fin 338 final

staged decision tree

type of capital budgeting analysis that models the decisions that management can make about the project after the project has started as a decision tree.

how do corporations select directors?

hold periodic elections usually once a year vote taken at annual meeting

preferred stock is a __

hybrid

__ reflects performance during the period

income statement

Because FCF is generated by a company's operations, the present value of expected FCF when discounted by the WACC is equal to the company's __

value of operations

the right to __ is often a distinguishing characteristic between different classes of stock

vote

depreciation expense is charged each __

year

4 financial statements

1) balance sheet 2) income statement 3) statement of stockholders' equity 4) statement of cash flows.

common stockholders rights

1) control of firm 2) preemptive right

2 widely used valuation models:

1) free cash flow valuation model 2) dividend growth model

valuing real options

1) if a project has an embedded real option, then management should at least recognize and articulate its existence 2) we know that a financial option is more valuable if it has a long time until maturity or if the underlying asset is very risky. If either of these characteristics applies to a project's real option, then management should know that its value is probably relatively high. 3) management might be able to model the real option along the lines of a decision tree

4 examples of real options

1) investment timing options 2) growth options 3) abandonment options 4) flexibility options.

types of growth options

1) lets a company increase the capacity of an existing product line 2) allows a company to expand into new geographic markets 3) the opportunity to add new products, including complementary products and successive "generations" of the original product

Companies have 2 primary sources of value:

1) value of operations 2) value of nonoperating assets

tracking stock (target stock)

A class of stock with dividends tied to a particular part of a company. To separate the cash flows and to allow separate valuations, a company can have classes of stock with dividends tied to a particular part of a company

decision tree

A form of project analysis in which possible future possible scenarios for cash flows are identified for each year in the project's life and in which managers can make decisions at future dates depending on the actual scenario occurring at that future date. It is called a decision tree because there are branches beginning at Year 0 (e.g., three possible scenarios) and because managers can make a decision at a future time (e.g., abandon the project or increase capacity, depending on the level of demand at that time), which leads to additional branches based on that decision

current liabilities

Accounts payable, notes payable, and accruals pay within a year

proxy fight

An attempt to take over a company in which an outside group solicits existing shareholders' proxies, which are authorizations to vote shares in a shareholders' meeting, in an effort to overthrow management and take control of the business. used if earnings are poor and stockholders are dissatisfied

A typical quote shows the ?

ticker symbol (MDVE), where the stock is traded (such as NASDAQ), and a time stamp

investment timing option

By waiting, a better-informed decision can be made adds value to the project and reduces its risk.

marketable securities

Can be converted to cash on very short notice and provide at least a modest return.

current assets

Cash, short-term investments, accounts receivable, and inventories convert to cash within a year

examples of different classes of stock

Class A: stock it offered to the public had no voting rights Class B: stock had 1 vote per share. Class C: stock, all of which was owned by the company's founders and executives, had 10 votes per share. All 3 classes had the same dividend rights.

__ reflect the estimated costs of the assets that wear out in producing goods and services

Depreciation and amortization

branch of decision tree

Each diagonal line leads to a branch of the decision tree each branch has an estimated probability

Scenario Analysis and Decision Trees

Each possible outcome is shown as a "branch" on the tree. Each branch shows the cash flows and probability of a scenario laid out as a time line The expected NPV is the weighted average of the three possible outcomes, where the weight for each outcome is its probability

__ is the cash flow available for distribution to all of a company's investors

FCF

Managerial choices that change operating profitability, asset utilization, or growth also change __

FCF (value of operations)

investment timing options

Gives companies the option to delay a project rather than implement it immediately. This option to wait allows a company to reduce the uncertainty of market conditions before it decides to implement the project

Stock price quotes and other information are readily available from __

Internet sources

growth option

Occurs if an investment creates the opportunity to make other potentially profitable investments that would not otherwise be possible, including options to expand output, to enter a new geographical market, and to introduce complementary products or successive generations of products allows a company to increase its capacity if market conditions are better than expected

embedded options

Options that are a part of another project. Also called real options, managerial options, and strategic options. they are a part of the project can dramatically affect the true NPV.

managerial options

Options that give opportunities to managers to respond to changing market conditions. Also called real options. they give managers a chance to influence the outcome of a project give managers the option to influence the returns on a project

flexibility options

Permit a firm to alter operations depending on how conditions change during the life of the project, such as the ability to produce different products to match changing demand.

founders' share

Stock owned by the firm's founders that have sole voting rights but restricted dividends for a specified number of years.

__ represent ownership and need never be "paid off."

Stockholders' claims (equity)

DCF Analysis with a Qualitative Consideration of the Timing Option

The discounted cash flow analysis suggests that the project should be accepted, but just barely, and it ignores the existence of a possibly valuable real option

options values

Value of opportunities to modify a project after its implementation, including expansion, contraction, or delay. Also includes additional opportunities that a project provides to a firm, such as introduction of complementary product line. so projects that expand the firm's set of opportunities have positive options values

__ is the overall return required by all of a company's investors

WACC

Managerial choices that affect risk, such as implementing riskier strategies or changing the amount of debt financing, also affect the __

WACC (company's value)

5 possible procedures to deal with real options

Use discounted cash flow (DCF) valuation and ignore any real options by assuming their values are zero. Use DCF valuation and include a qualitative recognition of any real option's value. Use decision-tree analysis. Use a standard model for a financial option. Develop a unique, project-specific model using financial engineering techniques

__ payable that are due within 30 days

accounts

abandonment option

allows a company to reduce a project's capacity or drop the project entirely if market conditions deteriorate.

abandonment options

allows a company to reduce the capacity of its output in response to changing market conditions. This includes the option to contract production or abandon a project if market conditions deteriorate too much.

preemptive right

allows current common stockholders to purchase any additional shares sold by the firm. enables current stockholders to maintain control

A company's __ usually begins with the chairperson's description of the firm's operating results during the past year and a discussion of new developments that will affect future operations

annual report

how can a balance sheet change daily?

as inventories are bought and sold, as fixed assets are added or retired, or as loan balances are increased or paid down

net worth of shareholders equation

assets - liabilities & preferred stock

book values

based on the amounts recorded by bookkeepers when assets are purchased or liabilities are issued

why are real assets are not passive investments?

because managerial actions after an investment has been made can influence its results

amounts shown on the balance sheets are called __

book values

Observe that this real timing option resembles a __ on a stock:

call option. A call gives its owner the right to purchase a stock at a fixed strike price, but only if the stock's price is higher than the strike price will the owner exercise the option and buy the stock

Although most firms have only one type of common stock, in some instances companies use __ to meet special need

classified stock

If a company could actually sell its assets at their book value, and if the liabilities and preferred stock were actually worth their book values, then a company could sell its assets, pay off its liabilities and preferred stock, and the remaining cash would belong to __

common stockholders

FIFO will report lower __ on the income statement than LIFO, but will report higher values for remaining __ on the balance sheet.

costs of goods sold; inventory

hybrid

cross between common stock and debt

3 major types of claims on this value:

debt, preferred stock, and common stock

FCF valuation model

defines the value of a company's operations as the present value of its expected free cash flows when discounted at the weighted average cost of capital (WACC) tool that clearly shows the connections between managerial choices and firm value

because there is no possibility of losing money under the __ option, this decision also lowers the project's risk

delay

A firm's common stockholders have the right to elect its __, who, in turn, select the senior __who manage the business

directors; executives

accrual example

doesn't pay its taxes or its employees' wages daily

decision node

each circle represents a decision point A place in a decision tree at which managers can make a decision based on the situation occurring at that point. Called a node because additional paths branch out, with each branch corresponding to the possible decisions.

The __ report what has actually happened to assets, earnings, dividends, and cash flows during the past few years, whereas the __ attempt to explain why things turned out the way they did.

financial statements; written materials

the preferred dividend is __, so preferred stockholders do not benefit if the company's earnings grow.

fixed

The stream of cash flows a firm is expected to generate in the future determines its __

fundamental value (intrinsic value)

an option's value is higher/lower the longer its time to expiration?

higher

The use of classified stock thus enabled the public to take a position in a conservatively financed growth company without sacrificing __, while the founders retained absolute __ during the crucial early stages of the firm's development

income; control

Valuing a real option requires __, both to formulate the model and to estimate the inputs

judgment

liquidity

length of time it typically takes to convert them to cash at fair market values

Assets are listed in order of __

liquidity

In a large, publicly owned firm, the __ typically have some stock, but their personal holdings are generally insufficient to give them voting control

managers

the option to delay is valuable only if it ?

more than offsets any harm that might result from delaying most valuable to firms with proprietary technology, patents, licenses, or other barriers to entry, because these factors lessen the threat of competition valuable when market demand is uncertain, but it is also valuable during periods of volatile interest rates, because the ability to wait can allow firms to delay raising capital for a project until interest rates are lower

is a stock with voting rights more or less valuable?

more valuable

besides stock price quotes, what else do websites provide?

total market value of stock (market cap), dividend, dividend yield, trailing twelve months of EPS

entity value

total value of a company

__ payable that are due within 90 days

notes

Each share of stock has __, so the owner of 1,000 shares has 1,000 votes for each director

one vote

any project that reduces the set of future opportunities destroys __ value

option

strategic options

options that often deal with strategic issues. Also called real options, embedded options, and managerial options. they are often associated with large, strategic projects rather than routine maintenance projects

Common stockholders are the __ of a corporation

owners

In the event of bankruptcy, __ ranks below debt but above common stock

preferred stock

In a small firm, the largest stockholder typically serves as __ and __

president and chairperson of the board

what does the preemptive right prevent?

prevents a transfer of wealth from current stockholders to new stockholders If not for this safeguard, the management of a corporation could issue additional shares at a low price and purchase these shares itself (Management could thereby seize control of the corporation and steal value from the current stockholders.)

Stockholders can appear at the annual meeting and vote in person, but typically they transfer their right to vote to another party by means of a __

proxy

accounts payable example

purchases supplies but doesn't immediately pay for them

managers are just as interested in __ risk as in measuring it

reducing

balance sheet

represent "snapshots" of its financial position on the last day of each year

the value of an option increases with the __ of the underlying asset

risk

One way to reduce __ is to structure projects so that expenditures can be made in stages over time rather than all at once.

risk gives managers the opportunity to reevaluate decisions using new information and then to either invest additional funds or terminate the project. This type of analysis involves the use of decision trees.

the managers of most publicly owned firms can be removed by the __ if the management team is not effective.

stockholders

the value of an option is higher if the current value of the underlying asset is high relative to its __

strike price

equity

sum of common stock and retained earnings

notes payable example

takes out a loan that must be repaid within a year

assets

the "things" the company owns

retained earnings

the cumulative amount of earnings that have not been paid out as dividends

market values

the current values as determined in the marketplace.

options

the right (but not the obligation) to take some action in the future

accumulated depreciation

the total amount of depreciation that has been charged on those assets

real options

they involve real, rather than financial, assets are opportunities for management to change the timing, scale, or other aspects of an investment in response to changes in market conditions. These opportunities are options in the sense that management can, if it is in the company's best interest, undertake some action; management is not required to undertake the action. These opportunities are real (as opposed to financial) because they involve decisions regarding real assets—such as plants, equipment, and land—rather than financial assets like stocks or bonds. Four examples of real options are investment timing options, growth options, abandonment options, and flexibility options.

the FCF valuation model can be applied to all companies, whether or not ?

they pay a dividend they are publicly traded or privately held. divisions of company not just whole company