CIMA Study Systems 2006: Management Accounting-Financial Strategy (CIMA Study Systems Strategic Level 2006)

647 Pages·2005·3.59 MB·English

by  John Ogilvie

CIMA’S Official Study System
Strategic Level
Management
Accounting –
Financial Strategy
John Ogilvie
Christine Parkinson
AMSTERDAM BOSTON HEIDELBERG LONDON NEW YORK OXFORD
PARIS SAN DIEGO SAN FRANCISCO SINGAPORE SYDNEY TOKYO
CIMA Publishing
An imprint of Elsevier
Linacre House,Jordan Hill,Oxford OX2 8DP
30 Corporate Drive,Burlington,MA 01803
First published 2005
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ISBN 0 7506 6715 X
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Important Note
A new edition of the CIMA Official Terminology is due to be published in
September 2005. As this is past the publication date of this Study System the
page reference numbers for ‘Management Accounting Official Terminology’
contained in this Study System are for the 2000 edition.You should ensure that
you are familiar with the 2005 CIMAOfficial Terminology (ISBN 0 7506 6827 X)
once published,available from www.cimapublishing.com
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Contents
The CIMA Study System xi
Acknowledgements xi
How to use your CIMA Study System xi
Study technique xiii
Management Accounting – Financial Strategy Syllabus xiv
Transitional arrangements xix
1 Formulation of Financial Strategy 1
1.1 Introduction 1
1.2 Objectives of profit-making entities 1
1.2.1 Financial objectives 2
1.2.2 Non-financial objectives 3
1.2.3 Agency theory 3
1.2.4 Shareholder value analysis 4
1.3 Objectives of not-for-profit organisations 5
1.3.1 The three ‘E’s 7
1.4 Public and private – similarities and differences 8
1.5 Assessing attainment of financial objectives 10
1.5.1 Financial performance indicators 10
1.5.2 Non-financial performance indicators 11
1.6 The three key decisions of financial management 12
1.6.1 Investment decisions 12
1.6.2 Financing decisions 12
1.6.3 Dividend decisions 13
1.7 Policies for distribution of earnings 13
1.7.1 Practical dividend policies 14
1.7.2 Theory of dividend irrelevance 16
1.7.3 Scrip dividends 18
1.7.4 Share repurchases 18
1.8 The impact of internal and external constraints on financial strategy 19
1.8.1 Internal constraints 19
1.8.2 External constraints 20
1.9 Developing financial strategy in the context of regulatory requirements 20
1.9.1 Corporate Governance and the Cadbury Report 20
1.9.2 The Greenbury Report 21
1.9.3 The Hampel Report 22
1.9.4 Regulatory bodies 22
1.9.5 The regulation of takeovers and the competition commission 24
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iv MANAGEMENT ACCOUNTING – FINANCIAL STRATEGY P9
S 1.10 Major economic influences 26
T
N
1.10.1 Interest rates 26
E
T
N 1.10.2 Term structure of interest rates 27
O
C 1.10.3 Inflation 30
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 32
1.11.3 Sensitivity analysis 35
1.12 Current and emerging issues in financial reporting 36
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 40
1.12.5 Inclusion of forecasts in the annual report 42
1.12.6 Reporting of human capital 42
1.13 Summary 43
Readings 45
Revision Questions 51
Solutions to Revision Questions 53
2 Financial Management 59
2.1 Introduction 59
2.2 The finance function 59
2.2.1 Evaluating key success factors in the management of
the finance function 60
2.3 The treasury function 60
2.3.1 The role of the treasury function 61
2.3.2 Cost centre or profit centre 61
2.4 Financial markets 62
2.4.1 Money market 62
2.4.2 Capital or securities market 63
2.4.3 The foreign exchange market 64
2.4.4 Derivatives markets 64
2.5 Share price volatility 64
2.5.1 Technical analysis or chartism 65
2.5.2 Fundamental analysis 65
2.5.3 Random Walk Theory 65
2.6 The efficient market hypothesis 65
2.6.1 Weak form 66
2.6.2 Semi-strong form 66
2.6.3 Strong form 66
2.6.4 Implications of EMH for financial managers 67
2.7 Investor ratios 67
2.7.1 Market price per share 67
2.7.2 Earnings per share 68
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MANAGEMENT ACCOUNTING – FINANCIAL STRATEGY v
2.7.3 The price/earnings ratio 68 C
O
2.7.4 Earnings yield 69 N
T
2.7.5 Dividend-payout rate 69 E
N
2.7.6 Dividend yield 69 TS
2.7.7 Dividend cover 70
2.7.8 Book value per share 71
2.8 Working capital management strategies 71
2.8.1 The investment decision 72
2.8.2 The financing decision 72
2.8.3 Multinational working capital management 74
2.9 Summary 74
Readings 75
Revision Questions 77
Solutions to Revision Questions 79
3 Sources of Long-term Finance 85
3.1 Introduction 85
3.2 Shareholders’ funds 85
3.2.1 Ordinary shares 85
3.2.2 Preferred and deferred ordinary shares 86
3.2.3 Preference shares 87
3.2.4 Reserves 87
3.3 Raising share capital – the stock market 87
3.3.1 New issues 88
3.3.2 Rights issues 89
3.3.3 Share splits and bonus issues 94
3.4 Debt finance 95
3.4.1 Debentures 95
3.4.2 Debt yields 96
3.4.3 Convertibles 98
3.4.4 Warrants 99
3.5 Medium-term financing 100
3.5.1 Term loans 100
3.5.2 Mezzanine finance 100
3.5.3 The lender’s assessment of creditworthiness 101
3.5.4 Leasing 101
3.5.5 Lease-or-buy decisions 104
3.6 Financing of small businesses 108
3.6.1 Venture capital 109
3.6.2 Business ‘angels’ 110
3.6.3 Government assistance 110
3.7 Summary 111
Readings 113
Revision Questions 117
Solutions to Revision Questions 123
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TS 4 Capital Structure and Cost of Capital 133
N
TE 4.1 Introduction 133
N
O 4.2 Measuring gearing 134
C
4.2.1 Capital gearing 134
4.2.2 Interest cover 136
4.2.3 Leverage 136
4.3 Cost of capital 137
4.3.1 Cost of equity 138
4.3.2 Cost of debt 142
4.3.3 Cost of preference shares 144
4.4 Weighted average cost of capital 144
4.4.1 Assumptions in the use of WACC 146
4.5 Marginal cost of capital 146
4.6 The traditional theory of gearing 148
4.7 Modigliani and Miller’s theories of gearing 149
4.7.1 Limitations of MM theory 154
4.8 Cost of capital and adjusted cost of capital 154
4.8.1 Adjusted present value 154
4.8.2 Adjusted cost of capital – Modigliani and Miller 156
4.9 Risk and reward 157
4.10 Portfolio theory 158
4.10.1 Systematic risk and unsystematic risk 161
4.11 The capital asset pricing model 162
4.11.1 Measuring beta values 164
4.11.2 The security market line 165
4.12 Using the CAPM as an investment tool 167
4.13 MM, CAPM and geared betas 168
4.13.1 Ungearing beta 168
4.13.2 Geared equity beta 170
4.14 Use of CAPM in investment appraisal 171
4.14.1 Limitations of CAP-M 172
4.15 Arbitrage pricing model 172
4.16 Summary 173
Readings 175
Revision Questions 181
Solutions to Revision Questions 187
5 Business Valuations 197
5.1 Introduction 197
5.2. Asset-based valuations 198
5.2.1 Choice of valuation base 198
5.2.2 Merits of asset-based valuations 198
5.3 Earnings-based valuations 198
5.3.1 P/E ratio valuation 198
5.3.2 Earnings yield valuation 199
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MANAGEMENT ACCOUNTING – FINANCIAL STRATEGY vii
5.4 Dividend-based valuations 199 C
O
5.4.1 Dividend yield 200 N
T
5.4.2 Dividend growth model 200 E
N
5.4.3. Problems of dividend-based valuations 200 TS
5.4.4 Capital asset pricing model 201
5.5 Cash-based valuations 201
5.5.1 Discounted cash flow 201
5.5.2 Shareholder value analysis 202
5.6 Business valuations and efficient markets 202
5.7 Intellectual capital 203
5.7.1 Forms of intellectual capital 203
5.7.2 The components of intellectual capital 205
5.7.3 Valuing intellectual capital 208
5.7.4 Comparative indicators 211
5.8 The impact of changing capital structure 213
5.9 Recognition of the interests of different stakeholder groups in
company valuations 213
5.9.1 Liquidation 213
5.9.2 Re-financing 214
5.9.3 Mergers and acquisitions 214
5.10 Summary 214
References 214
Readings 215
Revision Questions 223
Solutions to Revision Questions 227
6 Mergers, Acquisitions and Buyouts 235
6.1 Introduction 235
6.2 Terminology and types of merger 235
6.2.1 Terminology 235
6.2.2 Types of merger 236
6.3 The reasons for merger or acquisition 236
6.4 Defences against takeover 237
6.4.1 Before the bid 237
6.4.2 After the bid 238
6.5 Methods of payment for an acquisition 238
6.5.1 Cash 238
6.5.2 Share exchange 239
6.5.3 Other types of finance 240
6.5.4 Earn-out arrangements 240
6.6 The post-merger or post-acquisition integration process 240
6.6.1 Impact on ratios or performance measures 240
6.6.2 Acquirer’s post-acquisition share price 242
6.6.3 Example of share valuation,
its effects and reasons for acquisition 242
6.7 Reasons why mergers and acquisitions fail 248
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viii MANAGEMENT ACCOUNTING – FINANCIAL STRATEGY P9
S 6.8 Management buyouts 249
T
N
6.8.1 Financing MBOs 249
E
T
N 6.8.2 Evaluation by investors and financiers 250
O
C 6.9 Reconstruction 251
6.9.1 Effect on the share price of a listed company 252
6.10 Summary 252
Readings 253
Revision Questions 257
Solutions to Revision Questions 265
7 Investment Appraisal Techniques 275
7.1 Introduction 275
7.2 Accounting rate of return 276
7.3 Payback 278
7.3.1 Discounted payback 279
7.4 Discounting techniques 279
7.4.1 Net present value 279
7.4.2 Internal rate of return 280
7.4.3 Modified internal rate of return 283
7.4.4 Discussion of techniques 284
7.5 Capital rationing 285
7.5.1 Single-period capital rationing 286
7.5.2 Single-period rationing with
mutually exclusive projects 287
7.5.3 Single-period rationing with indivisible projects 288
7.6 Annual equivalent cost 288
7.6.1 Asset replacement cycles 290
7.7 Summary 291
Revision Questions 293
Solutions to Revision Questions 297
8 Advanced Investment Appraisal
Techniques 305
8.1 Introduction 305
8.2 Taxation 305
8.2.1 Depreciation and capital allowances 306
8.3 Inflation 307
8.4 Working capital 309
8.5 Identification of a project’s relevant costs and benefits 310
8.6 Linking investment in IS/IT with strategic, operational and
control needs 311
8.6.1 Benefits of a formal strategy 312
8.6.2 IS, IT and IM strategy 312
8.6.3 Content of information systems strategy 312
8.6.4 Cost–benefit analysis 313
8.6.5 Evaluating system performance 315
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MANAGEMENT ACCOUNTING – FINANCIAL STRATEGY ix
8.7 Adjusting for risk 316 C
O
8.7.1 Sensitivity analysis 316 N
T
8.7.2 Decision trees 319 E
N
8.7.3 Certainty equivalents 320 TS
8.7.4 The discount rate 320
8.7.5 Adjusted discount rate 321
8.7.6 Capital asset pricing model 321
8.8 Evaluating and reporting investment opportunities 322
8.9 Adjusted present value 324
8.10 Assessing investments as options on future cash flows 326
8.10.1 The abandonment option 326
8.10.2 Timing options 329
8.10.3 Strategic investment options 330
8.10.4 Valuing options 330
8.11 Project implementation and control 330
8.11.1 The investment cycle 330
8.11.2 Post-completion auditing 332
8.11.3 Benefits of post-completion auditing 332
8.11.4 Organisation of PCA 333
8.11.5 Role of post-appraisal in project abandonment 334
8.12 Summary 334
Readings 337
Revision Questions 343
Solutions to Revision Questions 349
9 Financing and Appraisal of Overseas
Operations 359
9.1 Introduction 359
9.2 Financing overseas operations – a global strategy 359
9.3 The effect of restrictions on remittances 361
9.4 The Euromarkets 361
9.4.1 Eurocurrency markets 362
9.4.2 Eurobonds 362
9.5 The effect of taxation 362
9.5.1 Double taxation relief 362
9.6 International capital budgeting 363
9.7 APV method 366
9.8 Summary 368
Revision Questions 369
Solutions to Revision Questions 373
Preparing for the Examination 381
Revision technique 381
Planning 381
Getting down to work 382
Tips for the final revision phase 382
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