Financial Strategy Flashcards
Constraints on financial strategy
1) Lack of funding
2) Need to keep investors happy
3) Economic factors
4) Regulatory bodies
5) Business strategy
Additional international constraints:
a) Foreign exchange risk
b) Political risk
c) Geographical seperation
d) Litigation
Ratio Analysis: Profitability and return
Return on Capital Employed:
Profit Margin:
Asset Turnover:
Ratio Analysis: Liquidity ratios
Current ratio: Inventory turnover: Receivables days: Acid test ratio: Payables days:
Ratio Analysis: Debt and gearing
Debt ratio (Total debts: Assets)
Gearing (Proportion of debt in long-term capital)
Interest cover
Cash flow ratio (Cash inflow: Total debts)
Ratio Analysis: Stock market ratios
Dividend yield Earnings per share Price/earnings ratio Interest yield Dividend cover
Ratio Analysis: Comparisons with previous years
% growth in profit Sales Changes in gearing ratio Changes in current/quick ratios Changes in asset turnover Changes in EPS, market price, dividend
Ratio Analysis: Comparisons with other companies in same industry
These can put improvements into perspective if other companies are going better, and provide evidence of general trends.
Growth rates
Retained profits
Non-current asset levels
Ratio Analysis: Comparisons with companies in different industries
Investors need to know differences between sectors.
Sales growth Profit ROCE P/E ratios Dividend yields
Information in accounts?
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Cost of Capital
- Elements of cost of capital
Risk free rate of return:
- Return required from risk free investment (e.g. yield on gov’t securities)
Business risk premium
- Increase in required rate of return due to uncertainty about future and business prospects
Financial risk premium
- Danger of high debt levels, variability of equity returns
PRIVATE COMPANIES
No market values available.
- take risk free rate or cost of capital for similar public companies adding premiums for business and financial risk
Valuation models
- Cost of capital if constant dividends paid
.
Valuation models
- Dividend growth model
Current year dividend x (1+div growth rate) over price
Net assets valuation method
Value of shares in class = net assets attributable to class/no of shares in class
Price - earnings ratio
P/E ratio = Market value/EPS
Mkt value = EPS x P/E ratio
Consider:
- industry
- status
- marketability
- shareholders
- asset backing and liquidity
- nature of assets
- gearing
Dividend valuation model
Price at time 0 = dividend (if constant) / cost of equity
OR
Price = dividend in year 1 / cost of equity less div growth rate
Dividend valuation models
- disadvantages
1) companies that don’t pay dividends don’t have zero value
2) need enough profitable projects to maintain value
3) dividend policy likely to change on take over time
Discounted cash flow
Value investment using expected AFTER-TAX cash flows of investment and appropriate cost of capital
Free cash flow
Value of company is sum of future free cash flows. Revenue - Operating costs \+ Dep'n \+ Interest (1 - tax rate) - Taxes - Debt repayment - Working capital - Investment expenditure
Problems with cash flow methods
- Difficult to select appropriate cost of capital
- Unreliable estimates of future cash flows
- Not best method for minority interests who lack influence on cash flows
Equity finance
- Disadvantages of listing
- loss of control
- vulnerability to takeover
- more scrutiny
- greater restrictions on directors
- compliance costs
- pressure for short-term profits
Equity finance
- Benefits of listing
- access to wider pool of equity finance
- higher public profile
- higher investor confidence due to greater scrutiny
- allows owners to realise some of their investment
- allows use of share issues for incentive schemes and takeovers
Initial public offer (IPO)
company sells shares to the public at large.
Offer for sale by tender allots shares at the highest price they will be taken up.
Costs of share issues
- underwriting costs
- stock exchange listing fees
- issuing house, solicitors, auditors, public relation fees
- printing and distribution costs
- advertising
Pricing share issues
- price of similar companies
- current market conditions
- future trading prospects
- premium on launch
- price growth after launch
- higher price means fewer shares and less earnings dilution
Information required by VCs
- business plan
- finance needs
- recent trading capital
- cash and profit forecasts
- management and shareholders
- current sources of finance