Course notes Flashcards
(325 cards)
1
Q
Define strategy
A
Strategic planning is concerned with the long-term direction of the business and how the business will achieve its objectives
2
Q
What is financial strategy?
A
Concerned with the financial aspects of the strategic planning process.
3
Q
What are the four key decisions to consider in financial strategy?
A
Financing
Investment
Dividend
Risk Management
All of the decisions are interrelated
4
Q
What is a stakeholder?
A
A stakeholder is an individual or group of individuals with an interest in the organisation
5
Q
What are the 8 categories of stakeholders?
A
Shareholder
Lenders
Directors/Senior managers
Employees
Customers
Suppliers
Government
Community
6
Q
Who are the shareholder agents?
A
Directors
7
Q
What is agency theory?
A
Says the directors will always put the shareholders’ objectives first.
They do need to consider the other stakeholders as they need to be happy to ensure that shareholder wealth is maximised
8
Q
What is the agency problem?
A
Refers to the situation where the directors may be tempted to act in their own interests rather than the shareholders
9
Q
Define sustainability
A
Meeting the needs of the current generations without compromising the needs of the future generations.
10
Q
Define sustainable development
A
Recognises the interdependence between business, society and the environment.
Initiatives by governments business and organisations to promote sustainable development.
11
Q
What are the two fundamental aspects to sustainability?
A
Impacts and dependencies
12
Q
What is double materiality?
A
Incorporated in the Corporate Sustainability Reporting Directive (CSRD)
Means companies must report on how sustainability issues might create financial risks for the company
AND
The company’s own impacts on people and the environment
13
Q
What makes up the ESG?
A
Environmental
Social
Governance
14
Q
What is the purpose of IFRS Sustainability Disclosure Standards?
A
Provide high-quality, transparent and comparable information which covers a range of ESG topics about which investors want information
15
Q
What is the general rule for sustainability report?
A
Environmental factors
Social factors
Governance factors
Policies, practice and performance
Targets
16
Q
Examples of measuring environmental impact for ESG
A
Pollutants and effluents released
Percentage of waste recycled
17
Q
Examples of measuring social impact for ESG
A
Employee turnover
Number of notifiable accidents
Supply chain sustainability
18
Q
Examples of measuring governance impact for ESG
A
Diversity of the board
Bribery and corruption training for employees
Board member expertise
19
Q
What are the challenges of ESG data?
A
Lack of comparability - can choose what they want to report
Insufficient measurable outcomes - often non-financial
Lack of assurance - data is not subject to normal assurance
Greenwashing - Companies provide the public with misleading or false information about the environmental impact of their products/operations
20
Q
What are ESG ratings?
A
Rating agencies use ESG metrics to grade a company’s ESG performance.
A good rating boost brands image and helps get cheaper finance
21
Q
What is the pay back period?
A
How many years of project cash flows are needed to recover the initial investment
22
Q
How do you calculate payback period?
A
Cumulative total of cash flows until you hit 0
Assume that cashflows are generated evenly throughout the year.
23
Q
What does ARR stand for?
A
Accounting Rate of Return
24
Q
What does the annual rate of return show?
A
% annual return on the project
25
How do you calculate ARR?
Average annual profit /average investment
Average investment
(Initial outlay + scrap value)/2
26
Net present value is what process
Summing the present value of all future cash flows at the cost of capital
Gives the profit of project in today's money
27
How do you make judgements on NPV?
If negative = DON'T DO IT
If positive = DO IT as it increase shareholder wealth
28
How do you calculate NPV?
Each cashflow and divide by (1+r)^n when r is the rate and n is the number of years
29
What is an annuity?
Constant annual cashflow with a set end date
30
How do you calculate an annuity?
PV = A/R *(1- (1/(1+r)^n))
r is rate
n is the number of years
a is the cash flow
31
What is a perpetuity?
A never-ending constant annual cash flow
32
How do you calculate a perpetuity?
PV = A/R
A is the cash flow
R is the rate
33
What is the IRR?
Internal Rate of Return
Represents the actual annual % return on the project
34
How do you calculate the IRR?
Using IRR on Excel and highlight the cashflows
35
Pros of payback period
Simple to calculate and understand
Can use initial screening tool
Recognises importance of liquidity
Focuses on nearest (most certain) future cashflows
36
Cons of payback period
Ignores the time value of money
Only considers the cashflows up to the date of payback
Encourages short-termism
No clear decision rule (e.g. set years)
37
Pros of Accounting Rate of Return or ROCE
Simple to calculate and understand
Looks at the entire life of the project
Reflects the way that external investors judge the organisation (% return)
38
Cons of Accounting Rate of Return
Ignores the time value of money
Based on profits, not relevant cashflows
Doesn't consider the length of the project (and therefore liquidity)
No clear decision rule
39
Pros of net present value
Takes into account the time value of money
Shows the shareholders wealth created by the project
Can allow for risk (by adjusting cost of capital)
Clear decision
Looks at entire project
40
Cons of net present value
Requires the cost of capital to be estimated several years into the future
Calculations can be time consuming and easily misunderstood
Doesn't factor in liquidity/time taken to generate return
Assumes you can reinvest proceeds at cost of capital
41
Pros of internal rate of return
Allows for the time value of money
Does not require an exact cost of funds to be estimated
Easy to interpret
Looks at entire project
42
Cons of internal rate of return
Ignores the size of the investment required and total cash inflows
Can give a conflicting answer to NPV when evaluating mutually exclusive projects (if projects of different length/size)
Assumes you can reinvest proceeds at the IRR.
43
Sensitivity calc formula for cost of capital
IRR-Cost of Capital
Over
Cost of capital
44
Sensitivity calc for cashflow inputs
NPV of project
Over
PV of cashflow input
45
Equivalent annual cost calc
NPV of project
Over
Annuity factor for project life
46
Profitability index calc
NPV
Over
Initial Investment
47
When do you take into consideration the inflation in NPV
When the cashflows include inflation you use
(1+m)=(1+real)*(1+inflation)
47
What non-financial factors should be considered when appraising new projects?
– Compliance of the project with current / future legislation
– Impact of the project on staff morale
– Impact on suppliers and customers
– Impact on the organisation’s reputation
– Sustainability of resources used in the project
48
How do you calculate the working capital in NPV
T0 is the full amount
Take the incremental part of the cashflow each of the following years
Then recover everything in the final year
49
What do you have to remember with tax in NPV?
The timing of the tax to make sure it falls in the correct T
50
What are the three factors for being a relevant cashflow?
Incremental - impacted by the decision
Future - Only future costs (anything past is sunk)
Cashflows - Ignore non-cash items e.g. depreciation
51
What is risk?
Number of known outcomes with known likelihoods
52
What is uncertainty?
Unknown range of possible outcomes
53
Expected values is when
You use probabilities of each outcome to get the most likely (expected) outcome
54
Problems with expected outcomes
Not an actual option
Only as reliable as the probabilities
Helpful over longer periods but not really over 1 period decisions
55
Sensitivity is used for risk or uncertainty?
Uncertainty
56
What does sensitivity analysis show?
The level of change that can happen before the wring decision is made
57
When is simulation useful?
Where many of the inputs to the NPV calculation can have several different outcomes
58
Negative of simulation
It does not determine how likely such a change is and cannot cope with multiple inputs changing at the same time
59
How can simulation be used?
Analysing the spread of results can help to better understand the project
60
How does adjusting the discount rate work?
Can be used on uncertainty or risk
Increasing cost of capital can give a more conservative outcome
61
How do you calculate correlation coefficient?
Use spreadsheet
=Correl(Data range 1, data range 2)
62
What are data outliers?
Observations that are abnormal and can therefore slightly distort the results
63
How do you calculate mean?
Use =average(data set) on excel
64
How do you calculate standard deviation?
=STDEV(cell range)
65
What is helpful about the standard deviation?
It tells you on average how far each results lies from the mean
66
What is con of standard deviation?
Can be higher just because data in the set is higher
67
What is better than standard deviation?
Co-efficient of variation
Gives the standard deviation as a percentage of the mean
Higher the percentage
Wider the spread
68
What are the 7 factors that determine the value of a business?
Sales growth rate
Operating profit margin
Corp tax rate
Investment in non-current assets
Investment in working capital
Cost of capital
Life of projected cashflows
69
How can the 7 factors of business value be used?
Forecast future cashflows
Split into period of competitive advantage (less than 10 years)
AND
Residual period (valued as a perpetuity or lump sum using P/E)
Discount WACC to find the value of business
Deduct market value of debt to find value in equity
70
What are the 5 real options that should be considered alongside NPV?
Follow-on options
Abandonment options
Timing options
Growth options
Flexibility options
71
What are follow on options?
Ability to launch future products off the back of this one, or extend life of the project e.g games console to see games
72
What are abandonment options?
The ability to exit a project early and sell the assets
73
What are timing options?
The ability to delay the start of the project to wait for favourable market conditions
74
What are growth options?
The ability to 'dip your toe in the water' with a small initial investment and then grow
E.g launch in different locations are different times
75
What are flexibility options?
The ability to change suppliers/ materials/ locations if a cheaper option becomes available
76
What are the risks when investing overseas?
Political risks
-Quotas (import limits)
-Tariffs (charges to imports)
-Non-trade barriers (legal/safety standards)
-Restrictions (on buying foreign companies)
-Nationalisation (of your assets)
-Minimum shareholding (by residents)
77
How can you mitigate the risk from quotas when expanding?
Negotiations with the government
78
How can you mitigate the risk from tarrifs when expanding?
Insurance against nationalism
79
How can you mitigate the risk from non-trade barriers when expanding?
Product strategies e.g. locate somewhere abroad to prevent the need to trade over barriers
80
How can you mitigate the risk from restrictions when expanding?
Management structure e.g. joint ventures
81
What are the three types of long-term finance?
Debt
Preference shares
Ordinary shares
82
What order do the sources of finance get paid back in?
Debt then pref shares then ordinary shares
83
What are the returns for the types of sources of finance?
Debt - Fixed interest
Pref shares - fixed dividend, paid before ordinary
Ordinary shares- discretionary dividend from accumulated profits
84
What is the capital return/liquidation for each source of finance?
Debt - if redeemable then do so at par or premium
Pref shares - Assume irredeemable unless told otherwise
Ordinary shares - No obligation to redeem
85
What is the tax impact of the sources of finance?
Debt - interest is deductible - leads to corp tax saving
All shares have no tax saving as dividends are not deductible
86
What is the control given by the sources of finance?
Debt - No voting rights
Pref shares - Only have voting rights if dividends are in arrears
Ordinary shares - Have voting rights
87
Levels of risk and reward with sources of finance
Debt
Low risk = low reward
Preference shares
Higher risk = Higher reward
Ordinary shares
Highest risk = Highest reward
88
What are the two sources of equity finance?
Rights issue
Public offer
89
How does the rights issue generate equity finance?
A company offers further shares, at a fixed price, to existing shareholders, in proportion to their existing holding
90
How do you calculate the theoretical share price after issuance and when would you use it?
Used when issuing rights share
TERP = (Total share value before + proceeds - issue costs + project NPV)
Over
Total shares before + new shares issued
91
How do you calculate the issue of one right in rights issue?
TERP - Subscription price
92
Pros and cons of rights issue
Pros
Lower costs than public offer
No impact on control (if everyone exercises their right)
Cons
Need to consider if the shareholders want to put more money in
Need to make the price attractive but high enough top generate income
93
Pros and cons of public offer
Pros
Large potential investment
Cons
Expensive - fees paid to banks and advisors. Need to underwrite the issuance also
94
What is it called when a company obtains a stock exchange listing at the same points as public offer?
It's called an Initial Public Offering (IPO)
95
If there is a public offer what are the two options?
Shares are sold to an issuing house - who offer shares to the public
Or
Shares are offered directly to the public
96
What are the two internal sources of finance?
Retained earnings
Improving working capital management efficiency
97
When you are doing EAC for replacement cycles how do you lay it out?
Do separate NPVs for each cycle
Divide NPV by relevant annuity factor
Then compare the results of each
Conclude
When doing the NPVs for each cycle only include the number of years in that cycle
Do not include the costs of replacement at the end
ONLY include the costs in that cycle
98
In dividend growth do you include or exclude special dividends?
Exclude
99
In regearing the Ba to give Be make sure you use the what values of equity and debt
Market values not the nominal values
100
What is the 'pecking order' to minimise issuance costs?
Retained earnings (no issuance costs)
Rights issues (low issue costs)
New issues (high issue costs)
101
What are the 4 types of debt?
Irredeemable
Redeemable
Convertible
Loan stock with warrants
102
Describe irredeemable debt
Pay fixed interest annually
Never redeem
103
Describe redeemable debt
Pay interest annually
Redeem at par or premium in n years
104
Describe convertible debt
Pay fixed interest annually and holder can choose to redeem or convert to ordinary shares at maturity
105
Describe loan stock with warrants
Pay fixed interest annually plus holder gets separate call options on ordinary shares
106
What has lower interest convertible or redeemable debt?
Convertible due to the sweetener of the conversion
107
What are representations and warranties in loan documentation?
Checks before the loan is made
Categories are
Legality of borrowing
Financial condition
108
What are guarantees in loan documentation?
The lender seeks a guarantee from a guarantor
109
What are covenants in loan documentation?
The borrow commits to do/refrain from doing certain things to protect the lender
Categories are
Providing information
Negative pledges
Financial covenants
Restrictions
110
What 5 issues should you consider when looking at the type of finances?
1) Impact on financial performance
2) Impact on financial position
3) Cost of the finance/impact on the WACC
4) Impact on the shareholders
5) Matching to term/risk
111
Green finance means?
Many different definitions
but
thought as financing of investments that provide environmental benefits.
Whole organisation approach
112
5 methods of green financing
Green loans
Sustainability linked loans
Green bonds
Green funds
Social bonds
113
What are green loans?
Loans specifically to help finance green projects
Demand growing
Often lenders offer better terms to borrowers that show they are reducing environmental impact
114
What are sustainability linked loans?
Differ from green loans in that they are loans for any purpose
The pricing mechanism means that loans are cheaper if the borrower achieve certain sustainability
115
What are green bonds?
Fixed interest bond used to raise money for climate and environmental projects.
Typically secured and have the same credit rating as a company's other debt obligations
Come with tax incentives
116
What are green funds?
To help investors target investment in companies with higher standards of social responsibility many stock markets product an index of firms that satisfy social and environmental criteria
117
What are social bonds?
Used to raise funds for projects that address or mitigate specific social issues and/or seek to achieve positive social outcomes
118
What are the four key components of Green Loan Principles?
Use of proceeds
Process for project evaluation and selection
Management of proceeds
Reporting
119
What are the two theoretical considerations in dividend policy?
Residual theory
Irrelevancy theory
120
What is residual theory?
Dividends only paid out after all projects with a positive NPV have been financed
Left over is dividends
Maximises shareholder wealth
121
What is the irrelevancy theory?
Companies can always invest in positive NPV projects
If cannot fund out of retained earnings then raise further funds
Shareholders will get a smaller share of returns from the new project, compensated with dividend received
If dividend too low, manufacture a dividend by selling shares
122
What are the 6 practical considerations in dividend policy?
Clientele effect - if dividend policy changes, shareholders may divest
Uncertainty - cash now is more certain for shareholders
Signalling - markets see dividend reductions negatively, reduces price
Agency - SH nervous Directors act in own interest
Tax - Shareholder may prefer dividends over capital gains
Liquidity - dividends should only be paid when there is enough cash to remain solvent
123
What are the alternatives to paying a cash dividend?
Share repurchase
Scrip dividend
124
What is formula for CAPM?
Ke = rf + B(rm-rf)
rf = risk free rate
rm = return on market portfolio
B = exposure to systematic risk
125
Pros of CAPM
Directly links risks and returns
Can be used when share price unknown
126
Cons of CAPM
Assumes:
Shareholders are diversified
All inputs will remain constant and at historic values
Investors can borrow and deposit at rf
Exposure to all systematic risks can be groups into one measure
127
What is the formula for dividend valuation model?
Ke = Do(1+g)
+g
Po
Do = dividend just paid
g = Dividend growth
Po = current ex-div share price
128
Pros of dividend valuation model
Calculates Ke based on market data
129
Cons of dividend valuation model
Assumes constant dividend growth which is unrealistic
Identifying ex-div share price is difficult for listed companies and very difficult for unlisted
130
What are the two methods to measure growth?
Historical dividend
Earnings retention method
131
What is the historical dividend method to calculate growth?
Old div x (1+g)^n = Div now
=Power(New/Old,1/growth periods)
132
What is earnings retention method to calculate growth?
g= br
b = % earnings retained
r = PAT/ opening shareholders funds
133
Who do you calc Kd for preference shares?
Kd = Do/Po
134
Who do you calc Kd for irredeemable debt?
Interest *(1-t)
/
Po
135
Who do you calc Kd for bank debt?
Interest rate x (1-t)
136
Who do you calc Kd for redeemable debt?
Find IRR of debt cashflows
to= MV
t1-tn=interest
tn = Redemption value
Multiply by (1-t)
137
Who do you calc Kd for convertible debt?
Use IRR as for redeemable debt
tn = higher of redemption and future MV of shares
Multiply by (1-t)
OR
Rate formula
138
When hedging make sure you convert from points by...
Multiply by 10
139
FRA is
Forward Rate Agreements
140
If FRA is 3-9 what does it mean?
Starts in 3 months and ends in 9 months
Therefore last 6 months
141
Who buys FRAs?
Borrowers
142
Who sells FRAs?
Lenders
143
How does the rates work on interest rate futures?
100-r
98 is 2% rate
144
In interest rate futures, do borrowers buy or sell?
Sell now
Opposite of FRA
145
In interest rate futures, do lenders buy or sell?
Buy now
Opposite of FRA
146
In interest rate futures, what is the standard size and length?
£500k
3 months
147
How do you calculate the number of contracts in interest rate futures?
=Loan size / 500k
*
Loan period / 3
148
How do you calculate the cash flow on futures in interest rate futures?
(Futures start - futures end) *3/12 *500 *no. contracts
149
In traded interest options, borrowers buy put or calls?
Put
Same as futures
150
In traded interest options, lenders buy put or calls?
Calls
Same as futures
151
In traded interest options, how do you calculate the number of contracts?
=Loan size / 500k
*
Loan period / 3
152
How do you calculate the premium in traded interest options?
No. contracts * 500k * 3/12 * % premium
153
What type of hedging can lapse and therefore you get an upside potential?
Options
154
How do you calc gain on option in traded interest options
No. contracts * 500k * 3/12 * (strike-spot)/100
155
What does in the money mean?
Gain if option used
Spot > strike
156
What does out of the money mean?
Loss if option used
Spot < strike
157
What does intrinsic value mean?
Value of option if exercised today
Never negative as you wouldn't do option so
158
What affects time value?
Volatility
Time till expiry
Interest rates
159
How does volatility affect time value?
Increased volatility
=
Increased time value
160
How does time to expiry affect time value?
Later expiry
=
Increased time value
161
How do interest rates affect time value?
Calls
Increase in interest value
PV exercise price down
Value of call up
Time value up as more desirable
162
Are put options buy or sell?
Sell
163
Are call options buy or sell?
Buy
164
How to you remember if put and calls are buy or sell?
Make sure there is a 3 and a 4 letter
So
put is sell (3 + 4)
call is buy (4 + 3)
165
Types of risk for foreign exchange rates
Economic (Long term risk from trading in foreign country)
Transaction - Gain/loss on short term foreign currency transactions
This is the one you hedge
Translation - accounting gains/losses from consolidation of a foreign sub
166
In forwards for foreign exchange rates, do you add or deduct a discount to the spot rate?
Add a discount
167
In forwards for foreign exchange rates, do you add or deduct a premium to the spot rate?
Deduct a premium
168
What is a forward in foreign exchange?
Binding agreement
You agree a rate now for a future transaction
169
How do you set up currency future transactions?
FX Receipt in future
= Buy £ later
So Buy now and sell later
FX Payment in future
= Sell £ later
So Sell now and buy later
170
How do you calculate the number of contracts for currency futures?
FX Amount / Futures price
Over
contract size (62500)
171
How do you calc gain or loss on futures in FX?
Contract size (62,500) * gain/loss on 1 contract * no. of contracts
172
What are the steps for currency options (OTC)?
What is the option 'on'? (Will state)
Then
What do I want to do with that currency in the future?
Gives put or call
Then
Pay premium
Then
Convert at
the strike price of option if beneficial
or
the spot rate if option is not beneficial
173
For traded currency options, how do you know if you want to buy or sell?
What you want to do in future do now
So FX receipt in future
Want to buy £ with it
So buy call options now
174
For traded currency options, how do you calculate number of contracts?
FX amount / strike price
Over
Contract size (31,250)
175
For traded currency options, how do you calculate the premium?
No. of contracts * Premium/100 * 31,250
Convert at spot rate
It is paid upfront
176
For traded currency options, how do you calculate the gain on option?
No. of contracts * 31,250 * (spot - strike)
Convert at spot rate outcome date
177
What is the set up for Money Market Hedge?
Home and Away columns
Now and future rows
178
In money market hedge, if you are making a payment in future in US what do you do in UK now?
Borrow because you deposit in US now to pay US in future.
179
In money market hedge, if you are receiving a payment in future in US what do you do in UK now?
Deposit because you borrow in US to make payment in future in US.
180
What are the steps to money market hedge?
Set up grid
Work out what happens in future abroad
What do you need to do abroad to be able to do that
Do opposite in UK
Do interest in UK
Effective interest is abroad/ uk
181
What is the formula for WACC?
(Ve*Ke) + (Vd*Kd) + (Vp*Kp)
Over
Ve+Vd+Vp
182
What is the traditional theory?
Introducing debt starts as a good thing
The WACC falls because the increase in Ke is small.
As level of debt increases, Ke rises faster, Kd starts to rise and therefore WACC rises.
There is an optimum balance
183
What is Miller and Modigliani - no tax (1958)?
Assume no tax
Total payments to investors are the same for equiv companies
Means the same total market value and same WACC
Means no optimum
WACC is the same at all gearing
184
What is Miller and Modigliani - with tax (1963)?
Tax benefit of interest
Payments to investors are higher of equiv company with debt
Means that company with debt have higher total market value, lower WACC
Optimum is to gear up - more debt
185
What are the 5 drawbacks of the three theories for capital structure?
Bankruptcy risk and costs - high gearing, high chance of insolvency
Tax exhaustion - the benefit of tax saving is eliminated with no profits
Agency costs - impact on board and company restrictive debt covenants
Availability of finance - not possible to gear up due to lack of assets or high business risk
Issue costs - with debt but none with retained earnings
186
Types of risk for a business in relation to WACC
Business risk
SPLIT INTO
Specific (unsystematic) business risk
AND
Systematic business risk
Financial risk
187
What is Specific (unsystematic) business risk?
Variability in PBIT due to factors specific to a company
Eg equip failure, labour strikes
Investors may be able to diversify this away
188
What is business risk?
Variability in PBIT
Comprises both specific and systematic risk
189
What is systematic business risk?
Variability in PBIT due to macro-economic factors
Eg FX moves, inflation
Impacted by business sector
Cannot be diversified against
Ba measures exposure
190
What is financial risk?
Additional exposure to systematic risk due to gearing and associated interest payments
Interest rates are additional fixed payments - Profit to loss if sales volume drops
191
If business risk changes
The steps in calculating this project specific discount rate using CAPM are as follows:
1) Locate suitable proxy company in new industry
2) Get equity beta, tax rates and gearing of proxy
3) Ungear proxy to get asset beta
Ba = Be
over (1+ D(1-t)/E)
4) Regear with our gearing
Be = Ba(1+D(1-t)/E)
5) Use CAPM to get Ke
6) Use Ke to get WACC
7) Use WACC to evaluate the project
192
If gearing changes how do you get the adjusted present value (APV)?
1) Find asset beta
Ba = Be
over (1+ D(1-t)/E)
2) Use asset beta and CAPM to get ungeared Ke
3) Find NPV using new Ke
4) Add PV of tax savings on interest of new debt
5) Deduct any debt issuance costs
6) Result is APV
193
What are the three levels of marketing efficiency according to efficient marketing hypothesis?
Weak form - reflects past info that is now fact
Semi-strong - past and public available info
Strong - all info public and private
194
What are the 9 factors of behavioural finance?
Overconfidence - bad investments, lack of knowledge
Representativeness - Over-reaction to news
Narrow framing - Concentrating too heavily on one piece of info
Miscalc of probabilities
Ambiguity aversion - avoiding new business areas
Positive feedback - rising continues, falling continues
Cognitive dissonance - holding on to long held beliefs
Availability of bias - diregard big picture focus on latest news
Convertism - underreaction due to resistance to changing opinion
195
When calculating the TERP for rights issue, do you add or minus issue costs?
Minus
196
When calculating the TERP for rights issue, do you add or minus NPV?
Add
197
How do you calc TERP?
Total value / Total shares
198
What are the two types of asset based valuations?
Net realisable value
Replacement cost
199
What is net realisable value asset based valuation?
NRV of assets less liabilities
Use when owner of business is forced to sell
200
What are the pros of net realisable value asset based valuation?
Useful to get minimal acceptable value
Assets more certain than income
201
What are the cons of net realisable value asset based valuation?
NRV of assets may be hard to estimate if specialised
Ignores goodwill
Need to estimate redundancy/ liquidation costs
202
What is replacement cost in asset based valuation?
Cost of setting up business from scratch
Use when buyer is looking to set an upper limit for bidding for the company
203
Pros of replacement costs asset based valuations
Useful to determine maximum price
Assets more certain than income
204
Cons of replacement costs asset based valuations
Estimating replacement costs can be difficult
Estimating goodwill would be difficult
Setting up a business may not always be possible
205
What are the 3 types of income based valuations?
Price-Earnings Ratio (P/E)
Earnings Yield (E/P)
Enterprise Value Multiple (EVM)
206
What is gross redemption yield?
Pre-tax cost of debt
207
What is the formula for P/E?
Share price/ EPS
EPS is earnings per share
208
What is the formula for E/P?
EPS/ Share price
209
How do you use P/E to get valuation?
P/E * Earnings
210
What is earnings?
Profit after tax and after pref dividends
211
What does High P/E means?
High investor confidence in future of co.
212
What can you sell a right to a share for?
TERP - Rights costs
2.38 - 2 = 0.38
213
How do you calculate the gross redemption yield?
Rate formula
(Periods, Payment, -PV, FV)
214
How do you calculate the issue price per debenture?
PV formula
(Rate, periods, payment, FV)
215
What are the 7 factors that drive business value ?
Sales growth
Operating profit margin
Corp tax rate
Investment in Non current assets
Working capital investment
Cost of capital
Life of cash flows
216
When do you use P/E or E/P ratio in income based valuations?
When seeking to convert current sustainable earnings (typically unlisted) into a share valuation
217
What is the formula for perpetuity with no growth?
Cash flow / rate
218
What is the formula for perpetuity with growth?
Cash flow0 * (1+g)
/
r -g
219
What are the pros of P/E and E/P?
Values the company
based on current
market valuations of
similar companies (i.e.
it is a market measure).
220
How many decimal places if FX rates?
4
221
How many decimal places are discount factors?
3
222
What are the cons of P/E and E/P?
Need comparable company
Based on historic EPS
Earnings used need to be sustainable
Based on accounting profits
Need to adjust downwards for non-marketability of unquoted companies.
223
How do you calculate the valuation of business using EVM?
EBITDA x EVM
224
What is EBITDA?
Earnings before Interest, Tax, Depreciation and Amortisation
225
What is the formula for annuity factor?
1/r * (1- (1/(1+r)^n)
226
What are real options?
Additional strategic options associated with a project
227
When do you use EVM for valuations?
When seeking to convert EBITDA into a company valuation
228
Pros of EVM in income based valuations?
Similar P/E but ignores financing + accounting decisions and tax
Enables the comparison of two companies which may differ in these areas
229
Cons of EVM in income based valuations
It is simplistic and reflects a point in time
Comparing the capital spend and tax management of two companies may be important
230
3 tips for income-based valuations
If PAT has been volatile over recent years, consider using average PAT
Consider whether you need to adjust the profits to make them sustainable
If you have a choice of P/E ratios to use, use the one of the company most similar to the one you're valuing
231
What are 4 types of cash flow based valuations?
PV of future cashflows
Dividend yield
Dividend valuation model
Shareholder value analysis
232
What is PV of future cashflows in cash flow based valuations?
The value of an asset is the PV of the cashflows it generate
Maximum price the bidder should pay is
PV of combined business cashflow - PV of bidders business cashflow
Discount cashflows after interest and tax at cost of equity
or
Discount cashflows before interest but after tax at the WACC = Ve + Vd, then deduct Vd
233
When do you use PV of future cashflows
When you have detailed projections of the future cashflows of a company
When you expect synergies from the combination of business
234
Pros of PV of future cashflows as a cash flow based valuation
Theoretically superior to asset based techniques
Not distorted by accounting policies
Factors in risk of investment + required return of bidder in the discount rate
Can factor in risk reduction/ synergies due to the combination
235
Cons of PV of future cashflows as a cash flow based valuation
Difficult to accurately estimate future cashflows
Difficult to estimate the appropriate discount rate
Need a time horizon to estimate over
236
What is the dividend yield and how is it used for cash flow based valuations?
Value = Dividend /Dividend yield
Dividend yield = Divi per share / share price
Used to convert current sustainable dividends (unlisted) into a share valuation
237
Pro of dividend yield as a cash flow based valuation
Values the company based on current market valuations of similar companies
238
Con of dividend yield as a cash flow based valuation
Have to find a comparable company whose dividend yield we can use
Based on historic dividends
Dividends used need to be sustainable
Will need to adjust downwards for non-marketability of unquoted companies
239
How is dividend valuation model used in cash flow based valuations?
Po = Do(1+g) / ke - g
Used to value non-controlling interest
240
Pros of dividend valuation model fro cash flow based valuations
Bases valuation on future dividend stream
Useful for valuing shares in non-marketable companies (with downward adjustment)
241
Cons of dividend valuation model for cash flow based valuations
Assume constant dividend growth (unlikely)
Have to estimate Ke (difficult)
Assumes constant Ke
Hard to use if deliberately low dividend policy
Growth based on historic data
Formula breaks down if g bigger or equal to Ke
Estimated growth can be distorted by inflation
Not useful for valuing controlling interests
242
How is shareholder value analysis used in cash flow based valuations?
Value is driven by 7 factors
- Sales growth
- Op. profit margin
- Corp tax rate
- Investment in NCA
- Life of cash flows
- Cost of capital
- WC investment
Use to forecast future cashflows
Split into competitive advantage (less than 10 years)
Residual period (valued as perpetuity or lump sum)
Discount at the WACC and deduct the MV of debt
243
Pros of shareholder value analysis in cash flow based valuation
Values the free cash flows of a company
Not distorted by accounting policies which can affect other methods
244
Cons of shareholder value analysis in cash flow based valuation
Valuation is dominated by the terminal value (for residual period)
Methodology heavily dependent on the inputs to the model
245
What are the 4 other factors in valuation?
Maximum price - a buyer would pay
Synergies - make sure to include cost savings where businesses merge
Value property at market value, then deduct an annual charge for rent
Value surplus assets and investments at current market value
246
3 steps to comment/advise on a range of valuations
Set out in a table
Comment on each valuation e.g pros and cons and relate to scenario
Conclude by suggesting suitable range of values
247
How do you value technology companies?
Asset - Could estimate amount to make assets from scratch
Doesn't consider future growth
Earnings - Discredits method as may not be earnings in younger years
Dividend - Unlikely to pay dividend in early years
Market multiples - Possible to use ratios of similar companies
Can be difficult to identify
DCF - Likely to be best approach is likely to be most valid
Takes in future growth
248
When valuing debt you have to?
Ensure you adjust for tax
249
Pros of organic growth
Costs are spread over time
Less disruption
250
Cons of organic growth
More risky
May be too slow
May be barriers to entry in new markets
251
Pros of growth by acquisition
Synergy
Reduction of specific risk - diversification
Horizontal intergration - reduce
competition
Vertical intergration - safeguard bus. position
252
Cons of growth by acquisition
Over-payment
Poor fit
Agency problem
253
3 methods of payment for shares
Cash
Shares
Loan stock
254
Pro of cash consideration for buyer of shares
More attractive to seller - get a better price
255
Cons of cash consideration for buyer of shares
Causes liquidity problems for buyer
256
Pro of cash consideration for seller of shares
Certain amount received
257
Cons of cash consideration for seller of shares
Immediate tax issues
No ongoing stake in the business
258
Pro of share consideration for seller of shares
No immediate tax issue
259
Con of share consideration for seller of shares
Uncertain value received
Transaction costs
260
Pro of share consideration for buyer of shares
Preserves liquidity
Ensures cooperation of seller in ongoing business
261
Con of share consideration for buyer of shares
Dilution of control of existing shareholders
262
Pro of loan stock consideration for buyer of shares
Avoids dillution of control of existing shareholders
Preserves immediate liquidity
263
Con of loan stock consideration for buyer of shares
Increases gearing
264
Pro of loan stock consideration for seller of shares
Lower risk than shares
265
Con of loan stock consideration for seller of shares
May prefer higher return of equity
266
Methods of divestment
Management buy-out (MBO)
Management buy-in
Spin-off (demerger)
Trade sale
Liquidation
267
What is management buy-in?
As for an MBO, but external managers buy the business
267
What is management buy-out?
Existing management of the business buy out the owners in order to greater control and financial reward
268
What is a spin off (demerger)?
Holding company gives the shares in sub to its shareholders
269
What is a trade sale?
The trade and assets are sold to a third party
270
What is liquidation?
Company is wound up, assets sold, creditors paid, amounts returned to shareholders
271
5 reasons to divest
To avoid the conglomerate discount (big groups undervalued)
Bad fit with other operations
Business to time intensive
Poor results
Need for liquidity
272
4 areas where directors and shareholders may come into conflict
Takeovers
Time horizon
Risk
Debt
273
How is the agency problem mitigated?
Appropriate management reward schemes
Corporate governance
Internal and external audits
274
Tips for income statement and balance sheet
Forecast income first
Calc retained profits for the year
Calc balance sheet lines
Leave cash as balancing figure
Make sure to split share premium and share cap
275
What to do if you have a forecasted cash deficit in cashflow?
Issue shares
Borrow
Sell surplus assets/liquid investments
Lag on supplier payments, incentives for customers to pay faster
276
What to do if you have a forecasted cash surplus in cashflow?
Use to increase sales via better credit terms
Reduce short term borrowing
Put on deposit on the money markets
277
5 ethical principles
Confidentiality
Objectivity
Integrity
Professional behaviour
Professional competence and due care
278
5 ethical threats
Intimidation
Familiarity
Advocacy
Self interest
Self review
279
4 actions to take when there is a conflict of interest
Notify both clients
Notify other relevant parties
Declare you do not act in the interest of one client alone
If it cannot be reduced the n resign from one
280
5 controls to mitigate threat of conflict of interest
Use separate engagement teams
Restricted access to client info
Clear guidelines for engagement team members on confidentiality & security
Use of agreements signed by employees & partners
Regular review of application of safeguards by senior partner/ compliance team
281
Ethical situations specific to FM
Ensure that written consent needed for anyone to share documents prepared for client use
Take into account the interests of all shareholders, unless acting for a specific group of them
Avoiding advising assurance clients on takeovers
Avoiding sponsoring / marketing / underwriting securities issuances for assurance clients
Avoid undertaking management responsibilities of an assurance client
Beware of self-interest threats / familiarity threats to objectivity during corporate finance assignments
282
What are the Environmental Cost Classifications?
Prevention - Stop impact - Staff training
Appraisal - Monitoring - Onsite inspections
Internal failure - internal waste - Waste disposal
External failure - external waste - fines
283
What is predictive analytics?
Use historic or current data to predict the future
284
What is prescriptive analytics?
AI/ Algorithms - Calculates best business decision
285
Advantage and disadvantages of prescriptive analytics
+ Gives a decision in a complex situation
- Advanced data science skills are needed
- Only as reliable as input data/programming
286
What is the Monte Carlo Simulation?
Hundreds of NPVs for one scenario
Alternative variables each time
Results in most common NPV
Range of possible outcomes
287
Advantage and disadvantage of Monte Carlo Simulation?
+ Shows spread of NPV's
+ Useful for problem solving
- No decision
- Computer based
- Expensive
- Probability assumptions needed
288
How do you do mean on excel?
=Average(data range)
289
How do you do standard deviation on excel? What is it?
=STDEV(Data range)
Show variability/ spread of dataset
290
How do you do coefficient of variation? What is it?
= Standard deviation / mean * 100%
Variability compared to mean
Better for comparing datasets of different scales
291
What percentage is covered by 1 standard deviations either side of mean in normal distribution?
68.2% of values
292
What percentage is covered by 2 standard deviations either side of mean in normal distribution?
95.4%
293
What percentage is covered by 3 standard deviations either side of mean in normal distribution?
99.6%
294
Outline three risks of interest rate swaps.
Counterparty risk: the risk that the other company will default before the completion of the agreement.
Position/market risk: the risk of unfavourable market movements of interest rates after the
company enters a swap.
Transparency risk: the risk that the financial statements may be misleading as a result of the swap.
295
What is loan stock with a warrant?
A loan that comes with separate call options
296
What is the advantage of loan stock with a warrant?
Lower interest rates
297
What is crowdfunding?
Equity
Pitching online to investors
Need to have attractive business plan
E.g. quality product, service or team
298
Advantages and disadvantages of crowd funding
+ Available to start ups
+ Increase awareness
+ Fast
- High admin
- Fee
- Legal/ advisory costs for due dilligence
299
What is peer to peer funding?
Debt
Can be secured or unsecured
Connects established business with investors
Need to have credit checks - track record
300
Advantages of peer to peer funding
+ Lower rates
+ Quick
+ More accessible for poor credit ratings
+ Tax savings
301
What is beat the market?
Selling and buying shares to make a profit
302
How do you beat the market in weak form?
Analysis of forecasts
303
How do you beat the market in semi strong form?
Insider trading (illegal)
304
How do you beat the market in strong form?
Pure luck
305
When does a positive NPV project affect the share price?
Weak - when evidenced
Semi - when announced
Strong - when board agrees
306
307
What does capital rationing mean?
The situation where a company doesn’t have sufficient funds to invest in all positive NPV projects
308
What does capital rationing mean?
The situation where a company doesn’t have sufficient funds to invest in all positive NPV projects
309
What does hard capital rationing mean?
Where an organisation would like to raise more funds but no stakeholder is prepared to invest.
This May results from potential returns not being high enough to compensate for the perceived risks involved.
External capital markets limit supply of funds.
310
What does hard capital rationing mean?
Where an organisation would like to raise more funds but no stakeholder is prepared to invest.
This May results from potential returns not being high enough to compensate for the perceived risks involved.
311
What does soft capital rationing mean?
An organisation could raise more funds but has decided not to. This may result from a concern that the available finance is too expensive or may result in a loss of control.
Internally limited
312
What do you do if projects are divisible in capital rationing?
Rank them but profitability index (NPV/Investment)
Choose highest
Work down
Divisible means can do half a project
313
What do you do if projects are divisible in capital rationing?
Rank them by profitability index (NPV/Investment)
Choose highest
Work down
Divisible means can do half a project
314
How do you deal with indivisible projects in capital rationing?
Can’t have half a project so just trial and error to make the most of the investment available.
Assumption that any fund not invested in a project will be deposited at the cost of capital
315
How do you deal with indivisible projects in capital rationing?
Can’t have half a project so just trial and error to make the most of the investment available.
Assumption that any fund not invested in a project will be deposited at the cost of capital
316
What is shareholder value analysis?
The process of analysis the activities of a business to identify how they will result in increasing shareholder wealth
317
What is interest rate parity?
The idea of how forward rates are set.
Uses normal interest rates in two countries and the spot rate to
Determine a fair forward exchange rate
Predict the future expected spot rate
The idea is the investor should be in the same position whether they invest here or exchange, invest and exchange back
No wins from foreign currency
318
What is interest rate parity?
The idea of how forward rates are set.
Uses normal interest rates in two countries and the spot rate to
Determine a fair forward exchange rate
Predict the future expected spot rate
The idea is the investor should be in the same position whether they invest here or exchange, invest and exchange back
No wins from foreign currency
319
What is purchasing power parity?
The law of one price
After translation an item should cost the same in any currency
Stops the idea of buying abroad because it’s cheaper
320
What is purchasing power parity?
The law of one price
After translation an item should cost the same in any currency
Stops the idea of buying abroad because it’s cheaper
321
What is the formula for interest rate parity?
Spot rate x
(1+overseas interest rate) / (1+uk interest rate)
322
What is the purchasing parity formula?
Spot rate x
(1+overseas interest rate) / (1+Uk interest rate)
323
What must you remember when doing the P/E ratio?
To get the average profit before interest and tax, so add up all of the ones that you’ve got, and divide by how many there are to get the average don’t just use the most recent one
This is to get the earnings figure, so you do that, and then you take off the interest on the tax to give you the actual earnings for like average
