PGDBFS 301 Cases in Business Finance and Strategy (CBFS) Conducted - - PowerPoint PPT Presentation

PGDBFS 301 Cases in Business Finance and Strategy (CBFS)

Postgraduate Diploma in Business Finance & Strategy

SESSION 02

Conducted by – Nadun Kumara

• 01. Last Session Recap

Do you remember the basics?

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01.01 – Last Session Recap

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Read Situational Analysis Assumptions & Missing information Problem Definition Strategic Analysis Alternatives Recommen- dations

R S A P S A R

• 02. Situational Analysis

The theories…

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02.01 – Situational Analysis

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Read

Situational Analysis

Assumptions & Missing information Problem

Definition Strategic Analysis Alternatives Recommen- dations

Situational Analysis Internal “SW”OT Ratio Analysis External SW“OT” PESTEL P5Fs

02.01 – Situational Analysis – SWOT

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02.01 – Situational Analysis – Ratio Analysis

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▸Gross Profit Ratio

02.01 – Situational Analysis – Ratio Analysis

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▸Net Profit Ratio

02.01 – Situational Analysis – Ratio Analysis

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▸ROCE

02.01 – Situational Analysis – Ratio Analysis

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▸Current Ratio

02.01 – Situational Analysis – Ratio Analysis

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▸Gearing Ratio

02.01 – Situational Analysis – PESTEL

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Political

Economical Social Technological Environmental

Legal

02.01 – Situational Analysis – P5F’s

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• 03. Strategic Analysis

More theories…

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03.01 – Strategic Analysis – Vision & Mission

▸ Vision ▸ Mission

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03.01 – Strategic Analysis – Goals & Objectives

▸ Goals ▸ Objectives

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03.01 – Strategic Analysis – Porter’s Generic Strategies

▸ Porter’s Generic Strategies

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03.01 – Strategic Analysis – Ansoff’s Matrix

▸ Ansoff’s Matrix

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03.01 – Strategic Analysis – BCG Matrix

▸ BCG Matrix

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03.02 – Strategic Analysis – Share and Company Valuation

▸ BCG Matrix

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Of use to:

• Investors
• Managers wishing to

understand what increases shareholder value

• Companies either

considering merger and acquisition activity, or the target of such activity (to

• rganise defences or

simply to know which price to sell at) 01. Stock Market Valuation 02. Net Asset Value Based Valuations 03. Income Based Valuations Valuation Approaches

03.02 – Strategic Analysis – Share and Company Valuation

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Stock Market Valuation = No. Shares x Current Market Price

The market value is “ theoretically correct” if the Efficient Market Hypothesis Holds Issues

• Managers may have extra

information

• Quotes share price does not

reflect the value of all shares

• Can’t do it for private

companies

• Usually requires a

substantial premium to get shareholders to give up their shares

• 02. Net Asset Based Valuation

Net Asset Valuation is has three main ways to value a companies assets. Net Book Value & Net Realisable Value/“Fairness Opinions” Effectively for both ways though the equation is the same. The only difference being how you value each of those different components.

Fixed Assets Current Assets

Non current liabilites Net Asset Value +

• =
• Uses historical costs which are both factual and available
• Ignores intangible assets such as goodwill, human capital & brand names
• Issues with depreciation method company has chosen (i.e. straight line vs

reducing balance)

• Doesn’t value the entity as a going concern, and has little link to future

wealth generation ability

• 03. Income Based Valuations

Income based valuations of shares and companies have the innate advantage in that they are orientated towards the future assuming that the company will continue to remain a going concern for the foreseeable future. Two main methods examined in this module are:

• Discounted Cash Flow Models
• Dividend Valuation Models

Gordon’s Dividend Growth Model

Example - Discounted Cash Flow Method

End of Year Cash Flow ( $ M) D/F (10%) Pv ( $ M) 1 20 0.909 18.18 2 32 0.826 26.43 3 40 0.751 30.04 4 30 0.683 20.49 5 20+100 0.621 74.52 169.66

Terminal Value 100M

• 03. Income Based Valuations

03.02 – Strategic Analysis – COST OF CAPITAL

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Options Available

• 2. Debt
• Debentures – 2.1

(Redeemable / Irredeemable)

• Long Term Loans /

Overdrafts – 2.2

• 1. Equity
• Ordinary Shares – 1.1
• Preference Shares –

1.2

• Internal Funding – 1.3

EXAMPLES

EXAMPLES

Internal Funding (1.3)

Combination of – RETAINED EARNINGS & RESERVES

Debentures (2.1)

• Debentures are loan instruments used to raise funds from a collection of investors.
• Debentures could be issued to investors, through securities exchange (for a listed company)
• r could be privately placed.
• A secured debenture is one that is specifically tied to an asset as security. The debenture

holder has a legal interest in that asset and the company cannot dispose of the asset unless the debenture holder agrees.

• Unsecured debenture has no assets tied to the outstanding hence carries a higher risk than

secured debentures from the lender’s perspective

• Debentures have the right to receive a fixed interest payments. The interest must be settled

in full before any dividend is paid to shareholders

• Even if a company makes a loss, it still has to pay its interest charges as it is contractual.

EXAMPLES

Loans / Overdrafts (2.2)

Features Debt Equity for the user (the company) Interest must be paid on time Repayments must be made on time The lender has the right to repossess assets A HIGH-RISK INSTRUMENT No capital repayment obligation Can choose whether to pay Dividends A LOW-RISK INSTRUMENT for the provider (the investor) Interest is contractual and must be paid. Capital is contractual and must be paid Can take over the assets if not paid on time A LOW-RISK INSTRUMENT No guarantee of returns or capital to be paid A HIGH-RISK INSTRUMENT Source : Corporate Finance Strategy by Keith Ward

Cost of Capital

How to CALCULATE? Is it “EQUITY”? COST OF EQUITY DIVIDEND GROWTH MODEL CAPM Is it “DEBT”? COST OF DEBT BANK LOAN / OD Debentures

Cost of Capital

Type of Funding Cost of Capital Equity - Ordinary Shares Expected Rate of Return by the future share holders to compensate risk , using CAPM Equity - Preference Shares Fixed dividends stated in the prospectus. Debentures Interest Rates stated in the prospectus Bank Loans Commercial interest rates set in the loan agreement Internal Funding Current Return On Investment (ROI) of the company

Cost of Capital – Equity – Ordinary Shares – Listed Companies ke = (d1 / p0) + g Gordon’s Dividend Growth Model

ke = Cost (k) of equity (e) d1 = Dividends in Y1 p0 = Price of Share in Y0 g = Growth rate in dividends

Capital Asset Pricing Model (CAPM) ke = Rf + (Rm – Rf) b

Rf = Risk Free Return Rm = Market Return b = Beta factor (risk factor)

Example Cost of Ordinary Shares - DGM

Problem Suppose the Gadget Company has a current dividend of £2 per share. The current price of a share of Gadget Company stock is £40. The Gadget Company has a dividend payout of 20% and at a dividend growth rate of 9.6%. What is the cost of Gadget equity?

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Example Cost of Ordinary Shares - DGM

Problem Suppose ABC Co. has a dividend growth rate

• f 8.05% and has a current dividend of £3.50

per share. The current share price is £42 per

• share. What is the cost of equity?

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Example Cost of Ordinary Shares - CAPM

Problem:

If the risk-free rate is 3%, the expected market risk premium is 5%, and the company’s stock beta is 1.2, what is the company’s cost of equity?

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Example Cost of Ordinary Shares - CAPM

Problem:

If the risk-free rate is 6%, the expected market risk premium is 4%, and the company’s stock beta is 1.5, what is the company’s cost of equity?

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Cost of Capital – Equity – Ordinary Shares – Unlisted Companies

• Estimate the ke of similar listed companies and then add a further risk premium for

business and financial risk

• To the Risk free rate (Rf) rate add estimated risk premiums for both the

Business risk and the Financial risk of the entity

Cost of Capital – Equity – Preference Shares

kp = Cost (k) of Preference (p) share DPS = Dividends per Share MPS = Market Price of Share Preference Shares - Irredeemable

kp = DPS / MPS

Preference Shares - Redeemable

kp = IRR of Preference Share

Example Cost of Preference Shares

Problem:

A company issues 10,000 shares 10% Preference Shares of £100 each. Cost of issue is £2 per share. Calculate cost of preference capital if these shares are issued (a) at a premium of 10%, and, (b) at a discount of 5%.

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Example Cost of Preference Shares

Problem:

A company issues 15,000 shares 12% Preference Shares of £100 each. Cost of issue is £5 per share. Calculate cost of preference capital if these shares are issued (a) at a premium of 5%, and, (b) at a discount of 4%.

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Cost of Capital – Debt

kd = I (1 - t)

Bank Loan / Overdraft kd = Cost (k) of debt (d) I = Interest rate t = tax rate MP = Market Price of Debenture IRR = Internal Rate of Return Debentures - Irredeemable

kd = [ I (1 - t) ] / MP

Debentures - Redeemable

kd = IRR of Debenture

Example Cost of Debt – Bank Loan

Problem:

A company is considering raising of funds of about GBP 100 million via a 14% institutional term loan. Assume a tax rate of 20%. What is the cost of debt?

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Example Cost of Debt – Bank Loan

Problem:

A company is considering raising of funds of about GBP 400,000 for 6 months via a 12% institutional term loan. Assume a tax rate of 20%. What is the cost of debt?

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Example Cost of Debt – Debentures

Problem: AG has $30 mn. par value of eight per cent debentures, which are redeemable at par in six years’ time. The debentures are trading at $101 per cent. The return on the market is 11 per cent, and the corporate tax rate is 30 per cent. You are required to calculate the Cost of Debt of the AG Company.

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Example Cost of Debt – Debentures

Problem: A company has $50 mn. par value of 10% debentures, which are redeemable at par in six years’ time. The debentures are trading at $105. The corporate tax rate is 20%. You are required to calculate the Cost of Debt.

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Cost of Capital - Overall (WACC)

k = Cost V = Value

keVe + kdVd + kpVp Ve + Vd + Vp

WACC =

Example WACC

Suppose the Widget Company has a capital structure composed of the following, in billions: If the post-tax cost of debt is 9%, the required rate

• f return on equity is 15%, and the marginal tax

rate is 30%, what is Widget’s weighted average cost of capital?

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Debt €10 Common equity €40

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THANKS!

Any HELP? nadun.shk@gmail.com 0773 796 063