P. 1
Notes_CF

Notes_CF

|Views: 3|Likes:
Published by ranesh79

More info:

Published by: ranesh79 on Apr 20, 2011
Copyright:Attribution Non-commercial

Availability:

Read on Scribd mobile: iPhone, iPad and Android.
download as PDF, TXT or read online from Scribd
See more
See less

04/20/2011

pdf

text

original

Financing ~ o-F

"
Required ROR •
\
,
100/0 ,
,
\
\
\
1
,
I
I
I
I
I
I
Distribution I
I
Dividend Yield & ([Sf{)
Capital Gain
, /) OBJECTIVE OF THE FIRM

Sales xx

Less: COGS x

I.i:thiWil?s

GP xx

Less: Op Exp x

Op

Less: Interest

xx x

NPBT Less Tax NPAT

I I

- - - - - - ... _1- __ ,..

FINANCIAL MANAGEMENT IS ABOUT

-----_---

.~

Investing Cost of Capital r""'-tJ)) ,

,

(~ i.) ""

...

-~-

---- ....

10/13/2010

r"' .. v~J .,_ j.D """""
/2..A) r2- '1. :1. c:''f. er",- )
1
.. , ...........
e ppl.,.yt...~ S ~F' . ~

The general valuation model:

Now

2

3

CF2

CF3

CFI

~IntrinSiC Value

Fig 5: SECURITY MARKET LINE (SML)

kos = krf + b, ( km W krf)

" " ..

..

/ Rate of I

I I

I I I Return I

I

I

I

..

..

..

"

-

I

I

\

I

\

\ ,

\

\

'\,

-+- ..1..- ... Beta

1.0

10/13/2010

2

(1) innovativeness,

(2) quality of management, (3) employee talent,

(4) quality of products and services, (5) long-term investment value,

(6) financial soundness,

(7) social responsibility, and (8) use of corporate assets.

Share

Price Staff are granted Option to Buy shares at $3

$2

r I I

G. I aln-r I

r r I I

$3

Now

Option Period

5 years

10/13/2010

3

4 steps in business analysis

1 . Strategy analysis

2. Accounting analysis

3. Financial analysis

4. Prospective analysis

What questions should analyst ask in deciding whether a firm is likely to achieve its intended advantage?

Key success factors Risk

Resource and capabilities Commitment to capabilities

Activities structured to support strategy Is competitive advantage sustainable? Potential changes in industry structure

10/13/2010

1;

I'

4

Is a flrm's strategy likely to create value?

Significant imperfection in products, labour, or financial markets in the industry?

Own and optimise economies of scope? Good fit of resources and businesses? Able to reduce agency costs and increase coordination among business units?

The Three Components of the Capital Markets

Firms other

10/13/2010

1

5

Constant Growth

Assume that the current dividend Do is given, and that the future dividend is growing at a compounding rate of g per year, and that the investor intends to hold the investment permanently, then the intrinsic value of the ordinary share

Do (I + g)! Do (l + g)J Do (I + g)"

V = ----------------- + ------------------ + - - - - + -----------.--- •• - + • - - - - - -

os (l+k~s)l (l+kosP (1+k"..)1

Simplifying,

Do (1 + g)'

Vos - ~~~----------------

kos - g

This formula is known as the Gordon growth model.

... ~

10/1312010

6

Q9

Questions on firm's cash flow

1. Strong CF from operating activities?

2. Ability to meet short term obligations?

3. How much cash invested in growth?

4. Pay dividends?

5. Rely on external financing?

6. Free cash flow?

Three forms of the EMH

10/13/2010

7

I

I ~

Before valuing the firm, we should "clean the account"

The objective - ensure that earnings or cash flow figures are sustainable, and not subject to "earnings management"

How?

Working on cash flow basis

Beware even CF statement can be

"manipulated"

Check the note - e.g, information about capital expenditure, make sure it is not over capitalized (i.e. pushing expenses to assets)

10/13/2010

8

Suggested procedure to produce a "clean" earnings figures:

Remove amortization of goodwill Remove "infinite" intangibles

Eliminate effect of any discontinued business Where new business is acquired during the year estimate the full year impact and adjust Remove any exceptional items, reconstruction or reorganization costs

Remove gain floss on non-trading assets

................

Remove write offs for bad debts or exceptional provisions for doubtful debts

Remove expense adjustments because of derivative positions (unusual, one off)

Make sure all finance leases are fully capitalized and depreciated

Eliminate any foreign currency gains or losses due to accounting translation

To calculate NOPAT, add back interest expenses

10/13/2010

,

9

10/13/2010

CL
TA .__TL = $lm
E =$3m
-
tf MARKET VALUE ADDED

The formula for MVA is:

MVA=V-K

where:

V is the market value of the firm, including the value of the firm's equity and debt.

K is the capital invested in the firm

(MVA is the present value of a series of EVA values.)

10

i
0 1 2 3 4 5
I "
I I
(30,000) 9,000 9,600 7,800 7,200 7,200 .,
II
I
I '-f'

\\.\\

~~ r---------------------------------------------~

CASH FLOWS OF THE PROJECT

@4%

o

2

4

1

3

5

~----------~----------_r----------~----------_r-----------_r

(30,000) 9,000 9,600 7,800 7,200 7,200

What does this mean? - - - - - ~ ~ ..

...

...

...

,

'.

36,501

The project should have a total value of $36,501 at the end of yearS

L

3

10/13/2010

I

I

II

r-

I . 0 ¥-

11

\\,\\,\1" \~

@4%

o

1

2

4

3

5

~----------~----------~----------~----------~-----------~

(30,000) 9,000 9,600 7,800 7,200 7,200

+

7,488

+

8,436

10,799

The expected cash flows will have a

total value of $44,452 ar the end of year 5

~-

10.529

-----.---- .......

44,452

What docs this mean'?

@4%

4

5

o

1

2

3

~----------~----------~----------~----------~-----------~

(30,000) 9,000 9,600 7,800 7,200 7,200

4·+.·r . LESS 36,501

What does this mean? - - - - - - - - - - - - .. 7,951

This project will generate a return of 4% PLUS $7,951 at the end of year 5. So, this project can be accepted.

10/13/2010

12

\>0,\\1

~ ~------------------------------------------~

@4%

4

o

1

2

3

5

\ ,,\ \?:>

\b r-------------------------------------------~

4-----------4-----------4-----------4-----------4------------4-

(30,000) 9,000

9,600

7,800

7,200

7,200

44,452 LESS 36.501

... ~ - ~ What does this mean?

"" ,

'"

'"

,

7,951

This project will generate a return of

4% PLUS A PRESENT VALUE OF $6,536 ,

~)Ix --~-

fl+i),O,{)

TO FIND NPV@4%:

o

1

2

4

3

5

4-----------4-----------4-----------4-----------4------------4-

(30,000) 9,000 9,600 7,800 7,200 7,200
8,654 ~ I I
+
8,876
+
6,934 (
+ 1~ "' - If
6.155 ~ I. ~ '-t' J
+
5,918 '11A'-<>
36,536 ~ -\- ,J- 0'-( ) t;; 10/13/2010

13

~~----------------------------~

\~\

TO FIND NPV @ 4%:

o

1

2

3

4

5

i-----------i-----------i-----------i-----------i------------i-

9,600

no.oOO) 9,000

7,800

7,200

7,200

........ _------

-~

8.654 + 8.876

+

6.934

+

6.155 + 5,9[8

=$6,536

TO FIND NPV @ 16%:

o

1

2

3

4

5

-r----------i-----------i-----------i-----------4------------i-

(30,000) 9,000

9,600

7,200

7,200

7,800

"

...

7,759

-------

--_

+

7,135

+ NPV;: PV (elF) - PV (COF)

4,997 ,;P

/

+ I == $27,296 - 30,000

3,977 "

,

+ , / '" ($2,704)

3.428 "

, ,

27,296 ./

10/13/2010

14

10/13/2010

\~._y l:,\

\ ~----------------------------------------------~

\

1 16%

4%

IRR

$6,536 I

o

$(2,704)

16% - 4%

IRR - 4%

6,536 + 2,704 6,536

IRR = 12.5%

Alternatively .

4%

IRR

16%

$6,536

o

$(2,704)

Positive NPV

As long as the investors do not ask for a return more than the IRR, the project should be accepted.

-==----' ..

15

Chapter t : EXERCISE 7: Payback Period Method

Initial outlay Year t CIF

Year 2 CIF

Year 3 CIF

(30,000)

9,0o_0 _

(21,000) 9,60=0'---- __ (11,400)

7,80...:..0 _

(3,600)

-:

3,600

Payback Period = 3 + ----------------- = 3.5 years Yr4 CIF

CAPITAL EMPLOYED = FA + Permanent CA

CA CL
. -- --~.- _,. -- -_. -- -----
Permanent CA
LTL
FA E Capital Structure

10/13/2010

16

Cash Conversion Cycle / Working Capital Cycle

Cash Conversion Cycle

Average Age of Inventory

+ Average Collection Period

-- Average credit purchase payment period

Cash Conversion Cycle (Activity 4.5)

122 days 91 days

t I

I I

46 days

SHOllTAGF OF \VORKING CAPITAL

....

167 days

10/13/2010

17

Cash Conversion Cycle

Another Company

16.6 days 21.9 days

I I~ __

I I

56.2 days

(17.7) days

10/13/2010

18

~ 'JIr.

To do so, a record date is set by the company. Investors whose names appear in the share register on the record date will receive the dividends payable.

3 Jan

25 Jan

31 Jan

AGM Declared Dividend

Record Date

Pay Dividend

Pcd Pxd

Scrip dividends (bonus issues)

Before After

CL $2m CL$2m
LTL$5m LTL$5m
TA K $20m K $20m
+
$8m
.>

- --
-
RE $10m:",
"-_ Rr $')
'& .. ~, ,I "--In 10/13/2010

1

Share Split

Before

After

CL $2m CL$2m
LTL$5m LTL$5m
TA K $20m K$20m
20m ordinary shares 40m urdinary shares
(~1 $1 @$0.50
RE $lOm RE $10m Share repurchase

Business Prospects remains

Mkt Price Per SharJ

"

"

"

" "

....

/' /'

...

t NPAT

EPS =

No of Shares 1

PE =

EPS l

\"'\

~'<~

10/13/2010

2

COST OF CAPITAL

Kos

Kps

Kd

x

x

x

Wos

Wps

Wd

TAX EFFECT ON COST OF DEBT
T=40% P&L After Tax P&L
Sales 1,000 x (I-T) 600
Less
Exp 500 x (l-T) = 300
Int 100 x (l-T) 60
PDT 400 240
Less T 160
PAT 240 10/13/2010

3

Exercise 6: Loneday Ltd has $50m 10% $100 debenture in issue. The current market price is $92 and the debentures are due to be redeemed in three years' time at par. Tax rate is 30%.

What is the cost of the debenture?

Answer .

The cost of debt can be estimated by :

(M-V)

I + ---------------

n

kd =;: --------------------------

(M+V)

2

where n is the number of years to maturity

M is the par value, which is also the redemption value V is the current value of the loan capital

10/13/2010

4

Exercise 6 Answer:

After tax kd

9.24%

Exercise 2:

Both XYZ and DEF companies have the same amount of long term capital, i.e. $500,000. For the company XYZ, it is all equity financed, whereas the DEF's debt/equity ratio is 2/3, and that the long term bond's coupon interest is 10%. The company income tax rate is 30%.

Find the ROE if the operating profit is : (a) $200,000; (b) $25,000.

Workings follows .

10/13/2010

5

Exercise 2 Workings:

XYZ

Bond @IO%

Nil

DEF

200,000

300,000

500,000

Equity Capital

500,000

Total

500,000

XYZ

DEF

Answers follows ....

$25,000 25,000

%

%

Exercise 2 Workings:

XYZ

DEF

Operating Profit

$200,000 200,000

Less : ? .

?

Less; ?

NPAT

?

ROE = -------

%

%

?

Answers follows ....

.#M# .

\~( ...

10/13/2010

6

Fig 5: SECURITY MARKET LINE (SML)

kos = krf + b, ( km N krf)

.. ... ~

/ Rate of I I

J I I

I

J Return I

I

I

~

.-

.-

.-

,-

-

\

\

\

\ \

1.0

-t--------'--------------+ Beta

Fig 3: EFFECTS OF PORTFOLIO SIZE

Total Risk

Diversifiable Risk "

"

"

"

"

"

"

"

Market Risk

Number of stocks

o

40

2000

10/13/2010

7

THE CONCEPT OF BETA

The tendency of a stock to move up and down with the market is reflected in its beta coefficient b.

Ifb = 1, the stock is considered an average-risk stock, which is defined as one that tends to move up and down in step with the general market as measured by some market index.

If b = 0.5, the stock is only half as volatile as the market - it wil! rise and fall only half as much - and a portfolio of such stocks will be half as risky as a portfolio ofb = I stocks.

If b = 2, the stock is twice as volatile as an average stock, so a portfolio of such stocks will be twice as risky as an average portfolio.

See Fig 6-9.

BETA = 1.0

Market return

10/13/2010

8

BETA = 0.5

Stock return

Market return

BETA = 2.0

Market return

10/13/2010

9

Exercise 1:

ALFA Ltd has only bonds and ordinary share in its capital structure. Its cost of debt is 8%, whereas its cost of ordinary share is 15%. Income tax rate is 30%.

Calculate the WACC if the proportion of debt is: (i) 0%; (ii) 30%; (iii) 75%; (iv) 100%.

Worktngs foitows .

Exercise 1 Working:

o

0.3

0.75

1.0

10/13/2010

10

Exercise 1 Answers

(a)

(b)

(c)

(d)

!
CL CL CL i CL
LTL
0.3 LTL
t-~
0.75
A E LTL
1.0 E 1.0
0.7 E )
0.25 12.18%

WACC= 15%

7.95%

5.6%

Trade Off Theory

Cost %

WACC

s

Debt Financing

o

Debt Financing Optimal Capital Structure

Vos

o

,

10/13/2010

11

Trade Off Theory

Cost %

WACC

n

Debt Financing Optimal Capital Structure

Tax Benefits

<

Bankruptcy Costs

Tax Benefits

>

Bankrupty Costs

Trade Off Theory

WA.CC

o

Debt Financing 40% ~ _ Optimal Capital Structure

-----~-~----------~-~

CL
,
TA LTL 40%"
E 60% , , ,

10/13/2010

'i

" ,

:j :f ':

12

t

You're Reading a Free Preview

Download
scribd
/*********** DO NOT ALTER ANYTHING BELOW THIS LINE ! ************/ var s_code=s.t();if(s_code)document.write(s_code)//-->