Contents. Section A Introduction. vii

Transcription

1 Contents Preface...xxv What does the book offer?...xxvi What resources does the book offer to the instructor?...xxix How does the book fit in with SAICA s competency framework for financial management?...xxxi Section A Introduction Chapter 1 Overview of financial management Learning objectives Introduction The context of financial management Development of financial management Links with economics Links with accounting The environment of financial management Forms of business organisations Taxation Taxation of company profits Dividend withholding tax What is the fundamental objective of financial management? Why is profit maximisation not the right objective for corporate finance? Manipulation of accounting profits Accounting profits and the cost of capital Risk Shareholders want management to maximise value Focus of financial management on decision-making Economic Value Added (EVA) What about the ethics of maximising value? The role of the financial manager Opportunities to create wealth Investment in operating assets Investment in financial assets Selecting the optimal finance mix Finance from capital markets The interaction of investment and financing decisions From the real world: BHP Billiton and Pioneer Foods Fundamental concepts of corporate finance Present Value Time value of money Risk and return No Arbitrage Principle Efficient markets Portfolio theory Capital asset pricing model Financial analysis Do managers act in the interest of shareholders? Management incentives, share options and the financial crisis Another agency problem: shareholders and bondholders Doing the right thing: ethics in business and King III Corporate Governance and King III The Board of Directors Sustainability and integrated reporting vii Financial_chapter 00_new.indd 7

2 Risk management The governance of Information Technology (IT) and its role in corporate finance Solvency and liquidity tests Business rescue Does corporate governance pay? Auditors Corporate Strategy Porter s Five Forces Model Rivalry among existing firms Threat of substitute products Threat of new entrants and barriers to entry Bargaining power of buyers Bargaining power of suppliers Competitive strategies: cost leadership and differentiation SWOT analysis PEST or STEP analysis Sustainability related issues Structure of the text Summary Appendix 1.1 Professional ethics and codes of conduct Appendix 1.2 Stakeholder considerations and good corporate citizenship Questions Section B Foundations for decision-making Chapter 2 The time value of money Is compound interest the most powerful force in the universe? Learning objectives Introduction Future value Single amount, single period Single amount, multiple periods, annual interest compounded Single amount, multiple periods, non-annual compounding Annual effective rate Continuous compounding Interpolation Series of investments, ordinary annuity (FVA) multiple investments and multiple periods Series of investments, annuity due Future values when the timing of the cash flows and the compounding periods differ Present values Single amount, single period, annual discounting Single amount, multiple periods, annual discounting Stream of cash flows, ordinary annuity (PVA) Stream of cash, annuity due Stream of cash flows, deferred annuity Uneven stream of cash flows Perpetuities Growing perpetuities Growing annuity Inflation and real returns Some real-world applications Retirement planning Loan amortisation schedules Mortgage loan viii Financial_chapter 00_new.indd 8

3 4 Financial calculators and spreadsheets Using financial calculators Using Excel spreadsheets The role of interest rates The expectations theory The liquidity preference theory The market segmentation theory Applying the time value of money principles to bonds Summary Self-study problems Solutions to self-study problems Questions Chapter 3 Risk and return The 21st Century: a time of financial crisis and recovery for equities Learning objectives Introduction The concept of risk Business risk Financial risk Total company risk Measuring expected return and risk Measuring the expected return on a single share Measuring risk for a single share The mean variance rule Interpreting the summary statistics Properties of a normal distribution Comparison of single shares Co-efficient of variation The z score Co-variance and correlation Risk and return in financial markets Emerging markets Volatility and time periods: the Rip van Winkle solution to risk What does Warren Buffett think? Risk-adjusted measures of performance From the real world: Unit Trust Funds Summary Self-study problems Suggested solutions Questions Chapter 4 Portfolio management South African unit trusts invest offshore to diversify risk Learning objectives Introduction Two-asset portfolio risk and return Measuring two-asset portfolio returns The principles of portfolio risk Measuring two-asset portfolio risk Positioning an investor on the efficient frontier Multiple-share portfolio risk and return The benefits of diversification Introducing a risk-free asset Beta analysis Beta as a measure of a portfolio risk ix Financial_chapter 00_new.indd 9

4 Beta and the capital asset pricing model (CAPM) The efficient markets hypothesis The weak form The semi-strong form The strong form Testing for market efficiency Weak-form tests Semi-strong form tests Strong form tests Evidence of the efficiency of the JSE Is the CAPM used in practice? Summary Guidance to portfolio management: the risk and return concepts linking Chapters 3 and Self-study problem Suggested solutions Appendix 4.1 Calculating the beta co-efficient Appendix 4.2 Perspectives: Estimating the beta co-efficient Appendix 4.3 Perspectives: Behavioural finance Questions Chapter 5 Financial statement analysis Companies and investors employ financial ratios to evaluate performance Learning objectives Introduction Annual financial statements and the Integrated Report Integrated Report Annual Financial Statements Statement of Comprehensive Income (Statement of Profit or Loss and Other Comprehensive Income) Statement of Financial Position Statement of Cash Flows Objectives of financial analysis and stakeholders Shareholders Credit grantors Management Employees Customers Suppliers Acquisition and merger analysts Auditors Government Limitations of accounting data Monetary expression Simplification and summarisation Flexible accounting policies Inflation Approaches to financial statement analysis Comparative financial statements Index analysis Common size analysis Ratio analysis Application of ratio analysis Liquidity ratios Asset management ratios Debt management ratios x Financial_chapter 00_new.indd 10

5 Profitability ratios Cash flow ratios Market value ratios Structured ratio analysis Du Pont analysis Failure prediction Financial distress models Limitations of ratio analysis Economic Value Added (EVA ) The use of EVA to measure performance at SABMiller Perspectives on EVA by Joel Stern What s behind the numbers? Understand the business and the industry sector Understand management s motives for selecting accounting policies Understand the key drivers of value Understand which accounting policies are flexible Accounting for leases Understand the warning signs Understand the business and financial risks facing the company Sensitivity analysis Further factors to consider when analysing a company From the real world Summary Guidance on Financial Analysis Self-study problems Solutions to self-study problems Appendix 5.1 Sustainable growth Questions Chapter 6 Valuations Pricing on the JSE and value: why Edcon used valuation principles to go private Learning objectives Introduction Valuation an overview What are the fundamental building blocks of a valuation? The effect of risk and return on valuations Required rate of return Valuation of debentures and bonds Debentures and bonds in perpetuity Redeemable debentures and bonds From the real world Valuation of preference shares Cumulative non-redeemable preference shares Non-cumulative preference shares Redeemable preference shares Valuation of ordinary equity Dividend discount model Constant growth in dividends Limitations Valuing shares with a non-constant growth rate From the real world: Woolworths Price multiples (relative valuation) The price-earnings (P/E) ratio Using EBITDA or EBIT multiples to determine enterprise value Market to book ratio Price to sales ratio xi Financial_chapter 00_new.indd 11

6 Free cash flow model (discounted cash flow model) Terminal values The Economic Value Added (EVA TM ) approach Valuation of rights The impact of share options on equity valuations Valuations and the financial manager Pitfalls Challenges Perspectives: Valuations in the real world Summary Self-study problems Solutions to self-study problems Appendix 6.1 Lack of marketability discount and other adjustments Appendix 6.2 Exploring selected issues in valuations Appendix 6.3 Perspectives: the subjective nature of valuations Questions Chapter 7 The cost of capital The weighted-average cost of capital (WACC) and the financial crisis Learning objectives Introduction The weighted-average cost of capital The weighted-average cost of capital principles and formula The pooling of funds approach Component costs of capital Cost of new debt (Kd) The cost of debt and Section 24J of the Income Tax Act Cost of preference shares (Kp) Cost of shareholders equity Dividend yield and growth method Capital asset pricing model (CAPM) Bond yield plus a risk premium method Weighting components of capital structure Calculating the WACC Breaks in the WACC Funds from the non-cash flow items Estimating the cost of capital of divisions Operating leases, capital structure and the weighted-average cost of capital The weighted-average cost of capital some practical issues The risk-free rate The market (equity) risk premium Surveys Using the dividend growth model to determine the market risk premium Other indicators of the market risk premium Warren Buffett s view Betas Adjustments to the cost of equity and WACC The financial crisis, emerging markets and the cost of capital Taxation The role of hurdle rates From the real world: The cost of capital of South African firms Summary Guidance on cost of capital Appendix 7.1 CAPM and the Fama-French Three-Factor Model Does CAPM work? Fama-French Three-Factor Model xii Financial_chapter 00_new.indd 12

7 Self-study problems Solutions to self-study problems Questions Section C Investment decisions Chapter 8 Capital budgeting Expanding horizons: Kumba scales up production to meet demand for iron ore Learning objectives Introduction Types of investment projects Replacement or expansion Independent and mutually exclusive projects Divisible and indivisible projects Capital budgeting techniques Net present value (NPV) The internal rate of return (IRR) Payback method Accounting rate of return Discounted payback The profitability index Modified internal rate of return Economic Value Added (EVA ) or economic profit Cash flow determination Beginning-of-project cash flows Annual operating cash flows Cash flow determination some rules Taxation Depreciation allowances Recoupments and scrapping allowances Taxation effects of replacement decisions Capital Gains Tax End-of-project cash flows Application Post-audits Summary Self-study problems Solutions to self-study problems Guidance on capital budgeting Appendix 8.1 NPV/IRR: Conflict in rankings Questions Chapter 9 Further issues in capital budgeting It is Ayoba time! Connecting Africa and the Middle East Learning objectives Introduction Comparing projects with unequal lives Unequal lives and project evaluation Replacement chains Equivalent annual annuities Equivalent annual costs Capital budgeting under inflation Inflation and the discount rate Investment bias Discounting cash flows at the real rate of return xiii Financial_chapter 00_new.indd 13

8 Depreciation deductions Adjusted real approach Capital rationing Capital constraints and project rankings Profitability index The ranking of indivisible projects Multi-period capital rationing Further perspectives on capital rationing Assessed tax losses The utilisation of assessed losses New ventures and ring-fencing provisions Synopsis Abandonment value and optimal economic lives Continuing evaluation Optimal economic life Replacement timing Real (strategic) options Examples of real (strategic) options Self-study problems Solutions to self-study problems Summary Appendix 9.1 Capital budgeting in the real world Appendix 9.2 Multiple internal rates of return Questions Chapter 10 Capital budgeting: Risk analysis A golden sunset Learning objectives Introduction Traditional measures of risk Expected value and probability distributions The Hillier model for multiple periods A note on expected values, probabilities and firm size Decision trees Certainty equivalents Sensitivity analysis Break-even analysis Zero net present value Accounting break-even analysis Scenario analysis Abandonment and expansion Monte Carlo simulation The capital asset pricing model Project beta of an all-equity firm Financial leverage and project betas More on market risk Risk-adjusted discount rates versus certainty equivalents Risk-adjusted discount rates versus the weighted-average cost of capital Further thoughts on risk analysis in capital budgeting Future uncertain cash outflows Volatility and risk a case study Corporate strategy and project risk Project management, project failure and other factors Self-study problems Solutions to self-study problems Summary xiv Financial_chapter 00_new.indd 14

9 Appendix 10.1 Capital budgeting risk analysis with Excel Questions Chapter 11 Working capital Every cloud has a silver lining Learning objectives Introduction What is working capital? The objective of working capital policy The working capital cycle The impact of inflation on working capital policy The impact of changes in sales on working capital policy Working capital policies Working capital financing policies From the real world Working capital management by small business Working capital strategies and cash flows Working capital management around the world Forecasting working capital requirements Forecasting sales Factors to be considered Subjective forecasting Objective forecasting Summary Self-study problems Solutions to self-study problems Questions Chapter 12 Current asset management and short-term financing Cash is King Learning objectives Introduction Credit policy Creditworthiness Setting the collection policy Setting settlement discount policy Analysing the impact of a change in credit policy on profitability Analysing the impact of a change in credit policy: net present value analysis Accounts receivable management Making money out of offering credit to customers From the real world: Truworths and Mr Price Inventory management Inventory models Inventory control systems Just-in-time (JIT) inventory management Supply chain management (SCM) From the real world: Shoprite Cash management Reasons for holding cash The management of float, cash concentration and electronic funds transfer Cash budgets Financing current assets Accruals Trade credit Factoring and invoice discounting Bank overdrafts Bankers acceptances (bank bills) xv Financial_chapter 00_new.indd 15

10 Revolving credit facility Repurchase agreements (Repo market) Short-term financing: advantages and disadvantages Summary Guidance on working capital Self-study problems Solutions to self-study problems Appendix 12.1 The derivation of the Economic Order Quantity (EOQ) model Questions Section D Financing decision Chapter 13 Sources of finance A lion retreats Learning objectives Introduction Financial markets Classification of financial markets Interaction between market classifications The Johannesburg Stock Exchange Alternative Exchange AltX The Development Capital Market (DCM) Alternative methods of obtaining a listing Raising capital by listed companies Setting an issue price Rights issue Some facts about market liquidity The JSE Derivatives Market The JSE Debt Market (Interest Rate Market) Financial institutions Banks Investment institutions Private equity and venture capital Special institutions Equity-related instruments Ordinary shares Retained earnings Preference shares Debt instruments Corporate bonds, notes and debentures Long-term loans Bank loans Fixed interest rate loans Variable interest rate loans Credit ratings Short-term debt Hybrid instruments Comparison of debt and equity Return Risk Control From the real world corporate bonds and borrowings Inflation-linked bonds Alternative sources of finance Peer-to-peer lending xvi Financial_chapter 00_new.indd 16

11 Crowdfunding Online invoice trading platforms Supply chain finance Financing for black economic empowerment (BEE) entities From the real world: An analysis of the Metropolitan and ABSA BEE transactions Guidance when presented with problems relating to sources of finance Summary Self-study problems Solutions to self-study problems Questions Chapter 14 Capital structure Learning objectives Introduction Risk profile Business risk Financial risk Leverage (gearing) Impact on earnings Impact on risk Optimal capital structure The Modigliani-Miller approach Trade-off theory Pecking order and signalling theories Debt financing, free cash flow and conflicts between management and shareholders Agency costs and inverted incentives: conflicts between shareholders and bondholders Investing in high risk projects Running off with the money No further investment by shareholders Playing for time Changing the capital structure of the firm The use of loan covenants to manage shareholder and bondholder conflicts From the real world: Loan covenants at Aspen and Gold Fields The impact of inflation The need for flexibility Target capital structure Short-term deviation from target Financial flexibility Market timing theory Debt and tax shields Financial leverage and a firm s weighted-average cost of capital Personal taxes Capital structures in South Africa and around the world From the real world Edcon: capital structure and valuation of tax shields Summary Guidance on capital structure Self-study problems Solutions to self-study problems Questions Chapter 15 Leasing Leasing in the airline sector is no laughing matter Learning objectives xvii Financial_chapter 00_new.indd 17

12 Introduction Types of leases Operating leases Financial leases Structuring of leases Direct lease Sale and lease-back Leveraged lease What are the effects of leasing on financial statements? What are the requirements of the International Accounting Standard (IAS17)? What is wrong with the analysis and accounting for leases? A new Accounting Standard for Leases: all non-property leases are now finance leases Advantages of leasing Changing technology Tax advantages Obtaining 100% debt financing Operating flexibility Reduction in operating leverage Coping with uncertain demand Specialisation effects on maintenance, residual values and purchase costs Standardisation of contracts Fewer restrictions Off-Statement of Financial Position financing Avoidance of capital expenditure controls and budgetary constraints Evaluating the leasing decision Selecting an appropriate discount rate Calculating the net present cost The net advantage of leasing and NPV From the real world The adjusted present value approach Summary Self-study problems Solutions to self-study problems Appendix 15.1 Operating lease capitalisation and other pertinent leasing issues Questions SECTION E INTEGRATED DECISIONS Chapter 16 Dividends and share buy-backs The dividend cut that made headlines around the world Learning objectives Introduction Dividend relevance active variable or passive residual? The residual approach to dividends Factors affecting the dividend decision The legal requirements of the Companies Act 71 of 2008: solvency and liquidity tests Contractual obligations Information content of dividends Taxation The nature of shareholders Dividend payment policies Stable dividend amount Stable payout ratio Stable dividend plus special dividend The payment of dividends What happens to the share price when a share goes ex-dividend? xviii Financial_chapter 00_new.indd 18

13 Share splits and capitalisation issues From the real world: Sub-division of the ordinary share capital of Assore Dividend reinvestment plans (DRIPs) and scrip dividends Share buy-backs What is the effect of a share buy-back on the Statement of Financial Position of a company? Why should companies repurchase their own shares? Requirements and consequences of engaging in a share buy-back From the real world Dividends in specie Dividend yields Summary Dividend policy and share repurchases: what is the evidence in South Africa Analysing the distribution decision guidance and practical application Self-study problems Solutions to self-study problems Questions Chapter 17 Mergers, acquisitions and corporate restructuring The Edcon leveraged buy out: American and Irish bonds Learning objectives Introduction Types of mergers Reasons for mergers Operating economies Managerial skills Tax considerations tax shield and assessed losses Use for excess liquidity Diversification Lower financing costs Replacement costs Technology Products, product pipeline and reserves The structuring of takeover offers and taxation Financing costs Capital Gains Tax (CGT) and Dividend Withholding Tax (DWT) Depreciation and wear and tear deductions Further issues to consider in acquiring shares or assets Are mergers successful? Terms of mergers Acquisition financed by cash Acquisition financed by share issue Post-merger price-earnings ratio Sharing the merger benefit Setting an offer Dividends, working capital and net asset value Dividends Working capital Net asset value Reverse takeovers Defensive tactics Proactive measures Reactive measures Legal procedures Regulation of takeovers Unbundling and spin-offs xix Financial_chapter 00_new.indd 19

14 Advantages Disadvantages Leveraged buy-outs Business rescue and the corporate restructuring of financially troubled companies Financial distress Is business rescue a viable option? The direct costs of bankruptcy/liquidation and business rescue Workouts What can the directors do to improve the chances of success of a business rescue From the real world Advising a financially troubled company South African mergers Amalgamated Banks of South Africa (ABSA) The hostile Nedcor bid for Standard Bank Investment Corporation The JD Group, Ellerines and African Bank The Nedcor BoE merger BHP Billiton The hostile Harmony takeover bid for Goldfields The takeover of ABSA by Barclays plc MTN acquisition of Investcom LLC AfriGroupe acquires AFGRI The unbundling of Goldfields gold mines into Sibanye Gold Vodacom s proposed acquisition of Neotel The battle for Adcock Ingram Woolworths acquisition of David Jones Summary Self-study problems Solutions to self-study problems Appendix 17.1 Mergers and acquisitions an overview and alternative approach to calculate exchange ratios Appendix 17.2 Due diligence Appendix 17.3 Business rescue in South Africa Questions Chapter 18 Risk management and derivatives What does Warren Buffett think about derivatives Learning objectives Introduction Risk management strategies Interest rate risk Refinancing risk Liquidity risk Currency risks Credit risk Market and commodity price risks General risks Rationale for financial innovation Fundamental derivative instruments Options Valuation of options Replicating portfolio Black-Scholes Option Pricing Model Put-call parity Using Excel to determine Black-Scholes option values The Binomial Option Pricing Model xx Financial_chapter 00_new.indd 20

15 Options, the Greeks and implied volatility Futures and forward contracts Pricing of futures and forward contracts Risk-reducing techniques Natural hedges (operational hedging) Hedging with futures, forwards, and options From the real world: SAA and hedging in the gold mining industry What does Warren Buffett think? Contracts for difference (CFD) Interest rate risk Hedging with interest rate swaps Duration and immunisation Hedging interest risk with Floors, Caps and Collars From the real world: SABMiller Derivative use by South African companies Return-generating techniques Asset securitisation Tax arbitrage Convertible securities Summary Solutions to self-study problems Self-study problems Appendix 18.1 Employee share options share based payments From the real world Appendix 18.2 Option trading strategies Appendix 18.3 A short introduction to hedge funds Appendix 18.4 Securitisation, banks and the financial crisis Questions Chapter 19 International financial management The end of the affair Learning objectives Introduction Historical perspective The balance of payments Current account Capital account Official reserves The foreign exchange market Direct and indirect quotations Bid ask spread Mid-rate Spot and forward transactions Points Forward rate and premium/discount Cross rates Forces behind exchange rate movements Interest rate parity The purchasing power parity theory (PPP) Big Mac exchange rates Integrating the interest rate parity and purchasing power parity theories Forecasting exchange rates Foreign exchange exposure Translation exposure Transaction exposure Economic exposure xxi Financial_chapter 00_new.indd 21

16 From the real world Hedging policies Forward contract Money-market hedge Currency options Currency of invoice Leads and lags Futures contracts Currency swaps Exchange control Covered-interest arbitrage The eurodollar market Offshore financing by South African companies Offshore borrowings Listing on foreign stock exchanges Documentary letters of credit Analysis of foreign investments Determination of future cash flows Determination of discount rate International portfolio diversification Analysis of a major project by BHP Billiton Summary Self-study problems Solutions to self-study problems Questions Chapter 20 Business planning and financial modelling It s a journey, not a destination Learning objectives Business plans What are the advantages of preparing a business plan? The content and structure of a business plan Background/strategy Products and services Markets and marketing strategies Operations and production process Management and executive team Legal, social and environmental factors Financial information and projections The components of the financial projections section Sensitivity and scenario analysis Porter s Five Forces What other factors will play a role in the financing decision? From the real world: Invenfin From the real world: Industrial Development Corporation Financial modelling The design and layout of financial models Avoiding spreadsheet errors The use of spreadsheet models in corporate finance The application of what-if analysis in Excel Financial models and topics in corporate finance Financial modelling and forecasting financial statements: an application Goal seek, data tables and sensitivity analysis Circular references in Excel Summary xxii Financial_chapter 00_new.indd 22

17 Appendix 20.1 Examples of Scenario Manager, Tornado Graph and Monte Carlo Simulation Appendix 20.2 Spreadsheet modelling for selected topics in corporate finance Chapter 21 Corporate Strategy and Business Models Corporate strategy and industry analysis What is strategy? Matrix models Michael Porter s Five Forces model Rivalry among existing competitors Threat of new entrants and potential competitors Threat of substitutes The power of customers The power of suppliers Porter s value chain Porter s four corners analysis Other strategic factors Analysis of competitors and customers Product life cycle The building blocks of a business model Customer segments Value propositions Channels Customer relationships Revenue streams Key resources Key activities Key partnerships Cost structure Disruptive technologies, 3D printing and the role of big data Summary Tables...T-2 Index... I-1 xxiii Financial_chapter 00_new.indd 23