Cambridge Judge Business School

MM6 FINANCE

Course Review

Dr. Bang D. Nguyen

Finance and Accounting Group

© Bang D. Nguyen
 Course Roadmap
 Sessions 1 and 2: Present Value and Valuation
of Stocks and Bonds
 Sessions 3 and 4: Capital Budgeting Decisions
 Sessions 5 and 6: Risk, Return, and the Cost
of Capital
 Sessions 7 and 8: Capital Structure

Bang D. Nguyen – MM6 Finance 2

  What is a firm (asset) worth?
◦ The value of any firm or financial asset is the PV
of its future cash flows.
 The tricky part is determining
◦ The size
◦ The timing
◦ The risk of those cash flows.
 Main takeaways
◦ Know how to calculate PV of future cash flows in
general and in special cases (perpetuity, growing
perpetuity, annuity, growing annuity etc.)
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  Sunk costs are not relevant: sunk costs are expenses that were
spent before and that are not related to investment decisions
 Opportunity costs do matter
 Side effects matter
◦ Erosion and cannibalism: if our new product causes existing customers
to demand less of current products, we need to recognize that.
◦ Synergies that create increased demand of existing products must be
recognized.
 NPV: difference between market value and cost
◦ Accept the project if the NPV is positive
◦ Has no serious problems. Preferred decision criterion.
 IRR: the discount rate that makes NPV = 0
◦ Undertake the project if the IRR is greater than the required return.
◦ IRR is unreliable with non-conventional cash flows or mutually exclusive
projects

Bang D. Nguyen – MM6 Finance 4

  Cash Flow from Operations
◦ OCF = EBIT + Depreciation – Current Taxes
 When no interest expense: OCF = NI + Depreciations
◦ OCF = Sales – CoGS – Taxes (Do not subtract non-cash deductions)
◦ OCF = (Sales – CoGS)(1 – T) + Depreciation*T
 Net Capital Spending
◦ Net Capital Spending = Purchase of fixed assets – Sales of fixed assets
= Ending fixed assets – beginning fixed assets + depreciation
◦ Do not forget salvage value (after tax, of course).
 Changes in Net Working Capital
◦ NWC = Total Current Assets – Total Liabilities
◦ Change in NWC = Ending NWC – beginning NWC
◦ Recall that when the project winds down, we recover NWC
 CF from the Firm (FCF; CF from the Asset)
◦ FCF = OCF - Net Capital Spending - Change in WC

Bang D. Nguyen – MM6 Finance 5

 Expected return i = rf + x( m - r f)

Security Market Line SML

m

rf

1.0 b

Bang D. Nguyen – MM6 Finance 6

  From the firm’s perspective, the expected
return is the Cost of Equity Capital
= rf +
i x ( m - rf )
 To estimate a firm’s cost of equity capital,
we need to know three things
◦ The risk-free rate, rF
◦ The market risk premium, rm – rf
◦ The company’s beta

Bang D. Nguyen – MM6 Finance 7

  The Weighted Average Cost of Capital
𝑬𝒒𝒖𝒊𝒕𝒚 𝑫𝒆𝒃𝒕
rWACC = x rEquity + x rDebt x (1-TC)
𝑬𝒒𝒖𝒊𝒕𝒚 𝑫𝒆𝒃𝒕 𝑬𝒒𝒖𝒊𝒕𝒚 𝑫𝒆𝒃𝒕

rWACC = x rE + x rD x (1-TC)
rDebt x (1-TC) is after-tax cost of debt
All items are in market value
 The WACC method when firm is levered: discount
the unlevered cash flows at the WACC
NPVWACC = 𝑻
𝑻
𝑾𝑨𝑪𝑪

 UCF is the unlevered cash-flow, calculated as if the

firm (or project) did not have debt (leverage)

Bang D. Nguyen – MM6 Finance 8

 IV. Capital Structure:
Key Takeaways from M&M
• M&M theorems are about the impact of the choice of
financing (D/E ratio) on the firm value, the return on and risk
of equity, and the return on the firm (WACC).
• In a world with no corporate taxes
• The value of the firm is unaffected by capital structure: VL = VU
EBIT x (1 – TC)
• Note that VU =
• Higher leverage increases the risk and return to stockholders.
rE = r0 + ×(r0 - rD) ; βE = β0 + ×(β0 - βD)
• In a world with taxes, but no bankruptcy costs
• The value of the firm increases with leverage:
VL = VU + TC x D
• Higher leverage increases the risk and return to stockholders.
rE = r0 + ×(1-TC)×(r0 - rD) ; βE = β0 + ×(1-TC)×(β0 - βD)
MM6 Finance - Bang D. Nguyen 9
 Summary: APV, FTE, and WACC
APV WACC FTE
Initial Invest. All All Equity Portion

Cash Flows UCF UCF LCF

Discount Rates r0 rWACC rE

PV of financing
effects Yes No No

MM6 Finance - Bang D. Nguyen 10

 V. How to Review the Course
• Step One: read recommended textbook chapters (2
hours each chapter). No need to understand all
details, all examples, but the main idea.
• Step Two: work on the lecture slides carefully.
Understand all examples and concepts in the slides.
• Step Three: do the Homework Assignments of each
session yourself. Only refer to the solution after.
• Re-do them if still not confident.
• Step four: re-do last year’s exam until you are
confident with it. Its solution is on the VLE.

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  10 minutes of pre-reading + 2-hour exam for
100% of the final mark.
 Closed book. University’s approved calculator
allowed. Total: 100 marks
 More marks for easier questions
◦ Calculations can be done even without calculator
◦ Most of the calculations can be done through the
datasheet provided
 Main formulas are given in the datasheet of the
exam
 You earn mark as far as you go: please do try to
work on all questions and explain what you did,
even without final solutions

Bang D. Nguyen – MM6 Finance 12

  Question 1 [30 marks in total]
◦ 10 to 12 very short, one-calculation problems on all topics of the
course
◦ Reference: Question 1 from last year’s exam
 Question 2 [30 marks]: Capital Budgeting Decisions
◦ Revise JBS plc. example in Lectures of Sessions 3 and 4, slides 30-36
◦ Revise Question 2 in last year’s exam
 Question 3 [20 marks] : Risk, Return, and the CAPM
◦ Revise Assignment 3, and example from the lecture slides
◦ Revise Question 3 in last year’s exam
 Question 4 [20 marks in total]: Capital Structure
◦ Revise Assignment 4, and examples from the slides
◦ Revise Question 4 in the last year’s exam
 If you need more practice: solve 2-3 end of chapter problems
of intermediary level per chapter. Solutions are on the VLE.

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