Table Of Content

IVne rFnriemqmueennt’lsy CAosrkpeodr aQteu Feisntaionnc ein: T hCeoorpryo arantde PFriancatniccee – t nhoew a iunt hitos rt htieradm ed biteiohnin –d a nPdie trhree Fr equently A sk ed vccooerrrppnooimrraamttee efifinnn.aacnnoccmee. awnedb ascitaed eumsei at htoe iar dedxrteesnss itvhee emxopsetr ifernecqeu einnt lyin avseksetmd eqnute sbtaionnkisn gin, DalLQlEou Fciurcryh io Questions in Salvi The book covers the theory and practice of corporate finance, and demonstrates how t •o uFsien afinncaniacli ael nthgeinoerye rtoin sgolve practical pro•bl e Cmoss. tK oefy ctoappiictsa linclude: C F C o r p o r a t e r • Valuation • Financial analysis o e • Financial policy • Financial management r qu F i n a n%C e By providing a short and a long answer to each question, Frequently Asked Questions p e ieanna sdCe op, rrmpacoatrkiasitnieng g Fi itcn oaar ncpcooenr avateelln ofiiwennsat n tachnieed r rsue saaeldifkeuerl . troe feerxetrnaccet ftohre satupdperonptsr iaotfe c ionrfpoormraateti ofinn awnicthe or ntly PYaasncna lL eQ Fuuirry, ,A Mnatuorniizoio S aDlavlilocchioFr, o m the a Pascal Quiry is a Professor of Finance at the leading European business school A team behind HEC Paris, and a managing director in the Corporate Finance arm of BNP Paribas, t s k Pierre Vernimmen’s specializing in M&A. e = e Corporate d Maurizio Dallocchio is Bocconi University Nomura Chair of Corporate Finance, and F FinanCe a former Dean of SDA Bocconi School of Management. i Q n u Yann Le Fur is a corporate finance teacher at HEC Paris business school and an e investment banker with Mediobanca in Paris. a s t Antonio Salvi is a Full Professor of Corporate Finance at Jean Monnet University, n i Italy. He also teaches corporate finance at EMLyon Business School and SDA Bocconi o C School of Management. n + e s i n 3 7 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 under- standing 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.) 1. 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 1 Frequently Asked Questions 1 2 Topics 409 50 years of research in finance 410 Ten deadly mistakes in corporate finance 412 Five mistakes in corporate valuation 423 M&A: Six mistakes to be avoided 429 Rating agencies 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 457 Transaction multiples: before and during the crisis 459 The making of an investment banker 469 Corporate finance books 472 Brainteasers – PART I 475 Brainteasers – PART II 478 Answers 481 True or false: test yourself 482 Answers 484 Crossword 487 Index 493 Frequently Asked Questions 1. What is Corporate Finance?. . . . . . . . . . . . . . 2 2. What are cash flows? . . . . . . . . . . . . . . . . . 4 3. What alternative formats of the balance sheet may companies use? . . . . . . . . . . . . . . . . . . 9 4. What is the working capital and how do companies manage it? . . . . . . . . . . . . . . . . . 15 5. What are the alternative formats of an income statement? . . . . . . . . . . . . . . . . . . . 19 6. How can we perform the financial analysis of a company?. . . . . . . . . . . . . . . . . . . . . . 26 7. What is the operating profit? . . . . . . . . . . . . . 32 8. What is the scissors effect? . . . . . . . . . . . . . . 35 9. How does operating leverage work?. . . . . . . . . 38 10. What is CAPEX? . . . . . . . . . . . . . . . . . . . . . 42 11. How can the credit risk of a company be assessed?. . . . . . . . . . . . . . . . . . . . . . . . . 46 12. How do we measure the profitability of a company?. . . . . . . . . . . . . . . . . . . . . . 50 13. What is the financial leverage effect and how does it work? . . . . . . . . . . . . . . . . . . . . . . 55 14. What are efficient markets? . . . . . . . . . . . . . . 59 15. What do we mean by discounting a sum? . . . . . 66 16. How do companies measure value creation? . . . 69 17. What is the NPV of a project? . . . . . . . . . . . . 76 18. What is the IRR of a project? . . . . . . . . . . . . . 81 19. How do companies deal with uncertainty in capital budgeting? . . . . . . . . . . . . . . . . . . . 88 20. How can real options be used in corporate finance?. . . . . . . . . . . . . . . . . . . . . . . . . . 92 21. What is risk in finance? . . . . . . . . . . . . . . . . 98 viii Frequently Asked Questions 22. Is there any relation between risk and return? . . 104 23. How are risk and return measured? . . . . . . . . . 108 24. What is diversification? . . . . . . . . . . . . . . . . 111 25. What are the efficient frontier and the capital market line? . . . . . . . . . . . . . . . . . . 117 26. What are the CAPM and the beta coefficients? . . 123 27. What is the cost of capital and how can it be estimated? . . . . . . . . . . . . . . . . . . . . . . 129 28. What are the most important debt products for companies’ financing? . . . . . . . . . . . . . . . . . 135 29. What do we mean by stock market analysis of a company? . . . . . . . . . . . . . . . . . . . . . . . . 147 30. What are financial options? . . . . . . . . . . . . . . 156 31. What are hybrid securities?. . . . . . . . . . . . . . 165 32. How are securities sold on capital markets?. . . . 178 33. What are the most important corporate valuation methodologies? . . . . . . . . . . . . . . . 189 34. What is the DCF method? . . . . . . . . . . . . . . . 194 35. What are valuation multiples? . . . . . . . . . . . . 202 36. What does the Modigliani and Miller theorem say? . . . . . . . . . . . . . . . . . . . . . . 209 37. What happens to the Modigliani and Miller theorem if we consider taxes and financial distress costs? . . . . . . . . . . . . . . . . . . . . . 213 38. What are the other real-world factors that affect the capital structure decision? . . . . . . . . . . . . 222 39. How do companies design their debt funding? . . 241 40. Can options be used for the analysis of the capital structure? . . . . . . . . . . . . . . . . . . . . 251 41. How can companies distribute their excess cash? 262 42. What are share buybacks and how do they work? . . . . . . . . . . . . . . . . . . . . . . . . . . . 272 43. What is the dilution of control in a capital increase? . . . . . . . . . . . . . . . . . . . . . . . . . 281 44. How many differenttypes of shareholdersdo we know? . . . . . . . . . . . . . . . . . . . . . . . . . . . 288 45. Why do companies go public? . . . . . . . . . . . . 296