Slide Deck 2-3-25 BMA 5 (Investment Decisions)
Page 1: Introduction
Course Title: ECON 1720: Corporate Finance Making Investment Decisions
Date: February 3, 2025
Instructor: Bradford M. Gibbs
Position: Urry & Comfort Family Senior Lecturer in Economics
Department: Economics
Page 2: Sources
Materials include diagrams and examples from presentations by Matthew Will.
Based on Brealey, Myers, & Allen's Principles of Corporate Finance (14th Edition) (McGraw Hill-Education).
Page 3: Agenda for Class
Housekeeping
Homework #1 solutions posted on Feb 5
Quiz #1 is scheduled for Feb 12
Homework #2 due on Feb 19
Charts of the Day
Recap
Alternative Measures of Return
Closing Remarks
Page 4: Charts of the Day - Manufacturing and BoP
Global manufacturing share data:
China leads, followed by U.S., Japan, and Germany.
Timeframe covered: 2003 - 2023.
Source: United Nations Industrial Development Organization.
Page 5: Charts of the Day - Good News
Net Worth/Disposable Income Ratio - Increasing since 1960.
Household Debt/Net Worth Ratio - Shows relative debt levels over time.
Data from Federal Reserve as of Sept 30, 2024.
Page 6: Charts of the Day - Diversification Benefits
Analysis of stocks outperforming the S&P 500:
Only 1/3 of index members beat the benchmark since 1999.
Illustration of financial performance trends since 1990.
Source: Bloomberg.
Page 7: Charts of the Day - Eurozone News
Comparison of growth vs. value stocks in the U.S. and Europe.
Observations as of Jan 31, 2025.
Source: BofA Global Investment Strategy.
Page 8: Charts of the Day - Dislocations
Analysis of consensus earnings estimates vs. share price for Tesla.
Events correlating with financial performance from 2020 to 2025.
Source: Financial Times.
Page 9: Charts of the Day - Tightening Spreads
Visual representation of High Yield (HY) vs. Loan Level (LL) spreads.
Changes presented from 2022 through 2024.
Source: The Daily Shot.
Page 10: Charts of the Day - EBITDA Redux
Mention of EBITDA metrics associated with U.S. Coast Guard.
Illustrative notes from February 2020.
Page 11: Meme of the Day - Importance of Excel
Highlighting Excel's crucial role in managing global financial systems.
Page 12: Meme of the Day - Revenue Terminology
Clarification that "revenues" equal "sales" and "turnover."
Source: Litquidity, Jan 30, 2024.
Page 13: DCF Modeling Recap
Overview of Discounted Cash Flow (DCF) modeling techniques.
Page 14: Recap on NPV
Time Value of Money: A dollar today is worth more than a dollar tomorrow.
NPV depends on forecasted cash flows and opportunity cost of capital.
Present values are additive: NPV(A + B) = NPV(A) + NPV(B).
Page 15: Cash Flow vs. Accounting Income
Example project costing $2,000 with cash incomes of $1,500 and $500 over two years.
Importance of cash flows over accounting income for accurate financial analysis.
Page 16: Aggregate vs. Equity Value
Breakdown of components constituting Enterprise Value including:
Market value of equity
Financial debt
Cash and equivalents
Net debt
Market value of minorities and associates.
Page 17: Unlevered Free Cash Flow (UFCF)
Calculation methodologies:
Top Down: EBIT + Depreciation & Amortization - Taxes +/- Change in Working Capital - Capital Expenditures.
Bottom Up: Net Income + After-tax Interest - Tax shield + Depreciation & Amortization +/- Change in Working Capital - Capital Expenditures.
Page 18: Unlevered Free Cash Flow (Cont'd)
Cash Flow to Firm (FCFF) available to all investors before debt payments.
Cash Flow to Equity (FCFE) remains after debt payments are accounted.
Page 19: Recap on Modeling Questions
Insightful questions regarding projecting revenues and cost patterns for financial modeling.
Page 20: DCF Analysis Summary - Birkenstock Valuation
Key metrics:
Discount Rate: 10.3%
Terminal Growth Rate: 2.8%
Implied EBITDA multiple: 6.8
Detailed projected revenues and cash flows from 2024 to 2033.
Equity Value per Share calculated at €31.40.
Page 21: Measuring Returns
Discussion on the measurement of returns from investments.
Page 22: Essential Questions
Consideration of various investment decision metrics beyond NPV.
Definition and pros/cons of Internal Rate of Return (IRR).
Page 23: Role of Financial Manager
Investment decisions reflect trade-offs in cash flow applications.
Page 24: CFO Decision Tools
Reference to surveys on CFO use of investment evaluation techniques from Graham and Harvey study.
Page 25: Book Rate of Return
Definition: Average income divided by average book value.
Limited relevance in manager decision-making due to reliance on tax and accounting figures.
Page 26: Payback Period
Definition: Duration to recover initial project cost via cash flows.
Flaws: Ignores time value of money and later cash flows.
Page 27: Payback Example
Implications of choosing projects solely on the 2-year payback period constraint.
Page 28: Internal Rate of Return (IRR)
Definition: Discount rate yielding NPV = 0; rule to invest above opportunity cost.
Page 29: IRR Calculation Example
Practical example of investment IRR calculation based on cash flows.
Page 30: IRR Graph Interpretation
Visualization displaying NPV against various discount rates - identified IRR at 28%.
Page 31: IRR Pitfalls
Pitfall 1: Concern when cash flow patterns change direction early.
Page 32: IRR Multiple Rates of Return Pitfall
Different discount rates can yield the same NPV.
Page 33: IRR Mutually Exclusive Projects Pitfall
IRR ranking limitations for conflicting project scales.
Page 34: IRR Summary Thoughts
Emphasizing importance of cash flow metrics over IRR in investment decisions.
Page 35: Closing Remarks
Note on comfort with NPV concepts; ongoing discussions scheduled.
Page 36: Upcoming Discussions
Review of concepts such as CAPM and WACC, with reminders for project preparations.