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Uni Final > Corp Finance And Strategy > Flashcards

Corp Finance And Strategy Flashcards

1
Q

What is Gross Working Capital?

A

Total current assets of a company
Focusing on resources available for daily operations.

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2
Q

What is Net Working Capital?

A

Current Assets - Current Liabilities
Measures financial health and liquidity.

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3
Q

What is the Cash Operating Cycle?

A

The sum of the inventory period and the accounts receivable period.
Representing the entire process from purchasing raw materials to collecting cash from sales.

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4
Q

Key Questions to ask in relation to Working Capital

A
  1. What should the firm’s total level of investment be in current assets?
  2. What should be the level of investment for each type of current asset?
  3. What should be the firm’s current liabilities?
  4. How should working capital be financed (short/long term)?
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5
Q

Factors Determining Working Capital

A
  • Industry
  • Type of Products
  • Manufacture or Buy-in
  • Level of Sales
  • Stock and Credit Policies
  • Management Efficiency
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6
Q

What is a RELAXED Working Capital Policy?

A
  • Maintains a larger cash balance
  • Invests more in marketable securities (quick liquidity)
  • Offers more generous credit terms
  • Invests heavily in stock/inventory
  • Potentially attracts more customers
  • Lower profitability due to high capital tied up in low-return assets
  • Lower risk, more flexibility in meeting financial needs
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7
Q

What is an AGGRESSIVE Working Capital Policy?

A
  • Minimises cash balance
  • Limited investment in securities, focusing on other uses of capital
  • Offers less generous credit terms to improve cash flow
  • Keeps stock levels as low as possible
  • Focuses less on customer attraction through credit terms
  • Aims to increase profitability by efficient use of capital
  • Higher risk in meeting financial obligations
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8
Q

Key Differences between Aggressive and Relaxed Working Capital Policies

A
  • Current Assets & Liabilities - significant differences in net capital
  • Total and Net Assets - how each strategy impacts the company’s asset structure
  • Planned Profit & Return on Capital Employed - highlighting profitability and efficiency
  • Current Ratio - indicating liquidity position
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9
Q

What is Optimal Working Capital?

A

Balancing risk, return and costs (carrying costs & shortage costs)

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10
Q

What are Carrying and Shortage Costs?

A
  • Carrying costs = costs that increase with additional investment in WC (additional warehouse space, additional inventory)
  • Shortage costs = costs that decrease with increased investment
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11
Q

Consequences of POOR Working Capital

A
  • Failure to invest in WC to expand production and sales may result in lost orders and profits.
  • Failure to maintain current assets (quickly converted into cash) can affect corporate liquidity - damage credit rating and increasing borrowing costs.
  • Poor control over WC is a major reason for overtrading problems (expanding company too big for level of WC)
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12
Q

Causes of Overtrading

A
  1. Initial under-capitalisation
  2. Over-expansion
  3. Poor utilisation of WC resources
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13
Q

Solutions to Overtrading

A
  1. Reducing business activity
  2. Increasing capital base
  3. Tight control over WC
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14
Q

Key Drivers in Trade Credit Management

A
  1. Trade Credit as a Strategic Investment
  2. Industry and Competitive Pressures
  3. Financial Capabilities - better access to capital markets, can afford to offer more generous credit terms.
  4. Efficiency and Information Asymmetry
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15
Q

Credit Mission & Goals

Effective Trade Credit Management

A
  • MISSION: to maintain/protect a portfolio of high-quality accounts receiveable and to develop sound credit policies, to increase sales, contribute to profit, aid customer loyalty and improve shareholder value.
  • GOALS:
    1. To restrict monthly debtors to 45 days
    2. To achieve agreed monthly cash collection targets
    3. To limit overdue debts to 30% of sales
    4. To limit bad debts to 1% of sales
    5. To resolve credit-related customer queries within 3 days
    6. To improve the relationship between the credit function and major customers - regular contact
    7. To convert 20% of existing customers to direct debit in the year
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16
Q

The 5 C’s of Credit Evaluation

A
  1. Capacity - ability to repay within specified time
  2. Character - customer’s willingness to adhere to agreed terms
  3. Capital - financial stability and borrowing habits
  4. Collateral - requirement of security against credit
  5. Conditions - alignment with industry norms and competitor terms
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17
Q

What is Factoring in terms of Trade Credit?

A
  • Factors (often bank securities) provide the following services, using invoices as security.
  • Sales Administration
  • Credit Protection
  • Provision of Finance
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18
Q

Advantages of Factoring

A
  1. Immediate Cash Flow
  2. Outsourced Administration
  3. Credit Protection
  4. Support for Growth
  5. Efficient Debt Management
  6. Flexible Financing Option
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19
Q

Disadvantages of Factoring

A
  1. Cost
  2. Customer Relationship Risks
  3. Perception Issues
  4. Selective Acceptance/Financing - won’t accept all invoices - only focusing on those that are low-risk.
  5. Administrative Responsibility - companies must manage their own credit control
  6. Eligibility Criteria
  7. Interest Rates
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20
Q

Inventory Classification
(3 groups)

A
  1. Pre-production Inventory
  2. In-process Inventory
  3. Finished Goods Inventory
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21
Q

Days Stock Ratio Analysis

A

To understand how quickly stock turns into cash:
Days Stock Ratio = (Average Stock / Cost of Sales) x 365

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22
Q

Economic Order Quantity (EOQ) Model

Purpose & Formula

A

Purpose: help managers to find the optimal stock level that minimises both holding costs and shortage costs.

EOQ = square root (2AC / H)
C = cost of placing an order
H = cost of holding a unit of stock for 1 year
A = annual stock usage

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23
Q

Limitations of EOQ Model

A
  • Seasonal or Unpredictable Demand
  • Exclusion of Certain Costs - e.g., goodwill or product disruptions - not quantifiable
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24
Q

Manufacturing Resource Planning (MRP)

A

Computer-based system for scheduling stock replenishment to ensure materials availability for production.

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25
Q

Just-In-Time Systems (JIT)

A

Aims for minimal or zero stock levels - materials delivered just before they are needed.

For successful implementation, requires:
- Robust links and information sharing with suppliers/customers.
- Commitment to quality and a ‘right first time’ culture
- Efficient logistics for smooth material movement

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26
Q

Cash Flow Forecasting
(4 steps)

A
  1. Forecasting Cash Inflows
  2. Forecasting Cash Outflows
  3. Calculating Net Cash Flow
  4. Cumulative Cash Flow Calculation
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27
Q

Cash Management Models

A
  • William Baumol Model - treating cash like inventory for control purposes.
  • EOQ in Cash Management - represents the short-term securities to be liquidated to replenish the cash balance.
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28
Q

How are Interest Rates relevant in Corporate Finance?

A
  1. Debt vs Equity - cheaper to issue debt? (long-term)
  2. Loan, hire purchase, leasing (medium-term)
  3. Cash vs Liquid Assets (short-term)
  4. Investment Appraisal - discount rates in NPV
  5. Capital Structure - cost of capital
  6. Portfolio Theory - risk-free rate of return
  7. Option Pricing - risk-free rate of return
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29
Q

Formula for calculating the Firm’s financing rate

A

Financing Rate = BOE Base Rate + Bank Premium + Term Premium + Credit Risk Premium

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30
Q

What does Interest Rate Risk Management depend on?

A
  • Forecasts of Future Interest Rates - if going to decrease, borrow long term.
  • Risk Aversion
  • Balance Sheet Structure and Durations - whether assets are more exposed.
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31
Q

How do you hedge your way out of short-term interest rate risk?

A
  1. Forward-Forward Loans - instead of waiting 1 month to borrow, can invest those funds for that 1 month, until when you need it for
  2. Forward Rate Agreements - fixing an interest rate
  3. Short-term Interest Rate Futures (STIR) - 3-months the most common
  4. Interest Rate Gurantees (IRGs) - options, caps, floors and collars - traded OTC
  5. Caps, Floors and Collars (maximum/minimum interest rate, collar is both)
  6. Interest Rate Options - underlying asset is an interest rate
  7. Interest Rate Swaps (IRS) - exchange fixed for floating
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32
Q

What is a Direct and Indirect Exchange Rate?

A
  • INDIRECT = foreign currency per unit of domestic (domestic appears second)
  • DIRECT = domestic currency per unit of foreign (domestic appears first)
33
Q

Market Conventions for Exchange Rates

A
  • EUR is always the base currency
  • GBP is the base currency if EUR is not the other
  • USD is always the base currency, unless for EUR, GBP, AUD and NZD
34
Q

How does expanding to foreign markets to enhance value?

A
  1. International Trade
  2. International Finance
  3. Licensing and Franchising
  4. Joint Ventures and Strategic Alliances
  5. Foreign Production
35
Q

Risks of Multinational Corporations (MNCs)

A
  • Agency costs are greater
  • Constraints - environmental, regulatory, ethical
  • Exposure to - exchange rate movements, foreign economies, political risk
36
Q

Importance of FX Risk

A

Impact on:
- Income to be received from international trade
- Amount paid for imports
- Valuation of foreign assets/liabilities
- Long-term viability of foreign operations
- Appraisal of an overseas investment project

More seriously:
- Undermine the competitive position of the firm
- Destroy profits
- Lead to loss of shareholder wealth
- Impact jobs, competitiveness, firm survival

37
Q

What is Transaction Risk?

A
  • Transactions already entered into and likely future obligations
  • Cash flows from existing contractual obligations
  • Variable value in the home currency as exchange rates move
  • Imports and exports
  • Investing (lending) or borrowing abroad
38
Q

What is Translation Risk?

A
  • The risk from translating foreign subsidiaries’ accounts into parent currency terms
  • Balance sheet effect - moving assets doesn’t affect balance sheet or bottom line
39
Q

What is Economic Risk?

A
  • Risk resulting from medium to long-term movements in exchange rates
  • Direct & Indirect
  • Law of one price - in the long-run, exchange rates will settle themselves
40
Q

Sources of FX Risk

A
  1. Transactions
  2. Financing
41
Q

Internal Mechanisms for Management of Transaction Risk

A
  • Pricing - increase selling prices
  • Invoicing - in a different currency
  • Leading - paying a foreign obligation before its due date
  • Lagging - paying after due date
  • Netting - subsidiaries netting out payment obligations by trading with each other
  • Matching - similar to netting but allows for payments and reciepts to third parties
  • Asset/Liability Management - Aggressive and Defensive
42
Q

External Mechanism for Hedging

(FX Risk Management)

A
  1. Money Market cover
  2. Forward Agreements
  3. FX Futures
43
Q

Hedging an FX Asset

A
  • if receiving foreign currency in the future, sell this to receive a fixed amount of home currency at maturity
  • If receiving the base currency, SELL PUTS
  • If receiving the other currency, SELL CALLS
44
Q

Hedging an FX Liability

A
  • if paying foreign currency in the future, buy this using options to pay out a fixed amount of home currency at maturity
  • if paying the base currency, PURCHASE CALLS
  • If paying the other currency, PURCHASE PUTS
45
Q

Objectives of Currency Swaps

A
  • Lending/Borrowing in a different currency
  • Hedging exchange rate risk and interest rate risk
46
Q

Advantages of Currency Swaps

A
  • Longer term instruments (typically 5 years)
  • OTC = private deal to suit firm’s needs
  • Removes FX risk on lending/borrowing
  • Preferential interest rates for parties using a swap compared to borrowing on their own
  • Access to money markets that otherwise would be too costly to use
  • Transform the cash flows of an asset/liability into a different currency
47
Q

Process of a Currency Swap

A
  1. Initial exchange of the principals at the current spot rate
  2. Ongoing exchange of interest payments on the principals
  3. Final exchange (return) of the principals at maturity at the ORIGINAL exchange rate
  4. FX risk is hedged provided the regular net interest payments are in one currency only
48
Q

Merger Waves

A
  • Big merger wave in 1900s, before WW1 and stock market crash
  • Second wave in 1910 - oligopolies
  • Third wave in 1955-1975 - big, diversified conglomerates.
  • Fourth wave in 1990s - predominantly hostile takeovers.
  • Current wave - driven by globalisation
49
Q

Example of a GOOD merger

A

Disney & PIXAR
- 2006, $7.4bn deal
- PIXAR valued at $57.57 per share, market capitalisation nearly $6.9bn
- Negotiation Outcome - Disney offered 2.3 shares for every PIXAR share
- Merger Goals - revitalise Disney’s animation
- Successful indicators - very successful movies released, “UP” for example
- Increased Production - twice-yearly films
- Strategic Gains - PIXAR benefits from Disney’s expertise in marketing

50
Q

Example of a BAD merger

A

Daimler & Chrysler
- Merger Goals - compete against Japanese manufacturers, address market overcapacity
- Significant integration challenges - staff resentment
- Daimler’s dominance
- Infrequent communication between CEOs

51
Q

Types of Merger

A
  1. Consolidation - brand new firm created
  2. Horizontal - 2 companies in similar lines of activity are joined
  3. Vertical - different stages of production chain
  4. Conglomerate - different/unrelated business areas
52
Q

Example of a Hostile Takeover

A

Cadbury (2009-2010) takeover of Kraft Foods

53
Q

Motives for Mergers

A
  • Synergy - combined entity will have a value greater than the sum of its parts
  • Bargain Buying - puchase of undervalued company
  • Managerial Motives:
  • remuneration
  • status
  • empire creation
  • thrill of the chase
  • strategy/game
  • survival
  • Third Party Motives = pressure or encouragement to merge from third parties
54
Q

Why does Pricing Efficiency matter in M&A?

A
  • To encourage investment
  • To provide signals to management
  • It is a pre-requisite for allocational efficiency
55
Q

Challenges to EMH

A
  • Calendar Anomalies - first/last 30 mins of the day, holiday effects
  • Characteristic Anomalies - size, value, profitability, investment
  • Short-term over-reaction/under-reaction
  • Bubbles & crashes
56
Q

Implications of EMH

A
  1. Investors - can’t ‘beat the market’
  2. Corporate Financial Reporting - prices react to earnings announcements
  3. Corporate Financing Decisions
  4. Corporate Investment Decisions
  5. Capital Budgeting - systematic risk
  6. Acquisitions
57
Q

Maintainable Earnings Process

(Valuation technique for M&A)

A
  1. Estimate maintainable earnings (average earnings)
  2. Establish acceptable rate of return on capital invested
  3. Capitalise earnings estimate by this rate of return to give valuation
  4. Given the earnings expected to be maintained, this is the value of the company that would deliver the required rate of return to investors.
58
Q

Dividends Process

(Valuation technique for M&A)

A
  1. Estimate the dividend to be paid
  2. Establish required dividend yield (from a comparable firm…)
  3. Divide estimated dividend by the dividend yield
  4. Given the dividend expected to continue, this is the value of the company that would deliver the required rate of return to investors
59
Q

What is a ‘toe hold’ in M&A?

A

Usually, the bidder purchases some of the target’s shares before making the offer.

60
Q

Defence Techniques to acquisition bids

A

Pre-bid:
- External Vigilance (aggressive publicity)
- Forewarned
- Placing shares in friendly hands (encourage company’s pension fund)
- Strategic defence investment (buy substantial proportion of shares in friendly firm)

Post-bid:
- Attack logic of the bid and quality of bidder’s management
- Encourage organisations to lobby against the bid
- Revision of profit forecast
- Pac-Man strategy

More dubious techniques:
- White Knight - offer company to a more friendly outside interest
- Crown Jewels - sell off high valued assets
- Golden Parachutes - making more expensive for bidding firm
- Poison pills - flip in, flip over
- Greenmail and Arbitrageurs - offer firm creating hostile takeover to buy back the shares

61
Q

Drucker (1981) - 5 Golden Rules for successful integration after a corporate takeover

A
  1. ‘common core of unity’ between acquired and parent companies
  2. mutually beneficial mindset
  3. acquirer to value the products, markets and customers of acquired
  4. suitability skilled top management needed
  5. facility cross-company promotions
62
Q

Jones (1986) - Multifaceted approach to company integration

A
  • establishing and communicating the initial reporting lines
  • quickly gaining control over critical elements of operations
  • performing a ‘resource audit’
  • updating corporate goals
  • adjusting organisational framework
63
Q

What is a Zombie Company?

A

A business that continues to operate despite being insolvent or barely profitable.
Often survive by continually refinancing their debts, or relying on external funding.

64
Q

Company Voluntary Agreement (CVA) process

Corporate Failure

A
  1. Insolvency
  2. Directors apply for a CVA via an Insolvency Practitioner
  3. IP charges a fee and administers the CVA
  4. Legal limits on what the company can do
  5. Breathing space to form a plan to repay creditors
  6. Management keep control of running the firm
  7. Protection from creditors
65
Q

Administration Process

Corporate Failure

A
  1. Directors and Creditors appoint Insolvency Practitioner to be administrator
  2. Court needs evidence that administration is better than liquidation
  3. Stops all legal action
  4. Breathing space to allow restructure, sale or closure
  5. Administrator is in control of running the firm (costly)
  6. Administrator decides if firm goes into CVA, liquidation, sold or closed down.
66
Q

Creditor’s Voluntary Liquidation Process

A
  1. Company stops trading and assets are liquidated for cash
  2. Winding-up of a company
  3. Directors inform shareholders of insolvency
  4. Shareholders appoint an IP as a liquidator
  5. IP then calls a meeting with creditors
  6. Costs paid by the Directors
  7. IP sells assets to pay off as many creditors as possible
67
Q

Compulsory Liquidation Process

A
  1. Creditors apply to the court for a winding-up petition
  2. Court needs evidence that debt is undisputed, attempts to recover have been made
  3. Petition is issued and court hearing is arranged (expensive)
  4. Liquidator is appointed by the court
  5. Cost of liquidator is paid first, any residual used to pay off creditors
68
Q

EXTERNAL Factors of Failure

A
  • Macroeconomic Factors - economic downturns, inflation and market volatility
  • Changes in Technology and Cosumer Demands - failure to adapt
69
Q

INTERNAL Factors of Failure

A
  1. Financial Factors - heavy operating expenses, insufficient capital
  2. Experience Factors - lack of business knowledge/experience
  3. Neglect - poor work habits, inefficiencies
  4. Fraud - deceitful practices
  5. Disaster - natural disasters
  6. Strategy Factors - management of receivables
70
Q

Can we predict failure?

A
  1. Identify financial distress - financial ratios, symptoms and causes
  2. Beaver’s Univariate Model (1966) - looks at one ratio at a time
  3. Altman’s Z score (1968) - amalgamates key financial ratios into a single score.
  4. Ohlson’s O-Score - predicts one-year bankruptcy risk, applies broadly across industries
  5. Credit Risk Models - credit modelling, linear probability models, logit/probit models, linear discriminant models
  6. Market Measures of Distress - equity volatility, short interest, bond spreads etc.
71
Q

Altman’s Z Score (1968) - elements of equation (x)

A

X1 = working capital to total assets (WC/TA)
X2 = cumulative retained earnings to total assets (RE/TA)
X3 = earnings before interest and taxes to total assets (EBIT/TA)
X4 = market value of equity to book value of total debt (MV/TL)
X5 = sales to total assets (Sales/TA)

72
Q

Text Mining Sentiment (Market Measure)

A

Transcrips released every quarter - what are the reasons for the current performance and how uncertain they are about the future?
Asymmetry of Information - when CEOs speak a lot, are they trying to give you more information or trying to create more noise?

73
Q

Merton’s Distance to Default (1974)

A

Using Option Pricing Theory (equity is treated as a call option on assets) to measure the ‘distance’ between a company’s assets and its liabilities, indicating the likelihood of default.

74
Q

Advantages of QUANTITATIVE Predictions of Failure

A
  • Access to data
  • Objective
  • Z-score is easy to calculate
  • Probability of Default is more difficult
  • Cover many companies
  • Warning signals
  • Screening
  • Distress v Failure
75
Q

DISADVANTAGES of QUANTITATIVE Predictions of Failure

A
  • Inputs may not be reliable
  • Limited inputs
  • No diagnosis
  • Distress v Failure
  • Confirming failure
  • Help to save the firm?
76
Q

Argenti Sequence - 3 possible paths companies go through when they fail

A
  1. Early Failure - never really took off
  2. Entrepreneurial Collapse - rise quickly, but collapse spectacularly
  3. Argenti A-Score - using historical data, assigns scores to different problem areas in management
77
Q

Advantages of QUALITATIVE Predictions of Failure

A
  • Intimate knowledge about the firm
  • Diagnosis
  • Detect distress earlier
  • Save the firm
78
Q

Disadvantages of QUALITATIVE Predictions of Failure

A
  • Signs of distress?
  • Subjective
  • Difficult access
  • One or few firms at a time
  • Reliability of information
  • Academic or practical
  • Early does not equal more accurate

Uni Final (12 decks)

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