Table Of Content

Advanced Diploma in Business Administration Study Manual CORPORATE FINANCE The Association of Business Executives William House • 14 Worple Road • Wimbledon • London • SW19 4DD • United Kingdom Tel: + 44(0)20 8879 1973 • Fax: + 44(0)20 8946 7153 E-mail: [email protected] • www.abeuk.com © Copyright assigned to ABE All rights reserved No part of this publication may be reproduced, stored in a retrieval system, or transmitted in any form, or by any means, electronic, electrostatic, mechanical, photocopied or otherwise, without the express permission in writing from The Association of Business Executives. ABE Advanced Diploma in Business Administration Study Manual CORPORATE FINANCE Contents Study Title Page Unit Syllabus i 1 The Context of Corporate Finance 1 Basic Principles of Companies 3 Financial Objectives 4 Corporate Governance 8 Corporate Financial Management 22 2 Company Performance, Valuation and Failure 31 Ratio Analysis 33 Using Ratio Analysis 40 Introduction to Share Valuation 48 Methods of Share and Company Valuation 49 Predicting Company Failure 55 Capital Reconstruction Schemes 59 3 Acquisitions and Mergers 61 Company Growth 63 The Regulation of Takeovers 67 The Acquisition/Merger Process 71 Measuring the Success and Failure of Mergers and Takeovers 74 Disinvestment 78 4 Financial Markets 83 Stock Markets 84 Other Sources of Finance 90 Other Financial Markets 92 Recent Changes in Capital Markets 93 Impact of the Markets on Market Decisions 94 5 Sources of Company Finance 95 Share Capital 97 Methods of Issuing Shares 100 Share Repurchases 107 Debt and Other Forms of Loan Capital 108 Short-Term Finance 117 International Capital Markets 118 Finance and the Smaller Business 121 6 Cost of Finance 125 Investors and the Cost of Capital 127 Cost of Equity 128 Cost of Debt Capital 131 Cost of Internally Generated Funds 135 Weighted Average Cost of Capital 136 Assessment of Risk in the Debt Versus Equity Decision 138 Cost of Capital for Other Organisations 140 7 Portfolio Theory and Market Efficiency 143 Risk and Return 144 The Impact of Diversification 146 Portfolio Composition 150 The Application of Portfolio Theory 157 Market Efficiency 159 8 The Capital Asset Pricing Model 171 Risk, Return and CAPM 172 Calculation of Betas 178 Validity of the CAPM 179 Practical Applications of CAPM 180 The Arbitrage Pricing Model 182 9 Capital Structure 187 Capital Gearing 188 Factors Determining Capital Structure 192 Theory of Capital Structure 196 Capital Gearing and the Effects on Equity Betas 202 10 Corporate Dividend Policy 205 Key Influences on Dividend Policy 206 Theories of Dividend Policy 211 Practical Aspects of Dividend Policy 213 11 Working Capital and Short-Term Asset Management 217 Working Capital 219 Overtrading 222 Cash Management 224 Management of Stocks 230 Management of Debtors 235 Creditor Management 242 Short-Term Finance and Investment 243 12 Capital Investment Decision Making 1: Basic Appraisal Techniques 255 Future Cash Flows and the Time Value of Money 257 Return on Investment (Accounting Rate Of Return) 258 Payback 259 Discounted Cash Flow 260 Net Present Value (NPV) 261 Internal Rate of Return 267 Cost/Benefit Ratio 270 Comparison of Methods 270 Impact of Taxation on Capital Investment Appraisal 271 Appendix: Discounting Tables 274 13 Capital Investment Decision Making 2: Further Considerations 285 Allowance for Risk and Uncertainty 286 Impact of Inflation on Investment Appraisal 288 Capital Rationing 289 Lease Versus Buy Decisions 291 Post-Appraisal Audit 293 Adjusted Present Value (APV) 293 Use of the Capital Asset Pricing Model 296 Worked Examples 297 14 Managing Exposure to Risk – Financial Derivatives 319 Principles of Hedging 321 Interest Rates, Risk and Exposure 325 Internal Techniques of Managing Interest Rate Exposure 328 Futures Contracts 329 Forward Rate Agreements (FRAs) 332 Interest Rate Swaps 333 Options 335 15 International Trade and Finance 351 Theory and Practice of International Trade 353 International Investment 358 Finance and International Trade 362 Exchange Rates 372 Risk and International Trade/Finance 379 Internal Methods of Managing Exchange Rate Risk and Exposure 380 External Methods of Managing Exchange Rate Risk and Exposure 382 i Advanced Diploma in Business Administration Corporate Finance Syllabus Aims 1. Understand the application of capital budgeting and investment appraisal techniques applied to complex situations. 2. Understand the financing decision and the uses and limitations of the weighted average cost of capital. The Modigliani Miller proposition and optimal capital structures. 3. Understand the portfolio approach to risk and uncertainty and the relationship between risk and return. 4. Understand the issues surrounding dividend and distribution policies. 5. Demonstrate a knowledge of the various business valuation techniques. 6. Understand the problems associated with foreign exchange management. Programme Content and Learning Objectives After completing the programme, the student should be able to: 1. The broad environment of financial decision-making involving corporate objectives and functioning of the capital markets: Evolution of financial management in response to economic and other external factors e.g. technical developments and inflation resulting in the globalisation of financial decision making. The agency problem, finance theory in practice incorporating market and other imperfections. Financial markets, market efficiency and short-termism. 2. The capital investment decision in practice, including unequal project lives, effects of inflation and risk: Identifying the relevant information in investment analysis. Evaluating replacement and other investment decisions. The problems of inflation and taxation. Replacement decisions. The control process as part of the investment decision. Post audit reviews. 3. The impact of risk and uncertainty on the financial decision-making process and the contribution of modern portfolio theory: The need to understand how uncertainty affects investment decisions. Managers’ attitudes to risk. Mechanics of portfolio construction. Determination of appropriate risk premiums to incorporate into discount rates. The capital asset pricing model and its limitations. 4. The financing decisions of firms, including leverage, debt/equity ratios and leasing decisions: Treasury management and working capital policy. Short term asset management. Gearing and the advantages of debt capital. Factors to be taken into account when designing a capital © Copyright ABE ii structure policy. The Modigliani and Miller contribution. Buy or lease decisions, effects on overall financing strategy. 5. The role of financial markets in the provision of finance and the efficiency of the markets in the pricing of securities: The key characteristics of the main sources of finance. The efficient market hypothesis and its practical implications. The derivatives market including the role of options, futures and swaps. 6. The dividend policy debate, including the implications of particular dividend distribution policies on the future of the firm: Competing views about the role of dividend policy. The implications of a change in dividend payouts. The “information content” of dividends. The theory of dividend policy. Market imperfections and the clientele effect. 7. Evaluation of acquisitions and mergers and the problems associated with the valuation decision: The reasons behind the choice of merger or acquisition as a strategic option. Financing of acquisitions. The valuation problem particularly related to unquoted companies. Evaluation of the success of a merger or take-over. 8. The impact of international trade on financial decisions, including the impact of exchange rates and the problems both financial and non-financial of international investment: Economic theory involving the operation of international markets. Understand the three forms of risk involved in international trade: currency risk, translation risk and economic risk. Internal and external hedging of these risks. Method of Assessment By written examination. The pass mark is 40%. Time allowed 3 hours. The question paper will contain: Six questions of which four must be answered. All questions carry 25 marks. Further Reading The ABE is keen to encourage students to read around their subjects although your study manual provides complete coverage of the syllabus for the examination. If you have time available once you have worked through the manual, you may wish to consult one or more relevant books from the ABE’s suggested reading list which can be found in each subject syllabus. Advanced Diploma students especially should supplement their study of the manual with wide reading of relevant journals, quality newspapers and contemporary media sources. Recommended Reading (cid:1) R Pike, and P Neale, Corporate Finance and Investment; 3rd edition, 1999 (Prentice Hall) Additional Reading (cid:1) G Arnold, Corporate Financial Management; 1998 (Pitman) © Copyright ABE 1 Study Unit 1 The Context of Corporate Finance Contents Page Introduction 3 A. Basic Principles of Companies 3 Types of Company 3 Regulatory Framework for Companies 4 B. Financial Objectives 4 The Prime Objective 4 Valuation of Companies 5 Shareholder Value Analysis (SVA) 6 Long-term Versus Short-term Objectives 6 Objectives of Multi-National Companies 6 Objectives of Public Sector Organisations 6 C. Corporate Governance 8 Company Stakeholders 8 Management/Shareholder Relationship and Agency Theory 13 The Cadbury Report 13 The Greenbury Report 17 Hampel Committee Report 18 The Combined Code 19 The Turnbull Report 21 Directors’ Emoluments 21 D. Corporate Financial Management 22 Financial Decision Making 22 Financial Functions in Organisations 23 The Role of the Finance Manager 24 Planning 25 Forecasting 26 (Continued over) © Licensed to ABE 2 The Context of Corporate Finance Budgeting 27 Cash Management 28 Economic and Government Influences 29 © Licensed to ABE