Chapter 4 Efficient Markets and Capital Financial Decisions
Chapter 4 Chapter 4 Efficient Markets and Capital Efficient Markets and Capital Financial Decisions Financial Decisions
What Sort of Financing Decisions? Typical financing decisions include: How much debt and equity to sell - When (or if)to pay dividends When to sell debt and equity Just as we can use NPV criteria to evaluate investment decisions,we can use NPV to evaluate financing decisions. 1
1 What Sort of Financing Decisions? What Sort of Financing Decisions? Typical financing decisions include: – How much debt and equity to sell – When (or if) to pay dividends – When to sell debt and equity Just as we can use NPV criteria to evaluate investment decisions, we can use NPV to evaluate financing decisions
How to Create Value through Financing 1.Fool Investors Empirical evidence suggests that it is hard to fool investors consistently. 2.Reduce Costs or Increase Subsidies Certain forms of financing have tax advantages or carry other subsidies. 3.Create a New Security Sometimes a firm can find a previously- unsatisfied clientele and issue new securities at favorable prices. In the long-run,this value creation is relatively small,however. 2
2 How to Create Value through Financing How to Create Value through Financing 1. Fool Investors • Empirical evidence suggests that it is hard to fool investors consistently. 2. Reduce Costs or Increase Subsidies • Certain forms of financing have tax advantages or carry other subsidies. 3. Create a New Security • Sometimes a firm can find a previouslyunsatisfied clientele and issue new securities at favorable prices. • In the long-run, this value creation is relatively small, however
Financial Decisions and Informational Efficiency Efficient:"1.Performing or functioning in the best possible and least wasteful manner;" Various definitions.For example: Allocative -most valuable projects financed. Operational -minimize costs of providing services. Informational -information is not 'wasted' 3
3 Financial Decisions and Financial Decisions and Informational Efficiency Informational Efficiency Efficient: “1. Performing or functioning in the best possible and least wasteful manner;” – Various definitions. For example: •Allocative – most valuable projects financed. •Operational – minimize costs of providing services. •Informational – information is not ‘wasted’
Efficient Market Hypothesis (EMH) An Efficient Market is One Where Information is Widely Available and Used Optimally. Good Deals'will not be available. Buying securities is a zero NPV investment NPV PV of Cash Flows -Price of security 4
4 Efficient Market Hypothesis (EMH) Efficient Market Hypothesis (EMH) An Efficient Market is One Where Information is Widely Available and Used Optimally. Ä‘Good Deals’ will not be available. ÄBuying securities is a zero NPV investment • NPV = PV of Cash Flows – Price of security