash flows 4–8, 21–2, 29–30, 43–5, 46–9, 66–74, 102–3, 104–10, 113–16, 130–3, 138–46, 150, 189–92, 194–201, 224–7, 230–2, 262–71, 272–80, 318–21, 382–90, 398–403, 414, 419, 455–6 cash ratio 49, 414 Castro, Fidel 487 CBs see convertible bonds CDSs see credit default swaps certificates of deposit 135, 389 CFROI see cash flow return on investment chief executive officers (CEOs) 332–4 China 422, 444 Chrysler 354, 368, 490 climate risks 101, 393 closed-ended funds 439, 441–2 Coca Cola 421 COGS see cost of goods sold Colombia 292 commercial risk 99 companies 61–5, 170–1, 178, 182–3, 229–32, 234–8, 288, 290–1, 292, 296–300, 301–11, 312–14, 322–4, 325–36, 337–53, 360–3 495 compensation issues 149, 201, 268–9, 275, 292, 293–4, 298, 308, 326–8, 470 competition 26–30, 36–7, 44–5, 184–6, 243–5, 350–2, 358–9, 378–9, 430–1 competitive takeover bids 350–1 conglomerate discounts 312, 314, 360–2 consolidated accounts 34, 56, 150, 191–2, 200–1, 275, 476 consolidation impacts 32 consolidation techniques 29, 200–1 contingent claims 251–60 contingent convertible capital 170–1 contract guarantees 451–3 contractors 449–53 contracts 310–11 control premiums for synergies 207–8, 315–21, 354–9, 430–1 conversion periods 167–8 conversion ratios 168 convertible bonds (CBs) 136, 149, 167–71, 173–4, 176, 186, 201, 243, 415–16 convertible preferred stocks 172–3 corporate finance 2–3, 410–11, 412–22, 442–3, 454–6, 472–4 corporate governance 292, 325–36, 352 corporate valuation methodologies 2–3, 189–93, 194–201, 202–8, 209–21, 258–60, 267–8, 296–300, 318–21, 423–8, 430, 459–68 correlations 112–16 cost of capital 69–70, 72–3, 80, 95, 129–33, 189–90, 195, 197–201, 203–8, 209–12, 213–21, 228–32, 274–5, 278–80, 301–11, 410–11, 421, 425, 455–6 cost of debt 56–8, 113, 129–33, 146, 210–12, 213–21, 248–9, 277, 364–71, 413, 416–18, 423–5, 433–7 cost of equity 40, 113, 129–33, 151, 190, 203, 209–12, 213–21, 222–7, 278–9, 410 cost of goods sold (COGS) 19–24 496 Index costs 19–25, 32–4, 35–7, 38–41, 88–91, 191–2, 213, 216–21, 226–7, 236–8, 249, 258–60, 374–80, 444–8 counterparty risk 99, 101, 180, 391, 392, 407–8 see also credit coupons 135–7, 160, 415 covariance 113–16, 123–8 credit card receivables 142–3 credit default swaps (CDSs) 407–8 credit derivatives 407–8 credit insurance 407 credit lines 140–1, 143, 230–2, 262–3, 383–90, 406–7 see also master credit agreements credit ratings 129, 132, 136–7, 172, 173, 219–20, 245–7, 373–80, 407, 432–7 credit risk 46–9, 99, 101, 180, 253–4, 258–60, 391, 392, 407–8, 435–7 credit scoring 435–7, 444–5 credit spreads 132 creditors 4, 6–8, 10–14, 15–18, 216–32, 251–61, 263, 277–8, 373–80, 385–90 see also bankruptcies; debt finance; trade payables cumulative abnormal returns (CARs) 63–5 currencies 29, 32, 99, 100–1, 136–8, 140–1, 397–403, 404–5, 453 currency options 404–5, 407 currency risk 29, 99, 100–1, 106–7, 391, 453, 455 currency swaps 402–3 current liabilities 10–14, 47–9 current ratio 48–9 Daimler 354, 490 Danone 273, 310, 427–8 days of inventories outstanding (DIOs) 15, 17 days of payables outstanding ratio (DPOs) 15, 17 days of sales outstanding ratio (DSOs) 15, 16 DCFs see discounted cash flows DDM 189 debt beta 424–5 debt finance 2–3, 7–8, 29–30, 46–9, 55–8, 99–101, 105–6, 129–33, 135–46, 165–76, 198–9, 209–12, 213–21, 222–32, 241–9, 275–80, 310–11, 361–2, 364–71, 373–80, 414–16, 423–5 debt policies 233–8 debt/equity ratios 414, 455–6 debtors 6–8, 15–18, 375–80, 385–90 default risk see credit risk defeasance 408 deferred costs 6, 18 deferred income 6, 18 deferred tax 9–14, 16, 199–200 degree of operating leverage (DOL) 41 delistings 290–1, 296–300, 314, 369 demergers 360–3 Deminor 333 depreciation 4, 6–8, 17, 19–24, 33–4, 42–5, 66–8, 145–6, 149, 194–201, 207, 225 derivatives 92–7, 149, 156–64, 396–403 Deutsche Bank 273, 292 Deutsche Telekom 272, 294 development capital funds 290–1 Diageo 245 dilution 147, 149, 166–7, 172–3, 228–32, 281–7, 289–90, 307, 415 DIOs see days of inventories outstanding directors see boards of directors disaster risks 100, 391, 393, 451 disclosures 326–36 discontinued operations 20, 34 discounted cash flows (DCFs) 189, 191, 194–201, 423–4, 455–6 discounting 66–8, 78–80, 81–7, 94–7, 104–10, 169–72, 182–4, 189–92, 195–201, 216, 253–60, 312–14, 315–21, 323–4, 422, 439–43, 459–68 discrete-time options pricing models 160–3 see also binomial models Index diversification 111–16, 117–22, 217–18, 237–8, 244–5, 289–90, 314, 361–2, 410–11, 413–14 divestments 45 dividend per share (DPS) 148, 149, 285–6, 297–8 dividend yield 148, 149, 172 dividends 7–8, 18, 20–7, 46–7, 113, 147–55, 160–1, 171–3, 211–12, 214–21, 223–7, 262–71, 276–8, 297–8, 313–14, 418–19 DOL see degree of operating leverage Dow Jones Industrial Average 62, 475 DPOs see days of payables outstanding ratio DPS see dividend per share DSOs see days of sales outstanding ratio dual listed stocks 439, 441–2 EADS 294 earnings 11, 38–41, 50 earnings per share (EPS) 69–70, 73–4, 147, 149, 150, 154–5, 263, 266, 279–80, 285–6, 297–8, 347, 356–9, 412–13, 418–19, 477 EasyJet 422 EBIT multiples 148, 153–4, 189–90, 202–8, 459–68 EBIT (operating profit) 20–4, 32–4, 41, 50–4, 55–8, 69, 148, 153–4, 189–90, 194–201, 202–8, 210–12, 214–21, 225–7, 435–7, 459–68 EBITDA 20–4, 46–9, 69, 72–3, 194, 202–8, 364–6, 414, 429, 459–68, 475 EBITDA multiples 202–8, 414, 429, 459–68 economic profits 69–70, 72–3 see also economic value added economic risk 100, 102, 451 economic value added (EVA) 69–70, 72–3 economies of scale 317 EDF 294 efficient markets 59–65, 78–80, 155, 202, 317, 360–1, 410–11, 438–43 497 EGMs see extraordinary general meetings Eiffage 308 Electrolux 302–3 Elis 364–70 emerging markets 127, 294, 333, 408, 425–6, 444–8 employee stock ownership programs (ESOPs) 293, 308 employee-shareholders 288, 292–4, 298, 301, 308 employees 19–24, 28–30, 33–4, 99, 101–2, 288, 292–4, 298, 301, 308, 311, 326–36, 393, 469–70 Endesa 351 Enel distribution network 267, 272, 425 ENI 115, 272, 294, 309 Enron 33, 325, 373 enterprise value (EV) 71–4, 130, 133, 154, 189–92, 195–201, 203–8, 209–12, 224–7, 251–61, 348–52, 364–71, 459–68 entrepreneurs 316–17 environmental risks 101–2, 393 E.ON 52, 272, 351 EPS see earnings per share equity finance 2–3, 7–8, 10–14, 29–30, 55–8, 129–33, 147–55, 165–76, 209–12, 213–21, 222–32, 235–8, 241–9, 275–80, 410, 414, 456 equity per share 69–70, 74, 201 equity risk premiums 127, 253, 259–60, 427–8, 479 Ericsson 331 ESOPs see employee stock ownership programs EU 447 EURIBOR 403 European-style options 156–63, 252–60 Eurostoxx 50 475 Eurotunnel 374 EV see enterprise value EVA see economic value added exceptional items 20–4, 34 excess cash distributions 262–71, 272–80, 419 exchangeable bonds 175–6, 186 498 Index execution phase of IPOs 179–82 expected returns 60–5, 67–74, 82, 108–10, 115, 117–22, 126–8, 147–55, 222–7, 263, 416, 421 expenses 19–25, 32–4 extraordinary general meetings (EGMs) 275–6, 352 extraordinary items 18, 20–4, 34, 249, 267–9 Exxon Mobil 332 Facebook 290 Fama, Eugene 60, 410, 438, 439–40 family-owned companies 288, 289–90, 305–6, 325, 368–9 financial analyses of companies 26–30, 32–3, 42–54, 375–80, 419–21, 473 financial assets 2–3, 5–8 financial breakeven points 40–1 financial crisis from 2007 143, 459–68 financial distress costs 213, 216–21, 226–7, 249, 258–60, 373–80 financial holding companies 288, 292 financial institutions 2–3, 137, 309–11 financial leases 144–6 financial markets 2–3, 410–11, 412–22, 444–8, 454–6, 472 financial risks 2–3, 102–3, 211–12, 391–3 financial scandals 325, 333, 373, 416 financial statements 4–14, 19–25, 61, 144–6, 194–5 see also balance sheets; cash flow ; income financing activities 5–8, 20–4, 33–4, 415–21 finished goods inventories 9–14, 19–24 fixed assets 5–8, 9–14, 17–18, 20–4, 27, 29–30, 42–5, 194–5, 198–9 fixed costs 29, 38–41, 90, 248–9 see also costs Ford 368, 424 Fortis 441 forward currency transactions 397–403 forward rate agreements (FRAs) 400–1 forward-forward rates 399–401 forwards 158, 396–403, 407–8 France 227, 288, 302–3, 309, 310, 313, 315, 328, 332, 374–8, 454–6, 459–68 France Telecom 272 FRAs see forward rate agreements fraud risk 100 free cash flows 5–8, 46–9, 133, 189–92, 194–201, 205–6, 237–8, 275 free float factor 148, 151–2, 313–14 Fr´ere Group 322–3, 478 G&A see general and administrative costs Galbani 367 Gas Natural 351 general and administrative costs (G&A) 19–24, 313–14 General Electric 314, 333, 362 General Motors 424 Germany 227, 288, 302, 315, 328, 332, 368, 375–8, 454–6, 459–68, 476 GIC 294 GlaxoSmithKline 419 golden parachutes 311 golden shares 309 Google 52, 438–9 Gordon terminal value formula 196–7, 418–19 government bonds 107, 109, 117–22 government shareholders 288, 294, 309 Grameen Bank 444 grey markets 185 gross margin 22, 29 Group Arnault 323 groups 10–14, 22, 29, 34, 56, 140–1, 150, 175, 190–2, 200–1, 230–2, 292, 298–300, 314–21, 322–4, 360–71 Gulf States 444 Index Hamada formula 131–2 hedge funds 186 hedging 186, 394–408, 470 Herm`es 305, 408 Hertz 367, 368 high-yield bonds 129, 136–7, 186, 242, 246–7 holding companies 288, 292, 301, 302–4, 312–14, 322–4 holding company discounts 312–14, 323–4 holding-period returns 108–10 hostile takeovers 337–8, 350–2 human resources 19–24, 28–30, 33–4, 99, 101–2, 288, 292–4, 298, 301, 308, 311, 326–36, 393, 469–70 hybrid securities 136, 149, 165–77, 229–30, 243, 415–16 IASs 275, 483, 486 IFI 313 IFRSs 396, 423, 476, 489 illiquidity discounts 321 income statements 19–25, 32–4, 194–5, 366 income tax 7, 10–14, 16, 19–24, 34, 195, 198, 202–3, 213–21, 222–7 see also taxes Indesit 4–6, 9–11, 15, 21–2, 46–7, 194–5, 197–8 India 227, 292, 376–8 industrial risk 99, 256 industrial/commercial/administrative synergies 191–2, 207–8, 315–21, 337–53, 354–9, 412–14, 430 inefficient markets 60, 438–43 inflation 100, 107, 112, 417–18 Infosys 52, 332 ING 274, 309 initial public offerings (IPOs) 178–86, 249, 291, 296–300, 321, 367, 444 insider trading 60–5, 352 institutional investors 137, 179–82, 288, 290–1, 292, 299, 325, 331–4 insurance 394, 395–6, 403–8, 451–3 insurance companies 137, 143, 156, 290–1, 292, 395–6, 407 499 intangible fixed assets 9–14, 29 Intel 52 interest payments 8, 56–8, 135–46, 173–5, 190–2, 198–201, 210–12, 214–21, 222–7, 248–9, 383–90 interest rate options 405–7 interest rate risk 29, 99–101, 105–6, 112–13, 129, 391 interest rate swaps (IRSs) 402–3 see also forward rate agreements interest rates 29, 40, 87, 99–101, 105–6, 112–13, 129, 131–3, 135–46, 155, 252–60, 389, 397–403 internal capital 227–32, 263–5, 456 internal rate of return (IRR) 80, 81–7, 146, 371, 455 Internet 206–7, 444–5 inventories 4, 6–8, 9–14, 15–18, 19–24, 29, 33, 49, 192, 476 inverted IRR rule 86 invested capital see capital invested investing activities 5–8 investment cash flows 5–8, 21–4, 389 investment projects 3, 69–70, 78–80, 88–91, 92–7, 274–5, 420–1, 449–53, 454–6 investment-grade securities 129, 137, 246 investors 2–3, 62–5, 121–2, 124–8, 178–88, 209–12, 227–32, 288–95, 312–14, 326–36, 389, 411, 438–43 IPOs see initial public offerings IRR see internal rate of return Islamic finance 476 ISS 333 Italian S&P MIB index 111 Italy 227, 288, 302, 313, 315, 328, 332, 376–8, 459–68 Japan 332 Jensen, Michael 411 Keynes, John Maynard 488 KIA 294 500 Index Knight, Frank 98 Korea 236, 292 Kuwait 294 Lafarge 425 Latin America 447 LBOs see leveraged buy outs LBUs see leveraged buildups leasing 143–6 Leeson, Nick 490 legal risk 102, 391, 393, 408, 451 letters of credit 139 letters of intent (LOI) 339–43 leverage effect 55–8, 211–12, 233–8, 277, 413, 414, 416–18, 424–5, 479 leveraged buildups (LBUs) 366–7 leveraged buy outs (LBOs) 136–7, 237–8, 249, 290–1, 293, 364–72, 418, 475, 480 liabilities 10–14, 47–9, 198–201, 394, 408 LIBOR 403 Lintner, John 124 liquidations 191–2, 209, 216–21, 373–81 see also bankruptcies liquidity 9, 12–14, 29–30, 47–9, 62–3, 99, 101, 151–2, 232, 265–6, 274–5, 296–300, 315–21, 362–3, 373–80, 389, 467 liquidity risk 99, 101, 391, 392 listed companies 178, 182–3, 229–32, 290–1, 296–300, 312–14, 325–36, 439–43, 455–6, 466–8 Lloyds 171 lock-up clauses 293, 458 lockbox systems 388 London Stock Exchange 475 look back options 404–5 Lubrizol 59 Lufthansa 38, 422 LVMH 323 management buy outs (MBOs) 237–8, 366–7 management packages 371 managers 149, 201, 233–8, 248–9, 264–9, 275, 277–80, 291, 292, 293–4, 298, 308, 316, 325–36 see also boards of directors; corporate governance margin analyses 22, 29, 35–41, 50–1, 194–5, 404, 420–1 Mariani, Massimo 429, 459 market capitalization 73–4, 147, 148, 152, 153, 154–5, 202–8, 312–14 market growth 26–30 market indicators of value-creation 69–70, 73 market makers 404–8 market multiples 203–8 market portfolios 120–2, 123–8, 410–11 market risk 26–30, 99–101, 112–16, 391–3, 410–11, 427–8, 452–3 market shares 26–30, 90 market value added (MVA) 69–70, 73 market values 69–70, 73, 76–80, 81–7, 147–55, 191–2, 198–201, 203–8, 248–9, 255–6, 282–7, 296–300, 312–14, 315–21, 423–5 marketing 2–3, 179–82 markets 26–30, 59–65, 78–80, 90–1, 155, 202, 317, 360–1, 410–11, 412–22 Markowitz, Harry 124, 410 martingales 61 master credit agreements 140–1 mathematics 410–11, 421–2 MBOs see management buy outs Mediobanca 441 memorandum of understanding (MOU) 339–43 Merck 305 mergers and acquisitions (M&As) 59, 61, 168, 191–2, 207–8, 299, 301, 307–11, 312, 315–21, 337–53, 360–3, 412–14, 429–31, 479 see also industrial/ commercial/administrative synergies; takeovers demergers 360–3 failures 354–5, 413–14, 430–1 post-merger value-creation assessments 354–9, 412–14 prices 337–53, 430–1 private companies 337–43 Index public companies 337–8, 343–53 strategic value 317–21, 355–9, 430 success factors 354–9, 362, 413–14 Michelin 305 micro-finance 444–8 Microsoft 52, 419 Miller, M 223–7 see also Modigliani and Miller theorem minority shareholders 297–300, 304, 315–21, 325–6, 333–4, 343–53, 429 Mittal 413 MKV firm 436 Modigliani and Miller theorem 131, 209–21, 222–7, 410, 476 money markets 137–8, 389 Monte Carlo simulations 88, 90–1 see also scenario analysis Moody’s 136, 173, 373, 432, 436 Morocco, tax rates 225, 227 mortgage bonds 135, 141–3 Moulinex 417–18 multiple IRRs 83–5 multiples 83–5, 148, 153–4, 189–90, 200–1, 202–8, 297–8, 357–9, 459–68 MVA see market value added natural disaster risks 100, 391, 393, 451 negative cash flows negative covenants 141, 229 negative NPV values 85–6 negative working capital 17–18 Nestl´e 310, 433 net asset values (NAVs) 12–14, 191–2, 439 net debt 5–8, 10–14, 46–9, 73–4, 130–3, 189–92, 198–201, 202–3, 230–2, 243–5, 414, 435–7, 459–68, 475 net debt/EBITDA ratio 47–9, 414, 459–68 net financial expense 5, net income (net profit) 4–8, 20–4, 30, 50, 51, 53–4, 55–8, 69–74, 147, 148, 149, 153, 154–5, 189, 501 190, 200–1, 202–8, 210–12, 263, 287, 297–8, 356–9, 412–14, 416–18, 421, 422, 477 net present value (NPV) 69–73, 76–80, 81–7, 88–91, 94–7, 105–10, 455 see also discounting net sales 19–24 Netherlands 227, 302, 309, 310, 328, 332, 454–6, 459–68 Nobel Peace Prize 444 Nokia 273 non-executive directors see independent boards non-voting shares 148, 171–2, 301, 302–3, 331–4 noncurrent assets 5–8, 9–14, 27, 29–30, 42–5, 194–5 nonoperating working capital 10–14, 15–18 nonrecurring items 20, 22, 24, 34, 54, 56, 149, 204, 207 NOPAT 72, 202, 204 normative analyses 30 Novartis 310 NPV see net present value OBOs see owner buy outs Office Depot 425 Olivetti 313, 323 optimal debt ratio 220, 223–7, 235–8, 247–9, 410, 414, 456 options 92–7, 149, 156–64, 166–7, 169–70, 201, 251–61, 308, 403–8, 411, 476 over-the-counter (OTC) options 158, 404–5, 407 owner buy outs (OBOs) 366–7 Oyer, Paul 469–71 P/E see price/earnings ratio P/E multiples 200–1, 202–8, 297–8, 357–9, 413–14, 422 ‘Pac-Man’ hostile takeover defenses 351 parents 10–14, 22, 29, 175, 200–1, 322–4, 334, 360–3, 449–50 Parmalat 325, 416 pay-out ratio 148, 150 payables 10–14, 15–18 502 Index payback 80, 455 PBR see price-to-book ratio pecking order theory 230–2, 455–6 pension funds 290–1, 292, 426–7 pension liabilities 199, 426–7 Pepsi 245, 432 perfect markets 209–12, 216–21 Pernod Ricard 309, 322, 425 Peugeot group 268, 307, 332, 427–8 Philipps 273, 309 PIPEs 291 ‘poison pills’ see shareholder rights plans political risk 100, 102, 391, 393, 408, 451–3 Porsche 331 portfolios 94–7, 111–16, 117–22, 123–8, 217–18, 313–14, 392, 410–11, 421–2, 442 preference shares 148, 171–3, 303, 331–4 premiums 127, 156–63, 168–9, 207–8, 253, 259–60, 299–300, 315–21, 395–6, 422, 427–8 prepayments 16 present values 66–8, 69–73, 81–7, 94–7, 104–10, 144–6, 174, 189–92, 215, 224–7, 358–9, 397–403 price-to-book ratio (PBR) 74, 148, 153, 201, 207 price/earnings ratio (P/E) 73–4, 147, 154–5, 200–1, 202–8, 266, 279–80, 287, 297, 357–9, 412–14, 422, 477 see also earnings per share prices 37, 60–5, 73–4, 76–80, 88–91, 100–3, 106–7, 135–6, 147–55, 178–88, 234–8, 262–71, 279–80, 298–9, 338–53, 415–16, 418–19, 430–1 primary capital markets 178–88, 227–32, 410–11 private auctions for private companies 338, 340–3 private equity funds 288, 290–1, 293–4, 364–72 private investors 247–9 probability distributions 90, 98–103, 108–10, 440–3 production/sales ratio 33 profits 7–8, 19–24, 29–30, 32–4, 37, 43–5, 50–4, 69–74, 147, 149, 150, 262–71, 272–80, 297–8, 347, 356–9, 412–13, 416, 418–19, 477 project finance 449–53 provisions 6, 10–14, 18, 29, 199, 225 proxy votes 331–2 public offers 337–8 purchases 15–18, 23–4 ‘pure play’ stocks 314 put options 94–7, 156–63, 251–61, 276, 476 quick ratio 49 R&D see research and development costs rating agencies 136, 173, 373, 432–4 raw materials 9–14, 16–18, 19–24, 33–4 recapitalizations 374, 379–80 receivables 9–14, 15–18 regression analysis 123–4, 464 regulatory risk 100, 102, 112, 391, 393, 408, 451 reinsurance markets 395–6 relative value ratios 358–9 remuneration committees 330 R´emy Cointreau 414 repos 389 research and development costs (R&D) 19–24, 218, 463 research in finance 107, 124, 273, 410–11, 474 reserved capital increases 301, 307 return on capital employed (ROCE) 30, 50–2, 55–8, 69–70, 72–4, 194–5, 197–8, 203, 255–60, 263–5, 286–7, 416–18, 420–1, 491 return on equity (ROE) 30, 50, 53–4, 55–8, 69–70, 74, 148, 416–18, 420–1, 491 returns 2–3, 30, 50–4, 55–8, 60–5, 66–74, 80, 81–7, 90, 98, 102–3, 104–10, 115–16, 117–22, 123–8, 146, 147–55, 178, 210–12, 214–21, 222–7, 303, 371, 410–11, 415–16, 421, 427–8, 438–43, 449–53 Index revenues 19–25, 35–7 rights issues 182–4, 283–7, 306–7 Rio Tinto 351 risk 2–3, 26–30, 46–9, 58, 81–7, 88–91, 98–103, 104–10, 112–16, 117–22, 123–8, 155, 180–2, 210–12, 233–8, 274–5, 391–3, 416, 449–53 risk analysis techniques 88–91, 391–3 see also Monte Carlo simulations; scenario ; sensitivity risk management 111–16, 137–8, 180–2, 274–5, 369–70, 410–11, 451–3 risk–free rates 102, 117–22, 125–8, 130–2, 148, 160–3, 209–12, 229–32, 252–60, 410, 424–8 risk–return ratios 117–22 road shows 180–2, 186, 458 ROCE see return on capital employed Roche 332 Rockefeller, John D 478 ROE see return on equity Roll, Richard 411 Ross, Stephen 411 Ryanair 422 S&M see selling and marketing costs Sacyr 308 Saint-Gobain 291 sales 15–18, 30, 32–4, 38–41, 50, 51, 194–201, 356–9, 459–68 Samsung 292 Santander 272, 354–5 SAP 412–13 savings 200 scenario analysis 88, 89–91 see also Monte Carlo simulations; sensitivity scissors effects 29, 35–7, 39 SEB 38 secondary capital markets 78–80, 184–6, 389, 410–11 secondary LBOs 367 securities 2–3, 5–6, 59–65, 73–4, 76–80, 99–103, 108–10, 111–16, 503 135–46, 155, 162–3, 165–76, 178–88, 189–92, 194–201, 227–32, 234–8, 262–71, 275, 279–80, 298–9, 338–53, 415–16, 418–19, 423–5 securities lending 389 securitization 135, 138, 141–3, 243, 370–1, 389, 408 security issues 389 security market line 127 self-hedging 394–6 selling and marketing costs (S&M), income statements 19–24 senior debt 142–3, 370–1 sensitivity analysis 88–9 separation theorem 122 shadow rating 434 share analyses 69–70, 73–4, 147–55, 189, 200–1, 202–8, 266, 287, 297–8, 357–9, 413–14, 419–21, 469–70, 477 share buybacks 7–8, 265–9, 272–80, 301, 307, 362–3 share capital 10–14 share issues 7–8, 178–86, 228–32 share transactions 337–8, 344–53, 355–9 shareholder rights plans (‘poison pills’) 301, 308–9, 310, 351 shareholders 137, 179–82, 262–71, 272–80, 288–95, 296–300, 301–11, 315–21, 325–36, 343–53, 360–3, 429 shareholders’ equity 8, 10, 12–14, 30, 48–9, 50, 53–4, 55–8, 69–70, 71–3, 74, 148, 153, 195–201, 251–61, 263, 356–9, 364–71, 416–18, 421, 432–7, 454–6 shares 7–8, 69–70, 73–4, 136, 147–55, 165–77, 178–88, 189–92, 227–32, 234–8, 241–9, 262–71, 275, 281–7, 291, 292, 296–300, 301–11, 331–4, 344–53, 367, 415–16 see also convertible bonds; dividends; equity finance; hybrid securities block trades 178, 184 bonus shares 168, 284–7 504 Index shares (continued) dilution 147, 149, 166–7, 172–3, 228–32, 281–7 IPOs 178–82, 249, 296–300 lock-up clauses 293, 458 non-voting shares 148, 171–2, 301, 302–3, 331–4 voting rights 148, 171–2, 292, 301, 302–3, 309–11, 331–4, 344–53 Sharpe, William 124, 410 Sherfin, Hersh 411 SIC-15 144 SIC-17 ‘Leases’ 144–5 signalling theory 233–8, 264–9, 277–80, 411 Singapore 294 Smoby 374 social security payables 16 Sodexo 276 solvency 9, 12–14, 30, 99, 274–5 Sony 332 SOTP see sum-of-the-parts method sources of finance 2–3, 15–18, 20–4, 29–30, 33–4, 43, 71–2, 85–6, 135–46, 209–21, 222–40, 241–9, 415–20, 444–8, 455–6 sovereign wealth funds (SWF) 294 Spain 227, 288, 302, 310, 315, 328, 332, 459–68 special purpose vehicles (SPVs) 142–3, 483, 486 see also securitization spinoffs 314 split-offs 360, 362–3 see also share buybacks spreadsheets 90, 132–3, 421–2 stakeholders corporate governance 326–36 information asymmetries 228–32, 455–6 Standard & Poor’s (S&P) 136, 173 standard deviations 93, 103, 108–10, 123–8, 161–3 Stanford University MBA graduates 469–70 start-up companies 247–9, 290–1 stock options 149, 201, 268–9, 275, 292, 293–4, 298, 308, 327–8 Stora Enso 425 strike prices 156–63, 403–8 subordinated debt 136–7, 142–3, 174–5, 370–1 subprime crisis from 2007 143, 459–68 subscription warrants 165–7 subsidiaries 10–14, 22, 29, 175, 200–1, 312–14, 322–4, 342, 360–2 see also groups Suez 272, 309, 322 sum-of-the-parts method (SOTP) 190–2 suppliers 326–36 swap points 398 swaps 137–8, 398–9, 401–3, 406, 407–8 swaptions 406 Sweden 302–3 SWF see sovereign wealth funds Switzerland 227, 301, 310, 314, 328, 332 syndicated loans, banks 139, 198–9, 243, 249 synergies see industrial/ commercial/administrative synergies takeovers 59, 191–2, 207–8, 299, 301–11, 337–53, 412–14, 429–31, 479 see also industrial/ commercial/administrative synergies; mergers cash payments 337–8, 344–53, 355–9 cost of capital 429 failures 354–5, 413–14, 430–1 hostile takeovers 337–8, 350–2 mandatory takeovers 337, 348–50 minority shareholders 343–53, 429 post-takeover value-creation assessments 354–9, 412–14 private companies 337–43 public companies 59, 191–2, 207–8, 299, 301–11, 337–8, 343–53 regulations 343–53 Index share transactions 337–8, 344–53, 355–9 success factors 354–9, 362, 413–14 taxes 347, 355 voluntary takeovers 337, 348–50 tangible fixed assets 9–14, 20–4, 244–5 Tata 292 tax credits 224–7 taxes 7, 9–14, 16–18, 19–24, 34, 112–13, 131–2, 144–5, 195, 198, 202–3, 213–21, 222–7, 249, 313–14, 355, 369–70, 377–8, 396, 418, 433–7, 455–6 TCI 292 technology risk 43, 44–5, 101–2, 374–5, 393 Telecom Italia 273, 309, 323 Telefonica 332 Temasek 294 Tesco 38, 52, 205–6 Thaler, Richard 411 time value of money 67–8, 455 time value of options 160–3, 255–60 TMT stocks 416 total shareholder returns (TSRs) 69–70, 73, 151–2 trade payables 10–14, 15–18 trade receivables 9–14, 15–18, 20–4 trade-off model 213–14, 247–9, 455–6 transaction costs 62–5, 209–12 transaction multiples 203, 207–8 trend analyses 30, 32–3, 38–41, 88–91 Treynor, Jack 124 trial-and-error IRR calculation methods 81, 85–6 true or false tests 482–6 TSRs see total shareholder returns Tunisia, tax rates 227 Turkey 444 Ubisoft 329 UK 227, 235, 288–9, 302, 308, 315, 325, 328, 332, 350, 366, 374, 375–8, 454–6, 459–68, 475 Ukraine 425 505 underlying assets 93–7, 156–64, 166–76, 251–60, 403–8 Unibail-Rodamco 262–3, 272 Unilever 52, 127, 205, 273, 414 Unistrat-Coface 408 unit trusts 292 unlisted companies 178, 182–3, 297–300, 312–14, 319–21, 466–8 US 227, 235, 268–9, 275, 276–7, 309, 315, 328, 332, 350, 373, 376–8, 395, 397, 454–6, 469–71 US GAAP 423, 483, 486 US-style options 156, 158–9 Valeo 425 valuations 93, 94–7, 108–10, 112–16, 148, 153–4, 155, 159–63, 166–7, 168–72, 179–82, 186, 189–93, 194–201, 202–8, 209–21, 253–60, 287, 296–300, 357–9, 411, 413–14, 418–19, 422 see also corporate valuation methodologies; prices; returns arbitrage theory 162–3, 411 binomial models 94–7, 160–3, 166–7 Black and Scholes option pricing model 160–3, 166–7, 411 convertible bonds 168–70, 186, 201 DCFs 189, 191, 194–201, 423–4, 455–6 EBIT multiples 148, 153–4, 189–90, 202–8, 459–68 EBITDA multiples 202–8, 429, 459–68 inventories 6, 18, 33, 192, 476 options 93, 96–7, 159–63, 166–7, 169–70, 253–60, 411, 476 securities 108–10, 112–16, 155, 162–3, 179–82, 189–92, 194–201, 418–19 value chains 26–30 value-creation 3, 26–30, 58, 69–75, 147–55, 191–2, 207–8, 245–6, 266, 278–80, 291, 315–21, 328–36, 354–9, 361–3, 412–22 variable costs 29, 38–41, 248–9 506 Index variance 103, 109–10, 113–16, 123–8 VAT 16–17 VDD see vendor due diligence vendor due diligence (VDD) 340–3 venture capital 290–1 Vivendi Universal 245, 273, 432 Vodafone 332 volatilities 93, 102–3, 106–7, 113–16, 160–3, 252–60, 298, 391, 424–7, 438–43 Volkswagen 331 voluntary takeovers 337, 348–50 voting caps 301, 309–10 voting rights 148, 171–2, 292, 301, 302–3, 309–11, 331–4, 344–53 WACC see weighted average cost of capital warrants 149, 165–7, 201, 276, 308–9, 352, 380 weighted average cost of capital (WACC) 69–70, 72–3, 132–3, 189–90, 195–6, 198–201, 209–12, 219–21, 274–5, 476, 478 Wendel 291 work in progress 9, 16–18, 19–24 working capital 5–8, 10–14, 15–18, 29–30, 194–201, 291, 435–7, 479 working capital turnover ratio 15, 17 World Bank 447 Worldcom 325 yield curves 399–400 yield to maturity see internal rate of return Yunus, Muhammad 444 Z-scores 435–7 zero-coupon bonds 167, 251–2
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