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Corporate Finance
University of Iowa School of Law
Miller, Robert T.

Corporate Finance Outline

Spring 2015

Prof. Miller

Intro to Valuation; Related Legal Problems

Intro Notes:

This is not the law, but essentially has the force of law due to SEC

: Putting dollar value on a legal right; 2 Broad Methods:

Market Price: Consensus Price based on Aggregate of Sophisticated People

:

Efficient Market
Information (sophisticated traders)
Volume (actual trades)
Rational Profit Maximizers (you don’t want irrational, idiosyncratic sales)

: If markets are generally efficient, why do people keep spending $$$ on fundamental analysis

Fundamental Analysis: find out what the right is really worth, not merely what it is being traded for (challenging and unpredictable endeavor)

a. Start w/ target à Analyze it financially

: “worth” and “value” can be used interchangeably

Market Value v. Intrinsic Value

Tri-Continental Corp. v. Battye (Del. 1950)(p.7) – “Closed-End” fund discounts

: Gen. S’Holdings Corp. merged with Tri-Con (its parent company) and the shareholders being bought out deployed their appraisal rights to determine the value of their shares “as a going concern” (i.e. no synergy or future value added). Gen. S’holding is a “closed-end” mutual fund: limited shares, cannot sell own shares back to firm. Gen. S’holding a leveraged firm; to determine its NET ASSET VALUE you must deduct its debts, but closed-end shares cannot be marketed to the company, only other investors. Cannot demand proportionate share of companies’ assets. (Open-end, NAV=Market Price). Closed-end funds have DISCOUNT (~20%).
: Fundamental analysis yields different value than what shares are actually trading (i.e. market value different than fundamental analysis value)
:

: Can’t use NAV b/c it’s a liquidation value and we need to calculate value “as a going concern” (which necessarily needs to be less for operating companies or else liquidation is the best business choice)

40% Weight to NAV (based on several dif. days average), 60% Weight to constructed Market Value – THIS MAKES NO SENSE!

Del. Sup. Ct: Agrees w/ original appraiser: excluded market value b/c no actual market for shares, calculated NAV based on month-end ave. over a reasonable time. Applied discount.

Full value of corporate assets is actually more than the value attributable to the shareholders
CLOSED-END DISCOUNT: Explanation changes view of proper price

-If liquidity à proper price is market price

-If irrationality à proper price is NAV

-Discount disappears if fund liquidates/merges w/ mutual fund

Paskill Corp. v. Alcoma Corp. (Del. 2000) – Del. Supreme Court applying Battye held that fund cannot discounted based on real estate closing costs when no assets were for sale at the time of the merger, or future tax liabilities

DGCL § 251 – Merger or Consolidation of Domestic Companies and LLCs

DCGL § 262 – Appraisal Rights

(b)(1) – target shareholders may dissent from a merger and request an appraisal only when the firm’s shares are NOT publicly traded, or the consideration in the merger is cash or anything other than publicly traded stock (i.e. Gen. S’holders wouldn’t have right to appraisal today)

Efficiency of Capital Markets

ECM Hypothesis:

3 Forms:

– all information incorporated (FALSE – e.g. insider trading)
– All public info incorporated, prices adjust to info immediately

Most people in the ‘80s believed this, but this suggests that investors trading on public info cannot beat the market (BUT Fama showed data suggesting that the returns of the 20 best mutual funds distributed randomly around ave. market return).
Data supports that individuals cannot systematically acquire and use public info before the stock price already reflects that info

– All past/historical pricing info incorporated into market. (strongest empirical support).

Efficiency Paradox:

Why would anyone pay securities analysts a lot of $ if they couldn’t produce systematic returns?

Mod. to hypothesis: price reflects info level of the best-informed trader and the degree of efficiency (i.e. accuracy of price), increases as more traders get full info

Irrational Pricing Might Occur – (e.g. Tech Boom/Bust; $32BB for a company that has no assets or revenues?)

EMH advocates argue that bubbles like this were caused by rational acts, that happened to be inaccurate
It’s possible to be dead wrong and still comply w/ EMH

Behavioral Finance/Economics:

: Although humans are generally rational, there are consistent and systematic ways in which they behave irrationally

E.g. parents’ fear of kidnapping v. swimming pool – availability heuristic

:

Miller’s “Anchoring” Experiment
Hindsight Bias
Regression to the mean

“Random Walk” Phenomenon:

Data suggests that stock/commodity prices yield random walk with 0.25% positive drift per week, thus today’s stock price gives investors almost no clue about likely change tomorrow.

EMH says à once a stock shows a predictable growth cycle, the cycle is apparent to investors who immediately correct it via trading.

Takeover Price Jumps:

Stock prices jump on announcement day, but generally not after that so the one day jump reflects the average value of the takeover premium.

Speculative Eff

ional behavior by all investors.
Model then assumes Market price exists at an equilibrium value where each investor’s evaluation is and the point at which they buy, hold, or sell. (Recognizes optimists, pessimists).

Elements of Valuation

Future Value: Inverse operation of discounting (see formulas handout)

FV = (P)(1+r)^t
Where: P = principal (present value); r = interest rate; t = # of years

Present Value:

PV = (FV)/(1+r)^t

Present Value of Stream of Annual Payments:

PV = P * ([1-(1+r)^-t]/r)

PV of Annual Payment in Perpetuity:

PV = (P/r)

:

Printed on “note” is the principal amount (“face” or “stated value”) and interest rate (“stated” or “coupon rate”)
: Face value = $1000, Stated interest = 8.5%, 10-year bond.

Use annuity formula to calculate yearly return (always discount back to present value on same date)
Use discount formula to determine the PV of return of principal in 10 years.

: If you discount a bond by the amount as the stated rate you merely get P back and transaction costs make it useless (highlighting that discount rate is critical).
Bond Buyers: think discount rate is lower than stated rate
:

Pure Time Value of Money (including subjective needs)

Risk (credit, etc.) – if a company’s credit goes down, yield could fall “below par,” but if the company is bought it could go “above par”
Interest Rates – bond prices inversely related to interest rates

: Bond interest is paid semi-annually (i.e. twice) thus making them more valuable b/c you get money quicker and money is present is worth more than money in future.

Capital Budgeting: Almost Exactly Like Valuation

NET PRESENT VALUE METHOD: Is the PV of future payments from the investment greater than the cost of the investment today? Does it have a Net Present Value?

(PV of Future payments) – (Cost of investment)> 0
If YES à do it, everytime
If NO à Walk away from investment
: Generally want opportunity w/ highest NPV

Internal Rate of Return Method: Implicit Interest rate on an investment

: Is the IRR greater than the cost of capital?