Topic 11: Unit Overview

Question 0

Financial Forecasting:

Group items under categories:

1. Forecast Business Outcomes:
2. Key relationships:
3. Policy decisions:

Answer 0

1. Forecast Business Outcomes: (vol, price, dependent on business case assumptions)
2. Key relationships: tax paid calc; dependent on given relationships, possibly externally imposed
3. Policy decisions: tgt div payout or debt levels. Dependent on outcomes of operating forecasts. Model can be used to test sensitivity of results t changes in these variables

Question 1

Financial Modeling:
Factors to consider for:
1. Revenue Forecasts:
2. Cost forecasts:
3. Working Capital:
4. Capital Expenditure
5. Tax Forecasts:
6. Dividends & Debt payments:

Answer 1

1. Revenue Forecasts: expected growth in vol & price
2. Cost forecasts: vol growth; gross margins, mix of fixed & variabel costs
3. Working Capital: forecasts of revenue & costs (incl activity ratios)
4. Capital Expenditure: new projects plus capital expenditure required to maintain existing or projected capacity
5. Tax Forecasts: tax on forecast taxable income, impact of carry forward losses
6. Dividends & Debt payments: may change as a result of forecast

Question 2

Balance Sheet Items:
Closing Balance = ?
Ending Balance = ?

Answer 2

Closing balance = Opening balance + increases - Decreases

Ending balance = beginning balance + additions - subtractions

Question 3

Balance Sheet

Net Fixed Assets =
Retained Earnings =
Cash Balance =

Answer 3

Net Fixed Assets(t) = Net fixed assets (t-1) + capex (t) - Deprec exp (t) - BV of assets sold (t)
Retained Earning(t)s = Ret Earn (t-1) + PAT (t) - Div Paid (t)
Cash Balance(t) = Cash balance (t-1) + mmt in cash balance (t)

Question 4

M&A

5 reasons why empirically, most f the value created by an acquisition is usually captured by the target:

Answer 4

1. With organic growth, project sponsor takes on completion risk and captures most of the NPV. With acquisition, acquirer pays up front for current expected performance. To be NPV +ve, must create further value
2. Acquisition process is competitive; designed to get max value for vendor. Can result in overpaying
3. Execution risk: risks to integrating 2 businesses
4. Large transactions require financing - acquisitions that use equity tend to underperform
5. Agency cost & mgmt hubris: mgrs have incentive to expand firm beyond the size that maximises shareholder wealth

Question 5

Reasons that shareholders in bidding firms rec close to zero return (3)

Answer 5

1. expectation that expected benefits will not be realised
2. expectation that buyers are being optimistic or have overpaid
3. agency costs, management seeks growth rather than value

Question 6

Dubious reasons for M&A

Answer 6

1. Using high P/E equity to make cheap acquisitions
   - multiples inflation (eg zero synergies, but acquirer erroneously inflates P/E, leads to appearance of value creation)
2. Misplaced reliance on earnings growth
3. Diversification (strategic - can mgmt really manage wide range of unrelated businesses?; financial markets - mergers cannot reduce systematic risk, and unsystematic risk could be diversified by shareholders rather than mgmt
4. capital structure & co-insurance (diversification effect may reduce variability; but this does not increase total value, it may shift value from eq to debt as lower variability increases security to lenders.)
   Coinsurance - companies guarantee each other’s debt when merged.

Question 7

M&A: dubious reasons for M&A

Examples of Misguided reliance on near term earnings growth:

Answer 7

• decisions made on earnings basis rather than value measures do not compare benefits with the required return.
• -finance project by eq; accretive to EPS if ROE > E/P. But need to compare with cost of capital
• -if financed with debt; EPS accretive if ROIC > after tax cost of debt. But need to compare with WACC
• if financed with cash; EPS accretive if ROIC>after tax interest on cash (but this is bot a measure of value)
• • backended transactions