CIMA P-9 Management Accounting Financial Strategy

724 Pages·2006·4.91 MB·English

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CIMA’S Official Learning System
Strategic Level
Management
Accounting –
Financial Strategy
John Ogilvie
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CIMA Publishing is an imprint of Elsevier
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First edition 2006
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Contents
The CIMA Learning System xi
Acknowledgements xi
How to use your CIMA Learning System xi
Study technique xiii
Management Accounting – Financial Strategy Syllabus xiv
1 Formulation of Financial Strategy 1
1.1 Introduction 1
1.2 Objectives of profit-making entities 2
1.2.1 Financial objectives 3
1.2.2 Non-financial objectives 3
1.2.3 Agency theory 4
1.2.4 Shareholder value analysis 5
1.3 Objectives of not-for-profit entities 7
1.3.1 The three ‘E’s 8
1.4 Public and private – similarities and differences 8
1.5 Assessing attainment of financial objectives 9
1.5.1 Financial performance indicators 9
1.5.2 Non-financial performance indicators 10
1.6 The three key decisions of financial management 11
1.6.1 Investment decisions 11
1.6.2 Financing decisions 12
1.6.3 Dividend decisions 12
1.7 Policies for distribution of earnings 13
1.7.1 Practical dividend policies 14
1.7.2 Theory of dividend irrelevance 15
1.7.3 Scrip dividends 17
1.7.4 Share repurchases 18
1.8 The impact of internal and external constraints on financial strategy 18
1.8.1 Internal constraints 18
1.8.2 External constraints 19
1.9 Developing financial strategy in the context of regulatory requirements 19
1.9.1 Corporate governance and the Cadbury Report 19
1.9.2 The Greenbury Report 20
1.9.3 The Hampel Report 21
1.9.4 Regulatory bodies 21
1.9.5 The regulation of takeovers and the Competition Commission 23
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S 1.10 Major economic influences 25
T
N
1.10.1 Interest rates 25
E
T
N 1.10.2 Term structure of interest rates 26
O
C 1.10.3 Inflation 29
1.10.4 Exchange rates 30
1.11 Modelling and forecasting cash flows and financial statements 31
1.11.1 Forecasting cash flows 31
1.11.2 Forecasting financial statements 31
1.11.3 Sensitivity analysis 35
1.12 Current and emerging issues in financial reporting 35
1.12.1 IFRS 1 first time adoption of IFRS 36
1.12.2 IFRS 2 Share-based payment 36
1.12.3 Reporting environmental issues 38
1.12.4 Reporting of social issues 39
1.12.5 Inclusion of forecasts in the annual report 41
1.12.6 Reporting of human capital 42
1.13 Summary 42
Readings 45
Revision Questions 53
Solutions to Revision Questions 55
2 Financial Management 61
2.1 Introduction 61
2.2 The finance function 61
2.2.1 Financial control 62
2.2.2 Evaluating key success factors in the management
of the finance function 62
2.2.3 Relationships with stakeholders 63
2.2.4 Outsourcing and shared service centres 63
2.3 The treasury function 63
2.3.1 The role of the treasury function 64
2.3.2 Cost centre or profit centre 65
2.4 Financial markets 66
2.4.1 Money market 66
2.4.2 Capital or securities market 66
2.4.3 The foreign exchange market 67
2.4.4 Derivatives markets 68
2.5 Share price volatility 68
2.5.1 Technical analysis or chartism 68
2.5.2 Fundamental analysis 68
2.5.3 Random Walk Theory 69
2.6 The efficient market hypothesis 69
2.6.1 Weak form 69
2.6.2 Semi-strong form 70
2.6.3 Strong form 70
2.6.4 Implications of EMH for financial managers 70
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2.7 Investor ratios 71 C
O
2.7.1 Market price per share 71 N
T
2.7.2 Earnings per share 71 E
N
2.7.3 The price/earnings ratio 72 TS
2.7.4 Earnings yield 72
2.7.5 Dividend-payout rate 72
2.7.6 Dividend yield 73
2.7.7 Dividend cover 73
2.7.8 Book value per share 74
2.8 Working capital management strategies 74
2.8.1 The investment decision 75
2.8.2 The financing decision 75
2.8.3 Liquidity ratios 77
2.8.4 The operating cycle 78
2.9 Overtrading 79
2.9.1 Symptoms of overtrading 80
2.9.2 Preventing overtrading 80
2.10 Multinational working capital management 80
2.11 Summary 81
Readings 83
Revision Questions 85
Solutions to Revision Questions 87
3 Sources of Long-term Finance 93
3.1 Introduction 93
3.2 Shareholders’ funds 93
3.2.1 Ordinary shares 93
3.2.2 Preference shares 94
3.2.3 Reserves 95
3.3 Raising share capital – the stock market 95
3.3.1 New issues 96
3.3.2 Rights issues 97
3.3.3 Bonus issues 102
3.3.4 Share splits 103
3.4 Debt finance 103
3.4.1 Bonds 103
3.4.2 Debt yields 104
3.4.3 Convertible bonds 106
3.4.4 Warrants 107
3.5 Medium-term financing 108
3.5.1 Term loans 108
3.5.2 Mezzanine finance 108
3.5.3 The lender’s assessment of creditworthiness 109
3.5.4 Leasing 109
3.5.5 Lease-or-buy decisions 112
3.5.6 Factoring 116
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S 3.6 Financing of small profit-making entities 118
T
N
3.6.1 Venture capital 119
E
T
N 3.6.2 Business ‘angels’ 120
O
C 3.6.3 Government assistance 120
3.7 Summary 121
Readings 123
Revision Questions 127
Solutions to Revision Questions 133
4 Capital Structure and Cost of Capital 143
4.1 Introduction 143
4.2 Measuring gearing 144
4.2.1 Capital gearing 144
4.2.2 Classification of debt and equity 145
4.2.3 Interest cover 149
4.2.4 Leverage 150
4.3 Cost of capital 150
4.3.1 Cost of equity 151
4.3.2 Cost of debt 155
4.3.3 Cost of preference shares 157
4.4 Weighted average cost of capital 157
4.4.1 Assumptions in the use of WACC 159
4.5 Marginal cost of capital 160
4.6 The traditional theory of gearing 161
4.7 Modigliani and Miller’s theories of gearing 162
4.7.1 Limitations of MM theory 167
4.8 Cost of capital and adjusted cost of capital 167
4.8.1 Adjusted present value 167
4.8.2 Adjusted cost of capital – Modigliani
and Miller 169
4.9 Risk and reward 170
4.10 Portfolio theory 172
4.10.1 Systematic risk and unsystematic risk 175
4.11 The capital asset pricing model 176
4.11.1 Measuring beta values 177
4.11.2 The security market line 178
4.12 Using the CAPM as an investment tool 180
4.13 MM, CAPM and geared betas 181
4.13.1 Ungearing beta 181
4.13.2 Geared equity beta 183
4.14 Use of CAPM in investment appraisal 185
4.14.1 Limitations of CAPM 185
4.15 Arbitrage pricing model 185
4.16 Summary 186
Readings 189
Revision Questions 195
Solutions to Revision Questions 201
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5 Business Valuations 211 C
O
N
5.1 Introduction 211
T
E
5.2 Asset-based valuations 212 N
T
S
5.2.1 Choice of valuation base 212
5.2.2 The strengths and weaknesses of asset-based valuations 213
5.3 Earnings-based valuations 213
5.3.1 P/E ratio valuation 213
5.3.2 Earnings yield valuation 214
5.4 Dividend-based valuations 214
5.4.1 Dividend yield 215
5.4.2 Dividend growth model 215
5.4.3 Problems of dividend-based valuations 215
5.4.4 Capital asset pricing model 216
5.5 Cash-based valuations 216
5.5.1 Discounted cash flow (DCF) 216
5.5.2 The strengths and weaknesses of DCF 217
5.5.3 Shareholder value analysis 217
5.6 Business valuations and efficient markets 217
5.7 Intellectual capital 218
5.7.1 Forms of intellectual capital 218
5.7.2 The components of intellectual capital 220
5.7.3 Valuing intellectual capital 224
5.7.4 Comparative indicators 226
5.8 The impact of changing capital structure 228
5.9 Recognition of the interests of different stakeholder groups
in company valuations 228
5.9.1 Liquidation 229
5.9.2 Re-financing 229
5.9.3 Mergers and acquisitions 229
5.10 Summary 229
References 230
Readings 231
Revision Questions 239
Solutions to Revision Questions 243
6 Mergers, Acquisitions and Buyouts 251
6.1 Introduction 251
6.2 Terminology and types of merger 251
6.2.1 Terminology 251
6.2.2 Types of merger 252
6.3 The reasons for merger or acquisition 252
6.4 Defences against takeover 253
6.4.1 Before the bid 253
6.4.2 After the bid 254
6.5 Methods of payment for an acquisition 254
6.5.1 Cash 254
6.5.2 Share exchange 255
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S 6.5.3 Other types of finance 256
T
N
6.5.4 Earn-out arrangements 256
E
T
N 6.6 The post-merger or post-acquisition integration process 256
O
C 6.6.1 Druker’s Golden Rules 256
6.6.2 Post-acquisition value enhancement strategies 257
6.6.3 Impact on ratios or performance measures 257
6.6.4 Acquirer’s post-acquisition share price 259
6.6.5 Example: Impact on stakeholders 259
6.6.6 Reasons why mergers and acquisitions fail 265
6.7 Exit strategies 266
6.7.1 Sell-off 266
6.7.2 Spin off 267
6.8 Management buyouts 267
6.8.1 Financing MBOs 267
6.8.2 Evaluation by investors and financiers 268
6.9 Reconstruction 269
6.9.1 Effect on the share price of a listed company 270
6.10 Summary 270
Readings 271
Revision Questions 275
Solutions to Revision Questions 283
7 Investment Appraisal Techniques 293
7.1 Introduction 293
7.2 Accounting rate of return 294
7.3 Payback 296
7.3.1 Discounted payback 297
7.4 Discounting techniques 297
7.4.1 Net present value 297
7.4.2 Internal rate of return 298
7.4.3 Modified internal rate of return 301
7.4.4 Discussion of techniques 302
7.5 Capital rationing 303
7.5.1 Single-period capital rationing 304
7.5.2 Single-period rationing with mutually exclusive projects 305
7.5.3 Single-period rationing with indivisible projects 306
7.6 Annual equivalent cost 306
7.6.1 Asset replacement cycles 308
7.7 Summary 309
Revision Questions 311
Solutions to Revision Questions 315
8 Advanced Investment Appraisal Techniques 323
8.1 Introduction 323
8.2 Taxation 323
8.2.1 Depreciation and tax depreciation allowances 324
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8.3 Inflation 325 C
O
8.4 Working capital 327 N
T
8.5 Identification of a project’s relevant costs and benefits 328 E
N
8.6 Linking investments with customer requirements and TS
product/service design 329
8.6.1 Reasons for developing new products or services 330
8.7 Linking investment in IS/IT with strategic, operational
and control needs 330
8.7.1 Benefits of a formal strategy 331
8.7.2 IS, IT and IM strategy 331
8.7.3 Content of information systems strategy 331
8.7.4 Cost-benefit analysis 332
8.7.5 Evaluating system performance 334
8.8 Adjusting for risk 335
8.8.1 Sensitivity analysis 335
8.8.2 Decision trees 338
8.8.3 Certainty equivalents 338
8.8.4 The discount rate 339
8.8.5 Adjusted discount rate 340
8.8.6 Capital asset pricing model 340
8.9 Evaluating and reporting investment opportunities 341
8.10 Adjusted present value 343
8.11 Assessing investments as options on future cash flows 345
8.11.1 The abandonment option 345
8.11.2 Timing options 348
8.11.3 Strategic investment options 349
8.11.4 Valuing options 349
8.12 Project implementation and control 349
8.12.1 The investment cycle 349
8.12.2 Post-completion auditing 351
8.12.3 Benefits of post-completion auditing 351
8.12.4 Organisation of PCA 352
8.12.5 Role of post-appraisal in project abandonment 352
8.13 Summary 353
Readings 355
Revision Questions 361
Solutions to Revision Questions 367
9 Financing and Appraisal of Overseas Operations 377
9.1 Introduction 377
9.2 Financing overseas operations – a global strategy 377
9.3 The effect of restrictions on remittances 379
9.4 The Euromarkets 379
9.4.1 Eurocurrency markets 380
9.4.2 Eurobonds 380
9.5 The effect of taxation 380
9.5.1 Double taxation relief 380
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