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Corporate Finance
Corporate Financing and the Six Lessons of Market Efficiency

How and where To spend the money

How and where To Source the money

(2)
FIRM’s OPERATIONS

(1)
FINANCIAL MANAGER FINANCIAL MARKET

(4a)

(3)
(1) Cash raised from investors (2) Cash invested in firm

(4b)

(3) Cash generated by operations (4a) Cash reinvested (4b) Cash returned to investors

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Example The government is lending you \$100,000 for 10 years at 3% and only requiring interest payments prior to maturity. Since 3% is obviously below market, what is the value of the below market rate loan?

NPV = amount borrowed - PV of interest pmts - PV of loan repayment

Example The government is lending you \$100,000 for 10 years at 3% and only requiring interest payments prior to maturity. Since 3% is obviously below market, what is the value of the below market rate loan? Assume the market return on equivalent risk projects is 10%.

 10 3,000  100,000 NPV = 100,000 − ∑ − (1.10) t  (1.10)10  t =1 = 100,000 − 56,988 = \$43,012

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• That loan was a good deal for you but a negative NPV for the Government! ( A subsidy of \$43,012) • What are the chances of getting investors to invest in your company that will result in a negative NPV for them?… Pretty low! • Firms have to assume that equity shares and bonds that they issue will have to be fairly priced • This is achieved though…

“Efficient Capital Markets”

Random Walk Theory
• The movement of stock prices from day to day DO NOT reflect any pattern. • Statistically speaking, the movement of stock prices is random (skewed positive over the long term).

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Random Walk Theory
Coin Toss Game

\$106.09

\$103.00
Tails

\$100.43

\$100.00

\$100.43

Tails

\$97.50
Tails

\$95.06

Random Walk Theory
S&P 500 Five Year Trend? or 5 yrs of the Coin Toss... [continues]

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