1. finance

Corporate Financial Management
Onestudy
Corporate Financial Management
Editorial Material Copyright Onestudy, 2008
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Onestudy – Corporate Financial Management
Study Skills
Help, I feel
overwhelmed by all
this information in the
textbook and the
notes, where do I
start?
First of all, you have enrolled for this course to achieve your goal.
Congratulate yourself; you are on your way to achieving a prestigious
qualification.
Don't feel overwhelmed, break your goal into bite-size chunks, achieving
little targets will motivate you and encourage you to keep going to
complete the entire syllabus.
Luckily, we are here to help you with your plan. Our scheme of work has
broken the syllabus down into modules. At the end of each module there
is question practice and syllabus reference points, completing these will
enable you to tick off each target, once you tick off all targets you have
achieved a milestone in that you can now do exam standard questions.
Help, I can't
remember
anything I
read!
Firstly, do you understand what you are reading? Recall will be a hundred
times easier if you understand the topic/concept. Try explaining the
concept to someone in your own words. Research suggests that students
learn more if they say words out loud.
Secondly, how often do you recall what you have read? A leading
academic writer, Geoff Petty, author of Teaching Today, states that the
best way to revise is “study-cover-recall-check”.
Study – Students look at the material making sure they understand it.
Cover – The files and books are closed.
Recall – Students write down all the key points that they can recall for
the topic.
Check- Students open their files and books again and check that the
recall was both correct and complete.
We have designed our notes in such a way to give you maximum learning
advantage:Firstly, we always use the syllabus as a reference point.
Secondly, our notes contain revision quizzes to enable you to identify
areas you are struggling with. Get your family or friends to ask you
questions to share the challenge of working towards your goal.
Thirdly, our scheme of work ensures you get exam standard practice from
an early stage, after these the real exam will not be a shock.
Studying is only difficult if you don't keep on top of it. Use our scheme of
work to achieve a weekly goal, fitting your studies around your life in this
way will make it more enjoyable, interesting and fun.
Need further advice and support?
Contact your tutor by email at [email protected]
Creating a Study Planner
On the following page we have provided you with a blank study grid. It is
very useful when commencing a professional programme to plan your
study time.
The main problem that most students face with this is that they are not
realistic enough when setting themselves targets. If unrealistic targets
are set, which you then fail to keep, it can have a hugely demotivational
effect, therefore sit back and consider the following:
1
How many weeks to you have between now and the examination?
Make sure you have a square for each week. Blank out all excess
squares.
2
If you have any holidays booked or any personal or work
commitments that are going to make a particular week impossible
to study – don’t ever kid yourself you will be able to study as well –
blank these squares off immediately.
3
Mark in the classroom tuition week if applicable.
4
Between now and any classroom tuition divide the number of
squares into the number of chapters in the study text you need to
study and assign them accordingly. Within these weeks if you have
any small personal or social commitments mark these in the boxes
eg sporting activities, nights out etc
5
Leave all squares between the classroom tuition week (if applicable)
and the exam week purely for question practice and reviewing past
examination papers. If not attending a face to face tuition session,
leave the last 2 weeks before the exam solely for this purpose.
6 Try to be realistic when apportioning your week, for example, most
law based subjects are better studied in short, sharp segments e.g.
an hour per segment whereas you will have to assign a good two to
three hour segment if studying an accountancy based subject.
Study Planner
Week 1
Week 2
Week 3
Week 4
Week 5
Week 6
Week 7
Week 8
Week 9
Week 10
Week 11
Week 12
Week 13
Week 14
Week 15
Week 16
Week 17
Week 18
Week 19
Week 20
Using the Distance learning pack
Suggested Approach
1. Read the chapter in the text book, attempt all the test your
knowledge and worked example sections.
2. Review the chapter
chapter in the onestudy notes.
3. At the end of the module:
a. Do the onestudy module quiz
b. Do the text book questions
c. Attempt the past paper questions
d. Review and rere-do the mind maps for each chapter.
4. Move on to the next module.
Note – Keep going back (for at least
least one hour a week) to the previous
modules and at the very least do the mind maps but try and do the
quizzes as well. You are trying to build up your long term memory.
ICSA Corporate Financial Management
Scheme of Work
I cannot stress the importance of practicing past questions. Ensure that
each time you study an area you attempt (or at a minimum read the
questions and answers below). The past papers are available on the ICSA
web-site using your log-in.
Date
Module 1
Module 2
Module 3
Syllabus
Area
Financial
objectives
Financial
requirements
Sources of
finance
Share and
loan capital
Subjects
Financial
objectives,
Financial
requirements
and their
impact on
business
planning,
Financial
markets
Share capital
Loan capital
and other
sources of
finance
Cost of capital
Capital
structure and
the cost of
capital
Study
Materials
Chapters 1,
2 & 3 of
ICSA text
book
Chapters 1,
2 & 3 of
Onestudy
notes
Chapters 4 &
5 of ICSA
text book
Chapters 4 &
5 of
Onestudy
notes
Chapter 6
Exam Questions
Nov 06 (1e)
June 06 (1g),
(1j)
Nov 05, (1a),
(1j)
June 05 (1a)
June 04 (f)
Dec 03 (a) (b)
Pilot (d), (j),
(3b)
Nov 02 (a) and
(i)
June 07 1(a),
1(b), 1 (h), 1(i)
Nov 06 (1d),
(1e), (1g), (1i)
June 06 (1a),
(1c), 3
Nov 05, (1b),
(1f), 6
June 05 1(b),
(c),(h),(j)
June 2004 (b),
(d), 3
Dec 03 (e) (h)
Pilot (b), (e),
(g), (i)
Nov 02 (c), (h)
June 07 (3)
Nov 06 (2)
June 06 (2b)
Nov 05 (1d),
(1h)
June 05 1(d),
(f), 2
Date
Syllabus
Area
Subjects
Module
Module 3
Portfolio theory
Capital
structure and and CAPM
the cost of
capital
Module 3
Capital
structure and
the cost of
capital
Working
Capital
management
Module 4
Study
Materials
Chapters 7 &
8
Exam Questions
June 2004 (h)
Nov 04 (a) and
(g)
Dec 03 (j)
Internet
question (2)
June 03 (d) and
5
Nov 02(f)
June 07 1(e),
1(g)
Nov 06 (5)
Nov 05 (1g)
June 05 (3)
June 04 (g) and
(j)
Nov 04 (d)
Dec 03 (4)
June 03 (2)
Pilot (a)
Capital
structure
Chapters 9
June 07 1(d), 6
June 03 (f)
June 05 (6)
Working
capital:
Planning and
control and
cash
management
Chapters 10
& 11
June 07 (2)
Nov 06 (1f)
June 06 (1b),
(4a)
Nov 05 (2)
June 05 1(g)
June 04 (5)
Nov 04 (e),(j)
Dec 03 (3)
Pilot (h)
Pilot 3(a)
Nov 02 (e) and
(4)
June 03 (b), (6)
Date
Subjects
Study
Materials
Chapter 12
Exam Questions
Syllabus
Area
Capital
Investment
appraisal
Capital
investment
appraisal
Module 5
Capital
Investment
appraisal
Planning capital
investment
decisions
Chapter 13
June 06 (6)
June 05 1(e)
and (5)
June 04 (2b)
Nov 04 (f)
Dec 03 (d)
June 03 (a) and
(g)
Module 6
Business
Reorganisati
on
Mergers and
acquisitions
Disinvestment,
business failure
and capital
reconstruction
Chapters 14
& 15
Nov 06 (1h), (4)
June 06 (1f), (5)
Nov 05 (1i), 3
June 04 (6),
Nov 04 (h) and
(5)
Dec 03 (5) and
(g)
Pilot (4)
June 03 (h), (3)
Nov 04 (3)
Module 5
June 07 1(c),
1(f), 4
Nov 06 (1a),
(1b), 3
June 06 (1d),
(1e), (2a), (4b)
Nov 05 (1e), 5
June 04 (a)and
(2a)
Nov 04 (2)
Dec 03 (f)
Internet
question (2)
Pilot (c), (6)
Nov 02 (b), (3)
June 03 (e) and
4
Dec 03 (2)
Date
Module 7
Syllabus
Area
International
Aspects
Subjects
International
trade
Internatioanl
Finance
Study
Materials
Chapters 16
& 17
Exam Questions
June 07 1(j), 5
Nov 06 (1j), (6)
June 06, (1h)
Nov 05 (1e), 4
June 05 (i) and
4
June 04 (i)
Nov 04 (i)
June 04 (e)
Corporate Financial Management Index
Exam notes and syllabus
Chapter 1 - Financial Objectives
12
18
Chapter 2 - Financial Requirements and Their Impact on Business Planning
31
Chapter 3 - Financial
Financial Markets
34
Chapter 4 - Share Capital
47
Chapter 5 - Loan Capital and Other Sources of Finance
53
Chapter 6 - Cost of Capital
69
Chapter 7 - Portfolio Theory
76
Chapter 8 - Capital Assets Pricing Model
87
Chapter 9 - Capital Structure
100
Chapter
Chapter 10 – Working Capital Management
119
Chapter 11 - Working Capital Management: Planning and Control
129
Chapter 12 - Capital Investment Appraisal
145
Chapter 13 - Planning Capital Investment
155
Chapter 14 - Mergers and Acquisitions
168
Chapter 15 - Disinvestment, Business Failure And Capital Reconstruction
181
Chapter 16 - International Trade
193
Chapter 17 - International Finance
200
The exam is split into two sections as follows
Section A
Section B
10 compulsory 4 mark questions
3 out of 5 twenty mark questions
40 Marks
60 Marks
The exam lasts 3 hours (180 minutes). This means that you must
allocate your time as follows:
Section A
Section B
7.2 minutes per 4 mark question
36 minutes per 20 mark question
72 minutes
108 minutes
We suggest that you take 10 minutes reading time and reduce section A
and B accordingly.
When you are ready to do your exam questions, use the times above to
practise under exam conditions.
The aim of the module is “to address the need for the Chartered Secretary to be
knowledgeable and competent in the skills of corporate financial planning, and in
understanding the impact of the fiscal environment on the organisation and its
decision-making.”
In previous studies, candidates will have gained a basic understanding of
management and financial accounting. This module will extend the depth of
knowledge and understanding of these basics and will give the candidate the
opportunity to develop the ability to apply the theories of financial management
to a variety of practical situations.
There are eight main areas within the Corporate Financial Management syllabus.
The following is an overview of these areas, including clarification of what is and
is not expected in the examination and advice to help candidates to perform
effectively.
(i)
Financial objectives and requirements
Candidates must ensure that he/she is able to:
Distinguish between the main types of organisation.
Identify the various stakeholders connected to an organisation.
Discuss the issue of corporate social responsibility towards the
stakeholders.
Distinguish between financial and non-financial objectives.
Consider how the objectives of a ‘not-for-profit’ organisation might
differ from the objectives of a ‘commercial’ organisation.
Discuss the problem of conflict of objectives including the ‘Principal–
Agent’ problem.
Justify
the
primacy
of
the
profit
motive
for
commercial organisations.
Recognise the duties and rights of directors.
Explain the ‘satisficing’ principle.
Understand the role of the financial audit.
(ii)
Sources of finance
Candidates must be able to:
Understand the role of the primary and secondary financial
markets.
Explain the requirements for a ‘listing’.
Discuss the implications of the Efficient Market Hypothesis for
corporate policy and financial management.
Discuss the advantages and disadvantages of going public.
Understand the risk-return trade-off.
Explain how markets can influence the finance decision.
Distinguish between different forms of debt finance offered by
commercial banks.
Identify the international money and capital markets and outline
their operation.
Explain other sources of finance including government aid and
grants.
(iii)
Share and loan capital
Candidates should ensure that he/she is able to:
Distinguish between Authorised and Issued Share Capital.
Explain different forms of share issue.
Highlight the advantages of Rights Issues over other forms of share
issues.
Explain the purpose and impact of making bonus issues, scrip
dividends and stock splits.
Recognise the relevance of a company’s dividend policy.
Explain the use of preference shares.
Distinguish between convertible debentures and debentures issued
with a warrant.
Assess the effect on EPS of the method used to finance a company.
Consider the Dividend and Interest Cover ratios.
Value shares using the dividend growth model and price earnings
ratio.
Value debentures.
(iv) Capital structure and the cost of capital
Candidates should show that he/she is able to:
Explain the concept of financial gearing.
Distinguish between financial and operating gearing.
Calculate the Weighted Average Cost of Capital.
Calculate the Debt/Equity ratio using short-term and long-term
finance.
Understand the cost of using retained profits.
Explain the advantages of financial gearing to the shareholder.
Consider the possible effects of gearing on the value of shares,
company risk and required return.
Understand the Traditional Theory of Capital Structure and compare
it with Modigliani-Miller’s theory, with and without tax.
Distinguish between systematic and unsystematic risk.
Understand the risk reduction effect of diversification (Portfolio
theory).
Explain the Capital Market Line.
Calculate the beta of a company.
Use beta to calculate the required rate of return of an investment.
Discuss the appropriateness of the CAPM in investment appraisal.
Use the Capital Asset Pricing Model to calculate the cost of capital.
(v)
Working capital management
Candidates should be able to:
Explain what is meant by ‘working capital’ and ‘working capital
management’.
Explain, and identify the symptoms, of overtrading.
Calculate and explain relevant ratios.
Identify the need for effective working capital management.
Distinguish between cash flows and profits.
Explain the importance of liquidity to survival.
Discuss the means of checking the creditworthiness of customers.
Explain the role of factoring and invoice discounting.
Consider the importance of creditors.
Explain the use of discounts in credit management.
Compare the costs of factoring with the cost of discounts for early
settlements.
Discuss the particular problems of credit management facing an
exporting company.
Explain methods used in control of stock.
Understand the benefits and dangers of a JIT system.
Identify the various form of bank finance available to small and
medium companies.
Discuss how the procedures for Treasury Management can be
applied by national and multinational organisations.
(vi)
Capital investment appraisal
Candidates should be able to:
Compare different methods used in appraising long term
investments.
Discuss the advantages of any one method over the others.
Use present value and annuity tables.
Explain the importance of the time value of money.
Explain the relationship between the rate of inflation and interest
rates.
Evaluate projects on a real terms and nominal terms basis.
Calculate capital allowances and associated tax relief (NB: 25%
reducing balance basis only).
Assess the impact of tax relief on the cost of borrowed finance.
Discuss the different methods of financing investments.
Compare finance leases with operating leases.
Contrast leasing with other methods of credit finance such as hire
purchase.
Identify the relevant cash flows associated with a Lease versus Buy
decision.
Compare hard capital rationing with soft capital rationing.
Use profitability indices to rank projects.
Consider the effect of risk on the likely outcome of a project.
Use sensitivity analysis.
Consider ways to reduce the level of risk of a project.
(vii)
Business restructuring
Candidates should be able to:
Explain the different types of expansions and the motives behind
them.
The methods used to finance the expansions.
Discuss the reasons for a public company becoming private.
Discuss Debt-Equity swaps.
Distinguish between acquisitions and mergers.
Explain the different types of mergers.
Discuss the motives for mergers.
Understand the different methods used to evaluate companies for
the purpose of merging.
Calculate share values using such methods as asset valuation and
dividend growth model.
Explain the difference between a management buy-out and a
management buy-in.
Predict the possibility of company failure using different models.
Consider the reasons for divestment.
(viii) International aspects
Candidates should be able to:
Discuss the reasons companies invest overseas.
Distinguish between an international and a multinational
corporation.
Understand the different forms of foreign exchange (FX) risk.
Understand different methods of hedging against risk.
Discuss the use of the forward market.
Discuss the use of the futures market.
Discuss the use of options in managing FX risk.
Discuss the various methods that can be used to finance overseas
investments.
Understand the issues surrounding the repatriation of profits.
Discuss the best methods of overcoming country risk.
Calculate the cost of hedging for import and export situations.
Calculate expected future exchange rates given the premium or
discount.
Chapter 1 - Financial Objectives
1. Decisions That a Company Must Make
Refer to your diagram at the front of your pack. Keep these
decisions in mind as they feed the entire CFM syllabus.
The investment decision – Which projects?
The financing decision – Loans, shares or earnings?
The dividend decision – Increase or reduce?
2.
Different Types of Companies
In CFM, a four mark question has been, “Why would a company go
public?”
This section is revision, ensure you are familiar with the different types of
companies and the advantages and disadvantages of each.
3.
Company
Characteristics
Public
May be listed – AIM or full.
Can issue shares to the
public.
Must have 2 members.
£50,000 share capital.
Associated with corporate
growth.
Shares more marketable.
Risk of takeover.
Private
Cannot offer shares to the
public.
Can be single member.
More control for owners.
Agency problem reduced due
to owner-managers.
Guarantee
Undertake to pay an agreed
amount if company is wound
up.
No shares.
Used for charities and clubs.
The Objectives of Companies
Companies
Exam focus – Maximisation of shareholder wealth will be assumed
to be main objective.
Other Objectives
Maximise profits
Good corporate citizen
Growth
Good employer
Innovation
Environment issues
4.
Stakeholders
Definition – A person or a body that has some kind of interest in the
success of the company.
The table below highlights how the views of stakeholders may
conflict.
Stakeholder
Shareholders
Banks and lenders
Business contact group
Management
Employees
Financial analysts and advisors
Government
The public
Objectives
1. Capital growth in share price
2. Specific level of dividends
3. Expand business
4. Maintain security of investment
5. Give details of donations
6. Relocate if appropriate to
expand
business
1. Safety of investment.
2. Adequate cash to pay interest
1. Firm deals honestly.
2. Pays promptly
3. Community interests
4. Quality service
1. High wages
2. Empire building
3. Satisficing (only doing as much
as is
required)
1. High wages
2. Good working conditions
3. Pension
4. Training and development
5. Job security
1.
Information to make decisions
1. Pay taxes
2. Obey law
3. Good corporate citizen
4. Comply with watchdog
regulations
1.
Political party donation
restrictions
2.
Restrict borrowing activities
3.
Invest in community
C
O
F
L
I
C
T
S
Stakeholder Theory
Provides a model which analyses the ways in which management
can take account of and satisfy the needs of the different
stakeholders.
Forms
Strong
Minimalist
Management is
answerable to all
stakeholder
groups and should
take account of
and try to satisfy
the needs of all
stakeholders
Management is
only answerable to
the shareholders
as owners
Pragmatic
Management is not
formally
answerable to all
stakeholder
groups but should
take account of
them for reasons
of commercial
practicality
5.
Agency Theory
This area has came up quite a few times for four marks. Note the
distinction between Agency theory and the agency problem
Agency theory - An agency relationship exists where one person
(agent) acts on behalf of another (principle).
Example – Management/shareholder relationship.
Agency problem – Management may not act in the best interests of
the shareholders as they are focused on their own financial reward.
Goal congruence – Achieved when objectives of agents match those
of principles.
How can Goal Congruence be achieved?
a)
Stock option schemes – Give senior managers a right to buy
shares at a fixed price at a specified time in the future.
Drawbacks – Do not have to buy shares.
May lead to share price volatility
Managers open new schemes with low exercise prices which
are likely to be exceeded.
b)
Profit-related incentives – Bonuses based on earning per
share.
Drawbacks – Accounts can be manipulated
Figures can be affected by external factors
Satisficing – Managers only do enough to provide an adequate
return rather than maximising return.
c)
General forces – If managers fail to maximise returns they
may be penalised in the job market.
Drawbacks – The more buoyant the market, the less
managers will have to do to secure lucrative jobs.
Exam note – Goal congruence and agency theory has been
examined several times.
Note the article from Chartered Secretary:
“Shell is joining BP in proposing to discontinue share options
to reward top executives. Shareholders have requested that
the group adjust its pay plans, which can allow directors to
gain large rewards because the share price is rising. Instead,
Shell would award shares in amounts linked to the Total
Shareholder Return (TSR) performance of the group,
calculated using price changes and dividends, relative to the
company’s four main rivals.”
6.
The Satisficing Principle
Since managers have objectives that are not identical with those of
shareholders they may be tempted to pursue their own agendas,
while doing only enough to provide a return that shareholders
consider adequate, rather than maximising shareholders return.
Key terms to revise and take to the exam – Agency problem, goal
congruence and the satisficing principle.
7.
The Audit
The audit should provide credible assurances for the shareholders.
The shareholders need to be confident that they can rely on what
the report and accounts tell them. The auditors are independent
accountants who have to certify that the company’s financial
statements present a ‘true and fair’ view.
A four mark question has asked, “What are the benefits of having a
companies accounts audited?”
Key terms – The auditors provide an independent opinion. They
have access to more information than shareholders. They can ask
for representations from management.
8.
Corporate Governance
Reports have been issued by several committees regarding
corporate governance; the process by which companies are directed
and controlled. If a company is listed on the stock exchange, it has
to state that it has complied with the combined code and if not
explain the deviations. The government has also indicated that if
companies do not adopt best practice it may introduce legislation on
corporate governance.
Cadbury Committee
This Committee published a code of best practice for the role of the
board and the composition of executive and non-executive
directors.
Greenbury Committee
This committee focused on directors pay. It included
recommendations on the establishment of remuneration
committees, made up solely of non-executive directors, to
determine executive director’s remuneration, service contracts and
reporting remuneration to shareholders.
Hampel Committee
This committee extended the work of the Cadbury committee. The
LSE published the Hampel Committee principles of good
governance.
Turnbull Report
Internal control guidance for directors of listed companies in the UK.
Higgs Review
Made proposals concerning the recruitment and appointment of
non-executive directors, their induction and professional
development, their tenure and remuneration, what should happen
when they resign, their liability and their relationship with
shareholders.
The Smith Report
Made recommendation on the composition and role of the audit
committee and on its reporting to shareholders.
The Combined Code 2003
The recommendations of all of the above reports were incorporated
in the new combined code on Corporate Governance in July 2003
Year
Report
Main Issues
1992
Cadbury Report
1995
The Myners
Myners Report
1995
The Greenbury
Report
1998
The Hampel Report
Report
1998
Combined Code
2003
The Higgs Report
2003
The Smith Report
Executive and Non-executive
Directors
Dealt with the relationship
between companies and
institutional investors including a
recommendation on opening a
dialogue
Focusing on Directors'
remuneration and the so called 'fat
cat' pay awards
reviewed the recommendations of
Cadbury and Greenbury and
covered such issues as Board
composition, role of the Directors,
Directors' remuneration and the
role of the Shareholders
Hampel Report suggested that the
Cadbury Report and the
Greenbury Report should be
"combined" into one code
Considered the role and
effectiveness of Non-executive
Directors
Guidance for audit Committees
2003
2003
The Revised
Combined Code
The Tyson Report
on the Recruitment
and Development
of NonNon-executive
Directors
Made up of:
Main principles
Supporting principles –
supplement main principles
Provisions – specific measures
companies should take
Effectiveness of the Board;
Broader identification and
recruitment of Non-executive
Directors
Corporate Governance Committees - Summary
1.
Smith
Composition and role of audit committee
2.
Cadbury
Role of board of directors
3.
Greenbury
Director’s pay
4.
Turnbull
Internal control
5.
Hampel
Extended work of Cadbury
6.
Higgs
Commented on effectiveness of nonexecutive directors
7.
Combined Code
Combines all other codes and is
compulsory for listed companies.
Below is an easy way and fun, pictorial way of remembering all the
seven names listed above. This technique is called the story technique
and is said to be one of the most effective memory techniques.
Delia SMITH
Delia SMITH is making a chocolate cake. She does an
AUDIT of her cupboards to assess what ingredients
she needs. She lays all the ingredients out on her
chopping BOARD and discovers that she needs some
CADBURY’S chocolate. (smith = audit, Cadbury =
board)
She therefore goes shopping for CADBURY’S.
As it is a nice day she goes through the beautiful GREEN park where
you have to PAY to get in. She pays and goes through the CONTROL
TURNstile.
(Greenbury = directors pay, Turnbull = Internal controls)
TURN
7.
She arrives at HAMPEL and HIGGS the
famous chocolate shop. Mr HAMPEL shows her the EXTENDED
collection of CADBURYS chocolate and Mr HIGGS comments on
the most EFFECTIVE one to buy. (hampel = extended the work of
Cadbury re the board, higgs = effectiveness of non-executive
directors)
She ticks all the ingredients off her LIST and goes home and
COMBINES all ingredients into a beautiful cake.
(combined code brings together all the gov codes)
9.
Public and NotNot-For Profit Sector
Objectives of the public and not-for profit sector:
Economy – Cheapest price
Efficiency – Best possible way
Effectiveness – Achieves its target