CONTENT

• INTRODUCTION
• CAPITAL BUDGETING
• WEIGHTED AVERAGE COSTS OF CAPITAL
• MEASURES OF LEVERAGE
• WORKING CAPITAL MANAGEMENT

In order to process huge transaction, a system is needed to be in place. Corporations have systems which controls and manage internal processes. It is known as CORPORATE GOVERNANCE.

Corporations mainly separate into various groups; shareholders, board of directors, employees
SHAREHOLDER THEORY VS STAKEHOLDER THEORY
shareholder theory- priorities interest of the shareholders.
Stakeholder theory – focus on the conflicts among the various stakeholder groups, and pursue interest in firm’s performance

Primary Stakeholders
– shareholders
– board of directors
– senior managers
– employees
– creditors
– suppliers

 

Stakeholder management and its four types of infrastructure
1. legal
2. Contractual
3. organizational
4. governmental

 

Principal Agent conflict – when interest of agents do not aligned with the principals. Principals are the owners of company; shareholders. Firm management and board members are agents.

information asymmetry – Managers who did ground have more information than shareholders

Annual general meeting – every fiscal year
proxy – for shareholders who unable to attend AGM, can vote via proxy
Special resolutions – occurs when a merger or takeover.
extraordinary general meeting – anytime when shareholders required to vote
Majority voting vs cumulative voting
Example; 3 candidates run for the election
Majority voting: each individual has only 1 vote
Cumulative voting: each individual receive the amount (in this case,3) of votes similar to the number of available candidates. The individual can assigned proportion of votes to the candidates.

Activist shareholders – major shareholders pressuring the companies for changes
proxy fight – favor of their alternative proposal and policies by seeking proxies
tender fight – an amount of shares during voting to take over the company.
hostile takeover – influence management of a company to allocate more policies in the interests of shareholders.
dual class structure – company ownership and voting structure.

Board structure
one-tier board – single board of internal and external directors
two-tier boards – supervisory board that excludes executive directors (supervisory board and management board)
staggered board*

independent directors vs
executive vs
non-executive director

type of board committees – 6: audit, governance, nominations, compensation/remuneration, risk, investment

Risks of poor governance and stakeholder management
– poor audit and board oversight process
– little increase in company value because of improper management.
– managers tend to pursue own benefits than company’s.
– poor compliance with regulations and reporting.
– tarnish reputation of company and incur legal cases.
– bankruptcy and defaulting debt.

 

ESG – Environmental, social and governance Factors

Refers to as ESG investing. AKA sustainable investing/responsible investing/ socially responsible investing.

Negative screening ( exclusionary screening or norms-based screening) – exclude companies who disregards human rights, corruption etc.
Positive screening – include companies who focus ESG factors

ESG integrations and ESG incorporation combines qualitative and quantitative characteristics into practices.

IMPACT INVESTING vs GREEN FINANCE vs THEMATIC INVESTING

 

type of investing	explanation
impact investing	promote environmental/social in the process of making profits
green investing	focus on sustainable investing
thematic investing	specific sector/industry on a single goal

 

 

CAPITAL BUDGETING - determine the worth and evaluation of investments/projects

definition: Analysis of capital projects
4 steps – generate, Analyze, create, monitor

 

type of Capital budgeting projects	Defintions	Example
replacement projects	– maintain business	continue existing operations
replacement projects	cost reductions	equipment obsolete, usable, replace/
expansion	grow business	forecast of future demand
new product/ market development	–	–
mandatory projects	governmental/ insurance company	safety-related or environmental issue
Others	not easily analyzed through Capital Budgeting project	corporate perks, research and development projects

 

5 principles of capital budgeting
1. based on cash flow
2. opportunity costs
3. timing of cash flows
4. After-tax basis
5. Financing costs in ROR.

Independent Vs mutually exclusive projects
project sequencing – the prioritizing of projects
Unlimited funds Vs Capital rationing

NPV, IRR, Payback Period (Discounted), Project Ranking, Profitability index

 

Valuing projects	formula
NPV
Internal Rate of Return
Payback period

 

 

Terms:
incremental cash flow
sunk costs
externalities
cannibalization
conventional cash flow pattern
unconventional cash flows

 

WACC – weighted average cost of capital
– Aka marginal cost of capital (MCC)
Capital components of the firms are debt, preferred stock,and common equity.
– MCC upwards slope
– investment opportunity schedule downward slope
optimal capital budget

After tax cost of DEBT: kd(1-t)
understand matrix pricing

Cost of PREFERRED STOCK: Dps / P

Cost of EQUITY CAPITAL
1. Capital Asset Pricing Model approach
( Kce = Rf + B [E(Rmkt) – Rf])

2. The dividend discount model approach – dividends are expected to grow at a constant rate.
Kce = (D1/P0) + g
g = (retention rate) (ROE) = (1-payout rate)(ROE)

3. Bond Yield plus risk Premium approach
Kce = bond yield + risk Premium

Marginal Costs of capital schedule – WACC for different amounts of fundings
Break points – occur when one of the capital components in the firm of WACC changes.
BREAK POINT = AMOUNT OF CAPITAL WHEN COST CHANGES / WEIGHT OF THE COMPONENT IN THE CAPITAL STRUCTURE

PROJECT COST OF CAPITAL
project’s beta – measure of its systematic or market risk

Pureplay method – when estimating the equity beta could not be determined due to insufficient public data, using a comparable project for estimation could be used.

BETA of a firm
– business risks of project
– finance structure
– higher dependent on debt financing, higher equity beta.

Asset BETA = Bequity [ 1 / 1 +((1- t) D/E)]

Project BETA = Asset BETA [ 1 + ((1 – t) D/E)]

requirements to understand the limits of theory

Country RISK PREMIUM – an additional risk associated with developing country due to insufficient data coverage. Added the market risk premium for calculation of CAPM:
Kce = Rf + B [ E(Rmkt) – Rf + CRP]

Sovereign yield spread – the difference in yield between a developing country’s government bonds and developed country’s government bonds

Flotation costs – process fees by IBs for raising external equity capital. Important to understand the correct treatment; it occurs at the initiation of a project.

MEASURES OF LEVERAGE
Over here, a firm has an amount of fixed costs known as leverage.
Business risk = sales risk + operating risk
Financial risk – risks that common stockholders need to bear when firm uses debt financing

Degree of operating leverage (DOL) =
% change in EBIT / % change in sales
Degree of Financial leverage (DFL) =
% change in EPS / % change in EBIT
Degree of Total Leverage (DTL) =
% change in EPS / % Change in Sales

Using financial leverage increases the potential of reward.

Breakeven quantity of sales – the quantity of products/services for which revenue equals total fixed costs.
Contribution margin = price – variable cost per unit.

Qbe = total fixed operating and financing cost / contribution margin per unit.

WORKING CAPITAL MANAGEMENT

 

primary sources of liquidity
– cash
– trade credit
– collecting receivables
– short term investment returns

secondary sources of liquidity
– long-lived assets
– debt agreements
– bankruptcy/ reorganizing company

What affects a company’s liquidity position?
drags and pulls
DRAGS on liquidity – delay / reduce cash inflows, or borrowing costs increases
PULLS on liquidity – accelerate cash outflows.

Some measurements on the company’s liquidity

 

Daily cash position – refers to the reserves a firm has to hold for daily transactions.
A firm can use cash to invest in short-term securities
– US Treasury bills
– Federal agency securities
– Bank COD
– Banker’s acceptance: guarantee from the bank of the firm (recipient) that payment will be made upon.
– Time deposits
– Repurchase agreements
– commercial paper: large, credible companies can issue debt securities.
– money market mutual funds
– adjustable-rate preferred stock

% discount = (Face value – price / face value)

Discount-basis yield (aka Bank discount yield)
= ( [face value – price] / face value) * (360/days) = % discount * ( 360/ days)
Money market yield
= ( [face value – price] / price) * (360/days)
Bond equivalent yield
= ( [face value – price] / price) * (365/days)
remember that BEY is two times the effective semiannual yield.

 

short-term funding from banks
– uncommitted line of credit
– committed line of credit
– revolving line of credit