Corporate Finance Flashcards
What is capital?
Which forms of capital can be differentiated?
Financial resources available to a company in the form of equity or debt.
Equity financing: financing from company’s own resources
Debt financing: Outside capital
What is a capital market?
Market in which investors (creditors or company shareholders) provide borrowers or investees with medium- or long-term financing in form of equity or capital.
Distinct from money market where money is lent to borrowers on a short-term basis.
Describe a perfect capital market.
When are they efficient/perfect?
A concept used in economic theory to enable financial problems to be analyzed as clearly as possible.
They are efficient (perfect) when:
- Frictionless
- Perfect competition exists
- Market participants operate with absolute rationality
- Information efficiency exists
Describe the characteristics of the perfect capital market.
Frictionless: Transactions do not incur costs or taxes; securities can be perfectly shared or traded (information efficiency); free of regulatory restrictions
Complete competition: Market participants are price takers = no effect on market price; raise or invest capital at a single interest rate
Rational market participants: seek to act logically in their best interest
Information efficiency: Information processing can cause market prices to change therefore any given time the market reflects all relevant and current information.
Describe information efficiency.
- Multiple information channels feeding info about a company (market sector analysis, economic and business reports, financial statements)
- Role of information procurement and distribution is significant.
- Processing of information itself can cause market prices to change
Efficiency: at any given time the market reflects all relevant and current information.
What is the problem with information efficiency in practise?
Every market participant wants to achieve a excess return (outperform the most efficient market player by obtaining and evaluation information).
Chances to outperform are not very high in a liquid market (buyers and sellers look for them)
Stock prices are said to be informationally efficient as they reflect a price to anyone at a given moment in time (everyone has equal access to the info)
- However: new info = direct price change
What distinctions can be made regarding information efficiency with stocks?
Distinction based on quantity of information.
- Weak-form: All past prices of a stock are reflected in the current market price.
- Semi-strong form: current market price reflects all public info and info on past prices. –> Analysis on financial statements to identify over- or undervalued stocks would not work due to new info changing the price immediately (most common form)
- Strong-form: current price also reflects private info (“insider info”) –> some market participants are better informed and can gain greater returns
What is the risk-return ratio?
The greater the risk an investor is prepared to take, the higher the potential returns on his/her investment and vice versa.
What is the goal of an investment portfolio?
How can it be achieved?
Goal is to minimize risk and maximize the potential level of return.
Diversification strategy of Markowitz:
- Investing in a variety of different financial instruments to spread risk
- bundling securities (portfolios) based on a strategy that optimizes risk/reward
- handling risk (unsystematic risk = diversifiable variance and risk and systematic risk/market risk = non-diversifiable variance
- Unsystematic risk can be reduced by adding an asset likely to fluctuate in its performance in ways that do NOT interfere with rest of portfolio –> Variance of return is minimized by the asset added to the portfolio
What are the questions the portfolio theory aims to answer?
- What should a single individual (investor) do to construct an optimized portfolio?
- Which criteria are relevant to this decision making process?
- How are investments assessed in relation to this process?
- What is the optimal capital-allocation strategy for any given expectations?
Describe the CAPM.
What are the underlying assumptions?
CAPM = Capital asset pricing model
- Not about rational, individual decision making: it is about the way decisions aggregate to create market equilibrium
- Overall risk cannot be eliminated through diversification
- Explains how to evaluate risky investment opportunities
- Uses concept of stock’s beta to assess the level of risk premium
Assumptions:
- Investors have a single period transactrion horizon
- market participants are risk-averse and look to maximize their utility
- Investors are price takers i.e. cannot influence prices via their individual decision making
- market participants have homogenous expectations regarding the returns on their securities
- Risk-free investment (i.e. risk-free returns can be generated)
- perfect capital market exists
What is Beta in the measure of risk?
What can be an issue regarding beta?
Important indicators to calculate within the CAPM.
Standardised measure of risk exposure of stocks or securities.
- Relative measure of risk
- Indicates the sensitivity of the return of an asset or security
Regression analysis to calculate beta.
Issue:
- CAPM is a single-period model referring to anticipated values but beta for the future is unknown
- Ex post values are used as basis for estimation of beta (monitoring period and level of precision have significant influence on beta)
- Beta is therefore not stable and can be subject to considerable fluctuations
What is the difference between loss and risk?
Risk and loss are not the same
An expected loss is not a risk
Risk is only unexpected potential loss.
Risks can be managed; loss should be avoided (e.g. by diversification)
What are price market risks?
Name five examples.
Price market risks are changes in the price of stocks, bonds and currencies due to market movements and/or changes in the yield curve and volatilities.
Currency risk: devaluation of foreign currency in which the investment is denominated. exchange rate of foreign currency into home country currency.
Inflation risk: devaluation of cash due to increase in price levels
Interest-rate risk: deviation from an expected rate of interest or adverse development of interest-rate (affects fixed- or floating-interest securities)
can be divided into:
- reinvestment risk and price risk: reinvestment = likelihood that an investor will need to reinvest at a higher rate than planned
- price risk: fixed-interest securities are subject to an price risk; if market-rate interest moves follow the purchase of fixed-interest rate securities = price of bond changes since the coupon payment amount is fixed
Equity price risk: possibility of negative movement in individual securities or assets as a result of reductions in price
Commodity risk: all losses as a result of unfavourable movement in the prices of commodities.
Next to the price market risks, which additional risks need to be assessed?
Country risk: can arise as a result of convertibility, transfer, freezing of payment on part of the country (hazard of political intervention in the financial market); foreign exchange restrictions
Liquidity risk: temporal structure of payment flows cannot be maintained at the level of quality sufficiently adequate to ensure liquidity.
Capital maintenance: possibility that the investor could lose some or all of the capital in the event of bankruptcy
Information risk: not all necessary information are available; particularly with involvement of intermediaries: asymmetries in information putting investors at a disadvantage
Settlement and management risk: misappropriation or disloyal management of capital places by the investor
Advocacy risk: representative exploits an investor’s interest to a disadvantage
Conditions risk: change of acquiring an investment at unfavourable terms.
Name all relevant risks that need to be managed.
Market price risks:
- currency risk
- inflation risk
- interest-rate risk (reinvestment and price risk)
- equity price risk
- commodity risk
Additional risks:
- country risk
- liquidity risk
Special investor risks:
- capital maintenance risk
- information risk
- settlement and management risk
- advocacy risk
- conditions risk
What can be done to minimise risk?
Name two measures.
Risk must be minimised within the scope of risk management.
Appropriate processes must be developed for identifying, measuring and managing financial risk.
Two measures:
- Sharpe ratio
- Treynor ratio
What is the purpose of the sharpe ratio?
How is it calculated?
Measure for risk management to identify, measure and manage financial risk
Provides measure of the excess return generated per added unit of absolute risk. Explicitly accounts for zero-risk interest.
“Reward-to-variability-ratio”
Calculated:
Quotient of its excess return and its total historical risk
SR = (portfolio return - risk-free rate of return) / standard deviation (volatility)
–> The higher the higher the performance; ranking possible
Every additional percent of risk is compensated with a risk premium of X (result)
What are advantages and disadvantages of the sharpe ratio?
+ intuitive interpretation of performance
+ simplicity of calculation
+ comparability
- lack of comparison with overall risk
- offers no insight into the composition of portfolio risk
What is the Treynor Ratio?
How is it calculated?
Risk management context:
Identifies the excess return generated per unit of added undiversifiable risk
“reward-to-volatility ratio”
Calculation:
Quotient of its excess return and its systematic or undiversifiable risk.
TR = (portfolio return - risk-free rate of return) / beta
–> Rating possible; absolute key ratio
What are pros and cons of the Treynor Ratio?
+ permits comparision with other portfolios and benchmarks
+ requires a determination of beta instead of the standard deviation
+ together with sharpe ratio can result into insights in portfolio structure
- disregards unsystematic risk
How is return calculated?
What types can differentiated?
Calculated:
Without subsequent outflows or inflows of funds.
Return = ((investment value at a later point in time / investment value now) -1) *100
–> Percentage change in the value of the initial investment
Return can be time-weighted and money-weighted.
What is a time-weighted return?
Is a return approach to measure historical performance, which compensates for external cash flows.
Net movements of value , which result from transfer into or out of the initial investment or portfolio.
Broken down into several periods
What is a money-weighted return?
Takes money value of cash flows into account
Starting value of the portfolio at the beginning of the year, end-of-year value and the cash flow attributed to the months involved.
Highly dependent on the timing of an investment or withdrawal (e.g. unfavourable time)
Money-weighted = internal rate of return
Indicates not only the timing of payment but also of what the market situation was like.
–> If money-weighted return is less than time-weighted return the investor’s timing of deposits and withdrawals was unfavourable.
What are the tasks of stock analysis?
What is the overall goal?
- Systematically compile and analyze all information pertaining to a company and its environment
- Come up with short- and long-term forecasts of trends in the price of a company’s stock
- Information collection and processing
- fundamental and market-based assessment
- outlook, forecast, scenarios
4 portfolio analysis
–> Goal: facilitate decision-making for selection, timing and asset allocation
Which methods for stock-price analysis can be applied?
Objective and subjective components
Objective =
- fundamental analysis
- technical analysis
- innovative methods
Subjective =
- surveys of experts
- intuitive methods
What is fundamental analysis?
To which type of stock-price-analysis does it belong?
- Each stock has an intrinsic value (fair value) based on internal and external data.
- A share can be over- or underrated based on its intrinsic value vs. the current market price.
- Factors to influence stock price: macro- and microeconomic data to be analyzed
Intrinsic value calculation with discounted clash flow method –> complex
Fundamental analysis = key ratio like
- price/earnings ratio (P/E) = price / earnings per share
- price/cash flow ratio (P/CF) = price / cash flow per share
Objective type of stock price analysis
What is the issue with P/E parameters?
How can this parameter be supported?
- Price per earning is a retrospective parameter
- Current price in relation to the companies last know annual earnings
- Market participants expectations (e.g. future earnings or lower risk) influence the price and are not factored in
- highly dependant on accounting standards in country (international comparability very questionable )
Supported by price/cash flow parameter P/CF to factor in cash flow as future oriented parameter.
What are pros/cons of P/CF parameters?
Defines the ratio of stock price to cash flow per share.
+ Cash flow considers a companies future flows of cash (future oriented) less malleable that the company’s profit.
+ Especially useful in international context (more meaningful statement for assessing a company (depreciation, amortisation and provision is taken into account; therefore disregard differences in accounting standards)
- bad investment = write-down but is not reflected in the P/CF
–> Should only be considered complementary
What can be influences on the share price of a company?
Actual share price is induced by a variety of influences:
- market participants’ expectation relative to economic trend
- sentiment indicators (i.e. positions of market participants)
- Future contracts (permit conclusions about market participants position)
- Forecasts of larger firms have impact on stock prices
- Speculative reasons as a result
What is the purpose of technical analysis?
What methods does it use?
What are the underlying hypothesis to apply technical analysis?
Technical analysis aims to forecast stock-prices.
Deals exclusively with price and trading volume trends of securities.
Forecasting methods are chart analysis as well as mathematical forecasting systems
Classic methods offer graphic presentation of stock price trends drawing on past price data to provide orientation for future price trends
Hypotheses for future development:
- price trends are the result of supply and demand
- numerous rational and irrational factors –> market constantly compensates
- prices tend to develop along lines of predictable phases and trends
- forecast changes in basic direction by changes in supply and demand
- past patterns by influencing factors repeat themselves because of human behaviour (under similar circumstances)
What is technical analysis?
Technical analysis aims to forecast stock-prices.
Deals exclusively with price and trading volume trends of securities.
Forecasting methods are chart analysis as well as mathematical forecasting systems
“chart technique”
Broken down into
- presentation analysis = follows trends in chart form
- formation analysis = examines geometric price trends (triangles; head-and-shoulder formations) to predict future price trends
- market analysis = trends and potential zones of support and resistance (make use of certain indicators)
What are innovative methods of analysis?
Chaos theory and neural networks
Chaos theory:
- assumes that movements in stock prices are not random but based on complex patterns
- assumes prices follow a nonlinear, dynamic process = effects are not just linear outcomes but causes influence on the cause (feedback) self-reinforcing effect
Neural networks:
- first artificial neural networks
- computer based to simulate models of learning (theory of learning)
- neural network processes are not yet widely utilized in practise
What is a capital structure?
Which distinctions can be made?
Refers to the composition of total funds (debt, equity and hybrid securities) that a company has at its disposal to finance its operations and growth.
- Equity capital provided by owners.
- Capital provided by creditors in form of debt capital.
What is an equity interest?
What is specific about it?
Grants specific rights to its owner including
- voting rights
- share of company profits
- share of company’s assets in the event of liquidation
Does not entitle to a compulsory return or any repayments.
What are debt securities?
- does not grant the right of influence
- credit is granted for limited duration
- legal entitlement to repayment
- creditors neither profit from gains made nor are affected by losses incurred
- receive a fixed income from debt security in form of interest payments
What does the term leverage effect refer to?
If ROI is constant then borrowing additional funds will result in increased income provided that the interest on borrowed capital remains lower than the overall income derived from the investment.
Starting point for capital structure optimization.
Focus on debt:equity relation in capital structure.
Basic theorem: The higher the debt the higher the return on equity.
Describe the characteristics of the net income approach of the traditional theorem of capital structure.
Extreme view of the optimal capital structure by Durand.
The capital structure decision is relevant for the valuation of a company based on the assumption:
- Cost of debt is lower than the cost of equity
- risk perception of investor does not change with the use of debt
- No personal or corporate income taxes exist
- -> Result: Ratio of debt to equity increases, the cost of capital will decline while the value of the company as well as the share price will increase.
- -> Debt financing to the maximum possible extent
Describe the characteristics of the net operating income approach of the traditional theorem of capital structure.
Extreme view of the optimal capital structure by Durand.
Capital structure is irrelevant and unrelated to the company’s value:
- cost of debt is lower than cost of equity
- risk perception of lenders of debt does not change with leverage (=consistent)
- market determines the value of a company as a whole (debt:equity split is irrelevant)
- no personal or corporate income taxes exist
- -> Because of risk perception of owners they will expect higher returns if the amount of debt increases –> Will offset any savings from lower costs for debt
- -> Capital structure does not affect the overall cost of capital = market value does not change
What is the traditional theorem?
Name three effects that can be observed.
Aims for a compromise between net income approach and net operating income approach.
Optional debt ratio (leverage) exists, when the average cost of capital is minimized.
Increases in a company’s debt proportion or leverage ratio increases the return for equity holders.
Observed Effects:
- Increasing the use of debt ensures that expensive equity is replaced by cheaper borrowed funds. WAAC will decrease as an result of increased level of debt.
- As indebtness increases, so does the risk related to owners’ tied-up equity; in turn increasing the return
- Level of debt is high = outside creditors view their shares as risky due to increased risk of insolvency; new creditors only when additional risk premiums are accepted - cost of indebtness increases
What is the Modigliani-Miller Theorem?
What are the underlying assumptions?
Asserts that under perfect market conditions, the market value of a company cannot be increased by altering the claims on its asset (i.e. changing debt-equity ratio)
Capital structure is irrelevant.
Assumptions:
- investment policy is taken as given
- investors demand a certain average gross return on their investment (same expectations)
- Companies can be divided into homogenous risk classes
- Allocating a company to a certain risk class permits a comparison with known market values of other companies in the same class
- perfect capital market exists (same risk class without debt = WACC is the same; price per share of profits is the same); no transaction cost, etc.
- equity investors have expectations in terms of their effective returns
- Borrowing costs are independent of debt-equity ratio
- interest rate on capital investments and borrowing is uniform
- Companies finance operations through risk-free debt capital or equal equity
- Cash flows are assumed to continue in perpetuity
What is the main difference between Modigliani-Miller Theorem and the traditional theorem?
Cost-of-equity rate does not remain constant even if there is a change in the amount of risk-free securities issued.
What are dividends?
Describe the dividend policy according to Modigliani-Miller.
Dividends are portions of a stock corporations’ profits distributed to stockholders.
M&M:
- irrelevance of company capital structure extends to dividend policy = self-financing by retaining earnings and profit distribution followed by issuing new shares
- dividend policy has no effect on the company’s value
What are drawbacks from the M&M model?
Highly simplified assumptions = unrealistic
No taxes or transaction costs are taking into account.
They can significantly influence the total value of a company
What are transaction costs and how do they occur?
Transaction costs must be evaluated when considering an optimal capital structure.
Arise through purchase of sales and securities.
Represent an outflow of funds with the result, that the free cash flow falls and accordingly the market value of a company.
Level of transaction costs is dependent on type of financing used –> typically lower when debt capital is used (profit participation of equity)
How is the capital structure influenced by taxes?
Taxes need to be taken into account when defining the value of a company.
Company value drops if taxes are brought to the equation (high taxes, lower cash flow, lower value)
Taxation is basically irrelevant to the relationship of debt-equity ratio and the company valuation because borrowing costs are usually tax deductible –> cheaper to use debt than equity capital (tax shield)
Value rises if debt increases
What are agency cost and what influence to a capital structure of a company do they have?
Usually neglected in the neo-classical models.
Arise as a result of separating ownership and management.
= monitoring cost (control expenditure and information acquisition)
= bonding cost (agent is trying to act credible to convey promises)
= residual loss (not economically viable to monitor all manager’s actions)
Agency cost lower the value of a company.
Describe the characteristics of the neo-institutional model.
Interests are intensifying when increased indebtedness of a company
neo-inst. models help to minimize the agency cost and reduce and optimize cost of capital.
Rising debt ratio is problematic with agency relationship
- new debt has negative impact on bonds already issued
- owners have strong interest to increase the value of their capital
–> Creditors are as a result more willing to expose themselves to risk = deterioration of capital structure
More unlikely to repay obligations (risk of bankruptcy)
Basic theory: market value keeps increasing until the marginal change in NPV of the tax savings is equal to the marginal change in capital value of the bankruptcy costs (optimal debt ratio) –> trade off theory
Describe “trade off theory”.
Increased indebtedness of company = decreasing likelihood to repay obligations = higher risk of bankruptcy
The market value keeps increasing until the marginal change in NPV of the tax savings is equal to the marginal change in capital value of the bankruptcy costs (optimal debt ratio) –> trade off theory
How do taxes change dividend policies?
Significant changes because taxes rates for retained and distributed profits exist.
Tax rate for distributed profit is lower than for retained profit it makes sense to distribute profits first and then appeal to the shareholders to reinvest. “pay out and plough back” policy.
Countries different tax systems must be considered when planning global policies.
How is the company value of levered company V(l) calculated?
Company value of all-equity firm V(u) - net present value of transaction cost \+ net present value of tax benefits from borrowed capital (tax shield) - net present value of insolvency cost - net present value agency cost
= company value of levered company V(1)
What are issues when trying to determine an optimal debt-to-equity ratio?
Large number of constraints involved
- Political aspects
- industry practices
very difficult to determine an optimum and not achievable in real-life
What are the four basic types of financing?
- External financing with debt = funds are provided for a certain time for a rate of interest (EXTERNAL + DEBT)
- Accrued liability reserves = from company’s own resources to finance current or future assets (INTERNAL + DEBT)
- External financing with equity = provided from outside by existing or new shareholders (important for startup or expanding) (EXTERNAL + EQUITY)
- Funds from retained earning = surplus of financial resources flowing into the company from business activities and out for goods or dividends (INTERNAL + EQUITY)
What is mezzanine financing?
Type of financing of both equity and debt.
Loan is provided that gives providers right to convert to equity if it is not paid in time and in full.
Treated as equity on balance sheet.
What is the fundamental difference between equity and debt financing?
Debt capital from creditors must be replayed in full at the agreed a timeframe.
Interest rates must be paid.
Contractual agreements as basis.
Greater security in case of bankruptcy
No right to control; no impact from losses or profits
Can lead to liquidity issues due to fixed amounts of payment of interest and principal
What is a collateral? Give some examples.
What are its functions?
Required in order to get debt financing from banks or financial institutes as form of securities.
E.g. liens on movable property and rights; retention or transfer of title; mortgages
Risk-sharing function = if investment fails, creditor obtains the value of the security
Incentive function = encourages to repay and adopt certain behaviour (e.g. risky actions)
How can behavioural risk be reduced?
Name 3 examples.
Collateral = Securities if investment fails (e.g. mortgages, retention of title; liens on movable property
Covenants/Loan convents = typically included in a lean agreement as strict terms that must be followed (e.g. obligation to disclosure of financial info; restriction of certain business activity)
Supplementary agreement = option of financial institution to cancel a loan agreement in response to certain behaviour
What is creditworthiness and what are criteria to analyse it?
Assess how likely a person or partnership is to default on their loan.
Usually conducted by a bank or financial institution as part of loan granting processes.
borrowers history of payment, availability of assets, extent of liabilities, credit rating, earning capacity and potential collateral offered
What documentation is required to assess the creditworthiness of companies?
- annual financial statements (tax accounts with explanations of profit/loss)
- credit status or interim balance sheet
- audit reports
- excerpts of registers (land, commercial register)
- presentation of sales performance
- financial plan for the duration
- schedule of available collateral
What is a trade credit?
What are pros/cons?
Short-term B2B agreement
Supplier allows payment for goods received at a later date
Often linked with discounts for earlier payment
Primarily serves to finance working capital.
Very good if start-up, unknown company or no bank loans possible due to profitability or collateral situation
\+ Immediately available \+ Convenient \+ No formalities \+ protection through retention of title \+ Relieves bank line \+ Full or partial payment possible depending on liquidity
- Amount of capital cost
- Risk of dependency on the supplier
What is a customer loan?
What are pros/cons?
Down payment is provided by the buyer prior to receiving goods or services and funding the full amount.
\+ Savings made (no interim loan needed) \+ quickly available \+ lack of documentation \+ usually cancellation option \+ reduces entrepreneurial risk
- Capital cost
- Dependency risk
- Compromises regarding products to be delived
What is lombard lending?
Movable assets belonging to the borrower are pledged in exchange for granting the borrower a short-term loan.
Against collateral in form of securities or commodities.
Name three variations of long-term loans.
Annuity loan = repayment of principal increases; interest decreases and overall amount is fixed
Installment loan = repayment of principal fixed; interest decreases and overall amount is decreasing
Fixed loan = repayment of principal none (only at the very end); interest fixed and overall amount is fixed (until prior to maturity –> full amount)
What are IOUs and warrants?
Long-term bond like larger-scale form of debt issued with a certificate stating the amount of securities/collateral pledged.
Only issued to top-rated borrowers by financial intermediaries
Financing term no longer than 15 years.
Which types of equity financing can be differentiated?
How can these types raise equity capital?
Personal companies or corporations.
Sole proprietors = single owner with unlimited personal liability; obtaining equity capital is very difficult and only possible via retained earnings (internal)
General partnerships = OHG; two or more partners all sharing equal personal liability in unlimited way; can be limited to at least one partner to a certain amount; possible to bring in new partners or increase equity stake (all partners carry management tasks)
Limited partnerships = KG; two or more partners with different personal liability (unlimited or limited possible); partners can exist without control but only with capital invested; very easy to raise equity capital by adding new partners (partners do not carry management tasks)
Limited liability corporation (LLC) = GmbH; founding capital is limited provided by partners; only limited to amount invested in company; very easy to raise capital by adding new partners (but no market for private stakes)
Stock corporations (Inc./Corp.) = AG; Capital stocks are liabilities on balance sheet; equity capital is made out of stocks; new stocks = new capital; controlled market (design of shares can differ)
What types of shares exist?
According to rights:
- common stock = shareholders’ right; financial rights
- preferred stock = higher dividends for lack of voting rights
According to transferability:
- Bearer instrument = Agreement + delivery
- Registered stock = entry into share register
What is leasing?
List two types and explain them briefly.
- Popular instrument for financing
- Company (lessee) is allowed to use the asset while lessor remains owner.
- Payment through instalments for use (very easy to calculate in financial plan)
- Avoids upfront financing
Forms:
> Operating lease: short-term or cancellable (lease term shorter than economic life of asset; terminable on short notice; lessor provides know-how+maintenance; no transfer of risk/reward)
> Finance lease: lease term longer than economic life and without option to cancel (full or partial amortisation possible)
- Full amortisation = initial cost of lessor paid back in leasing term in full
- Partial amortisation = No full repayment of asses in period
What is an operating lease?
Form of leasing contract with monthly payment between lessor (owner) and lessee (user) of the asset
Short-term or cancellable
- lease term shorter than economic life of asset
- terminable on short notice
- lessor provides know-how+maintenance
- no transfer of risk/reward)
What is a financing lease?
What forms exist? Describe them with pros/cons.
Form of leasing contract with monthly payment between lessor (owner) and lessee (user) of the asset
lease term longer than economic life and without option to cancel
> Full amortisation = initial cost of lessor paid back in leasing term in full by lessee. No option to terminate contract; Different options at the end of term:
- No-option-contract: lessee returns asset to the lessor without option to buy; no influence of asset but right to participate on profit of sale
- fixed price purchase option: option to buy at the end with fixed price already stated upon contractual agreement
- lease extension option: extension of leasing
Pro: financial planning is easy as rates stay fixed (purchase price is known)
Con: change to pay in full without option to use further (contractual risk)
> Partial amortisation = No full repayment of asses in period
- contract with right to require purchase: lessee must pay difference at the end
- contract with lessee participation in revenue surplus or sales downfall: after leasing term item is sold and lessee has to pay difference or gains surplus
- terminable partial amortisation contract: indefinite period of lease but terminable on notice period
What is factoring?
What are advantages?
Purchase of receivable by an organisation (factor) that specialised in the administration of sales ledgers and collection of receivables
Export factoring very common: exporting company sells titles of receivables to factor.
Factor bears risk and assumes responsibilities to collect receivables.
- Take advantage of discounts offered by suppliers
- saves costs in terms of account receivables and credit checks
- eliminates costs for recovery of claims
- prevents losses from insolvencies
- releases capital by reducing amounts owed
- improves balance sheet through reduction of receivables and liabilities
- potentially leads to revenue expansions if a credit shortage existed
What is forfaiting?
What are advantages?
Method of financial trading.
1 Involves the purchase of receivables for goods or services supplied by an exporter against promissory notes or bill of exchanges.
2 Importer issues a promissory notes or bill of exchange to pay exporter for the goods sold.
3 exporter sells promissory notes or bill of exchange to forfaiting bank at a discount
Forfaiter bears risk but very often is supported by bank guarantee or letter of credit by importer’s bank
Advantages:
- improves liquidity
- unburdens balance sheet of short-term receivables or contingent liabilities
- transfer risk (currency, political and transfer risk)
What is the difference between forfaiting and factoring?
Risk coverage:
- Factoring: credit risk
- Forfaiting: credit, transfer, currency and political risk
Type of receivables:
- Factoring: invoices
- Forfaiting: promissory notes or bills of exchange
Extent of receivables:
- Factoring: fixed
- Forfaiting: not fixed (current; long-term)
Payment terms:
- Factoring: 30-150 days
- Forfaiting: 6 moths to 6 years
Typical types of goods:
- Factoring: consumer goods services
- Forfaiting: capital equipment
Why are investments made?
What questions need to be answered?
Investments are made with the aim of receiving returns in the future that are greater than the initial outlay of finances.
Investments can be fixed (bonds, fixed deposits) or variable (equity stakes, property)
Questions:
- Does it make sense to invest? (investment issue)
- If multiple investment options are present, which one is most desirable? (selection issue)
- What should be the duration of an investment (optimal duration issue)
- Investment programs can consist of multiple investments which may depend on each other. Which should be selected in different circumstances? (investment program issue)
What is the difference between static and dynamic capital budgeting methods?
Name 4 types each.
Static:
- focuses on single period when calculating the value of an investment
- investment period is typically “hypothetical average period” of one year
- Target parameter can differ e.g. cost, profit, rate of return or payback period
Dynamic:
- time-adjusted method take timing of cash flows into consideration
- A cash flow today is worth more than a cash flow in the future due to the fact that money can generate interest (time value of money concept)
- CF not considered the same
Types:
Static: cost comparison, profit comparison method, ROI, static payback period
Dynamic: net present value, annuity method, IRR, Dynamic payback period
How is ROI calculated?
What does the result say?
ROI = earnings before interest / average capital employed
The higher the better (=more profitable) - a project is beneficial if ROI is above expected minimum profitability
Return on equity, return on total equity or earnings-to-sales ratio
What are pros/cons of ROI and how is it calculated?
ROI = earnings before interest / average capital employed
+ can be used despite different capital requirements between alternatives
+ enables comparison of different types of investment objects
+ allows for comparison of alternative capital investments
- Calculated profitability is based on short-term assumptions
- requires a constant capital investment (not like that in reality –> tied-up capital is reduced annually meaning profitability increases automatically)
- consideration on average annual earnings (1st year = 5th year) but disregards reinvestment of capital on an interest-bearing basis
- earnings are attributable to individual investment (difficult in practice)
- assumes that financial means can be invested into the minimum return
What is the Static payback period?
How is it calculated?
Static payment = amortisation calculation considers multiple periods and is based on revenues and expenditures.
Focus on estimates how long it takes until the cost of an investment I0 have fully flowed back.
The shorter the better.
Amortisation calculation:
I0 = sum of returns per period t
Payback period:
PP = acquisition value / average return
What are the pros and drawbacks from the static payback period / amortisation period?
+ useful in addition to other methods
+ easy to apply
+ provides insights into risk (the longer the PP the higher the risk)
+ insights for financial and liquidity planning possible
- no considerations to time period and development of earnings BEYOND the time of amortisation
- should only be used when returns remain consistent during time of use
- lack of consideration of diverse periods results in limited ability to compare investment objects
- attributability of proceeds can be problematic (product is created by multiple machines)
Why are static calculation methods not enough?
Several major disadvantages:
- ignore the decline or increase in value that occurs over time
- fail to consider uncertainties
- while easy to use, they often rely on unrealistic assumptions (e.g. consistent period of use)
What is the NPV?
How is it calculated?
What are conclusions of NPV?
Net present value is a dynamic capital budgeting method.
If earnings value exceeds the investment payment (NPV positive) the investment will assist in increasing the value of the company.
Takes cash flows anticipated at different points in time into account.
NPV0 = SUMn t=0 [ (incoming CF + outflowing CF) * 1 / (1+r)^t ]
Conclusions:
- net surplus of an investment expressed as today’s value of all future cash flows
- interest of the capital employed is higher than the discount rate
- present value is immediately realised growth of the investor’s asset
What is the IRR?
How is it calculated?
What are conclusions of IRR?
Internal rate of return is a dynamic capital budgeting method.
Mirrors interest on the invested capital (discount rate to NPV of 0)
An investment is worthwhile if its IRR is above the interest rate of alternative investments (the higher the better)
Can be used for investments with diverse revenues and expenditures to create a ranking.
Calculation:
NPV = 0
0 = SUM n t=0 [ (incoming CF - outgoing CF) * 1 / (1+r)^t ]
Due to nth degree solutions: In practise Linear Interpolation by discounting with two guessed interest rates and two npvs
R = i1 - npv1 * (i2 - i1) / npv2 - npv1
–> Investment is advantageous if IRR > capital market interest rate
What are disadvantages or IRR?
Internal rate of return (= dynamic capital budgeting method)
- attributability of series of cash flows often hard
- uncertainty of series of cash flows must be foreseen according to amount and time
- comparison of investments with different acquisition values and/or periods of use requires real or fictional gap investments -> much more difficult
- unambiguity of result only given when surplus over the entire period of use
What is the annuity method?
How is it calculated?
What are conclusions of annuity method?
dynamic capital budgeting method
NPV sums up surplus of the returns over time.
Most of the time annual average surplus is required = annuity
annuity A = average surplus per year
annuity rate a = factor to calculate annuity
a = (1+i)^n * i / (1+i)^n -1
A = NPV0 * a
–> if annuity is over zero the returns amount to a period surplus in the amount of the annuity (the higher the better)
What is the purpose of business valuation?
What are the primary functions?
- Determine the economic value of a company at a specific point in time.
- subjectively measured future utility of an enterprise
- Variety of reasons for valuation:
- strategic rationale = assessment of alternative strategic concepts; synergies
- specific rationale = decision-dependant occasions (change of ownership structure); decision-independent occasion (tax purposes)
- Primary function: advisory, brokerage, argumentation
- Secondary function: subordinate tasks (tax assessment, contractual design, accounting)
Describe the primary functions of business valuation.
Advisory function: Supplies key values for use in negotiations; defines upper and lower value limit
argumentation function: designed to substantiate perspective of the negotiating party; argumentation values should be close to other party’s reservation price
Brokerage function: Handle conflict situation to settle for a fair price (arbitral value) that sits between lower and upper value.
What valuation methods can be applied?
What is the difference?
Individual valuation methods: net asset value
Total valuation methods:
- comparative method (multiplies method)
- Future cash flow methods (DCF, EVA)
- Dividend discount model
total valuation methods are dominant in modern-day valuations. View the entire company as valuation object. Total = value is greater than sum of its parts
Individual valuation methods value the company according to the sum of the individually valued assets minus relevant debts.
What is the net asset value and how is it calculated?
Individual valuation method.
A company must be worth at least the amount that a potential buyer would save in expenditures to build an exact replica of that company from scratch.
Static, key-date-related view of the sum total of all values of a company’s individual assets and debts.
Value of the individual asset (gross asset value) - value of debt = net asset value
What is the comparative-value-method and how is it calculated?
Total valuation method used to estimate market price that the valuation object can potentially fetch if sold.
Calculated based on stock market price or the transaction volume of a comparable company.
- Multiplies are sector dependant
- should contain leeway to justify premiums and discounts as a function of risk involved
Value of company A = financial factor A * (Value of company B / financial factor B)
Different reference values as financial factor possible (EBIT, revenue, number of customers, etc.)
–> Linear relationship between reference value and company value is assumed (identical conditions relative to margins, investment, growth, risk structure)
What is the discounted-cash-flow method (DCF) and how is it calculated?
Total valuation method with future-orientation.
“Future cash flow method”
- Focused on the benefit an investor can derive from the company in the future
- Company’s value is the result of present value of estimated future financial performance
- Discounting of future expected cash-flows (profitability)
- Expected CF is significant indicator for self-financing and dividend-distribution of a company
Cash Flow 1: net income \+/- write-downs / write-ups \+/- increase / decrease of provisions \+/- other non-cash expenses/increases - investments = free cash flow
Cash Flow 2 (financing activities): Interest on outside capital - borrowing of outside capital \+ repayment of outside capital \+ profit distribution \+ equity repayments - equity injections = free cash flow (from financing activities)
How is CF1 calculated?
Cash Flow 1: net income \+/- write-downs / write-ups \+/- increase / decrease of provisions \+/- other non-cash expenses/increases - investments = free cash flow
How is CF2 calculated?
Cash Flow 2 (financing activities): Interest on outside capital - borrowing of outside capital \+ repayment of outside capital \+ profit distribution \+ equity repayments - equity injections = free cash flow (from financing activities)
What is EVA?
How is it calculated?
EVA is used to determine the annual value of a company
Profit related method of company valuation in combination with DCF
widely used in practice
Capital-charge equation:
EVA = NOPAT - WACC * Invested Capital
Value Spread Equation:
EVA = ((NOPAT / Invested Capital) - WACC) * Invested Capital
EVA = (ROCE - WACC) * Invested Capital
Company Value = SUM inf, t=1 ((EVAt / (1+WACC)^t )+ Invested Capital
How is NOPAT calculated?
Net Income
+ non-operating expenses
- non-operating income (Income from investments non essential to operation)
= operating profit after operating-conversion
+/- funding conversion (+interest on debt; - interest from leasing/renting
= operating profit after operating, funding conversion
+/- tax conversion (-taxes from non-op expenses)
- tax advantage (tax shield)
= operating profit after operating, funding, tax conversion
+/- shareholder conversion (correction of R&D expenses)
= NOPAT
How is the invested capital calculated?
Asset
+/- operating conversion (- assets non essential to business - securities)
= asset after operating-conversion
+/- funding conversion (+/- of leasing and rental properties; +/- interest free liab)
= asset after operating, funding conversion
+/- tax conversion (correction of deferred taxes)
= asset after operating, funding, tax conversion
+/- shareholder conversion (+ R&D; - marketing)
= Invested Capital
What is the DDM?
How is it calculated?
Discounted dividend model
Identifies dividends to be paid to stockholders in the future
Valuation method for companies
V0 = SUM inf t=1 ( Dt / (1+r)^t )
What is WACC?
How is it calculated?
Weighted average cost of capital
Average rate the company pays for capital
Not a company valuation method but input for EVA and DCF
Takes tax savings into account
WACC = EM/V * e + DM/V * i * (1-t)
What influences the WACC?
External & internal influences
Internal:
- risk structure (higher risk = higher risk premium)
- capital structure (equity/debt ratio)
- level of indebtedness
- commitment of capital provider
External:
- general situation on money and capital market
- risk-free rate of return
- company taxes
What is the circularity problem of equity?
How is it solved?
cost of capital; total company value and capital structure depend on each other
Problem of leveraged acquisition (LBO)
Capital structure is set as fixed for the entire lifetime of the company
Iterative approach
What is a merger?
Type of business combination characterised by greatest change to company sovereignty
Two companies unite economically to form a single company
Adoption = one company, typically the one acquired, loses its legal independence
Amalgamation = both companies transfer their assets to a newly created company
What is an acquisition?
one company buying another company by purchasing the property rights or a defined part of another company
- Majority part of share or major part of assets
- Acquirer has the option of exercising control without the acquisition target losing its independence as legal entity
- No consolidation like with mergers
asset deal = enterprise sells assets to acquirer by singular succession = maximizing cash flow; problems with tax and transfer of assets (thrid parties required)
share deals = more common, public tender offer to shareholders above market value under civil law; pressure on shareholders, if majority = squeeze out of rest
What is a cooperation?
short-term form of business combination where companies participate voluntarily to coordinate certain business functions with aim of improving competitiveness.
Joint venture, Strategic alliance or supply agreement
What is a joint venture?
contractual joint venture very useful when developing markets
Equity joint = bilateral cooperation through establishment of new independent enterprise by multiple parent companies
Contractual joint = no merger takes place; agreement between companies are based on legal obligations
What is a strategic alliance?
What are reasons for it?
Alternative to traditional acquisitions or mergers
based on capital-related or contractual cooperation elements
forged between individual areas within the value-chain
One company usually dominates
can be precursor for M&A activities
Reasons:
- Improved access to difficult markets
- improved capabilities through innovation
- financial benefits through economies of scale; reduced costs
- improved distribution capabilities
What is a supply agreement?
What are reasons for it?
Cooperations between companies acting as network partners
Contracts under law of obligation or articles of association
Legal relationship
network partner does business as general contractor and sole partner of the buyer
performance obligation and is fully liable to buyer (sole claim for remuneration)
What are market value related motivations for M&A?
Diversification: takeover of an undervalued company; management will stay in place; positive market outlook
Business Optimization:
- expectation of achieving increased value through reorganization
- potential increase of value within the target company
- replacing the current (inefficient) management
- optimizing processes, new technologies; spin-off divisions are sold
- liquidation of hidden reserves
Synergies:
- improve competitiveness at the divisional level;
- transfer of expertise, knowledge and experiences (intangible integration)
- centralisation of tasks (tangible integration)
Speculative:
- exploiting opportunities for arbitrage
- markets are imperfect (buyers if better informed)
- expectation of arbitrage profit
What are non-market value related motivations for M&A?
management motivation:
- increase influence, size, image, power
- problematic: principal-agent problem (size instead of value)
Sellers motivation:
- solve financial problems
- gain new opportunities for expansion
- procuring investment funds
- cash-out
- corporate reorganization
- resolve disagreements among shareholders
- solve problems of succession
What are the phases and contents of these phases of M&A?
Pre-Merger Phase
- strategic analysis and conceptual design
- consideration & decision making
- identify takeover targets and initiate contact
Transaction Phase
- interest on both sides
- NDA is signed
- letter of intent is signed (non binding price)
- Due diligence
- negotiation
- sign of final contract / closure
Integration Phase
- integration of corporate cultures
- knowledge management
- efficient management decision making (clear decisions, growth, synergies and new common culture)
What is due diligence?
What are the two main tasks within project-based analysis?
- Basic company valuation
- Assessment of whether takeover should occur
- Risk and opportunities analysis
- Protective role against risk associated with transactions
Tasks:
- collection and analysis of info+data for the process of assessing opportunities and risks
- dedicated analysis of a company or project prior to planning and decision-making
Why do M&A transactions fail?
- insufficient knowledge of planned strategy behind the transaction
- overestimation of synergy potentials resulting in high price
- lack of integration of merger strategy into the parents structure
What can be potential outcomes of due diligence?
Due diligence report or executive summary
Alternatives:
- deal-breakers: negotiations are discontinued
- influences on purchase price (risks, etc.) -> price reduction
- additional info = ok –> agreement
What are areas examined in a due diligence review?
Basic:
- basic company data
- company history
- other general information
External:
- Economic analysis
- sociodemographic analysis
- general legal and political environment
Strategic:
- business-policy objective and overall strategy
- review of the acquisition strategy
- review of acquisition-related areas
Parts:
- Financial: annual+budgeted financial statements, mgmt. accounting
- Marketing: sales, prices/conditions; industry competition growth
- HR: management efficiency, motivation, conditions
- Legal and tax: legal disputes, tax risks, tax design
- Environment: regulations, production processes, contaminated sites, limitations, liabilities, obligations
- Orga+IT: orga + technology used
What is a friendly takeover?
Takeover is initiated by contacting the management first
- Mgmt agrees to take over and starts price negotiation
- Mgmt stays fully or parcially in place
- Mgmt tries to convince shareholders
- positive contributions are assumed
- failed negotiation = hostile
What is a hostile takeover?
Takeover is initiated by announcement without discussion with the mgmt or mgmt rejects the offer
- only common for listed companies (private = owner has majority)
- purchasing offer directly to shareholders to claim majority
- tender offer is used
- lengthy acquisition process
What is MBO, MBI, LMBO and LMBI?
MBO = management buy-out is an acquisition form INSIDE the company by the former executive level employees (mgmt.); employee becomes owner
MBI = management buy-in is an acquisition form OUTSIDE the company by a manager
LMBO/LMBI = leveraged MBO/MBI with substantial funding from debt capital (>50%) because manager does not possess the full purchasing price; debt is paid back by CF of company
What is an IPO?
What is the reason for it?
Initial public offering when a company is first listed on the stock exchange
- Spin-Off: company disposes part of its business by selling new shares thereby creating a new company
- Privatization: goverment-run company listed on the stock exchange is becoming private by selling stocks
- Capital injection: private company wants to expand and requires money to do so (start-up in early stages)
What are advantages and disadvantages of stock exchange listed companies?
- improved access to liquidity
- better financing opportunities for the future
- better options regarding company acquisitions
- the opportunity to set up an employee share ownership scheme
- enhanced company image and reputation
- a more advantageous position when dealing with customers and suppliers
- loss of control
- requirement to share future profits
- loss of privacy (transparency)
- additional cost (implementing corporate governance)
What are the steps to launch an IPO?
Phase 1 - Planning and preparation: requirements, formalities and business plan is drawn up
Phase 2 - Structuring: consultants to perform due diligence, valuation, prospectuses, prepare roadshow, corporate governance
Phase 3 - Marketing: promote IPO; roadshow
Phase 4 - Pricing, allocation, and stabilization: Offering price is set, stocks are sold to private and institutional investors; prices will fluctuate massively due to speculation and settle
Phase 5 - Live as public company: Fulfil host of requirements, legal regulations, notifications, accounting rules and regulations, manage relationship between company and stockholders
What is private equity?
Who are the participants?
What are the goals for supplier and recipient of the capital?
- Funds injected into private companies by investors
- Financing of companies not listed at stock exchanges
- Liable or risk capital (venture capital)
Participants:
- investors that provide capital
- portfolio company to receive the financial capital
- private equity firm to intermediate transaction and invest indirectly
- advisors/consultants: support, brokerage services
- funds of funds (FoF) occupy a position between investor and private-equity firm
Goal of supplier:
- high rates of return; security and liquidity
Goal of recipient of capital:
- low financing cost, long-term investment and flexibility
What is corporate governance?
- legal and de facto organizational structure for the management and supervision of a corporation
- Deals with the relationship between shareholders as owners of an corporation and management that holds executive authority
- conflict of interest and supervision can be minimized
- framework, rules and practises to balance interests
What is external corporate governance?
What is internal corporate governance?
External = capital market mechanisms
- managers will make their decision according to rules and expectations of the capital markets
- capital markets have disciplinary effects and control mgmt behaviour
Internal = implemented within the company
- applicable regarding legislation of country
- deals with roles, competencies and functions
- interactions of various corporate bodies
- supervisory of executives either independent admin body or by supervisory committee
- executive and supervisory roles do not have to be strictly seperated
What types of internal corporate governance can be differentiated?
- deals with roles, competencies and functions
- interactions of various corporate bodies
- influenced by country’s cultural and historic background
One-tier board system (anglo-saxon)
- empathize on shareholders
- combines both managerial and supervisory responsibilities in one unified board of directors dominated by non-exec directors elected by shareholders
Two-tier board system (Europe Japan)
- roles and responsibilities are split between management board and supervisory board
- mgmt board runs day-to-day operations
- supervisory board (entirely non-exec directors) represent and are elected by both shareholders and employees
- supervisory board: appoint and dismiss mgmt, remuneration, included in major business decisions
Why is corporate governance particularly important in a market economy?
- public companies are models for larger corporations in market economy systems
- permanent asymmetries regarding information, interest and objectives (shareholders and mgmt) create the need for effective mechanisms to have disciplinary effects on mgmt
Using the example of executive compensation, explain how an internal corporate governance system functions.
- Compliance with corporate governance systems results in an increase in share price due to increased confidence of investors
- if managers remuneration is linked to companies performance and there is an increase in share price the mgmt gets a bonus
- interest of mgmt to implement good corporate governance
In contrast to SOX in the US, other counties are less regulated.
Why is that the case?
- Other countries do not want to intervene excessively in the workings of the free market economy
- capital markets have a disciplinary effect on the company mgmt
What is SOX?
- Sarbanes Oxley Act
- US legislation for important legal frameworks
- defines rules for the collaboration between companies and auditors
- stipulates executives to take higher degree of personal responsibility for the accuracy and completeness of financial statements
- prevents stakeholders to be mislead by the company
What are the two essential elements of the SOX?
1 Requirement to establish and maintain internal controls and processes for the disclosure of financial information and thereby ensuring accurate financial statements
2 Executive officers (CEO, CFO) must certify the financial statements and must guarantee the accuracy and completeness by being personally liable for any malpractice
What are the effects of corporate governance?
Analyzing the corporate performance on two levels:
- macro economical POV: examine the influence on macroeconomic indicators (competitive advantages of national economy, stability, employment)
- micro economic POV: seeks to find empirical evidence that it is related to companies success
Question if or to what extent CG is related to performance cannot be definitively answered.
Why do monitoring costs fall when corporate governance principles are applied?
- better transparency
- easier access to information relevant to the company
- procurement/information costs drop which causes monitoring costs to drop as well
Explain why the voice and exit strategies are both corporate governance instruments.
Voice
- right to vote at a general meeting
- majority can prevent executive mgmt passing resolutions (increase in mgmt salaries or approval of actions)
Exit
- sell-of of stocks decreases the company value
- decreased value = lower remuneration of mgmt (capital market mechanism)
- decreased value = higher risk of takeover = increaseed likelihood of replacement of mgmt
From the viewpoint of the agency theory, what effects does good corporate governance have on company performance as measured by the development of the stock price?
Positive (rising) prices since agency costs fall, therefore the value of the company increases.
lower agency costs due to:
- higher transparency
- easier access to info
- lower cost to procure info
Define financial planning.
- plan for future and fundamental decisions about investments, financing and how to pay upcoming bills related to operations
- Purpose: develop and maintain the liquidity of the company in short-term while determine the capital requirements to execute long term strategy
Differentiate between financial planning and budgeting types depending on the planning period.
Cash budgeting/liquidity planning = financial planning in stricter sense (forecast period: up to 1 year)
Capital planning = financial planning in broader sense
- related to long-term investment planning and strategic options for financing (forecast period: several years)
What steps are included in financial planning?
1 Reviewing the overall strategy (where does the company wanna go)
2 Developing a investment plan (identify capital assets needed to execute strategy)
3 Developing a financial plan (how the firm will raise funds to buy assets required)
4 Planning the cash budget (ensure sufficient funds for operational activities)
What are the outputs from the financial planning model?
- Projected financial statements
- financial ratios
- cash budget
What are inflows/outflows of the cash budgeting?
How is the net cash flow calculated?
How is the closing balance on liquid assets calculated?
Outflows:
- salaries, wages
- supplier account payables
- rent
- bank interest
- taxes
- other payments
Inflows \+ cash sales \+ expected account receivables \+ proceeds from sales of assets \+ other receivables
net cash flow = total inflow - total outflow
net cash flow
+ opening balance of liquid assets (cash, bank accts)
+ funds to be procured (loans, etc.)
= closing balance on liquid assets
How is the cash cycle calculated?
What does it say?
\+ Average supplier payment period \+ Average days raw materials in inventory \+ Average production time \+ Average days fished goods in inventory \+ Average collection period
= cash cycle
time period between money outflow until money inflow
Cash went out the door when the company pays the suppliers and did not get cash back until the cash cycle period end
What options are available for covering the external capital requirements of a company?
- injection of fresh equity capital
- borrow more debt capital
What is a key method for the projection of financial statements and ratios?
Percentage sales model
- future asset investment and financing is based on the forecasted sales
- assumes no spare production capacities
- additional sales will immediately require more assets and in turn more capital
- additional capital is the required capital in form of debt or equity
What are key financial ratios as the result of the financial planning model?
Long-term metrics:
- debt/equity ratio
- equity ratio (equity to total capital)
- debt ratio (debt to total capital)
asset structure:
- Investment ratio (ratio of current assets to fixed assets)
- current assets to total asset ratio
- Capitalization ratio (ratio of fixed assets to total assets)
Liquidity ratios:
- LR 1 cash ratio: ratio of cash + cash equivalents to short-term borrowing
- LR 2 quick ratio: ratio of cash + cash equivalents + cash receivables to short-term borrowing
- LR 3 current ratio: ratio of current assets to short-term borrowings
