Financial Management

Front cover
Juta support material
Title page
Imprint page
Contents - a concise overview
Table of contents
Preface
What does the book offer?
What resources does the book offer to the instructor?
How does the book fit in with SAICA’s Competency Framework and the Companies Act?
Section A: Introduction
	Chapter 1: Overview of financial management
		1 The context of financial management
			Development of financial management
			Links with economics
			Links with accounting
		2 The environment of financial management
			Forms of business organisations
		3 What is the fundamental objective of financial management?
			Why is profit maximisation not the right objective for corporate finance?
			Manipulation of accounting profits
			Focus of financial management on decision-making
			Economic Value Added (EVA)
			What about the ethics of maximising value?
		4 The role of the financial manager
			Opportunities to create wealth
			Investment in operating assets
			Selecting the optimal finance mix
			The interaction of investment and financing decisions
		5 Fundamental concepts of corporate finance
			Present Value
			Time value of money
			Risk and return
			No Arbitrage Principle
			Efficient markets
			Portfolio theory
			Capital asset pricing model
			Financial analysis
		6 Do managers act in the interest of shareholders?
			Management incentives, share options and the financial crisis
			Another agency problem: shareholders and bondholders
		7 Doing the right thing: ethics in business and King III
		8 Corporate Governance and King III
		9 Corporate Strategy
		10 Structure of the text
		Summary
		Appendix 1.1
		Appendix 1.2
		Questions
Section B: Foundations for decision-making
	Chapter 2: The time value of money
		1 Future value
			Single amount, single period
			Single amount, multiple periods, annual interest compounded
			Single amount, multiple periods, non-annual compounding
			Annual effective rate
			Continuous compounding
			Interpolation
			Series of investments, ordinary annuity (FVA ) – multiple investments and multiple periods
			Series of investments, annuity due
			Future values when the timing of the cash flows and the compounding periods differ
		2 Present values
			Single amount, single period, annual discounting
			Single amount, multiple periods, annual discounting
			Stream of cash flows, ordinary annuity (PVA )
			Stream of cash flows, annuity due
			Stream of cash flows, deferred annuity
			Uneven stream of cash flows
			Perpetuities
			Growing perpetuities
			Growing annuity
			Inflation and real returns
		3 Some real world applications
			Retirement planning
			Loan amortisation schedules
			Mortgage loan
		4 Financial calculators and spreadsheets
			Using financial calculators
			Using Excel spreadsheets
		5 The role of interest rates
			The expectations theory
			The liquidity preference theory
			The market segmentation theory
		6 Applying the time value of money principles to bonds
		Summary
		Self-study problems
		Questions
	Chapter 3: Risk and return
		1 The concept of risk
			Business risk
			Financial risk
			Total company risk
		2 Measuring expected return and risk
			Measuring the expected return on a single share
			Measuring risk for a single share
			The mean–variance rule
		3 Interpreting the summary statistics
			Properties of a normal distribution
			Comparison of single shares
			Co-variance and correlation
			Emerging markets
			Volatility and time periods: the Rip van Winkle solution to risk
			What does Warren Buffett think?
			Risk-adjusted measures of performance
		Summary
		Self-study problems
		Questions
	Chapter 4: Porfolio management
		1 Two-asset portfolio risk and return
			Measuring two-asset portfolio returns
			The principles of portfolio risk
			Measuring two-asset portfolio risk
			Positioning an investor on the efficient frontier
		2 Multiple-share portfolio risk and return
			The benefits of diversification
			Introducing a risk-free asset
		3 Beta analysis
			Beta as a measure of portfolio risk
			Beta and the capital asset pricing model (CAPM)
		4 The efficient markets hypothesis
		Summary
		Self-study problems
		Appendix 4.1
		Appendix 4.2
		Appendix 4.3
		Questions
	Chapter 5: Financial statement analysis
		1 Annual financial statements and the integrated report
			Integrated Report
			Annual Financial Statements
			Statement of Comprehensive Income
			Statement of Financial Position
			Statement of Cash Flows
		2 Objectives of financial analysis and stakeholders
			Shareholders
			Credit grantors
			Management
			Employees
			Customers
			Suppliers
			Acquisition and merger analysts
			Auditors
			Government
		3 Limitations of accounting data
			Monetary expression
			Simplification and summarisation
			Flexible accounting policies
			Inflation
		4 Approaches to financial statement analysis
			Comparative financial statements
			Index analysis
			Common size analysis
			Ratio analysis
		5 Application of ratio analysis
			Liquidity ratios
			Asset management ratios
			Debt management ratios
			Profitability ratios
			Cash flow ratios
			Market value ratios
		6 Structured ratio analysis
			Du Pont analysis
		7 Failure prediction
			Financial distress models
		8 Limitations of ratio analysis
		9 Economic value added
			The use of EVA to measure performance at SABMiller
		10 What’s behind the numbers?
			Understand the business and the industry sector
			Understand management’s motives for selecting accounting policies
			Understand the key drivers of value
			Understand which accounting policies are flexible
			Accounting for leases
			Understand the warning signs
			Understand the business and financial risks facing the company
			Sensitivity analysis
			Further factors to consider when analysing a company
		Summary
		Self-study problems
		Appendix 5.1
		Questions
	Chapter 6: Valuations
		1 Valuation – an overview
			What are the fundamental building blocks of a valuation?
		2 The effect of risk and return on valuations
		3 Required rate of return
		4 Valuation of debentures and bonds
			Debentures and bonds in perpetuity
			Redeemable debentures and bonds
		5 Valuation of preference shares
			Cumulative non-redeemable preference shares
			Non-cumulative preference shares
			Redeemable preference shares
		6 Valuation of ordinary equity
			Dividend discount model
			Price multiples
			Using EBITDA or EBIT multiples to determine enterprise value
			Market to book ratio
			Price to sales ratio
			Free cash flow model
			The Economic Value Added approach
			Valuation of rights
			The impact of share options on equity valuations
		7 Valuations and the financial manager
			Pitfalls
			Challenges
		Summary
		Self-study problems
		Appendix 6.1
		Appendix 6.2
		Appendix 6.3
		Questions
		Appendix A
		Appendix B
	Chapter 7: The cost of captial
		1 The weighted-average cost of capital
		2 The weighted-average cost of capital – principles and formula
		3 The pooling of funds approach
		4 Component costs of capital
			Cost of new debt
			The Cost of Debt and Section 24J of the Income Tax Act
			Cost of preference shares
			Cost of shareholders’ equity
			Bond yield plus a risk premium method
		5 Weighting components of capital structure
		6 Calculating the WACC
		7 Breaks in the WACC
		8 Funds from non-cash flow items
		9 Estimating the cost of capital of divisions
		10 Operating leases, capital structure and the weighted-average cost of capital
		11 The weighted-average cost of capital – some practical issues
			The risk-free rate
			The market (equity) risk premium
			Surveys
			Using the dividend growth model to determine the market risk premium
			Other indicators of the market risk premium
			Warren Buffett’s view
			Betas
			Adjustments to the Cost of Equity and WACC
			The financial crisis, emerging markets and the cost of capital
		Taxation
		Summary
		Appendix 7.1
		Self-study problems
		Questions
Section C: Investment decisions
	Chapter 8: Capital budgeting
		1 Types of investment projects
			Replacement or expansion
			Independent and mutually exclusive projects
			Divisible and indivisible projects
		2 Capital budgeting techniques
			Net present value
			The internal rate of return
			Payback method
			Accounting rate of return
			Other methods
			Economic Value Added or economic profit
		3 Cash flow determination
			Beginning-of-project cash flows
			Annual operating cash flows
			Cash flow determination – some rules
			Taxation
			Depreciation allowances
			Recoupments and scrapping allowances
			End-of-project cash flows
			Application
			NPV of project assuming no taxation
			NPV of project assuming no taxation, but including investment in working capital
			NPV of project, including taxation
		4 Post-audits
		Summary
		Self-study problems
		Appendix 8.1
		Questions
	Chapter 9: Further issues in captial budgeting
		1 Comparing projects with unequal lives
			Unequal lives and project evaluation
			Replacement chains
			Equivalent annual costs
		2 Capital budgeting under inflation
			Inflation and the discount rate
			Investment bias
			Discounting cash flows at the real rate of return
			Depreciation deductions
			Adjusted real approach
		3 Capital rationing
			Capital constraints and project rankings
			Profitability index
			The ranking of indivisible projects
			Multi-period capital rationing
			Further perspectives on capital rationing
		4 Assessed tax losses
			The utilisation of assessed losses
			New ventures and ring-fencing provisions
			Synopsis
		5 Abandonment value and optimal economic lives
			Continuing evaluation
			Optimal economic life
			Replacement timing
		6 Real (Strategic) options
			Self-study problems
		Solutions to the self-study problems
		Summary
		Appendix 9.1
		Appendix 9.2
		Questions
	Chapter 10: Capital budgeting: Risk analysis
		1 Traditional measures of risk
			Expected value and probability distributions
			The Hillier model for multiple periods
			A note on expected values, probabilities, and firm size
		2 Decision trees
		3 Certainty equivalents
		4 Sensitivity analysis
		5 Break-even analysis
			Zero net present value
			Accounting break-even analysis
		6 Scenario analysis
		7 Abandonment and expansion
		8 Monte Carlo simulation
		9 The capital asset pricing model
			Project beta of an all-equity firm
			Financial leverage and project betas
			More on market risk
		10 Risk-adjusted discount rates versus certainty equivalents
		11 Risk-adjusted discount rates versus the weighted-average cost of capital
		12 Further thoughts on risk analysis in capital budgeting
			Future uncertain cash outflows
			Volatility and risk – a case study
			Corporate strategy and project risk
			Project management, project failure and other factors
		Self-study problems
		Summary
		Appendix 10.1
		Questions
	Chapter 11: Working capital
		1 What is working capital?
		2 The objective of working capital policy
			The working capital cycle
			The impact of inflation on working capital policy
			The impact of changes in sales on working capital policy
		3 Working capital policies
		4 Working capital financing policies
		5 From the real world...
			Working capital management by small business
			Working capital strategies and cash flows
			Working capital management around the world
		6 Forecasting working capital requirements
		7 Forecasting sales
			Factors to be considered
			Subjective forecasting
			Objective forecasting
		Summary
		Self-study problems
		Questions
	Chapter 12: Current asset management and short-term financing
		1 Credit policy
			Creditworthiness
			Setting the collection policy
			Setting settlement discount policy
			Analysing the impact of a change in credit policy on profitability
			Analysing the impact of a change in credit policy: net present value analysis
		2 Accounts receivable management
			Making money out of offering credit to customers
		3 Inventory management
			Inventory models
			Inventory control systems
			Just-in-time (JIT) inventory management
			Supply Chain Management
		4 Cash management
			Reasons for holding cash
			The management of float, cash concentration and electronic funds transfer
			Cash budgets
		5 Financing current assets
			Accruals
			Trade credit
			Factoring and invoice discounting
			Bank overdrafts
			Bankers’ acceptances
			Revolving credit facility
			Repurchase agreements
			Short-term financing: advantages and disadvantages
		Summary
		Self-study problems
		Appendix 12.1
		Questions
Section D: Financing decisions
	Chapter 13: Sources of finance
		1 Financial markets
			Interaction between market classifications
			The Johannesburg Stock Exchange
			Alternative Exchange – AltX
			The Development Capital Market (DCM) and the Venture Capital Market
			Alternative methods of obtaining a listing
			Raising capital by listed companies
			Setting an issue price
			Some facts about market liquidity
			The JSE Derivatives Market
			The JSE Debt Market
		2 Financial institutions
			Banks
			Special institutions
		3 Equity-related instruments
			Ordinary shares
			Retained earnings
			Preference shares
		4 Debt instruments
			Corporate bonds, notes and debentures
			Long-term loans
			Short-term debt
		5 Hybrid instruments
		6 Comparison of debt and equity
			Return
			Risk
			Control
		7. Inflation-linked bonds
		8. Alternative Sources of Finance
		9. Financing for Black Economic Empowerment  entities
		Summary
		Self-study problems
		Questions
	Chapter 14: Captial structure
		1 Risk profile
			Business risk
			Financial risk
		2 Leverage
			Impact on earnings
			Impact on risk
		3 Optimal capital structure
			The Modigliani–Miller approach
			Trade-off theory
			Pecking order and signalling theories
			Debt financing, free cash flow and conflicts between management and shareholders
		4 A gency costs and inverted incentives: conflicts between shareholders and bondholders
			Investing in high risk projects
			Running off with the money
			No further investment by shareholders
			Playing for time
			Changing the capital structure of the firm
			Conflicts between shareholders and bondholders – the case of Edcon
		5 The impact of inflation
		6 The need for flexibility
			Target capital structure
			Short-term deviation from target
			Financial flexibility
		7 Debt and Tax Shields
		8 Financial leverage and a firm’s weighted-average cost of capital
		9 Personal taxes
		10 Capital structures in South Africa and around the world
		11 Edcon: capital structure and valuation of tax shields
		Summary
		Appendix 14.1
		Self-study problems
		Questions
	Chapter 15: Leasing
		1 Types of leases
			Operating leases
			Financial leases
			Structuring of leases
			Direct lease
			Sale and lease-back
			Leveraged lease
		2 What are the effects of leasing on financial statements?
			What are the requirements of the International Accounting Standard?
			What is wrong with the analysis and accounting for leases?
			A new Accounting Standard for Leases: all non-property leases are now finance leases
		3 Advantages of leasing
			Changing technology
			Tax advantages
			Obtaining 100% debt financing
			Operating flexibility
			Reduction in operating leverage
			Coping with uncertain demand
			Specialisation effects on maintenance, residual values and purchase costs
			Standardisation of contracts
			Fewer restrictions
			Off-Statement of Financial Position financing
			Avoidance of capital expenditure controls and budgetary constraints
		4 Evaluating the leasing decision
			Selecting an appropriate discount rate
			Calculating the net present cost
			The net advantage of leasing and NPV
		5 The adjusted present value approach
		Summary
		Self-study problems
		Appendix 15.1
		Questions
Section E: Integrated decisions
	Chapter 16: Dividends and share buy-backs
		1 Dividend relevance – active variable or passive residual?
			The residual approach to dividends
		2 Factors affecting the dividend decision
			The legal requirements of the Companies Act 71 of 2008: solvency and liquidity tests
			Contractual obligations
			Information content of dividends
			Taxation
			The nature of the shareholders
		3 Dividend payment policies
			Stable dividend amount
			Stable payout ratio
			Stable dividend plus special dividend
		4 The payment of dividends
			Share splits and capitalisation issues
			Dividend reinvestment plans (DRIPs) and scrip dividends
		5 Share buy-backs
			What is the effect of a share buy-back on the Statement of Financial Position of a company?
			Requirements and consequences of engaging in a share buy-back
		Summary
		Self-study problems
		Questions
	Chapter 17: Mergers, acuisations and corporate restructuring
		1 Types of mergers
		2 Reasons for mergers
			Operating economies
			Managerial skills
			Tax considerations – tax shields and assessed losses
			Use for excess liquidity
			Diversification
			Lower financing costs
			Replacement costs
			Technology
			Products, product pipeline and reserves
		3 The structuring of takeover offers and taxation
			Financing costs
			Capital Gains Tax and Dividend Withholding Tax
			Depreciation and wear and tear deductions
			Further issues to consider in acquiring shares or assets
		4 Are mergers successful?
		5 Terms of mergers
			Acquisition financed by cash
			Acquisition financed by share issue
			Setting an offer
		6 Dividends, working capital and net asset value
			Dividends
			Working capital
			Net asset value
		7 Reverse takeovers
		8 Defensive tactics
			Proactive measures
		9 Legal procedures
		10 Regulation of takeovers
		11 Unbundling and spin-offs
			Advantages
			Disadvantages
		12 Leveraged buy-outs
		13 Business rescue and the corporate restructuring of financially troubled companies
			Is business rescue a viable option?
			Advising a financially troubled company
		14 South African mergers
			Amalgamated Banks of South Africa
			The hostile Nedcor bid for Standard Bank Investment Corporation
			The JD Group, Ellerines and African Bank
			The Nedcor BoE merger
			BHP Billiton
			The hostile Harmony takeover bid for Goldfields
			The takeover of ABSA by Barclays plc
			MTN acquisition of Investcom LLC
			AfriGroupe acquires AFGRI
			The unbundling of Gold Fields’ gold mines into Sibanye Gold
			Vodacom’s proposed acquisition of Neotel
			The battle for Adcock Ingram
			Woolworths’ acquisition of David Jones
		Summary
		Self-study problems
		Appendix 17.1
		Appendix 17.2
		Appendix 17.3
		Questions
	Chapter 18: Risk management and derivatives
		1 Risk management strategies
			Interest rate risk
			Refinancing risk
			Liquidity risk
			Market and commodity price risks
			General risks
		2 Rationale for financial innovation
		3 Fundamental derivative instruments
			Options
			Replicating portfolio
			Black-Scholes Option Pricing Model
			The Binomial Option Pricing Model
			Options, the Greeks and implied volatility
			Futures and forward contracts
		4 Risk-reducing techniques
			Natural hedges
			Hedging with futures, forwards and options
			Contracts for Difference
			Interest rate risk
			Duration and immunisation
			Hedging interest risk with Floors, Caps and Collars
			What are some of the advantages of Collars?
			Derivative use by South African companies
		5 Return-generating techniques
			Asset securitisation
			Tax arbitrage
		Summary
		Appendix 18.1
		Appendix 18.2
		Appendix 18.3
		Appendix 18.4
		Self-study problems
		Questions
	Chapter 19: International financial management
		1 Historical perspective
		2 The balance of payments
			Current account
			Capital account
			Official reserves
		3 The foreign exchange market
			Direct and indirect quotations
			Bid–ask spread
			Spot and forward transactions
			Points
			Forward rate and premium/discount
			Cross rates
		4 Forces behind exchange rate movements
			Interest rate parity
			The purchasing power parity theory
			Nominal and real effective exchange rate
			Big Mac exchange rates
			Integrating the interest rate parity and purchasing power parity theories
			Forecasting exchange rates
		5 Foreign exchange exposure
			Translation exposure
			Transaction exposure
			Economic exposure
		6 Hedging policies
			Forward contract
			Money-market hedge
			Currency options
			Currency of invoice
			Leads and lags
			Currency swaps
		7 Exchange control
		8 Covered-interest arbitrage
		9 The eurodollar market
		10 Offshore financing by South African companies
			Offshore borrowings
			Listing on foreign stock exchanges
		11 Documentary letters of credit
		12 Analysis of foreign investments
			Determination of future cash flows
			Determination of the discount rate
		13 International portfolio diversification
		14 Analysis of a major project by BHP Billiton
		Summary
		Self-study problems
		Questions
	Chapter 20: Business planning and financial modelling
		1 Business plans
			What are the advantages of preparing a business plan?
			The content and structure of a business plan
			Background/Strategy
			Products and services
			Markets and marketing strategies
			Operations and production process
			Management and executive team
			Legal, social and environmental factors
			Financial information and projections
			The components of the financial projections section
			Sensitivity and scenario analysis
			Porter’s Five Forces
			What other factors will play a role in financing decisions?
		2 Financial modelling
			The design and layout of financial models
			Avoiding spreadsheet errors
			The use of spreadsheet models in corporate finance
			The application of ‘what-if’ Analysis in Excel
			Financial models and topics in corporate finance
		3 Financial modelling and forecasting financial statements: an application
			Goal seek, data tables and sensitivity analysis
			Circular references in Excel
		Summary
		Appendix 20.1
		Appendix 20.2
	Chapter 21: Corporate strategy and business models
		1. Corporate strategy and industry analysis
		2. What is Strategy?
		3. Matrix models
		4. Michael Porter’s Five Forces Model
			Rivalry among existing competitors
			Threat of new entrants and potential competitors
			Threat of substitutes
			The power of customers
			The power of suppliers
		5. Other strategic factors
		6. The Building Blocks of a Business Model
			Customer segments
			Value propositions
			Channels
			Customer relationships
			Revenue streams
			Key resources
			Key activities
			Key partnerships
			Cost structure
			Conclusion
		7. Disruptive technolgoies, 3D printing and the role of big data
		Summary
Index