F3 notes 2 Flashcards
Total Shareholder Return
(dividend in the period + share price movement in the period) / share price at the start of the period
3 E’s
Economy; efficiency; effectiveness
Non-financial objectives
stakeholder relationship; intellectual; human; socual; environmental / natural
Important economic factors
interest rates; inflation; exchange rates
PPP
S1 = S0 x (1 + r var)/(1+r base)
IRP
F0 = S0 x (1+ r var)/(1+r base)
Expectation theory
current forward rate (F0) is an unbiased predictor of the future spot rate (S1)
International risks
currency; cultural; goods in transit; credit; economic
ROCE
PBIT / TALCL
Return on equity
Profit after tax and pref dividends / (ordinary SC + Reserves)
Asset turnover
Revenue / TALCL
alternative ROCE
Operating profit margin x asset turnvoer
EBITDA benefits
fair measue if no control over financing or capex; roughly approxinates to operating cash flow; better underlying profit figure for comparison where there is high intangible content to asset base
Current ration
current assets / current liabilities
Quick / acid ration
(current assets - inventories)/current liabilities
Inventory turnover
Cost of Sales / inventories
Inventory days
Inventory / CoS * 365
Receivables collection period
Trade receivables / Credit Turnover * 365
Payables payment period
Trade payables / Credit purchases or CoS * 365
Debt to equity ratio
Long term debt / Equity *100
Debt to (equity + debt)
Long term debt / (Equity + long term debt)*100
Interest Cover
PBIT / Interest Payable
Debt Ratio
Long term debt / total assets
Earning per share (EPS)
Profit available to ordinary shareholders / no of shares
Divident yield
Divend per share / market share price * 100
Dividend payout ratio
Dividend per share / earning per share
Dividend cover
EPS / Dividend per share * 100
P/E ratio
Share price / EPS or Market Cap / PAT
Earning yield
EPS / Share price or PAT / Market Cap
GRI principles for content
stakeholder inclusiveness; sustainability; materiality; completeness
GRI principles for report quality
balance; comparability; accuracy; timeliness; clarity; reliability
GRI disclosues
Standard (strategy and analysis; organisational profile; identified material aspects and boundaries; stakeholder engagement; report profile; governance; ethics and integrity); specific standard disclosures (management approach; indicatiors - economic; environmental; social)
Benefits of environmental reporting
commitment to issues; reduces corporate risk; improved profitability; employee morale
Arguments against voluntary disclosure of env info
lack of comparibility; lack of reliability; only present positives; bias; info overload
Integrated Reporting
explain how businesses create value over time and links strategy and fin perf to scoail; env and economic environmetn
Integrated reporting captials
financial; manufactured; intellectual; human; social and relationship; natural
Integrated reporting principles
strategic focus and future orientation; connectivity of information; stakeholder responsiveness; materiality; conciseness; reliability and completeness; consistency and comparability
Content of integrated reports
organisational overview and external environment; governance structure and value creation; business model; impact of opportunites and risks upon value creation; strategy and resource allocation; performance; outlook; basis of prepartaion and presentation
Financial Decision Areas
investment; financing and dividend
Motives for holding cash
Transaction; precationary; speculative
Agency problem
directors not knowly focused on maximising shareholder wealth
Constraints
internal - stakeholder; agency issues; funding issues; stratefic factors. External - funding; regulatory; government; taxation; economic; investor relations
IFRS 7
Financual instruments: disclosures
IFRS 9
Financial instruments
Hedging
method of managing risk by using a hedged instrument such that any gains or losses that are made on the hedging instrument will offset any gains or losses on an underlying transaction or hedged item
Hedged item
asset; liability; firm commitment; highly probably forecast transaction; or net investment in a foreign operation that exposes the entity to risk of changes in fair values or future cash flows
Hedging instrument
designated financial instrument whose fair value or related cash flows should offset changes in the fair value or cash flows of a designated hedged item
Financial assets
cash; equity instruemet of another entity; contractual right to recevie cash; derivative standing at a gain
Financial liablity
Contractual obligation to deliver cash to another entity; derivative standing at a loss
Equity instrument
Contract that evidences a residual interest in the assets of an entity after deducting its liabilities
Derivates
Forward contract; futures contract; options; swaps; forward rate agreements
IFRS 9 recognition
when the entity becomes a party to the contractual provisions of the instrument
IFRS 9 initial measurement
most valued at fair value +/- transaction costs (add to asset deduct from liability). Assets held at FV through P/L exclude transaction csts. Movement for these & transaction costs go through P&L
Hedge accounting conditions
consists only of eligble hedging instruments and eligible hedged items; changes in FV or cash flows must have the potential to affect p&l; formal designation and doc of relationship; expected to be highly effective; economic relationship between item and instrument; effect of crredit risk doesn’t dominate calue change; hedge ratio is same for item and relationship effectiveness of hedge must be reliably measured
Types of hedge
Fair value (immediate on P&L); cash flow (specifically identifiable; highly probable; external party); hedged of net investments in a foreign operation
Cash flow hedge accounting
gain or loss on effective portiion (up to value or loss of gain) is recognised in reserves/OCI (and transferred to P&L when cash flow is recognised). Any excess is recognised immeditately in P&L
IFRS 7 disclosues
credit risks; liquidity risk; market risk
Term lenghts
short term: <1 year; Medium term: 1-4/5 years; Long term: >5 years
Short term finance
bank (overdraft; loan); commercial paper; bills of exchange; eurocurrency loans; factoring and invoice discounting; for export - letters of credit; export factoring; supplier credit; countertrade
Medium term
Term loans from bank; medium term notes (mtn); floating rate notes (frn); mezzanine finance; leasing; hire purchase (hp)
Long term
Term loans from bank; bonds (loan stock or debetntures - straight; zero coupon; deep discount; dual currency; convertibles; equity warrants); FRN; syndicated loans; eurobonds
Shareholding funding & other
ordinary shares; preference shares; retained cash; venture capital; loan guarantee scheme (LGS); business angels or corporate venturing
Money markets
short term interest rate markets for investing and borrowing. Enable borrowers and lenders to manage their working capital efficiently
Capital markets
long term debt and equity markets. Enable companies to manage their capital structure efficiently
Functions of stock market
raise finance; existing to sell investment; aid takeovers; enable private to realise investment by floating
Functions of corporate bond market
disintermediate (deal directly with lenders); raise new debt finance; sell debt; aid takeovers
Share price changes
economic factors; industry factors; company factors
Mthods of issuing shares
rights issue; offer for sale; public issue; placing; subscription offer
TERP
theoretical ex-rights price. Method - new value / new no of shares
Dividend valuration model - zero growth
ke = d/p0. In this case Ke=PAT / Market Cap or EPS/SP
Dividend valuration model - constant growth
ke = d1/P0 + g
Estimating growth
g = r x b (roce / return on assets x proportion of funds reinvested) or historic growth rates
Capital asset priceing model
k= Rf + (Rm-Rf)B. Rm-Rf = market risk premium. Rm = return on market as a whole
CAPM advantages
A: direclty links risk and return; calculate cost of equirt when div not growing constantly
CAPM disadvantages
can only be used when investors are diversified; assumes components stay the same (single perod); assumes investors can invest and borrow at risk free; assumes cap markets are perfect (no transaction csots; no tax; no dominant investor); beta values are based on historic data
Lenders percetion of risk
STRAP - securtiy offered; timeframe; repayment profile; amount requested; purpose
Credit ratings
A - high quality; BBB and BB - medium; B - speculative; C - poor and highly speculative
Types of security
fized charge - specific asset ; floating charge - not against specigic asset
convenant
requires or forbids certain actions e.g. keep ratios within …; keep accounts prepared; don’t pay dividends; don’t sell assets
interest rate risks
risk that loans are not renewed; gearing risk; risk of changing rates
Interest rate swaps
allows companies to switch between variable and fixed rate. Low costs; flexible; compaies with different credit ratings can borrow at best cost; allow capital restructuting. BUT counterparty risk; difficult to find swap partner directly
Currency swaps
get loan in different country through swap
Identifying a lease
conveys the right to control the use of an idenrified asset for a period of time in exchange for consideration.
Accounting treatment of lease - right use of asset
initially at cost then depericate over shorter of lease term and useful life but if reasonable certainty ownership will be obtained then useful life
Actuarial method
use implicit interest rate to add to running balance and deduct payments
Sum of digits method
n(n+1)/2 n=number of interest-bearing payments then line up backwards against years
Matching
duration; currency; pattern of cash flows
Finance costs
Issue costs (arrangement fees; underwriting fees; advisers fees); on-going servicing cost (dividends; interest; tax; reporting/info required)
Thin capitalisation
aims to stop compaines getting excessive tax relief on interest
WACC
Multiple spurces needs formula extension. Can use for hurdle rate of projects but risks must stay the same
Components of risk
business risk - beta factor. Financial risk
Portfolio and business risk
diversification eliminates unsystematic risk leaving systematic risk (general market factors) which is measured by a beta factor
Impact of debt - traditional theory
Adding debt makes sense up to a certain point. If gerating gets too high cost of equity and debt rise so WACC rises
Impact of debt - M&M (no tax)
As debt increases the benefits are offset by cost of equity increasing so WACC stays constant
Impact of debt - M&M (with tax)
because of tax relief lower cost of debt outweighs cost of equity increasing therefore use as much debt as possible
M&M assumptions
debt is always risk free; perfect capital markets; individuals and companies can borrow at the same rate; investors are indifferent between personally or corporate gearing
Impact of capital structure on company value -M&M with tac
Vg = Vu +TB (value ungeared + Tax*MV of debt)
Dividend policy - general factors
What do shareolders want? How will markets perceive the dividend announcement? Is there cash to pay a dividend? Tax implications? Availability and conditions surrounding debt financing? Are profits consistent / stable? Competitior policy?
Dividend policies
stable; constant %; zero dividends; residual theory; irrelevancy thoery
Share buyouts
A: doesn’t lead to future div expectations; may be favourable from an investor tax perspective; fewer shares therefore increase EPS and PS. D: increased div are sign of strength; often only big institutions benefit
Scrip dividends
Additional shares free of charge instead of cash
Reasons why valuation needed
seeking stock market floatation; buying another business; sell all or part; for banks lending; for tax purposes
Methods of valuation
asset based; earnings based; cash flow based
Asset based valuation
book values (only at historic); realiseable value (minimum acceptable price); replacement cost (more appropriate if trying to duplicate a business)
Asset based valuation (advantages and disadvantages)
A: quick and simple; gives starting point or minimum val; D: not as food at valuing on going potential; does not consider assets not on SoFP e.g. intangible; reliant on account conventions
Earnings based
P/E ratio. May need to adjust profit to get sustainable earnings. Earnings yield
Earnings val advantages and disadvantages
A: quick; considers future potential; useful for valuing unquoted; good for valueing a controlling company; D: adjustments needed; based on profit not cash; which P/E to use in a takeover
Cash flow based valuations
FCF to equity: PBIT + Dep - Tax - Capex - Interest + proceeed from disposal of fixed assets + changes in working capital + new debt raised - debt repaid
Cash flow based val - adv and disadv
A: considers future potential; can be used to value any; considers time value. D: future cash flows are estimates; requires a cost of capital to be estimated
Dividend yield
MV of shared = Div / Div yield. Div yeild = DPS / SP
Dividend growth model
rearrange to estimate value of equity in business. Views cash flows the shareholder might receive rather than overall cash flows gernerated
Dividend growth model - adv and disdvan
A: considers future cash flows to shareholder; relevant for minority interests. D: assumed fividends grow at a constant rate forever; requires a cost of equity to be estimated; spurious results arise for businesses that don’t pay dividends or where growth > cost of equity
Forms of intellectual capital
human; intellectual assets (drawings; software; reports etc.); intellactual property (patents; copyrights etc)
Valuation of intellectual capital
Calculated intagible value (CIV) - estimate annual return and then value as perpertuity. Market to book values - market cap - book value of assets (if no shre price use earnings based valuation). Tobins Q = market cap - replacement cost of assets
Efficient market hypothesis
Weak form - only historic info and tends in shre price are in current share price. Semi strong - adds all publically available new info. Strong form - adds all privately known info of the directors
Why acquire another business
improced market reach; eliminate competitor; asset strin and undervalued target; gain economies of scale/improve efficience/use big data; use of surplus cash
Operating economies
economies of scale; elimination of inefficeinces in target; staff reductions; combining expertise; vertical integration
Financial economies
financial (raising capital); tax; reduced risk
Other M&A benefits
acquiring new technology; knowledge and expertise / big data; quicker growth than organic
Forms of consideration
cash; shares; convertibles; bonds / loan stock issued to target company shareholders; earn-out arrangement
Cash acquistions
- value business; 2. suggest an initial offer abover the current share price but belwo maximum the business would be prepared to pay; 3. consider the likelihood of acceptance by other party and other factors
Acquistions with share exchagnges - max to pay
MV(A+B) - MV(A)
Regulation of takehovers
Market power; bid behaviour (sufficient info given to allow informed decisions; directors must allow shareholders to make decision; if control (30%) is acquired then a general offer to all remaining shareholders is normally required)
Defensice tactics - pre-bid
Effective comms with shareolders; poison pill; flip-in pills; alter constitution to require super majority (shark repellent); asset revaluation to make SoFP look healthier
Defensive tactics - post bid
Revised financial targets; issue rejection letter; look for white knight; try to get bid referred to competition authorities; issue negative statements about the bidders style; cultrue; counterbid for the the predator company
Post acquistion integration rules
- share a common core of unity; acquires ask “what can we offer them?”; acquirer treat with respect; acquirer provide top management with relevant company within a year; cross-company promotions of staff within one year
Post-acquistion value enhancement strategies
Review business units for cost cutting and synergies; consider staffing and possible redundancies; good comms of post-acq intentions; identify economies of scale; review of redundant assets and resource audit; strong marketing campaign implemented; align corporate objectives
Impact on stakeholders
shareholders in predator will want vfm; shareholders in target want decent price in correct format; stock market and regulator want rules followed; suppliers want continued relationships; employees want jobs; banks want no covenants breached
Demerger
allows focus. Distribute shares in the business to be spub off to shareholders of the companying carrying out the demerger in proportion to their shareholdign in the original company
Sell off
sold to third party for cash
Liquiditation
only when seeen as best way of returning any value to investors
Initial Public Offering
sale of shares on stock exchange realising cash for investors. Costly process with an uncertain outcome
Franchise
legally very complicated
Management buyout
key players: managemetn team; directors; financiers. Financed throguh management team; banks (senior - secured and subordinated - less secured debt; mezzaning) and venture captial
