100 QUESTIONS ON FINANCE

Working Paper WP-817 September, 2009

100 QUESTIONS ON FINANCE

Pablo Fern?ndez

IESE Business School ? University of Navarra Av. Pearson, 21 ? 08034 Barcelona, Spain. Phone: (+34) 93 253 42 00 Fax: (+34) 93 253 43 43 Camino del Cerro del ?guila, 3 (Ctra. de Castilla, km 5,180) ? 28023 Madrid, Spain. Phone: (+34) 91 357 08 09 Fax: (+34) 91 357 29 13

Copyright ? 2009 IESE Business School.

IESE Business School-University of Navarra - 1

The CIIF, International Center for Financial Research, is an interdisciplinary center with an international outlook and a focus on teaching and research in finance. It was created at the beginning of 1992 to channel the financial research interests of a multidisciplinary group of professors at IESE Business School and has established itself as a nucleus of study within the School's activities.

Ten years on, our chief objectives remain the same:

? Find answers to the questions that confront the owners and managers of finance companies and the financial directors of all kinds of companies in the performance of their duties

? Develop new tools for financial management

? Study in depth the changes that occur in the market and their effects on the financial dimension of business activity

All of these activities are programmed and carried out with the support of our sponsoring companies. Apart from providing vital financial assistance, our sponsors also help to define the Center's research projects, ensuring their practical relevance.

The companies in question, to which we reiterate our thanks, are: Aena, A.T. Kearney, Caja Madrid, Fundaci?n Ram?n Areces, Grupo Endesa, Royal Bank of Scotland and Uni?n Fenosa.



IESE Business School-University of Navarra

100 QUESTIONS ON FINANCE

Pablo Fern?ndez1

Abstract

This paper contains 100 questions that students, alumni and other persons (judges, arbitrageurs, clients...) have posed to me over the past years. They were recompiled so as to help the reader remember, clarify and, in some cases, discuss some useful concepts in finance. Most of the questions have a clear answer but others can receive several emphases. A short answer to all of the questions is provided at the end of the paper.

JEL Classification: G12, G31, M21

Keywords: flow, net income, intangibles, required return, simple return, weighted return, market premium, beta, value, book value, value creation, EVA, FCF, WACC.

1 Professor, Financial Management, PricewaterhouseCoopers Chair of Finance, IESE

IESE Business School-University of Navarra

100 QUESTIONS ON FINANCE

Introduction

This paper contains 100 questions that students, alumni and other persons (judges, arbitrageurs, clients...) have posed to me over the past years. They were recompiled so as to help the reader remember, clarify, study in depth and ? why not? ? discuss some useful concepts in finance. Most of the questions have a clear answer but others can receive several emphases. A short answer to all of the questions is provided at the end of the paper.

1. Is the net income of a year the money the company made that particular year or is it a number whose significance is quite doubtful?

2. Is depreciation the loss of value of fixed assets? 3. The so-called "cash flow" (net income plus depreciation) is a flow of cash, but is it a

flow to the shareholders or to the company? 4. The dividend is the part of the net income that the company distributes to

shareholders. As the dividend represents real money, the net income is also real money. Is that true? 5. The part of the net income that is not distributed to shareholders goes to reserves (shareholders' equity). As dividends represent real money, reserves are also real money. Is that true? 6. Does the shareholders' equity represent the savings a company has accumulated through the years? 7. Is book value the best proxy to the value of the shares? 8. Is a valuation realized by a prestigious investment bank a scientifically approved result which any investor could use as a reference? 9. Is it possible for a company with a positive net income and which does not distribute dividends to find itself in suspension of payments?

IESE Business School-University of Navarra

10. There are four ways a company can use the money it generates: a) buying other companies or assets; b) reducing its debt; c) distribute it to shareholders, and d) increasing its cash holdings. What other reasonable things can it do?

11. Assuming a company wishes to distribute money to its shareholders, is it better to distribute dividends or to repurchase shares?

12. Is the price of futures the best estimate of the /$ exchange rate?

13. How could we obtain an indisputable discount rate? How should we calculate the beta and the risk premium?

14. My company paid an extremely high price for the acquisition of another company; the price was recommended by the valuation of an investment bank. We now have financial problems. Is there any way to make that bank legally responsible for this situation?

15. Which currency has to be used in an international acquisition in order to calculate the flows?

16. Calculated betas provide different information if they are obtained by using daily, weekly or monthly data. Which data is the most appropriate?

17. Does is make any sense to calculate betas against local indexes when a company has a great part of its operations outside this local market? I have two examples: BBVA and Santander.

18. Is it possible to make money in the stock market when the quotations are going down? What is credit sale?

19. Which capital structure should we consider when calculating the WACC for a subsidiary valuation: the one that is reasonable according to the risk of the subsidiary's business, the average of the company or the one the subsidiary "tolerates/permits"?

20. Are there any ways to analyze and value seasonal businesses?

21. A financial consultant obtains different valuations of my company when it discounts the Free Cash Flow (FCF) as opposed to when it uses the Equity Cash Flow. Is this correct?

22. Which parameter better measures value creation; the EVA (Economic Value Added), the economic profit or the CVA (Cash Value Added)?

23. How could we project exchange rates in order to be able to forecast exchange differences?

24. Is it possible to use a constant WACC in the valuation of a company with a changing debt?

25. Which method should we use to valuate young companies with high growth but uncertain futures? Two examples were Boston Chicken and Telepizza when they began.

26. Which of these two methods is better: discounting the Equity Cash Flow or discounting the Free Cash Flow?

2 - IESE Business School-University of Navarra

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