Professional Documents
Culture Documents
CH 1: Financial Strategy Formulation and the role and responsibilities of senior financial executive
Financial Involve (planning): 1. Establish and identify objectives 2. identify alternative courses of action 3. evaluate 4. select 5. Implement ->
Planning and (Control): 6. monitor actual results to ensure that actual performance is proceeding according to the plan 7. Respond to divergences
Control from plan
Investment Investment Appraisal + Financing Decision + Dividend Decisions
Decision
Factors to Cost, risk, flexibility, matching/purposes, amount involved, security
consider for
Capital Structure
Methods of 1. Prospectus 2. Placing (with issuing house/institutional investor) 3. Stock exchange introduction 4.Offer for Sale (To issuing house
obtaining Stock and issuing house then to public) 5. Offer for sale by tender (Offered to public but not at fixed price)
market listing
Problems facing Risk, Security, Marketability of ordinary shares, Tax considerations, Cost, Lack of information, Funding gap, maturity gap
small businesses
in financing
Dividend Traditional theory Dividend payout influence the market value bc 1. Information content (Dividend signaling) 2. Transaction cost of
Relevance raising new finance avoided 3. Preference for current income 4. Distorting taxes
Theory
Dividend Modigliani and Miller (M&M) value of the firm is determined by its future earning stream and thus dividends and retention has no
Irrelevance impact. Assumptions: 1. $H knows everything 2. No transaction cost 3. No distorting taxes 4. Share price move in the manner
Theory predicted by the model
CH 3: Cost of Capital
Cost of Equity P0 = D0(1+g)/(Ke-g)
Share Capital
Gordon's Growth G = rb. Assumption: 1. Entity is entirely equity financed 2. Retained profit is the only source of finance 3. Constant proportion of
model earnings is retained (b) 4. projected earns constant rate of return (r)
Cost of Kps = D(net)/P0(ex-div)
Preference Share
Cost of debt Irredeemable: Kb = Interest (1-T)/MVd(Ex-div); Redeemable: Kb = yield to maturity = internal rate of return
WACC Basic Principles: Cost of capital required for investment appraisal = cost of raising more capital (historical cost of capital = irrelevant),
Assume that co. Maintain same mix of capital; Uncertainties and assumptions: (1) g = historical avg (2) assume that current share
price is a reflection on logical investor behavior- Perfect market condition (3) Corporate Tax is constant (4) Risk class= assumed same
as existing project
CH 6: Reporting financial Performance, Investment Appraisal techniques and the use of FCF
Investment Accounting Rate of Return (ARR = Annual profit post depreciation/Average investment), Payback period, Discounted CF:NPV and IRR
Appraisal (Yield = a%+NPVa/(NPVa-NPVb)*(b5-a%))
Techniques
Modified Internal Adv: 1. eliminate multiple IRR 2. address the reinvestment issue facing IRR 3. Provides ranking which is consistent with NPV 4.
Rate of Return Provide % instead of value; Steps to calculate: (1) Convert all investment phase output into a single equivalent payment at time 0 (2)
(MIRR) All net cash inflow convert to single terminal receipt at the end of the project's life, reinvestment rate using company's cost of capital
(3) MIRR =(Outflow/inflow)^1/t 1
Discounted Length of time the DCF required to recover the original cash outlay
Payback
Duration Avg time taken to recover the CF on an investment. Steps: 1. Calculate value of each fcf and discounted at DF, 2. Calculate each
year's DCF as a proportion of the original outlay, 3. Take the time from the investment and multiply with the proportion in (2), 4.
Sum the weighted year values Duration. If duration is based upon the avg time to recover the initial capital investment, DF = IRR; IF
the duration is based upon the avg time taken to recover the PV of the project, DF = Chosen hurdle rate.
Capital Rationing Hard vs Soft; Single period vs Multi-Period; Divisible (Profitability index/linear programming) vs Indivisible (Trial and error, integer
programming)
Dual Values Shadow prices which reflects the change in the objective function as a result of having one more or less unit of the scarce resource.
Free Cash Flow Cash that is not retained and reinvested in the business, available to be distributed to providers of capital = EBIT Tax + Depreciation
(FCF) WC CAPEX
Free Cash Flow Represents the funds available for distribution only to ordinary $H, measures the dividend capacity of the company = FCF Interest
to equity (FCFE) payments loan repayments + CF from issuance of debt
Dividend cover FCFE/Dividend paid
Risk Mtds of treating = sensitivity analysis, probability estimate of CF, certainty equivalent, adjusting Discount rate, simulation modeling
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Earn-out Purchase consideration = initial payment + balance depending upon the financial performance of the target co. Adv: 1. Reduce initial
arrangement payment, 2. reduce risk, 3. encourages managers to work hard
Methods of For Predator, Depends on 1. Control, 2. Earnings per share, 3. Authorized shares 4. cost to the co, 5. gearing; For target co, depends
Payment on 1. Taxation, 2. share price, 3. further investment
Accounting for Goodwill: (Acquisition) recognized (Merger) no; Value of shares exchanged: (Acquisition) recorded at market value (Merger)
merger and recorded at nominal value; Pre-post profit: (Acquisition) only post (Merger) Both pre and post based on conditions: 1. No party is
acquisition acquirer, 2. both party jointly manage the co, 3. Relative size of co is similar, 4. Equity holder receives consideration from the
combined business
Regulations of The city code of takeover and mergers- regulates acquisitions of quoted co in UK. Main obj: all Shareholders are treated fairly where
takeover $H should be informed of the identity of bidder, info and time to reach decision etc.
Office of free Responsible for ensuring acquisition will not result into monopoly. Competition commission has <= 6 months to conduct investigation
trade before reporting to the Secretary of State on whether the acquisition is agst public interest. Shareholder Model (Market-based
model) is designed to protect the rights of shareholders. Stakeholder regulations (Block-holder model regulation) is designed to
protect a wider group of stakeholders
Takeover 1. Appeal to shareholders on undervaluation 2. Appeal to Competition Commission 3. White knight defence- find more acquirers to
Defense compete, 4. Pac-mac defence reverse takeover, 5. Selling Crown jewels- selling off highly valued assets, 6. Golden parachute
Introducing attractive termination packages to senior executives and make it expensive, 7. Share-repellent/super majority Change
MA&AA to require very high % of shares to approve, 8. Poison Pill Give $H rights to buy future loan and preference share and
automatically convert into ordinary shares- make it expensive to buy
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Currency Swap Agreement btw 2 parties to exchange equivalent amt of currency at a predetermined agreed rate for a period and then re-
exchanged them at the end of the period. Benefits = Access to debt finance in another country less known, flexible and give co
exchange control. Risk: Market risk, credit risk, sovereign risk, liquidity risk
CH 16: The use of financial derivatives to hedge against Interest Rate risk
Forward rate Pre-agreed fixed interest rate for a specific level of borrowing for a given future period btw co and bank
agreement (FRA)
Interest rate Binding contract btw buyer and seller for delivery of agreed interest rate commitment on an agreed date at agreed price. Future
futures price = 100 r %, the higher the interest rate, the lower the future price. Borrower =SELL futures, Investor = BUY futures. Steps: 1.
What contract? (Months, buy or sell) 2. No. Of contract = (amt of loan/futures contract size)*(time period required for loan/3
months), tick size, 3. Calculate closing future price= future spot-basis, 4. Calculate profit/(loss) = contract price-closing price = gain
per contract = tick*contract size*no. Of contracts = total profit or loss, 5. Overall NCF
Options on Right to buy or sell the related interest rate futures contract. Borrower = PUT, Investor = CALL. Steps: 1. What contract? (Months, buy
Interest Rate or sell) 2. No. Of contract = (amt of loan/futures contract size)*(time period required for loan/3 months), tick size, 3. Calculate
Futures Premium and Calculate profit/(loss) = contract price-closing price = gain per contract = tick*contract size*no. Of contracts = total
profit or loss, 4. Overall NCF = borrowing cost + premium + Profit/(Loss)
Interest Rate Agreement to exchange their interest rate commitment. Benefits: 1. Lower than bank 2. Easy to organize 3. Flexible, reversible upon
Swaps agreement
Interest Rate Right to borrow or lend a notional amount for a given period at a specified interest rate on a specified future date. Borrower's
Options Option = CALL, Seller's Option = PUT
Interest Rate Right to a series of compensation if interest rates increase above the exercise price at each interest fixing date = borrower's option.
Caps
Interest Rate Right to a series of compensation if interest rates decrease below the exercise price at each interest fixing date = Lender's option.
Floors
Interest Rate Combination of purchasing interest rate cap and sell floors or vice versa to specify the range in which interest rate fluctuate. Adv:
Collars Lower overall premium. Borrower = buy cap sell floor, Investor = sell cap buy floor
Swaption Option to enter into an interest rate swap or currency swap = protection with flexibility. But once exercised irreversible
Macaulay's Total weighted avg time for recovery of a payment and principal in relation to the current market price of bond. Steps: 1. FCF, 2. PV
Duration of FCF @IRR, 3. Each year's FCF/MV of bond, 4. FCF/MV*time from investment, 5. Sum = weighted year values = measurement of
interest rate sensitivity. Bonds with higher durations have greater price volatility. Conclusion: Maturity increases, MV more sensitive
to interest rate; Coupon rate increase, duration decrease, less sensitive; Interest rate increase, duration decrease, less sensitive
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