Springer Texts in Business and Economics Pasquale De Luca Corporate Finance Fundamentals of Value and Price Springer Texts in Business and Economics Springer Texts in Business and Economics (STBE) delivers high-quality instruc- tionalcontentforundergraduatesandgraduatesinallareasofBusiness/Management Science and Economics. The series is comprised of self-contained books with a broadandcomprehensivecoveragethataresuitableforclassaswellasforindividual self-study. All texts are authored by established experts in their fields and offer a solidmethodologicalbackground,oftenaccompaniedbyproblemsandexercises. Pasquale De Luca Corporate Finance Fundamentals of Value and Price PasqualeDeLuca FacultyofEconomics UniversityofRomeSapienza Rome,Italy ISSN2192-4333 ISSN2192-4341 (electronic) SpringerTextsinBusinessandEconomics ISBN978-3-031-18299-0 ISBN978-3-031-18300-3 (eBook) https://doi.org/10.1007/978-3-031-18300-3 #TheEditor(s)(ifapplicable)andTheAuthor(s),underexclusivelicensetoSpringerNatureSwitzerland AG2023 Thisworkissubjecttocopyright.AllrightsaresolelyandexclusivelylicensedbythePublisher,whether thewholeorpartofthematerialisconcerned,specificallytherightsoftranslation,reprinting,reuseof illustrations, recitation, broadcasting, reproduction on microfilms or in any other physical way, and transmission or information storage and retrieval, electronic adaptation, computer software, or by similarordissimilarmethodologynowknownorhereafterdeveloped. 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Introduction ThisbookofCorporateFinancetriestosystemicallyintegratefirms’approachonthe market, on which the fundamentals of value depend, with that of investors in the financialmarketsonwhichpricesdepend. ThebookofCorporateFinanceisbuiltonthebasisoffourstrongbeliefs. First,themainaimofthefirmistomaximizetheequityvalueovertime,andthen forcurrentandfutureshareholders.Thenthisaimmustalwaysbeconsideredinthe long run where pursuing the shareholders’ value creation implies and requires satisfying of other stakeholders as well. It is in a perspective of short run that we mayhavedistortionsoftheshareholdervaluetheoryabletoattributetoittheblame for the incorrect behaviour of managers. Indeed, the maximization of the equity valueinthelongrunisdifferentand,mostrelevant,commonlyincontrastwiththe maximizationoftheequityvalueintheshortrun.Therefore,theproblemisnotthe shareholder-orientedcapitalismbutthedistortionduetotheshort-termismofsome managers. Second, finance has a fundamental role in the structured growth process of the firm.Corporatefinancegoesfarbeyondthenarrowboundariesasdefinedinthepast by influencing directly and in relevant way the most important strategic and operating choices of the firm. Today for the firm is not possible to image to make well business without to make well finance as well. Since the aim of the firm is to maximize the equity value in order to grow in a structured way, a good financial managermustalwaysthinkintermsofvaluecreation.Itrequiresadeepknowledge of the firm’s business and the behaviour of all its actors (customers, suppliers, employees, competitors, etc.), to invest capital with profit, as well as a deep knowledge of financial markets and investors’ behaviour about risk and expected return,toraisecapitaltobeinvestedinthebusiness. Third,fundamentalanalysisofthefirmisarelevantpartofthecorporatefinance and it is the starting point for financial managers, financial analysts, investors, financial advisors, and bankers, to well-understand the current state of the firm’s health,whereitcomesfromandwhereitisgoing. Inthiscontest,thefundamentalanalysisofthefirmisbasedontheEconomicand FinancialDynamicAnalysis(EFDA)ofthefirm.Itismorethanthesimplefinancial analysis commonly based on the financial statements and then focused on the past performance of the firm. The EFDA is not an accounting analysis and it must be vii viii Introduction never confused with the analysis of the accuracy of numbers on the basis of the accountingprinciples. The EFDA is based on economic and financial aggregates (operating and net income, invested capital and capital structure, free cash-flows to the firm and to equity) able to show clearly, simple and intuitively the effective economic and financialdynamicofthefirmovertimebyconsideringboththepastandthefuture connected in a single and unique evolution path. In this dynamic perspective, the focus is on evolution over time of the economic and financial items rather than on their static analysis with regard to a specific moment. Indeed each single number must be analysed in a systemic way with regard all other numbers on the basis of theirdynamicevolutionovertime. Indeed,themainaimoftheEFDAistosupportthedecision-makingprocessby evaluating the firm’s ability to create and to maximize the equity value over time through the systemic, constant, and continuous measurement of the effects of the strategic and operating decisions of CEO and managers on the economic and financial dynamic of the firm with regard to the past and the future. Specifically, theEFDAsupportsthedecision-makingprocessbymeasuringandevaluatingi)ex ante,theexpectedeffectsofthestrategicandoperationaldecisionsontheexpected economic and financialdynamic of the firm and then on its ability tocreate and to maximize value, and ii) ex post, the real effects of the strategic and operational decisionsmadeontheactualeconomicandfinancialdynamicofthefirmandthenon theeffectivevaluecreated. Sincethemainaimofthefirmistocreatevalue,thefuturetimeismorerelevant tothepasttime.Therefore,theEFDAisbasedmoreontheexpectedfuturedynamic ratherthanthepast.Thepastanalysisisrelevanttowell-understandtheperformance effectively realized by the firm in order mainly to evaluate the accuracy and reliabilityoftheassumptionsonwhichtheexpectedvalueofeconomicandfinancial itemsismadeintheexpecteddynamic. Fourth, the firm’s ability to create and to maximize the equity value must be measuredbyconsideringjointlythefundamentalanalysisofthefirm,basedonthe EconomicandFinancialDynamicAnalysis(EFDA),withthedynamicoffinancial markets. Indeed, the firm valuation is one of the most relevant fields in which the fundamentals of value based on the firm’s analysis meet the fundamental of asset pricing based on financial market analysis about risk and expected return. In this sense,thebaselineequationofvaluecreationstatesthatthefirmcreatesvalueifand onlyifthereturnoncapitalinvestedinthebusinessexceedsthecostofcapitalraised inthefinancialmarket.Consequently,themaximizationofthefirm’sequityvalueis based on two variables: 1) return on invested capital, where its maximization requires a deep knowledge of real markets and the business model of the firm and 2)costofcapital,whereitsminimizationrequiresadeepknowledgeofthefinancial marketsandthebehaviourofinvestorswithregardtotheriskandexpectedreturn. I believe that in the field of Corporate Finance theory and practice must be considered jointly. Then the book is defined by thinking of master's degree and Introduction ix doctoral students as well as financial managers, financial analysts and advisors, investorsandbankers. The approach used in the book is based on a rigorous quantitative analysis. All equationsused,althoughtheycanbefrighteningatfirstreading,theyalwayshavea directapplicationandtheirmainaimistohelpthedecision-makingprocessbothat strategicandoperatinglevelinordertomaximizethefirm’sequityvalue. To avoid weighing down the text no citations have been inserted except as deemed necessary (and if any of these are missing, I apologize in advance). All thetextsandpapersfromwhichIdrewareindicatedinthebibliographyattheendof thebookandalsointhiscaseIhopeIhavenotforgottenanyone. Thebookisorganizedintosevenparts. PartInamed“EconomicandFinancialAnalysisoftheFirm”isfocusedonthe Economic and Financial variables of the firm analysed in the perspective of the maximizationoftheequityvaluecreation. Chapters1–3investigatethefirm’sabilitytocreateprofitovertimeonthebasis oftheanalysisofrevenues,cost,andmarginstructures.Theaimistoinvestigatethe firm’s ability to produce profit margin over time in a stable and structural way at level of product, business unit, and corporate. Therefore, they analyse the main economic variables and their functions in order to maximize the profit and to minimizethecoststructure. Chapters 4–6 are focused on the Economic and Financial Dynamic Analysis (EFDA).Theanalysisreferstotheoperatingandnetincome,theinvestedcapitaland capitalstructure,andthefreecash-flowstothefirmandtoequity.Themainaimisto investigate the structural ability of the firm to create profit in its business, the sustainability of the invested capital and capital structure, and the firm’s ability to generate free cash-flows to equity that are structural, stable and in line with investors’expectations. Chapters 7–8 complete the economic and financial analysis by focusing on the analysisofthemainfinancialratiosusedinfinancialcommunityandthebasictool thatfirmcommonlyusetoevaluateitsinvestmentprojects. PartIInamed“RiskandReturninCapitalMarkets”isfocusedontheanalysisof investors’behaviouraboutriskandexpectedreturn. Chapters 9–12 are focused on the investor’s choice about risk and expected return.Threestepsarefollowed:first,weintroduce themeasurementofportfolio’s expectedreturnandrisk,second,wedeterminetheefficientfrontierforallinvestors on the market, third we introduce the expected utility for the definition of the optimum portfolio foreachinvestor.Theanalysisiscompletedbytheintroduction oftheSingleIndexModelthatisoneofthemostcommonmodelsusedtosimplify theportfoliotheory. Chapters 13–14 are focused on the analysis of the Capital Asset Pricing Model (CAPM)thatisthemostcommonandusedgeneralequilibriummodelinthecapital markets. The CAPM is analysed in its standard form and in its most common non-standardform. Part III named “Money, Interest Rates and Bond Markets” is focused on the analysisofinterestratesbehaviourandthebondprice. x Introduction Chapters 15–16 are focused on the analysis of definition of the equilibrium interest rate on the basis of the demand and supply of bond and the behaviour interestratewithregardtotheeffectsofshiftsindemandandsupplycurves. Chapter17introducestheanalysisoftheriskandtermstructureofinterestrate. PartIVnamed“FinancialPoliciesandCapitalStructureChoices”isfocusedon theanalysisofthefirm’sfinancialpoliciesanditscapitalstructurechoices. Chapters18–19analysethetwomainsourceoffinancingequityanddebtandthe optimumcapitalstructurechoicesonthebasisofthetheoriesabouttherelationship betweenthesechoicesandthefirm’svalue. Chapter 20analysesthe dividend policy ofthe firm and itsconnection with the firm’svaluecreation. Chapter 21 analyses the cost of capital on the basis of the firm’s choices about capital structure and the dynamic of financial markets on the basis of the asset pricing. PartVnamed“Valuation”isfocusedonthemodelsforfirm’svaluation. Chapters22–24introducethegeneralequationofvaluationanditsapplicationin the perspective of equity side, by analysing the equity valuation models, and asset sidebyanalysingthefirm’svaluationmodels. Chapter25introducesthefirm’svaluationonthebasisofmultiplesapproachby analysingthemostcommonmultiplesused. Part VI named “Options” is focused on the analysis and valuation of financial options. Chapter 26 is focused on the analysis of the main characteristics of financial optionswhileChapter27introducesthemainmodelstopricingfinancialoptions. PartVIInamed“SpecialTopics”isfocusedonthemainfinancialextraordinary operations. Chapter 28 analyses the Mergers & Acquisitions in the perspective of buy-side andsell-side. Chapter 29 analyses the investment in the firm in the perspective of Private Equity,VentureCapital,andHeadFund. Chapter 30 analyses the main aspect concerning the Initial Public Offering of thefirm. IhopeyouenjoythisbookasmuchasIenjoyedwritingit. Rome,Italy PasqualeDeLuca August2022