🔎 The Corporate Finance Perspective

Corporate Finance has a distinct perspective. It is also the perspective of the legal system.

Managers have a duty to maximize shareholder value. If you aren’t maximizing shareholder value, you’re not doing your job.

In corporate finance, we view shareholder value as coming from the NPV of the net cash flows generated by the firm’s assets.

An enterprise is a collection of assets that generate cash flows into the future.

Any project that increases NPV of net cash flows (ie free cash frows from PS 4) maximizes shareholder value. Therefore, you should raise additional capital to take on those projects. The weighted average cost of capital that you will pay as you raise new capital is known as your “Weighted Average Cost of Capital.” If a project has a positive NPV based on your WACC, you should pursue the project.

We will always be taking NPVs of cash flows.

In summary, to maximize shareholder value, you calculate the NPV of all projects using the WACC and you take the projects that have a positive NPV.

Corporate Finance Perspective, Part II

A key insight that we will explore in the future weeks is that…

A.) Market Value of the Assets

B.) Market Value of Liabilities + Market Value of the Equity

In other words, if we draw a “Market Value Balance Sheet,” then the Accounting Equation must apply to the market values:

$$MV \;Assets = MV \;Liabilities + MV \;of \;Equity$$

In corporate finance, we view shareholder value as coming from the NPV of the net cash flows generated by the firm’s assets.

Because all of the cash flows from the assets must go either to the debt or the equity, if you hold a portfolio of the debt and equity in the same proportions as the firm’s capital structure, your portfolio should earn exactly the expected return on the firm’s assets.

$$\begin{aligned} &MV \;Enterprise + Cash = \\ &MV \;Assets = MV \;Liabilities + MV \;of \;Equity \end{aligned}$$

If people are assets of a firm and companies sometimes acquire target companies to acquire that talent, then how do you measure the value of those human resources.

This is where the corporate finance approach shines.

As a side note, we can say that from an accounting perspective, people often show up as liabilities. However, the corporate finance perspective is different. From a CF perspective, there is a reason why the market cap is much greater than the Stockholder’s Equity. The reason is that the human resources of the firm and the other intangible assets of the firm will generate cash flows going forward.

But how do we measure the value not just of the human assets, but the value of the entire enterprise as an enterprise?

Generally, we do this by looking at market values (by looking at MV, we distinguish ourselves from the accounting perspective). We also assume that the market value of all of the assets (tangible + intangible) are equal to the market value of the claims on those assets. In other words,

$$\begin{aligned} &market \;value \;of all \;assets = \\ &market \;value \;of \;liabilities + market \;value \;of \;equity \end{aligned}$$ $$\begin{aligned} MV \;tangible \;assets &+ MV \;intangible \;assets \\ = MV \;liabilities &+ MV \;equity \end{aligned}$$

MV intangible assets (such as people, organization, brand) =

$$MV \;liabilities + MV \;equity - MV \;tangible \;assets$$

This would be one way of estimating the value that the market attributes to the intangible assets of the firm, including HR.

$$MV \;all \;assets = MV \;liabilities + MV \;equity$$

The value of a corporate enterprise as an enterprise is the value of the tangible and intangible assets minus the cash. We exclude the cash because the cash doesn’t tell you about the value of the corporation as an enterprise. In other words, it doesn’t tell you about the value of the corporation as a money making machine.

$$Enterprise \;value = MV \;Assets - Cash$$

Applying MV all assets =

$$MV \;debt \;claims + MV \;equity$$

We see that.

$$Enterprise \;value = MV \;debt \;claims + MV \;equity - Cash$$

👆 this is indeed the formula for Enterprise value.

A firm is just a “machine” that kicks off cash flows. The market value of those cash flows