Text book: Corporate Finance, Fifth edition by Dehzil natson

Unit 1: the nature of financial management

Corporate objective: maximizing the shareholder wealth

Financial Accounting: Information - external user to see
Manager Accounting: Information internal user to see: e.g: manager
based on historical data. based on profit
FM: you have a lot of profit doesnt mean you have CASH. The enfaces of FM is on Cash
(future)
3 main area:
- Fund raising (financing area)
- Making investment: (NPV) is the best to masimizing goal, IRR
Appraisal technique, risk and return trade off
- Dividends/ Retained earning => when to pay, to pay or not to pay, how much to pay?
- Addition: risk management

Objectives of corporation:
- To make profit
- Increase market share
- Sustain/survive
- To grow
- To provide jobs to workers/employees
- To be socially responsible
- To satisfy customers

What are finance function?
- Raising capital for corporation to support their operations and also investments
- Use appraisal technique and apply risk & return concept in selecting investment /projects
to maximize shareholder wealth: use our resource properly
Capitalist
Socialist
- Manage & balance the cash flow in the company while maintaining debt & equity capital
ratio that preserve the capital structure of the company (capital structure and working
capital management
1
)
- To develop corporate governance culture/ structure in corporation to encourage ethical
behavior/action that serve the best interest of shareholders
- To manage the risk exposure in the corporations taking into account of risk & return trade
of to maximize shareholder wealth

Why profit maximization should not be the corporate objective?
- Company can ignore the shareholder to max the profit
- Company is using the shareholder cash
- Risk and return. Shareholder dont want take risk
- Doesnt take in account Time value of money: Compounding and discounting
(Stress the efficient use of capital resource, Goal are not precise,
Shareholder wealth max = max of stock price
Agency proplem: structure of the op
E.g: manager job is to investment to choose highest positive NPVhighest risk
Fail Have loss
How to solve agency problem?
Make them part of you: reward them if they help you to max the profit\


1
manage current asset and current liability
Hermes 10 principle
Unit 2: Working capital management
Unit 3: Budgeting
Capital: the funds
Many types: - long term
- short term (working capital) invest for short term
Component: current asset (cash, inventory raw material, work in process, finish goods;
account receivable)
they are in the cycle:
1. their life span is short
2. they can be transform into another form frequently
I mplication of current asset for the financial manager: + due to the frequently of the cycle
any decision making regarding to WCM will have to be taken very frequently on a repeated
basis.
+ Each component of WC is closely related so mismanaged 1 component will bring adverse
effect on another component
+ Present value and book value of profit is not significant impact on the profit.
Working capital is the fund which is used for daily operation of business (e.g. finances the cash
conversion cycle (ccc) )
Working capital = current assets current liabilities
Positive CCC = manufacturing comp.
Negative CCC= service comp.
Negative WC implies this corporation has problem in fulfilling their short term obligation
The needs for working capital: + adequate stock of finished goods (minimum level) in order to
fulfill the demand of the customer regularly
+ adequate supply of raw material to make sure a continuous operation/production
Lack WC, not able to grant credit to customers
WC Cycle will tell us how many days the company operates without cash.
Working capital Management
1. Inventory management
Cost of ordering and holding should be the least (has to be kept minimum)
Stock out cost should be minimized
Re-order level (when you suppose to order) (EOQ)
2. Receivables management
Project expected sales
Monitor the credit days
3. Cash management
Cash budget
Control of cash inflow and cash outflow:
The means to finance working capital
- Suppliers credit
- Bank loan
- Promoters fund
Long term fund to short-term purpose: advantages (more spare money) disadvantages (interest
rate high)
Conclusion:
The management of WC is euqually important as the management of long-term finaical
investment
Shortermism: the trend of many manament now: only focus in short time
The business will not be able to carry on day-to-day activities without the availableity of
adequate WC
WC ratios
1. Current ratio/quick ratio (also known as liquidity ratio or cash ratio)
It measure the ability of the corp to payback the short time debts
Current ratio = CA/CL
Current ratio: Standard = 2:1
Quick ratio: standard = 1: 1 (also knowns as acit test ratio)
Quick ratio = (CA Inventory) /CL
It measure the ability of corp to payback the short time debts by using the most liquid assets

Make the comparison with the standard and the standard of the industry

2. Number of days accounts receiveable
Accounts receiveable x 365/value of sales
A low NDR number means that it takes a company fewer days to collect its accounts
receiveable
If a high NDR hard to collect money from customer selling its product to customers on
credit and taking longer to collect money
However it is more meaningful to create monthly or weekly trend of NDR
3. Number of days accounts payable (NDP)
Accounts payble x 365/purchases
Its an efficiency ratio that measure the average number of days a company takes to pay
its suppliers
A low ratio hghlights good WCManagement because the comp availing early payment
discount
This has to consider the liquidity ratio as well
4. Managing accounts receivable and payable
Advanatge of outsourcing?
- Doesnt need to deal with the debtors
- Receive 50% debt immediately
- More efficient at collecting funds than the company would be and saving the company
the costs of running its own department for collecting cash
- Factor will have better access to credit infor about customer than the company
- The funds becoming available are linked to the volume of sales so as the companys
activities increase so do its funds. Compare this with an overdraft which normally have a
fixed limit
Disadvanatges
- Cost to factoring which can be expensive
- Using a factor to collect debts may harm customer relations
- The company loses control of its accounts receiveable a important marketing tool
-
5. Number of days inventory
Raw material days = value of raw material x365/ Purchases
WIP days = value of WIP stock x365/ Cost of goods sold
Finished goods stock = value of FG x365/




Existing capital structure
+ D
+ E

D 0% 20% 30% 40% 50%
E 100& 90% 70% 60% 50%


Increasing the debt financing

Explain the Benefit / Risk? Critically examine

- Benefit: + tax relief
+ return to shareholder increase (base on external factor not 100% true)
+ Dilution of control
+ required rate of return is lower cost of financing is lower WACC is lower
value of company is increasing
-Risk:
+ the higher the financial risk shareholder
+ More restricted government cannot use the Cash flow in the Co. freely

USE THE RELEVANT THEORY TO SUPPORT (Capital structure
theory - ) gearing theory/ financing leverage
Gearing is the level of debt to the level of equity use by the company

Gearing:
+ Capital gearing ratio = Total debt / total capital
+ Gearing ratio = Debt / Equity
M&M no tax
M&M with tax
Traditional view
Pecking order theory
Trade off theory
Assume only D & E financing
WACC = (Ke xE) / (D+E) + Kd (1-T) x D / D+E
Objective to maximize shareholder return
1958: Modigiani & Millow
Capital structure has no relationship on the shareholder return
Perfect market (no transaction cost, no tax)

M&M no tax
the ore debt the co. use, the less the cost of debt
increase interest payment , the higher the risk or fluctuation in the
required rate of return by the shareholder
*No debt (100& equity)
E = 8000
EBIT =1,200
ROE = 1200/8000 x100&= 15%
WACC = ?
*50% debt 50% Equity debt at 10% interst, T=0%
EBIT = 1,200 less interest 10% (400)
EAT 800
ROE = 800/4000 = 20%
WACC = 0.5 x 10% + 0.5 x 20% = 5% +10% = 15%
WACC unchanged
Split to 3 part : Low gear Moderate gear High gear
0D/50E D50/50E D60/40E
M&M with tax (ignoring backrupcy risk)
the higher the amount of debt the higher the tax relief (tax shield)
Kd ----Kd (1-T) the lower the cost of financing
This higher of tax relief > the increase of financial risk of the Ke
Base on the example
The more debt you use, the lesser the WACC and the higher the Market value
However it also has some Disadvantages
EBIT 1000
Interest (100)
EBT 900
Less tax(30%) (270)
--------------------
630

EBIT 1000
Interest (250)
--------------------------------
750
Less tax (225)
-------------------------------
525
Total CF generated back to the capital provider = 200 + 525 = 775

Tax exhaustion

3. Kaplan (1986): more debt => more risk of financial distress: firm value decreases
- Direct cost: legal cost, consultant fees
- Indirect cost: Management ( negotiate with lenders); customer (reduce relationship,
reduce profitability); employees (seek for other attention)
If increasing debt gradually => firm values increases
If increasing debt significantly => firm values decreases
4. Traditional view model (static trade off theory)
If financial risks exceed benefit of debt => managers need to stop financing debt, otherwise
bankruptcy.
5. Pecking order theory
For a company to decide on the capital structure, it has to follow the order;
+ use retained earnings first
+ use debt
+ use equity
Justification:
- Cost minimizing: using retained earnings have no insurance costs; insurance cost of debt
< cost of equity
- Time: use RE no persuasion needed, persuasion time of debt holders < shareholders


ASM
Part A:
Word limit: in ppt slides + notes :1500-1800
Business manager in seminar
Theory: M&M tax, M&M no tax, traditional/static mod model, picking order theory

Part B: Informal report
Not required Executive Summary

WHAT YOU SHOULD DO:
- Expending further a bullet point by explain exactly what is meant by the statement
- Providing a practical example which the managers could identify with
- E.g: providing some empirical(rael world) evidence
- Present info in a clear structured way
- This will allow you to selectively introduce
- Present all the benefit and risk
Explain why we should applied Portfolio theory to the business

For example: to reduce the cost
Explain how cost ca be reduced
Use only PUPLIC debt
Part B:
What is mean by investor: the bond holder, shareholders,
Risk: Systematic, unsystematic,
Risk and return trade off: the higher the risk the higher the return
Portfolio theory:
CAPM: dont forget Beta, explain about Beta
How much you can get if you are a bond holder? What kind of bond you should invest?
Ratio: earning per share (EPS), P/E, Dividend yield, dividend cover
Choose 2-3 company and compare the EPS,
decide what company to u t

London stock exchane