Corporate Finance: Budgeting, Debt, Equity, and Leverage

Posted on Feb 22, 2025 in Finance

T.2: Capital Budgeting

  • Value of the project: €150,000
  • To calculate the years horizontally, input the revenues (45) and then calculate 45 + (45 * 0.1)
  • Depreciated value of investment = Cost of investment – Book Value
  • (-) Depreciation = DVI / Salvage Value or Value of the project * % Depreciation
  • EBIT = +Sales (Price per unit * number of units) – Cost of goods sold (variable cost * number of units) – Operating expenses – Depreciation
  • (-) Taxes = EBIT * (% tax)
  • (+) Depreciation
  • (-) Change in receivables = Sales * (Days of receivables / 360) (starting from year 0) –> Year 0 does not change; from then on, calculate Year 1 – Year 0
  • (+) Change in suppliers = Cost of goods sold * (days / 360)
  • (-) Change in inventories = Sales * % given /// If it’s the raw cost, take (cost of goods sold + other operating expenses + depreciation) * (number of days / 360)
  • (+/-) CAPEX: Year 0, input the cost of investment // Last year, input: Salvage Value
  • (-) Taxes on selling price = Last year’s CAPEX * % tax rate
  • FCF = EBIT – Taxes + Depreciation – …
  • Cumulative FCF = Keep the FCF the same for year 0; from then on, calculate Year 0 + Year 1 (because the first years should be negative until reaching a positive value that will be used for the payback)
  • Payback = The last year that was negative (e.g., 4 years) + ABS(Cumulative FCF of the last negative year / FCF of the last year)
  • NPV = Initial Investment (first value of year 0 of the FCF) + (FCF1 / (1 + r))^n
  • IRR = Same as NPV, but isolating the IRR as if it were the ‘r’
  • MIRR = ((FCF1 * 1.12 (reinvestment rate given) + FCF2) / FCF0 ))^(1/n)

In this particular example, the IRR gives an overly optimistic picture of the potential of the project, while the MIRR gives a more realistic evaluation of the project.

For both NPV and MIRR, the decision is to accept.

  • PV = first cash flow / (interest – growth rate)

T.3: Mini Case

Debt

  • Coupon Value per year = Face value * % annual coupon
  • Price of the bond: Year 1 = Face Value * % price when issued – 1y //// Last Year = Face Value
  • Transaction cost per bond = Transaction costs / Number of bonds
  • Price of the bond with transaction cost per bond = Price of the bond – Transaction cost per bond
  • Kd pretax (%) = (Coupon Value Year 1 + ((Face value – Price of the bond with transaction cost per bond) / Maturity (total years)) / ((Face Value + Price of the bond with transaction cost per bond) / 2)
  • Kd (%) = Kd pretax * (1 – % tax rate)

Explanation: For the debt that was issued and is currently on the balance sheet of the business, we had to pay a kd %. We have to take into account the difference between the marginal cost of Debt and the current debt cost.

Equity: CAPM

  • rf (risk-free interest rate) = 3.5%
  • beta = 1.3
  • Rm (market return) = 10%
  • Ke (cost of equity) = Rf + b(Rm – Rf)
  • DDM: g (growth) = 2% /// P0 (current market price) = €8 /// Book Value (Shares Value) = €2 /// EBIT = €20 Million /// Payout = 100% /// Common Stock = €36 Million
  • EBIT – interest [number of bonds * coupon value] = EBT
  • Number of bonds = long-term debt /// coupon value = Face Value * % coupon
  • EBT – tax (EBT * tax rate(%)) = Net Income
  • Number of Stocks = Common Stock / Book Value
  • Final Dividend = Dividends / Number of stocks
  • Dividends = Net Income * % Payout
  • Ke = (Final Dividend / P0) + g

Weight of Debt & Equity (Book Value)

  • Equity = number of stocks * book value + EBIT –> in % = E / (E + D)
  • Debt = long-term debt (given at the beginning) —> in % = 100% – E in %

Weight of Debt & Equity (Market Value)

  • Equity = number of stocks * P0 —> in % = E / (E + D)
  • Debt = long-term debt * (96%) price of the bond now –> in %

WACC or Cost of Capital

WACC = Equity market value in % * Ke (CAPM) + Debt market value in % * Kd

T.4: Financial Leverage

Market Value = 275,000 /// Number of Shares (outstanding) = 5000 /// Price per share = MV / number of Shares /// % of probability (3 scenarios: pessimistic, neutral & optimistic)

Calculate the number of shares if there is debt = number of shares – (debt / price per share)

(+) Sales (-) Variable Costs (-) Fixed Costs [in the case of 3 scenarios]

  • (+)EBIT: Neutral = given // pessimistic = neutral * % given inverse // optimistic = neutral * (1 + % increase)
  • (-) Interest (can be fixed and variable cost, variable cost = units * unit variable cost) = debt issue * % interest rate
  • = EBT
  • (-) taxes = %tax * EBT
  • = Net Income
  • EPS = Net Income / number of Shares
  • eEPS (only in the neutral column) = (EPS pessimistic * % pessimistic) + (EPS neutral * % neutral) + (EPS optimistic * % optimistic)
  • % of change EPS = (EPS pessimistic – EPS neutral) / EPS neutral
  • Standard Deviation (sd) (CALCULATE THE SQUARE ROOT OF EVERYTHING AFTER THIS CALCULATION) = ((EPS opt – EPS neutral)^2) * % opt) + ((EPS neut – EPS neutral)^2) * % neut + ((EPS pes – EPS neutral)^2) * % pes

The higher the standard deviation, the greater the risk for the company.

Explanation: Unfortunately, we cannot decide whether to accept the project or not as the volatility of the second situation (with debt) is more extreme (sd = 0.2728) than the first situation (sd = 0.2182). Knowing that we obtain a higher return on the second situation, but that it involves a higher risk, we do not know which one to choose.

  • ROE (%) = Net Income / Equity
  • % change in equity = (ROE pessimistic – ROE neutral) / ROE neutral

Equity = Market Value – Debt

Break-Even Point = (((EBIT – Interest) * (1 – tax rate)) / Number of shares) = EPS

Question 2: As we can see, when we get more debt, the risk increases as volatility increases (From -40% to 25% – From -64% to 40%). This change in risk is due to financial risk, while the other risk, which remains equal as there are no changes in the business activities, is called business risk (Crisis, wars in the industries, or Internal factors).

T.5 Dividend Policy

Capital Investment = 5,000,000 // Total Net Income = 7,500,000 // Number of Shares = 2,000,000 // Debt Equity Ratio (40%) // Market Price (P0) = €30

a) Residual Dividend Policy

Net Income to give = Net Income – Firm of equity

  • Firm of debt = Capital Investment * Weight of debt [Debt to equity ratio / (1 + Debt to equity ratio)]
  • Firm of Equity = Capital Investment * Weight of equity [100% – Weight of debt]

Dividends per share (DPS €) = Net Income to give / Number of Shares

b) Dividend Yield Calculation (%)

Dividend Yield = DPS / P0

c) The firm wants to provide a 5% dividend yield, calculate the payout

  • DPS(€) = P0 * Dividend Yield (5%)
  • Total Dividends = number of shares * DPS
  • PAYOUT(%) = Total Dividends / Total Net Income

Calculate ex-dividend date and payment date: The ex-dividend day is the last day to sell shares, the record day is where stock prices are established, and the payment day is when dividends are paid.

b) If you own 20,000 shares, calculate the gross and net total dividends you will receive on May 8:

  • Number of shares * DPS = Gross Dividend
  • Tax on dividends (19%)
  • Total Net dividends = gross dividend – 19%(gross dividend)

c) How much taxes you paid in total and when (the total of all this is the taxes):

  • Net Dividends = Gross dividend * 19%
  • Total to pay = 19% * 6000 + 21%(Gross dividend – 6000)
  • To be paid on the 21st of the following month = Total to pay – Net dividends

EQUITY ACCOUNTS: Common stock / capital surplus / return earnings / total owner’s equity // book value of the stock // number of shares = common stock / book value

a) How many new shares are going to be distributed? Show how Equity will change

  • New shares to be distributed = number of shares * % stock dividend –> add this to the number of shares
  • Capital surplus = P0 – book value
  • Common stock = new number of shares * book value
  • Capital surplus = new shares to be distributed * capital surplus + capital surplus (original)
  • Returning earnings = total owner’s equity – common stock – capital surplus
  • Calculate the price of the share after the stock dividend in the two previous situations: P1 = (P0 * number of shares 0) / number of shares 1

5&6. Cash $ 55,000 Equity $ 465,000 // Fixed assets 410,000 // Total 465,000

Market Value today = Equity / number of stocks // MV Tomorrow = MV Today – DPS // Total Dividends paid = DPS * number of stocks

Now make a new table with: Cash = Initial Cash – Total Dividends paid // next to this, put Equity = number of stocks * MV Tomorrow // below cash, put Fixed Assets and then calculate the total = Cash + Fixed Assets

Explanation: As we can see, the change has been done to the cash and Equity as we pay these dividends. We need cash to pay them, which will diminish that account in the balance sheet. On the other side, the price of the stock falls the same amount as the dividends, affecting the equity as well.

Ex.8: Money spent / EPS / P0 / number of shares

a) Cash Dividend:

  • DPS = Money spent / number of shares
  • P1 = P0 – DPS
  • Shareholders wealth = P1 * number of shares

b) Repurchase of shares:

  • Shares repurchased = Money spent / P0
  • New number of shares = number of shares – shares repurchased
  • Shareholders wealth = new number of shares * P1

Ex.9: FCF / Dividends (you may not use them) / PV of future cash flows / number of shares / tax rate / Equity = PV FCF

a) Price of the stock in the market (P0)

P0= Equity / number of shares

b) How is Jeff Miller going to achieve a zero payout policy on his own?

Payout (%) / number of shares Jeff / Total Dividends = FCF * (%Payout) / DPS = Total Dividends / number of shares // Total dividends Jeff = DPS * number of shares Jeff // P1 = P0 – DPS // Purchase of new shares = Total dividends Jeff / P1

  • Total Shares of Jeff = number of shares of Jeff + Purchase of new Shares –> Round up this result