QP (B) Jun 2020

Jun 2020
HKICPA QP Module B
Corporate Financing

Quicksheet Summary

Kin W. Chan HKICPA

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Quicksheet
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01 Ethics in business
Concepts
No. Item Details
C1 Code of Ethics Fundamental principles (5) – Integrity, Objectivity, Professional competence and due care,
for Confidentiality, Professional behaviour
Professional
Accountants Threats (5) –
(COE) 1. Self-interest
2. Self-review (Review by the same person)
3. Advocacy (Promote an opinion -> subsequently objectivity may be comprised)
4. Familiarity (Close relationship)
5. Intimidation (Threat to do)

C2 3-step strategy 1. Analyse the consequences

solving 2. Analyse the actions
dilemmas 3. Make a decision

C3 American Principles and causes / Means / Ends or consequences

Accounting 1. Determine the facts
Association 7- 2. Define the ethical issue
Step Model 3. Identify the major principles, rules and values
4. Specify the alternatives
5. Compare values and alternatives
6. Access the consequences
7. Make your decision

C4 Corporate Corporate Social Responsibility (CSR) – The Continuing commitment by business to contribute to
Social economic development while improving the quality of life of the workforce and their families as well
Responsibility as of the community and society at large.
(CSR)
CSR is linked to the concept of sustainability.
Sustainability
Sustainable development is development that meets the needs of the present without compromising
the ability of future generations to meet their own needs.

C5 CSR – Target CSR – Increase value of shareholders / recognize the obligations to others.
and Why Stakeholders – Employees, Customers, Suppliers, Communities, Society as a whole

Why? Reputation
Attract the ethical customers and investors; Increased staff loyalty and morale; Protection or
enhancement of reputation
Economic benefit – Energy Saving / Low Cost from water efficiency and energy efficiency.

C6 Reporting on  Voluntary
CSR  Co2 emission (some countries require)
 More common in countries with more Institutional Investors than in countries with most
family owned businesses
 Content: Quantified measures / favourable aspects

C7 Sustainability Global Reporting Initiative: Triple Bottom Line – Economic, environmental and social performance
Preserve and enhance 6 Capitals: Financial/ Manufactured / Intellectual / Human / Social / Natural
HK Development: Increase the quality of life / Not damage the prospects of future generations/
reducing the environmental burden

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C8 Listing Rule- Encourage to produce ESG (Environmental, Social and Governance) report annually (either as a
Environmental, separate report or as part of the annual report)
Social and 4 subject areas
Governance -Workplace quality
Reporting -Environmental protection
Guide -Operating practices
-Community involvement
->
Integrated Reporting: Content Structure (Financial and Non-financial)
Integrated Organisational overview and external environment
Reporting Governance
(International) Business model
Risk and opportunities
Strategy and resource allocation
Performance
Outlook
Basis of preparation and presentation

C9 Integrated Long Term sustainability

Reporting Report on Environmental, social and financial
Forward looking information about the company’s strategies and business plan
United report
Relationship between financial and non-financial performance
Complete assessment of the company’s performance and prospects

C10 ESG Reporting HKEX Listing Rule: Listed companies are required to produce annual Environmental, Social and
in HK Governance (ESG) Report from 1 Jan 2016 on a “comply or explain” basis

As part of annual report / information on their websites or in a standalone report

ESG Reporting guidelines – The boards are charged with the responsibility of overseeing ESG risks.
A suitable governance structure / Effective management systems / Reporting Principles (Materiality /
Quantitative / Balance / Consistency)

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Techniques
No. Item Details
T1 Phrases used  Do Nothing
in Ethic  Insider Trading
Questions  Firewall
 Conflict of Interest
 Compromise

T2 Case for For employee (if need to resign)

Employees 1. Please report back to Compliance department
2. If no feedback, resign or report to the authority

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02 Strategy formulation and choice

Concepts
No. Item Details
C1 Strategic Level of Strategy: Corporate / Business (SBU) / Operational
Management
Objectives quantified; Shareholder expectation as a goal
LT; Forward Looking; Goal Oriented; Adapting the organisation to its environment

A. Strategic Position
1. Corporate Appraisal: Environmental
PESTEL
Political, Economic, Socio-cultural, Tech, Environment and Legal

2. Corporate Appraisal: Industry

Porter’s 5 Forces
(New entrant & Existing rivalry; Customers & Supplier; Product Substitute)
(6th Force: Complementors (for Strategic alliances))

3. Corporate Appraisal: Resources and limiting factors

9M Models
Machinery / Make-up / Management / Management information / Markets / Materials / Men and
women / Methods / Money

4. Corporate Appraisal: Position audit

SWOT analysis
Internal： Strength, Weakness
External ：Opportunities, Threat

Gap analysis
Measure and analyses the gap between the planned objectives and extrapolated existing
performance

Value chain
Value activities are the means by which a firm creates value in its product
(Primary Activities Inbound – Operations– Outbound – Marketing – Service;
In – Hedge resource prices
Op – Asset Turnover
Out – On time
Market – Brand; Customer satisfaction
Service – Customer Support
Support Activities Procure-IT-HR-Firm Infrastructure)

Critical success factors

A small no. of key goals vital to the success of the organisation

5. Corporate Appraisal: Product / service portfolio models

Product Life Cycle
Development -> Introduction-> Growth-> Maturity -> Decline,

BCG Boston Consulting Group

(Market Share and Growth: Star ……….Dog; Cash Cow (High Share and Low Growth)…?)

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B. Strategic Choice

Ansoff’s Matrix
Market (Exist / New) Product (Exist / New)
Market (Exist) / Product (Exist) – Market Penetration 滲透(Advertising)
Market (Exist) / Product (New) – Product development
Market (New) / Product (Exist) – Market development
Market (New) / Product (New) – Diversification 多樣化 (All new)

Porter’s Competitive Strategies

All Products: Cost Leadership / Differentiation
Product focus: Cost Focus / Differentiation focus

Industry life cycle

Introduction: Increase market awareness
-> Growth: Create consumer demand
-> Maturity: Defend market share and extend product life cycles
-> Decline: Consolidate, maintain, harvest or exit

Suitability – Strategy Fit

Feasibility – Enough Time and Resources
Acceptability – Accepted by Stakeholders

C. Strategy into Action / Strategic Implementation

Resource / Operations / Organisation

C2 Stakeholder Internal (Management/ Employees)

Connected (Shareholders / Customers / Suppliers / Financiers)
External (The community / Government / Pressure groups)

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Techniques
No. Item Details
T1 PESTEL

T2 Qualitative
Qualitative Measure – Also needed to be quantified (e.g. Score for Customer Satisfaction)

T3 Porter’s 5
Forces
(Sixth Force)

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03 Financial analysis and strategy

Concepts
No. Item Details
C1 Financial Maximise shareholders’ wealth
Management (Investment/ Financing / Dividend / Risk management)

C2 Financial Profitability
Objectives 1. ROI (Profit/ Capital Employed)
2. ROCE (Operating Profit or PBIT / Capital Employed);
3. Profit Margin (Net or Gross Profit / Sales)

Liquidity
1. Current Ratio= Current Assets / Current Liabilities;
2. Quick Ratio= (Current Assets – Inventories) / Current Liabilities
3. Cash Operating Cycle = Debtor Days + Inventory Days – Creditor Days
4. Interest Cover (Covered by Profit: PBIT / Interest)

Efficiency
1. Asset Turnover = (Turnover / Asset or Turnover / Capital Employed)
2. Inventory Turnover = (Cost of Sales / Average Inventory)
3. Sales Revenue / net working capital = (Sales revenue / (Current Assets – Current Liabilities))

Gearing
1. Operating Gearing (Fixed Cost/Total Costs or Contribution / Operating Profit)
2. Financial Gearing (Debt / Equity or Debt / Debt plus Equity)

Investor Ratio
1. Return on Equity = Earnings attributable to ordinary shareholders / Shareholders’ equity
2. Dividend Yield (Div / MV), Dividend Cover (Covered by Earning: Earning /Div)
3. EPS = Profit distributable to ordinary shareholders / Weighted average number of ordinary
shares
4. P/E = Market price of share / EPS

C3 Secondary Profit margin * asset turnover = ROCE

ratios
PBIT Sales Revenue PBIT
------------------- * ----------------------- = ------------------------
Sales Revenue Capital Employed Capital Employed

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Techniques
No. Item Details

T1 Capital Capital Employed = Total Assets – Current Liabilities

Employed

T2 Cash Cash Operating Cycle = Debtor Days + Inventory Days – Creditor Days
Operating
Cycle
Illustration Profitability vs Liquidity

e.g.
100+30-20=110 (20 days to pay the supplier)
100+30-60=70 (60 days to pay the supplier; cash conversion day REDUCED a lot)

T3 ROI

T4 ROCE ROCE

ROCE for an investment (i.e. ARR Accouting Rate of Return)

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04 Cost measurement and analysis in service and

manufacturing environments
Concepts
No. Item Details
C1 Traditional Traditional Absorption Costing
Absorption More production costs are direct Costs
Costing Production overheads are driven by production activity (Machine Hour / Labour Hour
->
ABC (Activity
Based Costing) ABC (Activity Based Costing)
-> Long Term
TDABC (Time
Driven Activity Particular Cost driven by Non-volume related cost drivers
Based Costing) High Implementation Cost and ongoing maintenance cost

Different Activity Units (i.e. Machine Hour / Setup frequency)

Unit Level activities / Batch-related activities / Product- sustaining activities / Facility-sustaining
activities

Cost per Unit of Activity

Resource COST DRIVER are used to allocate overheads to COST POOL

TDABC (Time Driven Activity Based Costing)

Activity Unit = Minutes

Capacity Cost Rate (CCR) Or Cost per time unit of capacity = Total Resource in $ / Total Available
capacity in minutes excluding idle time

Estimated time per minute of activity -> Know capacity utilization (Theoretical vs Practical capacity)
Unused Capacity – cause resources problem

C2 Activity Based -Value

Management -Draws upon ABC as a major source of information
-Tracing resource consumption and costing final outputs
-Value Added / Non-value added

C3 Cost Volume Sales 15 Unit

Profit (CVP) Sales @ 10 each
Analysis Variable Cost @6 each
Contribution Margin (10-6) = @ 4 each

Fixed Cost 40

Sales – VC – FC = Profit
150 – 90 – 40 = 20

Sales – VC = CONTRIBUTION = FC + Profit

150 – 90 = 60 = 40 + 20

Break even (Unit) -> Profit = 0 ; Contribution / unit = Contribution per unit = FC / unit (e.g. 4 = 40 / unit) -> Unit =
10
Break even (Sales) -> Profit = 0; Contribution / Sales = C/S Ratio = FC / Sales (e.g. 60 / 150 = 40 / Sales) -> Sales =
100
Unit requiring profit 100; Contribution / unit = Contribution per unit = (FC + Profit) / unit (e.g. 4 = (40+100)/unit) ->
Unit = 35

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C4 Pricing 1. Cost-plus
Target Price: Actual Cost 5 + Profit Margin 2 = Selling Price 7 [Features Cut or Standardization]
2. Absorption cost pricing formulae
3. Variable cost pricing formulae (remove the need for allocation of fixed costs)
4. Minimum pricing (achieve a stated target)

C5 Total Quality Quality Costs

Management 4 areas – Prevention, Appraisal, Internal Failure and External Failure

Try to eliminate all waste / cost of poor quality

C6 Costing Target Costing – Business Process Management

Method Target Cost = Selling Price 10 – Profit Margin 2 = 8 [To do value engineering ..vs Actual Cost 9
because target cost gap]

Life Cycle Cost – Medicine (Research)

Standard Costing

Kaizen Costing

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Techniques
No. Item Details
T1 Cost Excluded Sunk Cost / Committed Cost
for Allocated Cost when functions are shared by existing staff
consideration

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05 Performance measurement systems

Concepts
No. Item Details
C1 Strategic vs Target (vs Detailed); Whole Organisation (vs Departmental); External (vs Internal)
Operational
planning &
Control

C2 Benchmarking Benchmarking
Adv. – Continuous Improvement /Position audit / Cost enhancement;
Disadv. – Best Practice identified with difficulty

Benchmarking reference: Other divisions in the same company, competitors and industry

C3 Cash flow Marginal Cash Flow = Contribution margin – Change in working capital
Marginal Cash Flow = Net of the variable cash inflows generated by operations (S-VC) after financing
the variable working capital

Operating Cash Flow = EBIT – Change in net operating assets

Net Operating assets = All Assets – Current Liabilities (Not include Cash and Overdraft)

Net Cash Flow = Operating cash flow less interest, tax, dividends and extraordinary items and
changes in equity, provision for tax and provision for dividend

C4 Common size Common Size analysis can be used to compare or benchmark financial performance against other
trend analysis firms within the same industry; and to get a different picture about trends for one firm.
and index
analysis (e.g. Divided each number by total assets)

Index analysis expressed the amounts of a particular income statement or statement of financial
position item as a percentage of the amounts of same item in the base year.

C5 Non-Financial Value – Easy to understand and use effectively

Performance
Indicators Productivity measures

In relation to employees: Measure morale, skills and training of the workforce

TQM

Quality of Services – Measure of customer satisfaction

C6 Short-termism Bias: So Encourage long term view by setting manger’s rewards to share price and quality based
target

C7 Balanced Balanced in Financial and Non-financial

Scorecard Financial/Customer/Internal/Innovation and Learning

C8 Performance The performance pyramid highlights the links running between an organisation’s vision and its
pyramid functional objectives

C9 Building Block Dimensions, standards and rewards attempt to overcome the problems associated with performance
model measurement in service businesses

C10 Agency Theory Agency Theory: Shareholder vs Management

Share Option / Contribution to L/T Objective / Quality based

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Techniques
No. Item Details
T1 Capital Capital Employed = Total Assets – Current Liabilities
Employed
T2 Cash Cash Operating Cycle = Debtor Days + Inventory Days – Creditor Days
Operating
Cycle
Illustration Profitability vs Liquidity

e.g.
100+30-20=50 (20 days to pay the supplier)
100+30-60=10 (60 days to pay the supplier; cash conversion day REDUCED a lot)

T3 Marginal
Cash Flow

T4 Operating
Cash Flow

T5 Net Cash
Flow

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T6 Productivity
Measure

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06 Performance measures for organizational units

Concepts
No. Item Details
C1 Responsibility Cost centre / Revenue centre / Profit centre / Contribution centre / Investment centre
Accounting
Controllability

C2 ROI / Residual ROI %

Income RI /
Economic Value Residual Income = a measure of the centre's profits after deducting a notional or imputed interest
Added EVA cost.
(e.g. Divisional Profit / Operating Profit – Input interest* Investment)

EVA = NOPAT – WACC*Net Asset

(Economic Profit; Goodwill, research, development expenditure and advertising costs -> included
as Assets)

C3 Transfer Price Corporate profit maximisation (Tax)

Divisional profit maximisation (Affect behaviour and decisions)

Min – Sum of the supplying division’s marginal cost and opportunity cost of the item transferred
Max – The lowest market price at which the receiving division could purchase the good or services
externally, less any internal cost savings in packaging and delivery

Transfer price
 *Market value
 *Full Cost
 *Full Cost (plus)
 Marginal cost
 Standard cost
 Opportunity cost
 Negotiated

C4 OECD Tax In 2016 the Organisation for Economic Co-operation and Development (OECD) produced a
Avoidance framework to prevent tax avoidance through Base Erosion and Profit Shifting, (BEPS).

Over 100 countries are in the process of implementing laws to comply with the BEPS framework
which aims to prevent the exploitation of mismatches between international tax regimes by
multinational companies.

This includes further reducing the scope for multi-national companies to use of artificial transfer
prices to shift the recognition of profits to lower tax jurisdictions.

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Techniques
No Item Details
T1 Residual
Income

T2 Economic
Value Added

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07 Treasury management
Concepts
No. Item Details
C1 Decentralisation Centralized – Strategic Planning, Low Interest Rate, Greater level of expertise
(Divisionalisation)
/ Centralisation Centralized (Repetitive Processes Only)
Treasury
Department Decentralized – Local Need, Autonomy, Responsive; Speculation

C2 Cost Centre / Cost Centre – No Incentive

Profit Centre / Profit Centre – Incentive; Speculation
Service Centre Service Centre – Charges for the service it supplies to other members of the group
Treasury
Department

C3 Centralised
Treasury
Function

C4 Hong Kong as a To attract multinational and mainland corporations to centralise their treasury functions in Hong
centre for Kong.
treasury
operations Interest expenses related to intercompany borrowings become tax deductible

Additionally, profits tax for qualifying treasury activities undertaken by corporate treasury centres
will be halved, from the regular Hong Kong corporate tax rate of 16.5% down to 8.25%.

C5 Corporate Maintain complete control over the transaction and avoids external banking costs
treasury centre Take advantage of investment opportunities
(In house banks) Achieve optimal procurement and usage of capital
Reduction in fees

C6 Automated Improved financial risk management

Treasury Greater cash visibility (is required to achieve the most efficient management of a company’s cash
Management resources)
System (TMS) Improved business continuity
Reduction in fees

C7 Corporate Case: One Belt One Road

Treasury Centres Case: COSCO Shipping
– Updated
Technology and Treasury Function
Software as Services
Cyber Security
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Techniques
No. Item Details
T1 Treasury
Functions

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08 Working capital management

Concepts
No. Item Details
C1 Cash Operating Cash Operating Cycle = Debtor Days + Inventory Days – Creditor Days
Cycle
Accounts receivable collection period = (Average Trade receivables/ Credit Sales revenue) * 365 days

Raw materials inventory holding period = (Average raw materials inventory / Annual purchases) * 365
days
Production / work-in-progress (WIP) period = (Average WIP / Cost of Sales) * 365 days
Finished goods (FG) inventory holding period = (Average FG inventory / Cost of Sales) * 365 days

Accounts payable payment period = (Average trade payables / Purchases or Cost of sales) * 365 days

C2 Economic
order quantity
(EOQ)

C3 Reorder level Reorder level (ROL)= maximum usage * maximum lead time
Maximum inventory level = ROL + ROQ – (minimum usage * minimum lead time)
Minimum inventory level = ROL – (average usage * average lead time)
Average inventory = Minimum inventory level + ROQ/2

C4 JIT Just in Time Zara

Pull Scheduling (Stage B pull Stage A)
Great Visibility

C5 Factoring Without recourse (Factor take full responsibility) / With recourse

Disclosed / Undisclosed

Invoicing discounting

C6 The Baumol Determine Cash Q to be raised

model

C7 The Miller-Or Cash Management

model

Upper Limit = Lower Limit + Spread

When reaching upper limit (too much cash)-> Use cash (upper limit- return point) to buy Securities
When reaching lower limit (too few cash)-> Sell Securities (Return point – Lower limit) to get cash

C8 Working Aggressive: Non-current assets financed by short-term finance -> Profitability but risky
capital funding Conservative: High level current assets financed by long-term finance -> Not Profitability but safe
strategy Matching or Moderate: Non-current assets by long-term finance; Current assets financed by short
term finance

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C9 Hold Cash Regular transactions / Precautionary motive / Speculation

C10 Over- Only Liquidity Focus

Capitalization Overinvestment in current assets
More AR Cash Inventory; Less AP

Indicators
Sales/Working Capital ratio reduced; High Current ratio / Quick ratio; Long turnover period for
inventory and AR

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Techniques
No. Item Details

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09 Types and sources of finance

Concepts
No. Item Details
C1 Internal Retained Earnings / Increase working capital efficiency
Financing Adv.: Flexible / Not involve change in D/E / No dilution in control / No Issue Cost
Disadv: Shareholders sensitive to loss of dividend / Opportunity cost (Dividend not paid to shareholder)

C2 Bonds Bonds – Loan notes or Debentures

-Redeemable

Redeemable at maturity date

Most redeemable bonds have an earliest and a latest redemption date. For example, 12%
debenture stock 2017–19 is redeemable, at any time between the earliest specified date (in 2017)
and the latest date (in 2019). The issuing company can choose the date.

-Irredeemable

-Floating rate

-Zero coupon

-Convertible bonds
Bonds Market price = 1,420 per 1,000 nominal
Conversion ratio: $1000 bond = 30 shares
Conversion value = Conversion ratio * Market price per share = 30*41.5 = 1,245
Conversion premium = Current market value – Conversion value = 1,420- 1,245 = 175

Others
-Deep discount bonds

-Subordinated loan

C3 Reasons Availability, Market conditions, Duration, Spread of maturities (returning money back), Fixed or floating
influencing rate, Purpose, Flexibility, Security and Covenants
choice of
debt
finance

C4 Off balance Not appear on the statement of financial position

Sheet -e.g. Consignment basis (Stock paid by a third party) / Asset back securities
financing
C5 Leasing Operating Lease / Finance Lease / Sale and leaseback

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C6 Stock

Right 供股 (Existing Shareholders)

Open Offer 公開招股 (Existing Shareholders)

Placing 配股 (Non-Existing)

Consideration Issue 代價發行

Scrip dividend 以股代息/ 红股

Stock Split 股份拆細

Share Buyback 回购

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Techniques
No. Item Details
T1 Holding period Holding Period Yield = IRR
yield 1 2 3
-970.56 56 56+1038.78
HPY = 9.13%

T2 Right Issue HSBC 2 供 1 （65 Current Price; 供股价 40）

calculation 2*65=130
1*40=40
Theoretical ex-rights price = (130+40)/3= 56.67

T3 Right issue Exercise

handling Or
Renounce and Sell out

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10 Dividend policy
Concepts
No. Item Details
C1 Dividend policy Constant Dividend

Constant Payout ratio

Residual theory: Distribute deducting + NPV investment opportunities

Irrelevancy Theory: MM: Value of company unaffected by the distribution of dividend

Vs
Signalling effect of dividends

C2 Framework for FCFE < Dividend -> Too much dividend

analysing FCFE > Dividend -> Inadequate dividend
dividend policy ROCE > Required return -> Good Projects
ROCE < Required return -> Bad Projects

C3 Share Buyback Reducing No. of Shares

Adv:
Increase EPS / ROE
No Commitment (compared with Dividend)
Pass a signal to the market with attractive valuation

Disadv:
Increase D/E
Only benefit for the shareholder willing to sell
Negative impression: Running out of project
Support of Share price may be temporary

C4 Dividend Information Content Effect

Signalling Positive Signal: a positive signal of the company possessing strong future earnings
Effect Negative Signal: limited positive NPV investment opportunities

C5 Return Investors requiring Return (Dividend and Capital Gain)

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Techniques
No. Item Details
T1 Dividend Policy Totally different views - Irrelevancy Theory vs Signalling Effects

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11 Identifying, measuring and managing financial risks

Concepts
No. Item Details
C1 Business Risk vs Business Risk – Commercial activities and operations
Financial Risk Financial Risk – The risk that financial conditions (e.g. the cost of borrowing, the yield from
investments, the availability of money to borrow, customer bad debts) could change or be less
favourable than expected, resulting in a deterioration of business positions in financial terms (i.e.
profitability and solvency)

C2 Financial risk Liquidity risk

Day-to-Day, Short Term, Long Term

Interest rate risk

Foreign exchange risk

Economic risk, Translation risk, Transaction risk

Commodity price risk

Credit risk
Counterparty risk, Country risk (Political, Regulatory, Economic), Settlement/ Delivery risk

C3 Risk Risk Management is the process of identifying and assessing (analysing and evaluating) risks and the
Management development, implementation and monitoring of a strategy to respond to those risks.

Risk = Probability * Financial consequences

Managing Risk
Terminate – Avoidance
Tolerate – Retention (Active or Passive)
Transfer – Insurance / Non-Insurance Transfer
Treat – Loss Control

C4 Foreign Transaction risk – Normal international trading transactions

exchange risk
Economic risk – International competitiveness of a company

Translation risk – Accounting results

C5 Exchange rate Purchasing Power Parity

fluctuation
1GPB = 1.5 USD

Future Expected Spot Rate

USD 1.5*(1.05) Inflation US 1.5291

----- ------------------------------- = ---------
GBP 1 * (1.03) Inflation UK 1

All goods same price

Inflation US more -> USD devaluation

*********************************************************************

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Interest Rate Parity

1GPB = 1.5 USD

Forward Rate

USD 1.5*(1.092) Interest Rate US 1.5291

----- ---------------------------------------- = ---------
GBP 1 * (1.0712) Interest Rate UK 1

USD Int High -> USD devaluation

*********************************************************************

The Fisher effect

(1+i)=(1+r) (1+h)
i nominal rate
r real rate

(1+5%) = (1+r) (1+4%)

r= 0.9615%

*********************************************************************

International Fisher Effect

1+interest rate UK 1.045 (1+inflation rate UK)

--------------------------------- = ------------------------------------
1.05 (1+ interest rate US) 1.03 (1+inflation rate US)

Interest rate UK = 6.5%

C6 Basics of foreign 1. Invoice in Home Currency

risk 2. Matching receipts and payments
management 3. Matching assets and liabilities
4. Leading and lagging – Payment in advance or Delay payment
5. Netting

C7 Derivatives – FX 1. Forward 远期合约

OTC / Customized / Counterparty Risk / Settlement Risk / Market Liquidity Risk
2. Future 期货合约
Exchange Traded / Size Fixed / Maturity Date Fixed /Margin
3. Option
Right / Premium / OTC or Exchange
4. Swap
Currency Swap (USD ⇔ EUR) Notional Exchanged
(For Interest rate : Interest Rate Swap (Fixed ⇔ Float) Notional Not Exchanged)

USD

Co (US) Co (UK)

USD GPB
GPB

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C8 Money Market Payment SFr in 3 Month Time
Hedging Original: GBP (3 Mths) -> [PAY] SFr 5,000,000 (3 Mths)
NOW: GBP (Now) -> SFr (Now)
So
Borrow GBP (Now) -> SFr (Now) X < 5,000,000
|
| X(1+Deposit Rate) = 5,000,000
|
SFr (3 Months) 5,000,000 [WILL PAY]

Receipt SFr in 3 Month Time

Original : [RECEIVE] SFr 5,000,000 (3 Mths) -> GBP (3 Mths)
NOW : SFr (Now) -> GBP (Now)
So
Borrow SFr X <5,000,000 (Now) -> GPB (Now)
|
| X (1+Borrowing Rate) =5,000,000
!
SFr (3 Months) 5,000,000 [WILL RECEIVE TO PAY BACK THIS BORROWING]

C9 Gap Exposure Positive gap: Interest sensitive assets > interest sensitive liabilities (lose if interest rate falls)
Negative gap: Interest sensitive assets < interest sensitive liabilities (lose if interest rate rises)

C10 Duration Duration = weighted (by time) average of the present value of future cash flows

C11 Yield Time (x) Yield (y) ….Up with time (Normal Yield Curve)

Liquidity preference theory: High interest rate compensating longer term

Expectation theory: Forward rate depends on expectation
Market segmentation theory: Different segments in the market

C12 Interest rate Matching – Liabilities and assets with a common interest rate are matched
risk
management –
Internal
Hedging

Smoothing – Keep a balance between its fixed rate and floating rate

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C13 Derivatives – 1. Forward rate agreements FRA 遠期利率協議 (Forward)
Interest Rate FRA: Fix Short Term Interest Rate; Swap: Fix Long Term Interest Rate] [i.e. Forward Contracts]
Co (Hold Floating Rate Note) -> ○
F i ↑ -> Buy FRA to fix the interest Rate
i.e. Int 8%; Fix at 5%; Bank -> 3% -> Co
Int 2%; Fix at 5%; Co -> 3% -> Bank

Feature: Fix, Short Term, OTC

Adv: Flexibility, Tailor-made
Disadv: Counterparty Risk, Forgone the gain

2. Future 期货合约
P=100-i : Price of Contract
Borrower ○ F i ↑ p ↓ Short Interest Rate Future
Loan : i ↑ -> Int ↑ -> CF –ve
Short Future: i ↑ –> P ↓ -> CF +ve

Feature: Fix, Short Term, Exchanged

Adv: No counterparty risk
Disadv: Size fixed, Margin paid, difficult to 100% hedge

3. Option
Caps, Floor and Collars [i.e. Option]
Co (Hold Floating Rate Note) -> ○
F i ↑ -> Buy Cap maximum to pay Cap
Collar (Range) – Buy Cap and Sell Floor

Base Rate Cap (6%) Collar (Buy Cap 6%

and Sell Floor 4%)
2% 2% 4%
4% 4% 4%
6% 6% 6%
8% 6% 6%

Feature: Right, Set Max to pay (Cap); Set Min to receive (Floor); Save Premium (Collar), OTC (Cap
, Floor and Collar) or Exchanged (Interest rate Option)
Adv: Protection
Disadv: Premium paid

4. Swap
Interest Rate Swap (Fixed ⇔ Float) Notional Not Exchanged

6%

Co Bank

HIBOR+3%
HIBOR

Feature: Fix, Long Term, OTC

Adv: Flexibility, Tailor-made, Interest Payment (as a whole reduced)
Disadv: Counterparty Risk, Forgone the gain, Service Fee by Bank

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Techniques
No. Item Details
T1 Interest Rate Cap – Buy Put Option on p
Collar Floor – Buy Call Option on p

Collar – Buy Cap (-Premium) Sell Floor (+Premium)

Zero Cost or Low Cost Collar: Buy a cap 8% and sell a floor 6%.

When Market Interest up to 10%, Need to pay 8%

When Market Interest down to 5%, Need to pay 6%

T2 Basis risk

Example

T3 Interest Rate Short Future: 92.1

Future – Tick Close Future: 90.74
No. of Contract = 32
Future Contract = 5,000,000
Future Contract for notional deposit = 3 Month

Gain on future = (Contract Size * Contract Period / 12) * Movement * No of Contract

= 5,000,000 * 3/12 * (92.10-90.74)% * 32 = 544,000
OR
Gain on future = Tick Value * No of Tick * No. of Contract
= ((5,000,000 * 3/12) /10000) * (92.10-90.74)% *10000 * 32
= 125 * 136 * 32
= 544,000

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T5 Hedging Logic FX
If derivative wins, Derivative (CF +ve) covers the loss in payment or receipt (CF –ve)
If derivative loses, Payment or Receipt (CF +ve) covers the Derivative (CF –ve)

HK Co (Will Receive GBP)

○F GBP ↓
1. Forward: Sell GBP Forward Contract
2. Future: Short GBP Future
(Close the position by long GBP Future)
3. Option: Buy Put Option on GBP
(If GBP ↓ lower than exercise price -> exercise; otherwise lapse)
4. MM Hedge: Exchange GBP to HKD Now

HK Co (Will Pay GBP)

○F GBP ↑
1. Forward: Buy GBP Forward Contract
2. Future: Long GBP Future
(Close the position by short GBP Future)
3. Option: Buy Call Option on GBP
(If GBP ↑ higher than exercise price -> exercise; otherwise lapse)
4. MM Hedge: Exchange HKD to GBP Now

For Currency Swap, HK Co. (Need GBP, but borrow HKD cheaper) -> Borrow HKD to swap with UK
Subsidiary (Need HKD, but borrow GBP cheaper)

Interest Rate
If derivative wins, Derivative (CF +ve) covers the loan (CF –ve)
If derivative loses, Loan (CF +ve) covers the Derivative (CF –ve)

Borrower (HIBOR)
Borrower ○ F i↑
1. FRA: Buy FRA
2. Future ○ F p ↓ : Short Interest Rate Future
(Close the position by long interest rate future)
3. Cap / Collar: Buy Cap or Collar (Buy a Cap and Sell a Floor)
(For Cap / Collar, If I ↑ higher than Max int rate -> exercise the option (cap) to pay Max int rate)
(For Collar, If I ↓ lower than Min int rate, the option (floor) is exercised by the buyer so Min int
rate is required to be paid)
4. Swap: Pay Fixed, Receive HIBOR

Depositor (HIBOR)
Depositor ○F I↓

1. FRA: Sell FRA

2. Future ○F p ↑: Long Interest Rate Future
(Close the position by short interest future)
3. Floor: Buy Floor or Collar (Buy a Floor and Sell a Cap)
(For Floor / Collar, If I ↓ lower than Min int rate -> exercise the option (floor) to receive Min int
rate)
4. Swap: Pay HIBOR, Receive Fixed

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T6 Exchange Rate USD/YEN = 115 (1 USD = 115 YEN)

Selection HKD/JPY = 15.311 (1 HKD = 15.311 YEN)
POUND / HK$ 12.8438 – 12.8488 (1 Pound = 12.8438-12.8488 HK$)

Banks are working for you; Banks PAY LESS to U; RECEIVE MORE from U
If u want to buy Pound from the bank, say Pound 1,000, Bank Receive HKD 1000*12.8488 = 12,848.8
If u want to sell Pound to the bank, say Pound 1,000, Bank pay HKD 1,000 * 12.8438 = 12,843.8

If u want to buy HKD from the bank, say HKD 10,000, Bank Receive GBP 10,000/12.8438= GBP 778.59
If u want to sell HKD to the bank, say HKD 10,000, Bank pay GBP 10,000/ * 12.8488 = GBP 778.28

T7 Premium When comparing with total cost of using Forward vs. Options. Including the Premium (with Interest
income forgone on premium) in Option.

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12 Investment appraisal
Concepts
No. Item Details
C1 ROCE/ 1. ROCE (Accounting Rate of Return)
Payback/ Estimated average or total profit
IRR/ --------------------------------------------------- *100%
NPV Estimated average or initial Investment

2. Payback 回本期
– Only Part of Cashflow, Easy to Understand

Discounted Payback

3. IRR – Internal Rate of Return 内部回报率

IRR – Nonconventional Cashflow (More IRRs)

4. NPV

NPV – NPV +-> Increase shareholder wealth; It is the best including cost of capital

ROCE Payback IRR NPV

1. Easy to ✔ ✔ More Easily X
Understand understood
(Compared with
NPV)
2. Time Value X X ✔ ✔
of Money

3. Absolute Relative (Ignore Relative (Ignore Relative (Ignore Absolute

Measure / Size of Size of Size of
Relative Investment) Investment) Investment)
Measure

Advantages Quick; Simple C/F; Simple Commonly used Best Method;

(Compared with Cost of Capital
NPV) included

Disadvantages Accounting Ignore part of Multiple IRR if Difficult to

Profit – Cashflow Non- estimate the CF
Manipulation; conventional & Cost of Capital
C/F; / Cost of Capital
Reinvestment varied
Assumption
cannot be
substantiated

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C2 NPV NPV
-Real or Nominal CF
-Tax paid timing
-Tax allowable depreciation
-Working Capital
-Probability
-Sunk Cost (e.g. After 2 years, reappraisal the projects)
-Opportunity Cost (e.g. Profit foregone)

-Post Completion Audit (Independent)

C3 NPV NPV
Format -Operating (Calculation of Tax)
(1. Including in Operating Profit ..Then Addback OR
2. Depreciation Tax Benefit)
-Capital Expenditure
-Working Capital

C4 Sensitivity Sensitivity Margin = NPV / (PV of project Variable)

Analysis
i.e. When PV reduces % (sensitivity margin) then NPV =0)

The lower the percentage = the more sensitivity is NPV to the project

C5 Capital Divisible: Profitability Index …Ranking

Rationing NPV (Not Including the capital investment) / PV of Invested Capital (i.e. Normally Yr 0)

Non-divisible: Trial and Error

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Techniques
No. Item Details
T1 Continuous Constant Growth
growth after
4 years 1 2 3 4 5 6
onwards / 101 102 103 120 120(1+0.03) 120(1+0.03)2 ……
starting year =>
5
1 2 3 4
101 102 103 120
Perpetuity
2,060
Year 4
101 102 103 2,180
onwards
NPV = 1,802.41

Working
Calculate separately for Starting after 4 years / at year 5 (say r=9%)
5 6
120(1+0.03) 120(1+0.03) 2 ……

120(1+0.03)
= ---------------- = 2,060 (PV at yr 4)
(0.09-0.03)

***********************************************************************************

Perpetuity
Year 4 onwards 30.25
1 2 3 4 5 6
14 18.5 20.75 30.25 30.25 30.25 ……
=>
1 2 3
14 18.5 20.75
177.94
14 18.5 198.69

NPV= 149.54

Working
Calculate separately for Starting at year 4 (say r=17%)
4 5 6
30.25 30.25 30.25 ……

30.25
= --------- = 177.94 (PV at yr 3)
(0.17)

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T2 Annuity Calculate PMT
using TVM
Method Loan 1000 : Each Year Payment
0 1 2 3 4 …….. 10
+1000 -X -X ……………………….- X
r=4%

1000 = X X X
----------- + -------------- +…….. ------------------
(1 + 4%) (1 + 4%)^2 (1 + 4%)^10

1 1 1
1000 = ( ----------- + -------------- +…….. ------------------) X
(1 + 4%) (1 + 4%)^2 (1 + 4 %)^10

[2nd] CLR TVM (Setting END)

PV=1000; I/Y = 4; FV=0; N= 10; CPT PMT = -123.29

Alternative ways to do

Using 1: Annuity Formula = 1-((1+r)^-n) = 8.1109 ; X = 1000/8.1109 =123.29

----------------
r

2: Annuity Table = 8.111

3: Find the annuity using CF -> Annuity = 8.1109

Calculate FV

Invest 10 each year, Return 3%

Year 30 Future Value

0 1 2 3 4 ……..29 30
-10 -10 -10 ……………….. -10

[2nd] CLR TVM (Setting END)

PV= 0; PMT=-10; N= 30; I/Y=3 CPT FV = 475.75

T3 Payback Yr 0 1 2 3 4
Calculation -100 60 40 30 10
Payback period = 2 years

Yr 0 1 2 3 4
-120 60 40 30 10
Payback period = 2.x years
Not yet paid back after 2 years (120-60-40)=20.
So 20/30 = 0.67 years

Payback period = 2.67 years

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T4 NPV (All)

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T5 IRR
Interpolation

Horizontal Short Vertical Short

----------------------- = -------------------
Horizontal Long Vertical Long
If 10% discount  NPV 28,250
If 20% discount -> NPV -23,150

IRR% - 10% 28,250

----------------------- = -------------------
20% - 10% 23,150+28,250

IRR = 15.5%

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13 Cost of capital
Concepts
No. Item Details
C1 Cost of Capital Cost of Capital = Risk free rate of return + Risk Premium (Business + Financial)

C2 Using Dividend
Growth Model P = d0 (1+g) / (ke-g)
P= d1 /(ke-g)

Growth Rate Method Calculation

Div 20x1 (1+g)^4 = Div 20x5

G=br (profit retained * rate of return on new investment)

DVM: Not incorporate risk, g constant, assume no issue costs

C3 CAPM CAPM: Required Return = Rf+ Beta (Rm-Rf)

Beta : (700.HK 1.06) Systematic Risk

Rm : Market Expected Return
Rm- Rf : Equity Risk Premium / Market Risk Premium
Beta(Rm-Rf) : Risk Premium

CAPM : Systematic risk Only (Unsystematic risk not exist as portfolio fully diversified)
Difficult to determine : Rf, Beta (historical), Rm

C4 Cost of Debt i(1-T)

Bond Price Down -> Yield Up

Return required by bond holders = Rf + Credit Spread

Return required by equity holders = Rf + Risk Premium

C5 WACC WACC = Ve/V Ke + Vd/V Kd (1-T)

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Techniques
No. Item Details
T1 Cost of Debt
Calculation

T2 Value of Bond
if Discount
Rate changes

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14 Capital structure
Concepts
No. Item Details
C1 Capital Traditional
Structure (3 -> Ke rises a little bit when debt level is ok -> WACC drops
theories) -> Ke rises sharply when the level of gearing increases -> WACC rises
WACC (Min) -> Value (Max); Optimal Capital Mix

MM
Ke increases linearly as the value of debt relative to the value equity increases

MM without Tax
Debt Increase -> Ke Increase …..WACC no change

MM with Tax
Ke increases -> WACC falls -> 100% Gear up

C2 MM with Tax: Vg = Vu + DT
Market value Debt increase -> Ke Increases; Tax Shield -> WACC drops -> V increases

C3 MM with Tax: Kg = ku + (Ku-Kd) Vd (1-T)

Cost of equity ----
Ve

C4 MM with Tax : K adj = Ku (1-T L)

Adjusted Cost L = Vd / (Vd+Ve)
of Capital
Or using normal way to calculate WACC

C5 βe Beta / βe / Equity Beta / Geared Beta (Equity and Debt)

βa /Asset Beta /Ungeared Beta (Only Equity)

700.HK Tencent 1.1

HSI 23,000 -> 25,000 Up 8.696%
700.HK 200 -> 219 Up 8.696%*1.1 = 9.566%

C6 Pecking Order Pecking Order theory

Theory

Firm Prefer Retained Earning > Debt > Convertible > Preference Shares > Equity because of
convenience or low transaction costs instead of getting optimal Capital Structure

No WACC Minimization -> No Value Maximization (No Optimal Capital Structure)

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C7 Project- Retail Company having a business in project of property development
Specific Cost of Not use Existing WACC because of different business risk
Capital
Reference to Cheung Kong or property industry:

βe -> Ungear Industry to Asset beta -> Re-gear using project Debt Equity Ratio

βe E+D (1-T)
--- = ------------ assuming beta factor of debt = 0
βu E

C8 The existence Bankruptcy costs – High level of gearing -> Increase risk of the company
of other Agency costs – Restrictive covenants imposed by providers of debt finance
market Tax exhaustion – Not enough profits from which to obtain all available tax benefits.
perfections
prevent the
levels of debt
advocated by
MM (i.e. 100%
Debt)

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Techniques
No. Item Details
T1 Traditional
View
/
MM (No Tax) /
MM (With Tax)
Illustration

Traditional view – WACC min found when Debt increase Ke increase

M&M (No Tax) – Ke increase linearly as Debt increase; WACC constant
M&M (Tax) – Continuous Increase Debt; WACC decrease

Traditional
-> Ke rises a little bit when debt level is ok -> WACC drops
-> Ke rises sharply when the level of gearing increases -> WACC rises
WACC (Min) -> Value (Max); Optimal Capital Mix

MM
Ke increases linearly as the value of debt relative to the value equity increases

MM without Tax
Debt Increase -> Ke Increase …..WACC no change

MM with Tax
Ke increases -> WACC falls -> 100% Gear up

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T2 Change of Ke,
Kd and WACC
Illustration

T3 Calculating General Method

WACC (2 1. Ungear Industry Beta (Geared) -> Beta (Ungeared)
Ways) 2. Regear Beta (Ungeared) -> Project Beta (Geared)
3. CAPM -> Ke
4. WACC

MM Formula Method
1. Ungear Industry Beta (Geared) -> Beta (Ungeared)
2. CAPM (Using Beta (Ungeared) -> Ku
3. MM : Adjusted Capital Structure K adj = Ku (1-T L) where L= Vd / (Vd+Ve)
OR
3. MM: Kg = ku + (Ku-Kd) Vd (1-T) -> WACC
----
Ve

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15 Regulatory environment
Concepts
No. Item Details
C1 Listing Rules Listing Rules
“Comply or Explain”
Recommended best practices (RBP)

C2 Corporate Separation of Chairman and CEO

governance Board composition
issues Remuneration
Internal controls

C3 Insider dealing

C4 Listing Rules Pass one of three financial tests

-a profits test (Reported a profit of at least HK$20,000,000 in its most recent financial year and total
reported profits at least HK$30,000,000 in the two preceding years combined.

-a market capitalisation/revenue/cash flow test or

-a market capitalisation/revenue test

C5 Professional Sponsors – For IPO application, Channel of communication between the company and the Listing
Advisers Division of the SEHK

Compliance advisers – A newly-listed company must appoint a compliance adviser for the period
beginning of the date of the listing of its shares and ending on the publication of its results for the first
full financial year that begins after listing

Underwriters – New issues of shares must usually be fully underwritten.

C6 HKEx There are a large number of reporting requirements in respect of listing on the HKEx. There are
Reporting two major areas that affect CPAs; (1) the accountants' report and pro forma financial information
requirements required in relation to listing, and (2) the continuing obligations to provide reports of interest to
investors.
(1)
 All accountants' reports must be prepared by certified public accountants,
 A three-year history must be provided which must include the disclosures required under the
relevant accounting standards adopted
(2)
 By not later than 30 minutes before the opening of SEHK trading, an issuer must advise the
Exchange of any changes in the number of shares, e.g. bonus issues, rights issues, etc.
 The issuer must submit a monthly return to the SEHK containing such prescribed information
as movements in equity securities and debt securities.
 The listed issuer must provide an interim report for the first six months of the financial year. This
report must comply with certain provisions and be issued no later than three months after the
end of the interim six months.

 The issuer must publish its preliminary annual results as soon as possible after the end of
the financial year, and no later than three months after the end of the financial year.
 The issuer must publish its preliminary interim results as soon as possible after the end of
the six-month period, and no later than two months after the end of that period.

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C7 Listing Rules / Listing Rule

Code /
Recommended (1) Director’s responsibility, Delegation (May) but remain responsible,
Practice (2) Directors must take Active interest in the company’s affairs
(Based on 6th (3) Board - 1/3 Independent Non-executive Director
Edition LP) (4) Remuneration Committee– Chaired and Majority (Independent Non-executive Directors)
(5) Termination of auditors with the approval of shareholders in a general meeting
(6) At least 3 independent non-executive directors, of whom at least one must have appropriate
professional qualifications or accounting or related financial management expertise.
(7) Listed companies must also establish an audit committee comprising non-executive directors
only, with a minimum of three members, and at least one should hold a relevant
qualification.
(8) The Rules include a requirement for companies to include a Corporate Governance Report in
their annual report. [QP (B) 2017 Dec]

Model Code under Listing Rule

(9) A requirement of the Model Code of the Hong Kong Stock Exchange is that directors must
not deal in shares of their company when they are in possession of inside information. In
addition they must not deal in the company’s shares in the period 60 days before publication
of its annual results or in the period 30 days before publication of its quarterly results (if any)
and half-year results. [QP (B) 2017 Dec]

Codes (Corporate Governance Code, Corporate Finance Advisor Code of Conduct)

Corporate Governance Code

(1) Board review the time required from a director to perform his responsibilities
(2) Provide all directors with monthly updates giving a balanced and understandable
assessment of the issuer’s performance, position and prospects
(3) Issuer should have a corporate strategy and a long-term business model
(4) Composition of board – A balance of skills, experience and diversity of perspective
(5) Separation of chairman and CEO [QP (B) 2017 Dec]
(6) Internal Control – Sound and effective internal control to safeguard shareholders’
investment

Corporate Finance Advisor (CFA) Code of Conduct

Aims: Promote professional and ethical conduct, Set out recommended best practice, Consistent with
other regulations and guidelines, Accords with International standards

Content: Conduct of business, Competence, Conflicts of interest, Standard of Work, Duties to the
client, Communicate with regulators, Personal account dealings

Recommended Practice
Details of remuneration payable to members of senior management on an individual and named basis
are disclosed in the annual report [QP (B) 2017 Dec]

C8 Free float A rule specifying the minimum number of shares in public hands

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Techniques
No. Item Details
T1 Detailed
Listing
Rules

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16 Financial markets
Concepts
No. Item Details
C1 Capital market Capital market – Long term
/ Money Money market – Short term
market

C2 Efficient Form efficiency

market Weak – Prices reflect all relevant information about past price movement
hypothesis Semi-Strong – Past price movement and public information
Strong – Past price movement, public information and insider knowledge

C3 Central The risk can be mitigated by using a central counterparty (CCP)

Clearing of
Over-Counter
(OTC)
Derivative
contracts

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Techniques
No. Item Details
T1 Price-in Stock price – price-in the result announcement expectation; Surprise information may happen.

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17 Business valuations
Concepts
No. Item Details
C1 Valuation In general
Future Cash Flow (Ok) -> Discounted Cash Flow (Simplified Version – Dividend Model)
Estimation of g, cost of capital, growth rate, CF/Div

(-) -> Earning based valuation P/E (Compared with same industry)
One year only, Liquidity premium, Control Premium, Different in capital
Structure

(No) -> Net Asset Value Excluding Goodwill (For Min Acquisition price)
Goodwill treatment / Realisable Value or Replacement Cost

C2 Discounted 1. FCFF
Cash Flow Free Cash Flow from the Firm (Equity Owner and Long Term Debt Owner)
3 Parts
EBIT
-Tax on EBIT

Non Cash Item adjustments

+Depreciation
-Working Capital Increase

Cash Item not Included in Earning before

-Capital Expenditure

Value of Equity = Value of Firm – Value of Debt

Terminal Value = FCFF1/( r-g)

2. Earnings

3. Dividend

C3 Earning based 1. PE -> Equity Value

valuation 2. EV/EBIT (Industry) -> Firm Value (Equity + Debt)
3. EV/EBITDA (Industry) -> Firm Value (Equity + Debt)

C4 Net Asset Choice: Historical basis / Replacement basis / Realisable basis

Value 1. As a measure of the “security” in a share value
2. As a measure of comparison in a scheme of merger (Add on asset backing)
3. Floor value of a business

C5 Debt Valuation V = i / k (Similar to D of preference share / k or CF/k )

Perpetually

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Techniques
No. Item Details
T1 FCFF (Interest) Interest is excluded because interest costs are taken into account in the capital charge.(WACC)

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18 Mergers and acquisitions

Concepts

No. Item Details

C1 Merger Vertical: Supplier
|
Co
Vertical: Co
|
Chain Store

Horizontal Integration： e.g. Café De Coral --- Fairwood

Conglomerate Integration

C2 M&A M&A
Adv: Speed, Lower Cost, Intangible Assets, Overseas Markets
Disadv: Business risk, Financial Risk, Acquisition premium ($), Managerial Incompetence, Integration

Synergy – Revenue, Cost and Financial (Diversification, Cash slack, Tax benefits and debt capacity)

Reasons for Failure : Agency Theory, Error in valuing, Lack of goal congruence, Failure to integrate,
inability to manage change

Management Buy Out (Original Management Buy the Company)

Management Buy In

Earn-out Arrangement : Seller keep performed if still EARN for a while -> Money OUT (Remaining)

Cash offer vs Share Exchange

Acquirer : Consider
Dilution of EPS, Cost to the company, Gearing, Control, Authorised share capital increase, Borrowing
limits increases
Target: Consider
Taxation, Income, Future investments and share price

C3 Defensive Pre-bid : Communication w shareholders, Revalue non-current assets, Crown Jewels (Sell Valuable
Tactics Asset), Poison pill (Existing Shareholder increase share cheap), Change the Article of Association
(Super majority), Golden Parachute ($->Mgt)

Post bid: White Knight (Control), White Squires (No Control), Pacman, Competition Rule, Litigation
(Target: Invite regulator to stop)

C4 EPS - PE Target Low PE, predator will rise in EPS (Bootstrapping - Buy Low PE -> EPS Increase)
Target High PE, predator will fall in EPS

C5 Due Diligence Commercial, Financial, Legal and Others (Corporate culture, IT, Intellectual Property and
Environmental)

C6 The Global Due with 2 main agency problems:

regulatory Protection of Minority interests and stakeholder interests
framework

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C7 Key aspects of Mandatory bid rule
takeover
regulation

The principle of equal treatment

Transparency of ownership and control

The squeeze-out and sell-out rights

The one share-one vote principle

Board neutrality and anti-takeover measures

C8 Hong Kong
Specific
takeover
regulation
-Purpose

C9 Hong Kong 1. All shareholders are treated even-handedly.

Specific 2. Control Changes -> General offer 全面收購 to all other shareholders
takeover
3. During the course of an offer, neither an offeror nor the offeree company …may furnish
regulation
information to some shareholders which is not made available to all shareholders.
-The General
4. An offeror should announce an offer only after careful and responsible consideration
Principles
5. Shareholders should be given sufficient information.
6. Full and prompt disclosure
7. Right of control should be exercised in good faith.
8. Directors of an offeror and the offeree company must always, act only in their capacity as
directors.
9. At no time after a bona fide offer 真實 has been communicated…
10. Cooperation with the Executive, the Panel and the Takeovers and Mergers Appeal
Committee
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C10 Hong Kong
Specific
takeover
regulation
-Rules of the
Codes

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Techniques
No. Item Details
T1 Synergy No shareholder Wealth is changed by M&A only; Except if there is Synergy OR Change of Expectation
-the value of the combined group.

T2 Merger and 1. Lowering Gearing (Gearing Ratio)

Acquisition – 2. Asset Backing (Asset per Share)
Quantified 3. Lowering PE – Bootstrapping (PE)
Reasons 4. Synergies – (EPS or Value)

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19 Corporate reorganization and change

Concepts
No. Item Details
C1 Reconstruction Financial reconstruction
Portfolio reconstruction
Organizational restructuring

C2 Unbundling Divestments (Disposal of Assets)

Demergers (Splitting up of corporate bodies)

Sell-offs (Sell part of a company to 3rd parties)

Spin-offs (No change in ownership; New Company set)

Carve-outs (Detaching parts of company; New company set)

Management buy-outs (Manager buys)

Management buy-in (Outsider buys)

Leveraged buy-outs (LBO) (A publicly listed company acquired by a private company) with substantial
borrowing
Adv: costs of meeting listing requirements can be saved, protected from volatility in share prices, less
vulnerable to hostile takeover bids, concentrate on the long-term needs of the business, closer to
management in a private company
Disadv: the company loses its ability to have its shares publicly traded. If a share cannot be traded it
may lose some of its value.

Delisting
Reasons: No more Listing related costs, frees the company from certain transparency and disclosure
obligations, low stock market valuations, provides strategic and financial freedom

C3 Venture Venture capital may be provided to fund business start-ups, business development, MBOs and the
Capital purchase of shares from one of the owners of the business.

High Risk, Early Stage Investment, Exit Route identified.

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Techniques
No. Item Details
T1 Spinoff & New company is setup
Crave-out

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20 Business failure and insolvency

Concepts
No. Item Details
C1 Excessive High gearing policy / Capital losses / Complex ownership structure / Overtrading / Overpaying for an
Debt acquisition / Under-performance / Excess working capital / A recessionary economy

Overtrading – Rapid or excessive expansion activity without consideration of the ability of the
company’s management to manage or fund the strategy

C2 Common Cash management / Poor relationship with bank / Inadequate hedging of financial risk / Financial
problems with speculation / Fraud / Excessive borrowing
finance and
treasury Preventive measure – Regular CF forecasts / regular dialogue with its relationship bank / Approved
policy on financial gearing and borrowing / Strictly limits on permissible exposures

C3 Reasons for Inadequate management / Weak capital structure / Lack of financial management / High cost
business structure / Failure of big projects and acquisitions
failure
C4 Beaver’s
failure ratio

Less than 0.3 fail within five years

C5 Z-Score

Variations of the Z-score model have been developed. A version for private
companies (Z1 or Z') reflects that they do not have a market value for their
share capital. A version was also developed for emerging markets and nonmanufacturing
industrial companies (Z2 or Z''). The Z'' version omitted the
sales/total assets ratio, which was very sensitive to the industry and the
country.

In addition, interpretations of the original model have been developed as a

result of average Z-scores worldwide getting lower, with increased availability
of bond market finance.

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C6 Insolvency Voluntary winding-up (By Insolvent Company)
Involuntary winding-up (By Creditors)
Compromise – ¾ in value of the creditors
Financial reconstruction schemes

C7 Process of
Involuntary
Winding up

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Techniques
No. Item Details
T1 Z-score Modification is required for non-manufacturing companies.

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Calculator
No. Item Details
G1 Use of Texas Instruments BAII Plus
Calculator
(I) NPV

Yr 0 1 2 3
-10,000 5,000 5,000 5,000
Cost of Capital = 5%

[CF]
[2nd] [CLR WORK]
CF0=-10,000 [ENTER]
↓ C01= 5,000 [ENTER]
↓↓ C02=5,000 [ENTER]
↓↓ C03=5,000 [ENTER]
[NPV]
I = 5 [ENTER]
↓ NPV= [CPT]
3,616

IRR

Yr 0 1 2
-100 0 121
CF]
[2nd] [CLR WORK]
CF0= -100 [ENTER]
↓ C01= 0 [ENTER]
↓↓ C02= 121 [ENTER]
[IRR]
[CPT]
10

G2 Use of Texas Instruments BAII Plus

Calculator
(II) NPV

Yr 0 1 2 3 4 5 6 7 8 9 10
56 56 56 56 56 56 56 56 56 1056
Cost of Capital = 6%

[CF]
[2nd] [CLR WORK]
CF0=0 [ENTER]
↓ C01= 56 [ENTER]
↓ F01= 9 [ENTER]
↓ C02= 1,056 [ENTER]
[NPV]
I = 6 [ENTER]
↓ NPV= [CPT]
970.56

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G3 Use of Texas Instruments BAII Plus
Calculator
(III) TVM

Calculate PMT (Setting END)

[2nd] CLR TVM

1000 [PV]
4 [I/Y]
10 [N]
[CPT] [PMT]

PV=1000; I/Y = 4; FV=0; N= 10; CPT PMT = -123.29

Calculate FV (Setting END)

[2nd] CLR TVM
-10 [PMT]
30 [N]
3 [I/Y]
[CPT] [FV]

PV= 0; PMT=-10; N= 30; I/Y=3 CPT FV = 475.75

If BGN shown, Change to BGN to END

[2nd] BGN
[2nd] SET

If No BGN shown (It means END) Change to END to BGN

[2nd] BGN
[2nd] SET

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Techniques
No. Item Details
T1 Annuity Texas Instruments BAII Plus
Calculation
Annuity Factor calculated by NPV

Yr 0 1 2 3 4 5 ……9
1 1 1 ……… 1

Cost of Capital = 15%

[CF]
[2nd] [CLR WORK]
CF0=0 [ENTER]
↓ C01= 1 [ENTER]
↓ F01= 9 [ENTER]
NPV]
I = 15 [ENTER]
↓ NPV= [CPT]
4.7716

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QS - Calculator
P.67 Kin W. Chan