## Info

(b) The concept of proportional rate In our example of a loan at 10 , we would say that the 5 rate over six months is proportional to the 10 rate over one year. More generally, two rates are proportional if they are in the same proportion to each other as the periods to which they apply. 10 per year is proportional to 5 per half-year or 2.5 per quarter, but 5 half-yearly is not equivalent to 10 annually. Effective annual rate and proportional rates are therefore two completely different...

## Tv

Where r is the market (free-risk) interest rate, TV is the terminal value and N the horizon of analysis. The duration of assets can be alternatively interpreted as 1 a measure of when, on average, the cash flows on the assets come due 2 a measure of sensitivity of asset value to a 1 change in interest rates. An alternative - and conceptually better - measure of duration can be obtained regressing the changes in asset value (for listed companies) or in the operating income (for listed, unlisted...

## The predominance of npv and the importance of irr

Each investment has a net present value (NPV), which is equal to the amount of value created. Remember that the net present value of an investment is the value of the positive and negative cash flows arising from an investment, discounted at the rate of return required by the market. The rate of return is based upon the investment's risk. From a financial standpoint, and if forecasts are correct, an investment with positive NPV is worth making since it will create value. Conversely, an...

## The Dividend Discount Model DDM

The DDM is based on the assumption that the value of a company is given by the stream of dividends the investor expects to receive over a period of time. Assuming that the growth rate of dividends and the cost of equity are constant from 0 to to and the growth rate of dividends cannot exceed the cost of equity, then we can say -rewriting the Gordon formula (Chapter 27) - that the cost of equity is What if there are no dividends In Chapter 38 it is shown that many companies around the world do...

## Section

In 2005 sales dropped slightly due to volume and price effects. In 2006 and 2007 sales picked up again thanks to volume effect (price and mix effect being close to 0 due to pressure on prices from Asian competition). Indesit has succeeded in developing sales in countries with lower equipment rate (mainly eastern Europe and Russia). Operating margin dropped from 6.8 to 5.2 as Indesit fell victim to a scissors effect, not being able to pass on to clients the sharp increase in raw material costs...

## Dividend distribution in practice

1 Payout ratio and dividend growth rate In practice, when dividends are paid, the two key criteria are the rate of growth of dividends per share the payout ratio (d), represented by All other criteria are irrelevant, frequently inaccurate and possibly misleading. For example, it is absurd to take the ratio of the dividend to the par value of the share since par value often has little to do with equity value. Hence the difficulty for a company of meeting a dividend yield objective. It is the...

## Reconciling the different methods of valuation

If markets are efficient, all of the valuation methods discussed so far should lead to the same valuation. In reality, however, there are often differences among the sum-of-the- parts value, the DCF-based value and the peer-comparison value. You must analyse the source of these differences and resist the temptation to average them 17 Breakup of ABNAmro, Scottish & Newcastle, Hagemayer. (a) Analysing the difference between sum-of-the-parts value and discounted cash flow value If the...

## Restrictive covenants

We shall discuss the four main types of covenants, but our list is far from comprehensive. They can concern corporate investment and production policies net debt and subsequent debt issues early redemption provisions. (a) Corporate investment and production policies The purpose of such covenants is chiefly to protect debtholders against the possibility that the firm will substitute more risky assets for the existing ones. Any investment in other companies, mergers, absorption or asset disposals...

## Separating management control from financial control

(a) Different classes of shares shares with multiple voting rights and non-voting shares As an exception to the general rule, under which the number of votes attributed to each share must be directly proportional to the percentage of the capital it represents (principle of one share, one vote), companies in some countries have the right to issue multiple-voting shares or non-voting shares. In the Netherlands, the USA and the Scandinavian countries, dual classes of shares are not unfrequent. The...

## THE limits of limited liability

Modern economies are based largely on the concept of limited liability, under which a shareholder's commitment can never exceed the amount invested in the company. It is this rule that gives rise to the conflicts between creditors and shareholders and all other theoretical ramifications on this theme (agency theory). In bankruptcy, managers can be required to cover liabilities in the event of gross negligence. In such cases, they can be forced to pay back creditors out of their own pockets,...

## Startup costs

Startup costs are costs incurred in relation to the creation and the development of a company, such as incorporation, customer canvassing and advertising costs incurred when the business first starts operating, together with capital increase, merger and conversion fees. Impairment losses are netted off directly against assets, and provided that these losses are justified, there is no need for any restatements. Conversely, we regard impairment losses on tangible assets as nonrecurring items. As...

## General features of corporate financing

Corporate managers have at their disposal a wide range of products for financing or investing cash surpluses. These products differ in terms of type of counterparty, maturity and seniority of redemption rights as well as the existence of collateral or accounting, legal and tax advantages. However, this wealth of options can become confusing when trying to compare the actual cost of the various products. We therefore distinguish between bank and market products (or intermediated vs. market...

## More on the shareholders required rate of returns

Shareholders cannot demand more from their investments than is warranted by the degree of risk. We refer here to the mythical figure of 15 , which is frequently proclaimed to be the minimum return required. In our view, this is a pipedream. Under current market conditions, a return of about 10 on a share with average risk seems reasonable. This corresponds to the 10-year government bond rate of about 4.5 , plus a risk premium of 5.5 . Expecting 15 is too demanding and completely unjustified,...

## Strengthening the position of loyal shareholders

In some countries, a company can issue new shares on terms that are highly dilutive for the existing shareholders. For example, to fend off a challenge from activist shareholders, the Philadelphia bank, Sovereign Bank, issued 25 of its share capital to the banking group Santander in 2006. The new shares can be purchased either for cash or for contributed assets. For example, a family holding company can contribute assets to the operating company to strengthen its control over this company....

## Usa

Whereas a control premium can (and must) be justified by subsequent synergies, there is no basis for a minority discount. In fact, a shareholder who already has the majority of a company's shares may be forced to pay a premium to buy the shares held by minority shareholders. On average in Europe, the premium paid to buy out minorities is in the region of 20 , less than that paid to obtain control. Indeed, majority shareholders may be willing to pay such a premium if they need full control over...

1 1 Market value of the firm 1 Financial distress and agency costs - Kd - Ke - K 1 1 Market value of the firm 1 Financial distress and agency costs - Kd - Ke - K According to the extended tradeoff model, the optimal leverage is obtained where the weighted average cost of capital reaches the minimum point k . This is also the point where the value of the company is maximised. In our example, this value is around 11.9 while the optimal leverage ranges between 15 and 25 . As always, a word of...

## Exchangeable bonds

An exchangeable bond is a bond issued by one company that is redeemable in the shares of a second company in which the first company holds an equity interest. Thus while a convertible bond can be exchanged for specified amounts of common stock in the issuing firm, an exchangeable bond is an issue that can be exchanged for the common stock of a company other than the issuer of the bond. At maturity, two cases are possible. If the price of the underlying shares has risen sufficiently, holders...

## Capital employed and invested capital

So far in our analysis, we have looked at inflows and outflows, or revenues and costs during a given period. We will now temporarily set aside this dynamic approach and place ourselves at the end of the period rather than considering changes over a given period and analyse the balances outstanding. For instance, in addition to changes in net debt over a period we also need to analyse net debt at a given point in time. Likewise, we will study here the wealth that has been accumulated up to a...

## Sensitivity analysis

One important risk analysis consists in determining how sensitive the investment is to different economic assumptions. This is done by holding all other assumptions fixed and then applying the present value to each different economic assumption. It is a technique that highlights the consequences of changes in prices, volumes, rising costs or additional investments on the value of projects. To perform a sensitivity analysis, the investor 1 fixes a base-case set of assumptions and calculates the...

## Definition

In the United States, for example, companies do not have to pay taxes on 70 of the preferred dividends they receive on preference shares investment they have made in other firms. This tax saving might then be shared with the issuing company, enabling the company to bring the preferred dividend rate down. Preference shares are created on the occasion of a capital increase by the decision of the shareholders at an extraordinary where applicable general meeting. The...

## The evidence from the real world

According to conventional wisdom, there is an optimal capital structure that maximises enterprise value by the judicious use of debt and the leverage it offers. This enables the company to minimise its weighted average cost of capital - that is, the cost of financing. Why do we say that Because there is enough evidence showing that the leverage of companies is not highly volatile. If the leverage doesn't change so often it means that companies are generally satisfied with the level of debt they...

## Pros and cons of the cash flow approach

The advantage of the discounted cash flow approach is that it quantifies the often implicit assumptions and projections of buyers and sellers. It also makes it easier to keep your feet closer to the ground during periods of market euphoria, excessively high valuations and astronomical multiples. It forces the valuation to be based on the company's real economic performance. You might be tempted to think this method works only to estimate the value of the majority shareholder's stake and not for...

## THE impact of future transactions

When equity-linked securities convertible bonds, mandatory convertibles, bonds with warrants attached, stock options, etc. have been issued, financial managers must factor these potential new shares into their per-share data. Here again, we must adjust in order to obtain an average number of outstanding shares. As there is at least potential dilution, we have to assume full conversion in calculating the per-share data EPS, BV S, etc. on a fully diluted basis. This is easy to do for convertible...

## EQUITY lines

The way an equity line works is that a company issues warrants to a bank which exercises them at the request of the company when it needs to raise equity. Equity lines smooth the impact of a capital increase over time. The shares issued when the warrants are exercised are immediately resold by the bank. The strike price is the average price over a short period 5 days in recent operations , less a discount of about 10 . The number of warrants that can be issued at any one time depends on the...

## Mandatory convertibles

Unlike convertible bonds, for which there is always some risk of nonconversion, mandatory convertibles are necessarily transformed into equity capital unless the issuing company goes bankrupt in the meantime since the issuer redeems them by delivering shares no cash changes hands at redemption. Mandatory convertibles are hybrid securities, which automatically convert into a predetermined number of shares dependent on the stock price at the time of conversion. They are closer to equity than debt...

## Section 254 Medium term notes

A medium term note MTN is essentially a plain vanilla debt security generally with a fixed coupon and maturity date. MTNs are generally noncallable, unsecured, senior debt securities with investment-grade ratings. Notes can be issued either as bearer or registered securities. There are two important differences between MTNs and corporate bonds 4 Certain MTN issues are underwritten by investment banks, making them indistinguishable from the distribution process MTNs are normally sold on a...

## Cash Flow Return On Investment CFROI

The original version of cash flow return on investment CFROI corresponds to the average of the internal rates of return on the company's existing investments. It measures the IRR earned by a firm's existing projects. CFROI is the internal rate of return and it is equal to 1 the company's gross capital employed GCE , i.e. before depreciation and adjusted for inflation. GCE is computed by adding depreciation back to the book value of the assets to arrive at an estimate of the original investment...

## Evolution Of Financial Indicators

Accounting, economic and stock market criteria Cash flow return on investment CFROI ROCE-WACC NAV, EVA or Economic profit, MVA, TSR Predictably, the indicators cluster around a diagonal running from the upper left-hand corner down to the lower-right hand this reflects the companies' diminished ability to manipulate the indicators over time. Gradually, investors become more experienced and financial markets become more influential, and therefore are less prone to misinterpreting company data....

## The Arbitrage Pricing Theory apt

In some ways, the APT Arbitrage Pricing Theory model is an extended version of the CAPM model. CAPM assumes that the return on a security is a function of its market risk and therefore depends on a single factor market prices. The APT model, as proposed by Stephen Ross, assumes that the risk premium is a function of several variables, not just one, i.e. macroeconomic variables V1, V2 Vn , as well as a company noise. rJ a b1 x ryi bi x V bn x rvn Company specific variable The model does not...

## An assessment of a companys accounting policy

We cannot overemphasise the importance of analysing the auditors' report and considering the accounting principles adopted before embarking on a financial analysis of a group's accounts based on the guide that we will present in Section 8.4. If a company's accounting principles are in line with practices, readers will be able to study the accounts with a fairly high level of assurance about their relevance, i.e. their ability to provide a decent reflection of the company's economic reality....

## Two ways of analysing the balance sheet

A balance sheet can be analysed either from a capital-employed perspective or from a solvency-and-liquidity perspective. In the capital-employed analysis, the balance sheet shows all the uses of funds for the company's operating cycle and analyses the origin of its sources of funds. A capital-employed analysis of the balance sheet serves three main purposes to understand how a company finances its operating assets see Chapter 12 to compute the rate of return either on capital employed or on...

Among factors used in determining risk, the criteria by which liquidity can be measured size, free float, transaction volumes, bid-ask spread are often statistically significant. In other words, the required return on a security often appears to be a function of liquidity. In order to avoid confusion, it is preferable to separate the liquidity premium due to free float, transaction volumes, bid-ask spread from the so-called size premium. Size premium is the additional remuneration due to the...

## Case study indesit

Is Indesit solvent end of 2007 Yes, as it has equity of 580m and intangible assets and goodwill of 406m. In addition, although the value of intangibles is always questionable, in the case of Indesit, the image of the group's brands leads us to think that there is clearly value in the intangibles. Does Indesit create value It should, given the high level of returns generated in 2006 and 2007 We can observe that over this period, share price rose from 8.8 to 10.6 end of 2007 , outperforming the...

## Emerging markets

In developing countries, calculating the cost of capital of an investment raises some practical problems. The risk-free rate of local government bonds is often just wishful thinking, since these countries have little solvency. The local risk-free rate and betas of local peer groups are rarely measured, let alone significant, given the limited size of financial markets in these countries. We suggest Bancel and Perrotin's 1999 system for calculating the cost of capital in such cases Government...

## Bookbuilding and accelerated bookbuilding

Like a rights issue, a block trade is done via book-building. However, while rights issues allow companies to raise significant funds for investment, a block trade does not raise any new capital or have any direct impact on the company's business. Moreover, fewer shares are usually involved in a block trade than in a capital increase. Block trades are thus simpler deals than capital increases and require less marketing. Book-building is faster, top management is less involved or not involved at...

## Translating the accounts of foreign subsidiaries

The translation of the accounts of foreign companies is a thorny issue because of exchange rate fluctuations and the difference between inflation rates, which may distort the picture provided by company accounts. For instance, a parent company located in the euro zone may own a subsidiary in a country with a soft currency.18 Using year-end exchange rates to convert the assets of its subsidiary into the parent company's currency understates their value. From an economic standpoint, all the...

## Value Of A Put Option

Time value diminishes with the passage of time, as the closer we get to the maturity date, the less likely that the price of the underlying asset will exceed the strike price by that date. Time value vanishes on the date the option expires. This means that an option is worth at least its intrinsic value, but is there an upper limit on the option's value In our example, the value at maturity of the call option on sterling is as follows If sterling is trading above 61.5, the option is worth the...

## What does it mean to discount a sum

To discount means to calculate the present value of a future cash flow. Discounting into today's euros helps us compare a sum that will not be produced until later. Technically speaking, what is discounting To discount is to depreciate the future. It is to be more rigorous with future cash flows than present cash flows, because future cash flows cannot be spent or invested immediately. First, take tomorrow's cash flow and then apply to it a multiplier coefficient below 1, which is called a...

## Personnel cost

This is a very important item because it is often high in relative terms. Although personnel cost is theoretically a variable cost, it actually represents a genuinely fixed cost item from a short-term perspective. A financial analysis should focus both on volume and price effects measured by the personnel expense -ratio as well as the employee productivity ratio, which is measured sales production value added average headcount average headcount average headcount Since external analysts are...

## THE different methods

The method chosen for a capital increase depends 1 first of all on whether or not the company is listed 2 then on how eager current shareholders are to subscribe. When the large majority of current shareholders are expected to subscribe to the capital increase and it is not necessary or desirable to bring in new shareholders, the transaction comes with pre-emptive subscription rights the transaction is then called a rights issue . The issue price of the new shares is set and announced in...

## What are provisions for employee benefits and pensions

Pension and related commitments include severance payments, early retirement and related payments, special retirement plans, top-up plans providing guaranteed resources and healthcare benefits, life insurance and similar entitlements that, in some cases, are granted under employment contracts and collective labour agreements. A distinction is made between defined benefit plans where the employer commits to the amount or guarantees the level of benefits defined by the agreement. This is a...

## Reference Rates In Europe

EONIA Euro Overnight Index Average European money-market rate. This is an average rate weighted by overnight transactions reported by a representative sample of 64 European banks. Computed by the European Central Bank and published by Reuters. EURIBOR European Interbank Offered Rate European money-market rate corresponding to the arithmetic mean of offered rates on the European banking market for a given maturity between 1 week and 12 months . Sponsored by the European Banking Federation and...

## Irr

The point of this example is that when considering two mutually exclusive investments, the financial manager typically concludes that the one offering the highest IRR is necessarily the one that should be chosen. If in this case we had to choose only one project, and we rank them based on their IRRs, we would choose to invest in the small-scale project. However, the large-scale project generates a much higher NPV this project thus creates more wealth for shareholders. The NPV tells us to...

## Liquidity

A security is said to be liquid when it is possible to buy or sell a large number of shares on the market without it having too great an influence on the price. Liquidity is a typical measure of the relevance of a share price. It would not make much sense to analyse the price of a stock that is traded only once a week, for example. A share price is relevant only if the stock is sufficiently liquid. A share's liquidity is measured mainly in terms of free float and trade volumes. a Free float The...

## Deeply subordinated debt

These financial instruments present the four following features, which are also presented by ordinary share capital and provide the undertaking with financial flexibility. 1 Permanency the instrument must be perpetual, and early redemption features must be under the sole control of the issuer. 2 Ranking in case of liquidation, the securities must rank senior only to share capital. 3 Conditional payment of interest under certain conditions, such as non-payment of dividends to shareholders,...

## Speculation

In contrast to hedging, which eliminates risk by transferring it to a party willing to assume it, speculation is the assumption of risk. A speculator takes a position when he makes a bet on the future value of an asset. If he thinks its price will rise, he buys it. If it rises, he wins the bet if not, he loses. If he is to receive dollars in a month's time, he may take no action now because he thinks the dollar will rise in value between now and then. If he has long-term investments to make, he...

## Capital rationing and the present value index

Sometimes there is a strict capital constraint imposed on the firm, and it is faced with more NPV positive projects than it can afford. In order to determine which project to pursue, the best formula to use is the Present Value Index PVI . This is the present value of cash inflows divided by the present value of cash outflow Present value of inflows Present value of outflows By using the Present Value Index, financial managers can rank the different projects and then select the investment with...

## Difficulties in practical application of the capm

The first difficulty one encounters when using the CAPM is determining the risk-free rate which, all things considered, is just a theoretical concept. The term risk-free means no risk of default and no coupon reinvestment risk. Zero-coupon government bonds come the closest to meeting this definition. However 1 While governments' power to mint currency means that their risk of default is low, they still have some risk the Argentine default in 2002 is one illustration . 2 In order to have zero...

## Evaluating real options

Option theory sheds light on the valuation of real options by stating that uncertainty combined with flexibility adds value to an industrial project. How appealing It tells us that the higher the underlying volatility, and thus the risk, the greater the value of an option. This appears counterintuitive compared with the net present value approach, but remember that this value is very unstable. The time value of an option decreases as it reaches its exercise date, since the uncertainty declines...

## The value of a perpetuity

A perpetuity is a constant stream of cash flows without end. By adding this feature to the previous case, the formula then looks like this F F F PV -T -T7 - As n approaches infinity, this can be shortened to the following The present value of a 100 perpetuity discounted back at 10 per year is thus A 100 perpetuity discounted at 10 is worth 1000 in today's euros. If the investor demands a 20 return, the same perpetuity is worth 500.

## Restructuring provisions

a What are restructuring provisions Restructuring provisions consists of taking a heavy upfront charge against earnings in a given year to cover a restructuring programme site closures, redundancies, etc. . The future costs of this restructuring programme are eliminated through the gradual write-back of the provision, thereby smoothing future earnings performance. b How are they accounted for Restructuring costs represent a liability if they derive from an obligation for a company vis- -vis...

## The npv decision rule

Calculating the NPV of a project is conceptually easy. There are basically two steps to be followed 1 write down the net cash flows that the investment will generate over its life 2 discount these cash flows at an interest rate that reflects the degree of risk inherent in the project. The resulting sum of discounted cash flows equals the project's net present value. The NPV decision rule says to invest in projects when the present value is positive greater than zero NPV gt 0 invest NPV lt 0 do...

## Net present value and EVA A comparison

Economic value added is a throwback to the net present value rule. In fact, it can be demonstrated that the present value of the economic value added by a project over its life is the net present value of the project. In order to achieve this result, the project must have a salvage value of zero, and the present value of depreciation must be equal to the present value of initial investment, discounted back over the project's life. In other words, we must assume that the cash flow from...

Like those issuing fixed-rate securities, companies issuing floating-rate securities need to pay investors a return that covers the counterparty credit risk. Consequently, a fixed margin spread is added to the variable percentage when the coupon is calculated. For instance, a company may issue a bond at 3-month Euribor 0.45 or 45 basis point . The size of this margin basically depends on the company's financial creditworthiness. The spread is set once and for all when the bond is issued, but of...

## What are perpetual subordinated loans and notes

As their name suggests, these instruments are never redeemable and thus continue to pay interest as long as the borrower remains solvent. They have no duration because there is no contractual undertaking for repayment, which may take place when the issuer so wishes. Note that if the issuer is liquidated, holders rank for repayment after other creditors as they are subordinated loans but before shareholders. Perpetuals are booked under financial debt or equity depending on their characteristics...

## Eliminating intragroup transactions

18 A soft or weak currency is a currency that tends to fall in value because of political or economic uncertainty high inflation rate . The Nepal Rupee is a good example. Consolidation entails more than the mere aggregation of accounts. Before the consolidation process as such can begin, intra-group transactions and their impact on net income have to be eliminated from the accounts of both the parent company and its consolidated companies. Assume, for instance, that the parent company has sold...

## How portfolio management works

The financial theory described so far seems to give a clear suggestion invest only in highly diversified mutual funds and in government bonds. However, not all investors subscribe to this theory. Some take other approaches, described below. Sometimes, investors combine different approaches. First, we shall consider the difference between a top-down and a bottom-up approach. In a top-down approach, investors focus on the asset class shares, bonds, money-market funds and the international markets...

## Arbitrage

In contrast to the speculator, the arbitrageur is not in the business of assuming risk. Instead, he tries to earn a profit by exploiting tiny discrepancies which may appear on different markets that are not in equilibrium. An arbitrageur will notice that Fortis shares are trading slightly lower in London than in Brussels. He will buy Fortis shares in London and sell them simultaneously or nearly so at a higher price in Brussels. By buying in London, the arbitrageur bids the price up in London...

## Disregard the type of financing

When comparing an investment's return with its cost of financing what we will call weighted average cost of capital in Chapter 23 , the two items must be considered separately. In practice, since the discount rate is the cost of financing the investment weighted average cost of capital , interest expense, repayments or dividends should not be included in the flows. Only operating and investment flows are taken into account, but never financing flows. This is the same distinction that was made...

## Riskfree assets

By definition, risk-free assets are those whose returns, the risk-free rate rF , is certain. This is the case with a government bond, assuming of course that the government does not go bankrupt. The standard deviation of its return is thus zero. If a portfolio has a risk-free asset F in proportion 1 Xh and the portfolio consists exclusively of Heineken shares, then the portfolio's expected return E h,f will be equal to ECrnF 1 XH x f Xh x E th F E rH f x Xh 21.2 The portfolio's expected return...

## How are they accounted for

6 An intangible asset with indefinite useful life to be precise. Impairment losses are computed based on the value of Cash Generating Units CGU . The firm needs to define a maximum number of largely independent CGUs and allocates assets for each one. Each year, the recoverable value of the CGU is computed if there is indication that there might be a decrease in value or if it includes goodwill.6 If the recoverable value of the CGU is lower than the carrying amount, an impairment loss needs to...

## Dilution profit and losses

1 WHAT ARE DILUTION PROFIT AND LOSSES Where a parent company does not subscribe either at all or only partially to a capital increase by one of its subsidiaries that takes place above the subsidiary's book value, the parent company records a dilution profit. Likewise, if the valuation of the subsidiary for the purpose of the capital increase is less than its book value, the parent company records a dilution loss. For instance, let us consider the case of a parent company that has paid 200 for a...

## The expanded net present value

Since options allow us to analyse the various risks and opportunities arising from an investment, the project can be assessed as a whole. This is done by taking into account its two components - anticipated flows and real options. Some authors call this the expanded net present value ENPV , which is the opposite of the passive NPV of a project with no options. Based on the preceding sections, this gives When a project is very complex with several real options, the various options cannot be...

## Operating and financial leverage

Operating leverage is the variability of earnings to corresponding changes in revenues. A firm that has high fixed costs relative to total costs will have a high operating leverage, because the cyclicality of operating income will change proportionally more than when sales change. Operating leverage A EBIT A Sales A firm with a high operating leverage experiences higher variability in EBIT than companies with lower operating leverage. Other things being equal, a higher operating leverage will...

## From value to price 2 the efficient markets

In addition to financial communication, the relationship between value creation and price requires another condition the efficiency of financial markets. An efficient market is one in which the prices of financial securities at any time rapidly reflect all available relevant information. The terms perfect market or market in equilibrium are synonymous with efficient market. In an efficient market, prices instantly reflect the consequences of past events and all expectations about future events....

## Net present value

It should now be clear that the concept of value corresponds perfectly to the measure of net present value. Financial management consists of constantly measuring the net present value of an investment, project, company or source of financing. Obviously, one should only allocate resources if the net present value is positive, in other words, if the market value is lower than the present value. Net present value reflects how allocation of the company's resources has led to the creation or...

## From value to price 1 financial communication

If a company wants the financial market to price its securities fairly, it is necessary but not sufficient that it provides the market with all relevant financial information about its cash flows, particularly information regarding the magnitude, the risks involved, and timing of all such flows. If the market receives inadequate information, then it will be unable to assess the real capacity of the firm to create value. Therefore, it is always necessary to communicate promptly to investors all...

## Financial assessment

The scissors effect is first and foremost the product of a simple phenomenon. The scissors effect is what takes place when revenues and costs move in diverging directions. It accounts for trends in profits and margins. If revenues are growing by 5 p.a. and certain costs are growing at a faster rate, earnings naturally decrease. If this trend continues, earnings will decline further each year and ultimately the company will sink into the red. This is what is known as the scissors effect.

## Puma Cost Of Debt

Readers should not let themselves get bogged down by this equation, which is based on an accounting tautology. The leverage effect is merely a straightforward factor that is used to account for return on equity, and nothing more. The ratio of net debt to shareholders' equity is called financial leverage or gearing. The leverage effect can thus be expressed as follows - x Return on capital employed After-tax cost of debt Return on equity is thus equal to the return on capital employed plus the...

## Effective annual rate nominal rates and proportional rates

This section will demonstrate that discounting has a much wider scope than might have appeared to be the case in the simple financial mathematics presented previously. a The concept of effective annual rate What happens when interest is paid not once but several times per year Suppose that somebody lends you money at 10 but says somewhere in the fine print at the bottom of the page that interest will have to be paid on a half-yearly basis. For example, suppose you borrowed 100 on 1 January and...

## Difference Between Irr And Roce

So, what is the return on capital employed In the first case, it averages at 29.8 and in the second case it is 35 . Do you really believe that just changing an accounting method can influence the intrinsic profitability of a project Of course not, and this example clearly illustrates the flaw inherent in the criteria. Although the highest returns are usually obtained on projects with the longest durations, accounting rates of return do not take into account the date of the flow. Hence, they...

## Problems specific to mutually exclusive projects

Further problems may arise when a choice must be made among several investments or securities , as is often the case in reality. Investments have different cash flow timetables that are all equally attractive. In this case, the investment decision is not about whether to invest or not, but rather it is about which investment to make. This situation refers to mutually exclusive investments. This occurs when there are two projects, A and B, and you can either accept A, accept B, or reject both...

## Return on equity

The leverage effect is much ado about nothing how a company can create wealth margins' analysis what kind of investment is required to create wealth capital expenditure and increase in working capital how those investments are financed through debt or equity. We now have everything we need to carry out an assessment of the company's efficiency, i.e. its profitability. A company that delivers returns that are at least equal to those required by its shareholders and lenders will not experience...

## Deferred tax assets and liabilities

1 WHAT ARE DEFERRED TAX ASSETS AND LIABILITIES Deferred taxation giving rise to deferred tax assets or liabilities stems either from differences in periods in which the income or cost is recognised for tax and accounting purposes or from differences between the taxable and book values of assets and liabilities. On the income statement, certain revenue and charges are recognised in different periods for the purpose of calculating pre-tax accounting profit and taxable profit. In some cases, the...

## Product Life Cycle

Question of market growth, we need to look at the product life cycle. Growth drivers in a developed economy are often highly complex. They may include technological advances, new products e.g. high-speed internet connection changes in the economic situation e.g. expansion of air travel with the rise in living standards changes in consumer lifestyles e.g. eating out changing fashions e.g. snowboards, catamarans demographic trends e.g. popularity of cruises owing to the ageing of the population...

## Corporate Finance

Theoretically, the financial manager sells expected future cash flows that can derive only from the company's business operations. A company cannot distribute more cash flow to its providers of funds than its business generates. A money-losing company pays its creditors only at the expense of its shareholders. When a company with sub-par profitability pays a dividend, it jeopardises its financial health. The financial manager's role is to transform the company's commercial and industrial...

## Scope of consolidation

The scope of consolidation, i.e. the companies to be consolidated, is determined using the rules we presented in Section 6.1. To determine the scope of consolidation, one needs to establish the level of control exercised by the parent company over each of the companies in which it owns shares. a Level of control and ownership level The level of control9 measures the strength of direct or indirect dependence that exists between the parent company and its subsidiaries, joint ventures or...

## Different Examples Of The Scissors Effect

The company loses its grip on costs Costs The company loses its grip on costs Costs The rate of revenue growth decreases but the rate of growth in costs remains unchanged The cost of a production factor increases significantly while revenues are slower to increase owing to inertia Revenues fall slightly while costs remain unchanged Revenues post strong growth exceeding that in costs scale effect Revenues post slow growth while costs decline slightly owing to efficiency gains, for instance...

## Financial analysis is more of a practice than a theory

The purpose of financial analysis, which primarily involves dealing with economic and accounting data, is to provide insight into the reality of a company's situation on the basis of figures. Naturally, knowledge of an economic sector and a company and, more simply, some common sense may easily replace some of the financial analysis techniques. Very precise conclusions may be made without sophisticated analytical techniques. Financial analysis should be regarded as a rigorous approach to the...

## Bibliography

For more about the economic analysis of companies S. Chopra, P. Meindl, Supply Chain Management, 2nd edn., Prentice Hall, 2003. Ph. Kotler, Marketing Management, 11th edn., Prentice Hall, 2003. B. Moingeon and G. Soenen, Corporate and Organisational Identities, Routledge, London, 2003. M. Porter, Competitive Strategy Techniques for Analyzing Industries and Competitors, Free Press, 199S. W. Stevenson, Operations Management, McGraw-Hill Irwin, 2oo4. J.C. Tarondeau, Strat gie Industrielle, Vuibert...

## Benefits and drawbacks of scoring techniques

Scoring techniques represent an enhancement of traditional ratio analysis, which is based on the isolated use of certain ratios. With scoring techniques, the problem of the relative importance to be attached to each ratio has been solved because each is weighted according to its ability to pick out the bad companies from the good ones. This said, scoring techniques still have a number of drawbacks. Some weaknesses derive from the statistical underpinnings of the scoring equation. The sample...

## Normative Margin

Nowadays, a great deal of the analysis of financial statements for past periods is carried out for the purpose of preparing financial projections. These forecasts are based on the company's past and the decisions taken by management. This section contains some advice about how best to go about this type of exercise. All too often, it is not sufficient to merely set up a spreadsheet, click on the main income statement items determining EBITDA or operating profit if depreciation and amortisation...

## How operating leverage works

Operating leverage links variation in activity measured by sales with variations in result either operating profit or net income . Operating leverage depends on the level and nature of the breakeven point. Breakeven is the level of activity for which total revenue cover total charges. With business running at this level, earnings are thus zero. Put another way if the company does not reach breakeven i.e. insufficient sales , the company posts losses if sales are exactly equal to the breakeven...

## The principles of credit scoring

Credit scoring is an analytical technique intended to carry out a preemptive check-up of a company. The basic idea is to prepare ratios from companies' accounts that are leading indicators i.e. two or three years ahead of potential difficulties. Once the ratios have been established, they merely have to be calculated for a given company and cross-checked against the values obtained for companies that are known to have run into problems or have failed. Comparisons are not made ratio by ratio,...

## Normative analysis and financial rules of thumb

Normative analysis represents an extension of comparative analysis. It is based on a comparison of certain company ratios or indicators with rules or standards derived from a vast sample of companies. For instance, there are norms specific to certain industries in the hotel sector, the bed-night cost must be at least 1 1000 of the cost of building the room, or the sales generated after three years should be at least one-third of the investment cost the level of work in progress relative to the...

## Expert systems

Expert systems comprise software developed to carry out financial analysis using a knowledge base consisting of rules of financial analysis, enriched with the result of each analysis performed. The goal of expert systems is to develop lines of reasoning akin to those used by human analysts. This is the realm of artificial intelligence. To begin with, the company's latest financial statements and certain market and social indicators are entered and serve as the basis for the expert system's...

## Comparative analysis or comparing similar companies

Comparative analysis consists of evaluating a company's key profit indicators and ratios so that they can be compared with the typical indicators and ratios of companies operating in the same sector of activity. The basic idea is that one should not get up to any more nonsense than one's neighbours, particularly when it comes to a company's balance sheet. Why is that Simply because during a recession most of the lame ducks will be eliminated, and only healthy companies will be left standing. A...

## What is financial analysis for

Financial analysis is a tool used by existing and potential shareholders of a company, as well as lenders or rating agencies. For shareholders, financial analysis assesses whether the company is able to create value. It usually involves an analysis of the value of the share and ends with the formulation of a buy or a sell recommendation on the share. For lenders, financial analysis assesses the solvency and liquidity of a company, i.e. its ability to honour its commitments and repay its debts...

## Treasury shares

Treasury shares are shares that a company or its subsidiaries owns in this company. These shares may have been bought for the purpose of stabilising the share price i.e. for listed companies or being granted to employees, i.e. as part of a stock option plan or reinforcing a shareholder or being remitted to holders of convertible bonds if they request conversion of their bonds into shares or simply because they were considered at a given moment to be a good investment. We will examine in more...

## Gaap Working Capital

Development costs must be treated as intangible fixed assets provided that a whole series of conditions are met related to the technical feasibility of the project such that the final asset may be used or sold the intention of completing the project the ability to sell or use the asset the way in which the asset will generate future profits the ability to measure cost related to the project's development. All R amp D costs must be expensed as incurred except some specific IT web developments ....

## EQUITY method of accounting

When the parent company exercises significant influence over the operating and financial policy of its associate, the latter is accounted for under the equity method. Significant influence over the operating and financial policy of a company is assumed when the parent holds, directly or indirectly, at least 20 of the voting rights. Significant influence may be reflected by participation on the executive and supervisory bodies, participation in strategic decisions, the existence of major...

## How should financial analysts treat them

Whatever their original purpose, we recommend deducting treasury shares from assets and from shareholders' equity if this has not yet been done by the accountants. From a financial standpoint, we believe that share repurchases are equivalent to a capital reduction, regardless of the legal treatment. Likewise, if the company sells the shares, we recommend that these sales be analysed as a capital increase. Treasury shares must thus be subtracted from the number of shares outstanding when...

## Net debt

The company's gross debt comprises debt financing, irrespective of its maturity, i.e. medium- and long-term various borrowings due in more than one year that have not yet been repaid , and short-term bank or financial borrowings portion of long-term borrowings due in less than one year, discounted notes, bank overdrafts, etc. . A company's net debt goes further by taking into account cash and equivalents e.g. petty cash and bank accounts and marketable securities. All things considered, the...

## Theory and Practice

Pascal Quiry Maurizio Dallocchio Yann Le Fur Antonio Salvi Corporate Finance is a very useful reference book for students and for operators who will get great help in the present complex environment to learn the principles of the financial markets and their practical application. Written with a clear and logical approach it shows also some interesting cases that make study easier and stimulating. Gabriele Galateri, Chairman of Telecom Italia The book, newsletter, and website are all very...

## Accruals

Accruals are used to recognise revenue and costs booked in one period but relating to another period. To accrue basically means to transfer revenue or costs from the P amp L to the balance sheet. The main categories of accruals are prepaid costs, i.e. charges relating to goods or services to be supplied later. For instance, three-quarters of a rental charge payable in advance for a 12-month period on 1 October each year will be recorded under prepaid costs on the asset side of the balance sheet...

## Goodwill

It is very unusual for one company to acquire another for exactly its book value. Generally speaking, there is a difference between the acquisition price, which may be paid in cash or in shares, and the portion of the target company's shareholders' equity attributable to the parent company. In most cases, this difference is positive as the price paid exceeds the target's book value. a What does this difference represent In other words, why should a company agree to pay out more for another...

## Proportionate consolidation

A difficult question to solve when preparing the accounts is what method to use when the parent company exercises joint control with a limited number of partners over another company joint ventures . The key factors determining joint control are i a limited number of partners sharing control without any partner able to claim exclusive control , and ii a contractual arrangement outlining and defining how this joint control is to be exercised. IFRS used to allow the use of the proportionate...

## Full consolidation

The accounts of a subsidiary are fully consolidated if the latter is controlled by its parent. Control is defined as the ability to direct the strategic financing and operating policies of an entity so as to access benefits. It is presumed to exist when the parent company holds, directly or indirectly, over 50 of the voting rights in its subsidiary holds, directly or indirectly, less than 50 of the voting rights but has power over more than 50 of the voting rights by virtue of an agreement with...

## Summary

23 From THE COST OF EQUITY TO THE COST 24 The TERM STRUCTURE OF INTEREST 26 Other debt products 507 31 Value and corporate finance 629 32 Valuation techniques 649 33 Capital structure and the theory 35 Debt, equity and options theory 721 36 Working out details The design of 37 Internal financing Reinvesting 38 Returning cash to shareholders Dividend policies 788 40 Choice of corporate structure 835 41 Corporate governance 862 42 Taking control of a company 876 43 Mergers and demergers 899 44...

## Preface Of Working Capital Management

To the Deloitte IFRS MNC Advisory IFRS team, and in particular Elisabeth Baudin, for helping us on the first part of the book. To Thibaud De Maria, Pierre Foucry, Nance Garro, Pierre Laur, Guillaume Mallen, Laetitia Remy, Georges Watkinson-Yull, Weikang Zhang, and students of the HEC Paris and Bocconi MBA programmes for their help in improving the manuscript. To Altimir Perrody, the vernimmen.com webmaster. To Isabelle Mari -Sall for her help in transforming our scribblings into a proper...