Corporate Finance for Minor Finance Complete Study Guide
Corporate Finance
Minor Finance Summary
C.C Osendarp
Contents
1 Free Cash Flows and Project Analysis 3
1.1 What Is Free Cash Flow? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3
1.2 Net Present Value (NPV) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3
1.3 Accelerated Depreciation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4
1.4 Internal Rate of Return (IRR) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4
1.5 Profitability Index (Capital Rationing) . . . . . . . . . . . . . . . . . . . . . . . . . . 5
2 CAPM, Beta, and Cost of Capital 5
2.1 Capital Asset Pricing Model (CAPM) . . . . . . . . . . . . . . . . . . . . . . . . . . 5
2.2 Beta: Levering and Unlevering . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5
2.3 WACC Formula . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6
2.4 Comparable Firm / Pure-Play Analysis . . . . . . . . . . . . . . . . . . . . . . . . . 6
2.5 Multi-Division Beta (System of Equations) . . . . . . . . . . . . . . . . . . . . . . . 6
3 Capital Structure and Tax Shields 6
3.1 Modigliani–Miller (MM) Theorems . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6
3.1.1 Perfect capital markets (no taxes, no bankruptcy costs) . . . . . . . . . . . . 7
3.1.2 With corporate taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7
3.2 Share Repurchase Funded by Debt . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7
3.3 Excess Cash Repurchase . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8
3.4 Adjusted Present Value (APV) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8
4 Dividends and Share Repurchases 8
4.1 Dividend Policy in Perfect Markets (MM) . . . . . . . . . . . . . . . . . . . . . . . . 8
4.2 Dividend Signaling (Imperfect Markets) . . . . . . . . . . . . . . . . . . . . . . . . . 9
4.3 Rights Issues (Seasoned Equity Offerings) . . . . . . . . . . . . . . . . . . . . . . . . 9
5 Mergers, Acquisitions, and LBOs 9
5.1 Types of Mergers . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9
5.2 The Free-Rider Problem in Takeovers . . . . . . . . . . . . . . . . . . . . . . . . . . 10
5.3 LBO / MBO Pricing . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10
5.4 Stock-Swap Merger Pricing . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10
5.5 Acquirer Share Price Reaction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11
5.6 Takeover Defenses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11
5.7 Venture Capital / Startup Valuation . . . . . . . . . . . . . . . . . . . . . . . . . . . 11
1
,Corporate Finance for Minor Finance Complete Study Guide
6 Agency Problems and Financial Distress 11
6.1 Debt Overhang . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11
6.2 Asset Substitution (Risk-Shifting) . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12
6.3 Leasing as a Solution to Debt Overhang . . . . . . . . . . . . . . . . . . . . . . . . . 12
6.4 Bankruptcy Costs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13
6.5 Optimal Capital Structure (Trade-off Theory) . . . . . . . . . . . . . . . . . . . . . . 13
6.6 Free Cash Flow Hypothesis . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13
7 Real Options and Leasing 13
7.1 Types of Real Options . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13
7.1.1 Option to Wait . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13
7.1.2 Option to Expand . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 14
7.1.3 Option to Abandon . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 14
7.2 Leasing . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 14
8 Information Asymmetry and Equity Issuance 14
8.1 Pecking Order Theory . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15
8.2 Equity Issuance Under Asymmetric Information . . . . . . . . . . . . . . . . . . . . . 15
8.3 IPO Auction Pricing . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15
9 Hedging and International Finance 16
9.1 Hedging with Forwards and Futures . . . . . . . . . . . . . . . . . . . . . . . . . . . 16
9.2 Actuarially Fair Insurance Premium . . . . . . . . . . . . . . . . . . . . . . . . . . . 16
9.3 International Finance and Market Integration . . . . . . . . . . . . . . . . . . . . . . 16
10 Expected Returns, Risky Debt, and Distress Costs 17
10.1 Expected Return vs Yield-to-Maturity . . . . . . . . . . . . . . . . . . . . . . . . . . 17
10.2 Bankruptcy Costs in Firm Value . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 18
11 Key Formulas Summary Table 18
12 Open-Question Topics and Model Answers 18
12.1 Free-Rider Problem in Takeovers . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 19
12.2 Pecking Order Theory . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 19
12.3 Debt Overhang . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 19
12.4 Pecking Order vs Trade-off Theory . . . . . . . . . . . . . . . . . . . . . . . . . . . . 19
12.5 Direct vs Indirect Bankruptcy Costs . . . . . . . . . . . . . . . . . . . . . . . . . . . 19
12.6 IRR Rule Failures with Mutually Exclusive Projects . . . . . . . . . . . . . . . . . . 19
13 Quick Reference: Exam Strategy 20
2
, Corporate Finance for Minor Finance Complete Study Guide
Free Cash Flows and Project Analysis
What Is Free Cash Flow?
Free Cash Flow (FCF) measures the cash a project or firm generates that is available to all investors
(debt and equity), independently of how the firm is financed.
Free Cash Flow Formula
FCF = (1 − Tc ) × EBIT + Depreciation − CAPEX − ∆NWC
where Tc is the corporate tax rate, CAPEX is capital expenditure, and ∆NWC is the increase
in net working capital (positive = cash outflow).
Common exam mistake
Interest expense is never included in FCF. FCF belongs to all capital providers; interest
is a payment to debt holders and is already accounted for in the discount rate (WACC). A
decrease in NWC is a cash inflow (negative ∆NWC).
Exam example (Jan 2024, Q1)
EBIT = €129.1m, Depreciation = €12.1m, ∆NWC = +€25.3m, CAPEX = €27.0m, Tc = 35%.
FCF = (1 − 0.35) × 129.1 + 12.1 − 27.0 − 25.3 = 83.9 + 12.1 − 27.0 − 25.3 = €43.7m
Exam example (Jan 2025, Q2)
EBIT = €73.0m, Depreciation = €25.1m, ∆NWC = −€2.3m (decrease ⇒ cash inflow), CAPEX
= €15.2m, Tc = 30%.
FCF = 0.70 × 73.0 + 25.1 − 15.2 − (−2.3) = 51.1 + 25.1 − 15.2 + 2.3 = €63.3m
Net Present Value (NPV)
NPV and standard cash-flow patterns
T
X CFt
NPV =
(1 + r)t
t=0
CF
Perpetuity (constant CF forever): V =
r
CF1
Growing perpetuity: V =
r − g
CF 1
Annuity (n periods): V = 1−
r (1 + r)n
NPV with depreciation and taxes (Jan 2025, Q6)
Investment = €150,000 over 5 years, revenues €100k/yr, costs €40k/yr, Tc = 20%, cost of
capital r = 5%.
Annual depreciation = €30,000.
Annual FCF = (100,000 − 40,000 − 30,000) × (1 − 0.20) + 30,000 = 24,000 + 30,000 = €54,000
3
Corporate Finance
Minor Finance Summary
C.C Osendarp
Contents
1 Free Cash Flows and Project Analysis 3
1.1 What Is Free Cash Flow? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3
1.2 Net Present Value (NPV) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3
1.3 Accelerated Depreciation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4
1.4 Internal Rate of Return (IRR) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4
1.5 Profitability Index (Capital Rationing) . . . . . . . . . . . . . . . . . . . . . . . . . . 5
2 CAPM, Beta, and Cost of Capital 5
2.1 Capital Asset Pricing Model (CAPM) . . . . . . . . . . . . . . . . . . . . . . . . . . 5
2.2 Beta: Levering and Unlevering . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5
2.3 WACC Formula . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6
2.4 Comparable Firm / Pure-Play Analysis . . . . . . . . . . . . . . . . . . . . . . . . . 6
2.5 Multi-Division Beta (System of Equations) . . . . . . . . . . . . . . . . . . . . . . . 6
3 Capital Structure and Tax Shields 6
3.1 Modigliani–Miller (MM) Theorems . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6
3.1.1 Perfect capital markets (no taxes, no bankruptcy costs) . . . . . . . . . . . . 7
3.1.2 With corporate taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7
3.2 Share Repurchase Funded by Debt . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7
3.3 Excess Cash Repurchase . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8
3.4 Adjusted Present Value (APV) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8
4 Dividends and Share Repurchases 8
4.1 Dividend Policy in Perfect Markets (MM) . . . . . . . . . . . . . . . . . . . . . . . . 8
4.2 Dividend Signaling (Imperfect Markets) . . . . . . . . . . . . . . . . . . . . . . . . . 9
4.3 Rights Issues (Seasoned Equity Offerings) . . . . . . . . . . . . . . . . . . . . . . . . 9
5 Mergers, Acquisitions, and LBOs 9
5.1 Types of Mergers . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9
5.2 The Free-Rider Problem in Takeovers . . . . . . . . . . . . . . . . . . . . . . . . . . 10
5.3 LBO / MBO Pricing . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10
5.4 Stock-Swap Merger Pricing . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10
5.5 Acquirer Share Price Reaction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11
5.6 Takeover Defenses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11
5.7 Venture Capital / Startup Valuation . . . . . . . . . . . . . . . . . . . . . . . . . . . 11
1
,Corporate Finance for Minor Finance Complete Study Guide
6 Agency Problems and Financial Distress 11
6.1 Debt Overhang . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11
6.2 Asset Substitution (Risk-Shifting) . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12
6.3 Leasing as a Solution to Debt Overhang . . . . . . . . . . . . . . . . . . . . . . . . . 12
6.4 Bankruptcy Costs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13
6.5 Optimal Capital Structure (Trade-off Theory) . . . . . . . . . . . . . . . . . . . . . . 13
6.6 Free Cash Flow Hypothesis . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13
7 Real Options and Leasing 13
7.1 Types of Real Options . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13
7.1.1 Option to Wait . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13
7.1.2 Option to Expand . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 14
7.1.3 Option to Abandon . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 14
7.2 Leasing . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 14
8 Information Asymmetry and Equity Issuance 14
8.1 Pecking Order Theory . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15
8.2 Equity Issuance Under Asymmetric Information . . . . . . . . . . . . . . . . . . . . . 15
8.3 IPO Auction Pricing . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15
9 Hedging and International Finance 16
9.1 Hedging with Forwards and Futures . . . . . . . . . . . . . . . . . . . . . . . . . . . 16
9.2 Actuarially Fair Insurance Premium . . . . . . . . . . . . . . . . . . . . . . . . . . . 16
9.3 International Finance and Market Integration . . . . . . . . . . . . . . . . . . . . . . 16
10 Expected Returns, Risky Debt, and Distress Costs 17
10.1 Expected Return vs Yield-to-Maturity . . . . . . . . . . . . . . . . . . . . . . . . . . 17
10.2 Bankruptcy Costs in Firm Value . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 18
11 Key Formulas Summary Table 18
12 Open-Question Topics and Model Answers 18
12.1 Free-Rider Problem in Takeovers . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 19
12.2 Pecking Order Theory . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 19
12.3 Debt Overhang . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 19
12.4 Pecking Order vs Trade-off Theory . . . . . . . . . . . . . . . . . . . . . . . . . . . . 19
12.5 Direct vs Indirect Bankruptcy Costs . . . . . . . . . . . . . . . . . . . . . . . . . . . 19
12.6 IRR Rule Failures with Mutually Exclusive Projects . . . . . . . . . . . . . . . . . . 19
13 Quick Reference: Exam Strategy 20
2
, Corporate Finance for Minor Finance Complete Study Guide
Free Cash Flows and Project Analysis
What Is Free Cash Flow?
Free Cash Flow (FCF) measures the cash a project or firm generates that is available to all investors
(debt and equity), independently of how the firm is financed.
Free Cash Flow Formula
FCF = (1 − Tc ) × EBIT + Depreciation − CAPEX − ∆NWC
where Tc is the corporate tax rate, CAPEX is capital expenditure, and ∆NWC is the increase
in net working capital (positive = cash outflow).
Common exam mistake
Interest expense is never included in FCF. FCF belongs to all capital providers; interest
is a payment to debt holders and is already accounted for in the discount rate (WACC). A
decrease in NWC is a cash inflow (negative ∆NWC).
Exam example (Jan 2024, Q1)
EBIT = €129.1m, Depreciation = €12.1m, ∆NWC = +€25.3m, CAPEX = €27.0m, Tc = 35%.
FCF = (1 − 0.35) × 129.1 + 12.1 − 27.0 − 25.3 = 83.9 + 12.1 − 27.0 − 25.3 = €43.7m
Exam example (Jan 2025, Q2)
EBIT = €73.0m, Depreciation = €25.1m, ∆NWC = −€2.3m (decrease ⇒ cash inflow), CAPEX
= €15.2m, Tc = 30%.
FCF = 0.70 × 73.0 + 25.1 − 15.2 − (−2.3) = 51.1 + 25.1 − 15.2 + 2.3 = €63.3m
Net Present Value (NPV)
NPV and standard cash-flow patterns
T
X CFt
NPV =
(1 + r)t
t=0
CF
Perpetuity (constant CF forever): V =
r
CF1
Growing perpetuity: V =
r − g
CF 1
Annuity (n periods): V = 1−
r (1 + r)n
NPV with depreciation and taxes (Jan 2025, Q6)
Investment = €150,000 over 5 years, revenues €100k/yr, costs €40k/yr, Tc = 20%, cost of
capital r = 5%.
Annual depreciation = €30,000.
Annual FCF = (100,000 − 40,000 − 30,000) × (1 − 0.20) + 30,000 = 24,000 + 30,000 = €54,000
3
