CFS

ARR

Average annual profit/ average or initial investment

Ways to fun MBO

• mangement equity

• VC

• Borrowing from bank

SICCLIO

7 Drivers of SVA

SVA Discussions

• Say range of values

• Sale depends on negotiation between seller and buyer

• SVA high growth may be unrealistic

• Sale proceeds from liquidation not certain as assets may sell for less than estimates

How APV works

• if gearing changes then can’t use WACC/NPV as assumed gearing the same

• APV used equity discount rate

• Discount operating CFs by costs and benefit of new finance

• So adjust; + for tax saved on loan interest, - for costs of raising finance

PV Calc for finding price of debenture

Rate of return (YTM/gross yield)

No. Years

Annual interest

Redemptions value

RBF IRR

Monthly IRR: use normal formula with the cost at the top

Annual IRR: (monthly %+ 1)^12 - 1

APV Method

• Find NPV using ungeared Ke

• Add PV of tax saving from interested paid on the new debt

• Deduct finance issue costs of debt

WC Policies

Aggressive (short term funds)

Moderate (fluctuate w fluctuating CA and short term fund, permananent CA and long term)

Conservative (long term finance)

G Formula

(Oldest-newest) ^ (1/n) - 1

ARR/ROCE Pros

• Simple to calc and understand

• Entire life of project

ARR/ROCE Cons

• ignore time value money

• No clear decision rule

• Based on profit not relevant cashflow

Payback Pros

• simple to calc and understand Entire life

• Highlights importance of liquidity

Payback Cons

• ignores time value money

• Encourages Short-termism

• No clear decision rule

NPV Pros

• Time value money

• Shows shareholder wealth created

• clear decision

• Entire life of project

NPV Cons

• c.o.c estimated years into future

• Doesn’t factor liquidity

• Misunderstood and time consuming to calc

IRR Pros

• time value money

• Easy to interpret

• Entire life of project

IRR Cons

• ignores size of investment required and cash inflows

• Assumes can reinvest proceeds at IRR

Non- Financial Factors

• compliance w future legislation

• Sustainability

• Reputation

• Impact on suppliers and customers

Relevant Costs

• Costs impacted by decision

• Include opp cost

• Exclude absorbed fixed costs, sunk costs, dep

EAC (Asset Replacement)

NPV/ Annuity Factor

Profitability Index

NPV/initial investment

Sensitivity of Total Revenue

Contribution less tax

Old NPV/New NPV %

Sensitivity of change in COC

Take IRR of the Total CF

Real Options

• Follow-on (launch future products)

• Abandonment(exit early and sell assets so good if uncertain with sales demand)

• Growth (can launch additional locations)

• Timing (delay and wait for favourable market)

• Flexibility (can change supplier/location/market if cheaper options available)

Political Risk Solutions

• Negotiate w host gov

• Insurance - ECGD

• Contract production to local sources

• JV with domestic companies

Factors for international sub

• local finnace costs

• Tax system

• Restrictions on dividend remittance

Sensitivity Analysis Pros

• Decision making as assesses individual variables

• Simple

• Identify critical areas to be monitored

Sensitivity Analysis Cons

• ignores probability

• Not optimising technique so no clear amswer

• Assumes changes to variables can be made independently

Simulation Pros

• More than 1 variable changing can be assessed

• More possible outcomes

• Probabilities of outcomes

Linear Regression Pro

• Simple to use and to explain

• Predict impact of variables beyond current estimates

Linear Reg Cons

• Not always linear relationship

• Impact of 1 variable at a time with basic reg

• Less meaningful if data is inaccurate

• Correlation doesn’t mean causation

Prescriptive analytics Pros

• identify optimum investment decision while considering multiple variables

Prescriptive analytics Cons

• complex to build model and needs specialist data science skills

• Need reliable data

Data Biases (5)

• Selection (not at random)

• Self-selection (customers respond to survey)

• Omitted variable (excluded from data model)

• Cognitive (on hoe data is presented)

• Confirmation

Coefficient Variance

SD/Mean

Expected NPV Pro

• Average so easily understood

• Single number for each choice

Expected NPV Cons

• EX not correspond to any outcome

• EX doesn’t show spread of results

• EX is long run average

• Prob hard to estimate

CAPM Pros

• Links risk of investment to required return

CAPM Cons

• Assumes investor diversified so only systematic (Beta) risk

• Ignores stakeholders not diversified so agents problem potential

• Assumes can borrow/lend at rf

• Historic figures used

Treasury Centralisation Pros

• Economies of scale

• Reduced risk

• Reduced borrowing needs (net cash surplus and borrowing needs )

Treasury centralisation Cons

• Less local autonomy

• Less responsive to local demand changes

• Requires lots of investment

• Overlook local finance opp

Key Digital Innovations List

• cloud based treasure management systems (no infrastructure)

• ai

• Distributed ledger tech (blockchain)

Risk Types

• gearing

• Credit

• Liquidity

Financial risk types

• Interest rate

• FOREX

• commodity price

WC Calc

Rec + Inv + Cash - Pay

IRP

• Link currency + money markets

• Difference between forward rate and spot rate can’t be exploited to make risk free gains

• Take the middle of spot rate

• Take middle IR

• Calc middle FR and this will be middle of the premium

Asset Types

• NCA

• Permanent CA

• Fluctuating CA (seasonal factors)

Extending Rec Pro and Con

+Higher sales so profit

- Interest in overdraft and bad debts

Debt Factoring Explanation

• Chase late payments

• Admin of debt collection

• Credit insurance (take on loss of bad debts)

• Advance client before debts collected

Debt Factoring Pros

• Save admin costs

• Reduce potential for bad debts as credit analysis

• Flexible

Debt Factoring Cons

• Fees

• Loss of goodwill if factor aggressive

• Indicates financial difficulty

Supplier Discount Benefit Formula

• benefit % = discount received/amount paid if discount taken x 100

Annual % Cost Formula

(1+R)=(1+r)

• R= annual interest rate

• r= rate period

• n = no period in a year

Over trading

• Increase in sales rev and fall in profit margin as discounts

• Increase in TP and overdraft

• Increase in rec and inv

• Worse liquidity ratio

Credit Risk Management

• Bill of exchange (guaranteed by buyers bank so seller sell bill to 3rd party now)

• Letter of credit (exporter receives payment and buyer gets credit period)

• Export factoring

Business Partnering Cons

• Ignoring controls as compromise objectivity

• Job can be stressful if residence by operational managers

Debt Holders Risk

• Lower than SH so lower return

• Debt is secured

• More certain returns

• Sometimes redeemable

TERP

(Market cap pre RI + RI proceeds + NPV)/total no. shares after RI

RI Factorw

• Issue cost

• Issue price at discount to persuade to subscribe

• Shareholder reactions (may think badly if asked for more funds, prompt to sell shares)

• Control (if all SH exercise rights then no change)

Underwriting

• Fixed fee there’ll purchase securities not subscribed

• Expensive

Venture C

• Equity stake in high growth potential company

• 20- under 50% control

• Influence and advise management

Convertible Loans

• Fixed return securities that can be converted into shares

• Can obtain funds at lower IR

• Short-term gearing

• Issue equity cheaply

Crypto and Cons

• Secured by cryptography to prevent fraud

• No 3rd party - P2P

• Volatility + Security + Privacy

Crowdfunding Pros

• good for start ups

• Quick

• Build awareness

Crowdfunding Cons

• Fee to website

• Legal costs

• Admin of investor requests for info

P2P Pros

• Lower IR as competition with lenders

• Quicker as evaluating loans is more streamlined than bank loans

• Accessible for low credit rating

AI Uses in Finance

• Credit scoring

• Loan approval

• Matching lenders to buyers

• Forecasts

ESG

• Green loans

• Green bonds

• Sustainability linked loans

• Green funds

Green Loan Principles

• State and quantify use of proceeds

• Sustainability objectives

• Reporting

Ethics

• Advising assurance clients on takeovers

• Marketing or sponsoring clients

• No management responsibilities for client

Market Hypothesis

• Weak form eff (info on past price movements and past info, analyse forecast and actions of company)

• Semi strong (publicly available info used, insider trading, when project is announced its positive NPV)

• Strong (all info available, positive NPV when board agrees to undertake project)

Investor Behaviours

• Overconfidence

• Narrow framing

• Miscalc of prob

• Ambiguity aversion

• Cognitive dissonance

DVM Cons

• Constant G is unrealistic due to variations

• Estimates of future div based on historical data but may change due to conditions

• Shares have vlaue due to div - some investors may pick a lower div policy because of capital gains

Earnings Retention Model

g=ARR x b (proportion profits retained)

RE formula

Opening RE + PAT - Div = Close RE

Earnings Retention Model Cons

• Reliance on acc profits (estimates)

• Assumes r and b constant

• Inflation can distort ARR if assets valued at historic cost basis

Cost of preference shares Kp Formula

P= D/Kp

Cost of Debt Formula Kd

P= I (1-T)/Kd

I is annual interest paid on bond

WACC Formula

WACC= ((MVe + Ke) + (MVd x Kd))/ (MVe + MVd)

YTM Formula

• RATE

• No. periods

• Amount interest in each period

• MV of asset

• Value at maturity

Coat of loan stock (YTM)

YTM x (1-T)

Why is D cheaper than E?

• D is secured

• Returns for DH more certain

• D redeemable

• DH paid before SH

Traditional view capital structure

• as introduced D, WACC falls as benefits outweigh increase in Ke

• as this grows, SH ask for higher returns and will outweigh benefits of D

• at extreme D, Kd rises so WACC increases

• So an optimal level gearing exists

M&M 1 Assumptions

• capital market perfect

• Investors rational and risk averse

• No trans costs

• No tax

M&M 1

• As D introduced, Ke rises

• Extra D offsets extra Ke

• WACC same

M&M 2

• D company pays less CT

• More cash to investors so co. worth more

• Reduces WACC as more than offset increase in Ke

Issues with Gearing

• Bankruptcy costs

• Agency costs (loan covenants restrict actions of directors)

• Tax exhaustion (reduced taxable profits to 0 no more benefit)

Considerations of Gearing for companies

• Business risk (gearing adds financial risk to business)

• Tangible assets easier to borrow with as can secure

• Small firms less attractive so more E

• Higher tax rate, more D

• Issue costs

M&M Div Irrelevance

• pattern of div is irrelevant for determine SH wealth

• Company always invest in + NPV

• Need raise funds from these projects

• Existing SH receive less returns from new project but offset by div receiving now

• Pattern irrelevant

Div Policy - Why relevant?

• Uncertainty (cash now more certain so want div now)

• Clientele Effect (invest in company because of div policy so wont want it to change)

• Signalling (div reduction signal bad news so share price fall)

• Bird in hand

• Tax effect (div rather than CGT)

• Risk project may be negative NPV

Div Policy - why not relevant?

• M&M (SH wealth not increased by div but by increased by positive NPV project)

• DIY div

• Pecking order theory (RE before RI and share issues)

Scrip div

• free shares instead of cash div

• avoid liquidity issues

• swap cash for capital gain

Sensitivity : Sales Rev/Vol

NPV/ Contribution after tax

Sensitivity: Sales Price

NPV/ Sales Rev after tax

Sensitivity: COC

IRR - COC/ COC

Organic Growth Pros

• Costs spread

• Less diruptuon as no intervention with new staff or systems

Organic Growth Cons

• More risky as new market

• Slow process

• Barrier to entry

Acquisition Cons

• Interest of directors not SH

• Bidding company SH lose out on over paying or high transaction fees

Why max price for takeover higher than MV?

• Synergy with both co.

• Risk profile may be lower