Corporate Financial Strategy 4th edition Dr Ruth Bender Setting the context contents Learning objectives Risk and return The twostage investment process What does good look like NPV illustration Working Insight 13 ID: 643043
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Slide1
Chapter 1Corporate financial strategy: setting the context
Corporate Financial Strategy
4th edition
Dr Ruth BenderSlide2
Setting the context: contentsLearning objectivesRisk and returnThe two-stage investment process
What does ‘good’ look like?
NPV illustration (Working Insight 1.3)
Value is created ‘above the line’ (Figure 1.4)Individuals have different risk appetites (Figure 1.5)The seven drivers of valueEconomic profit (Working Insight 1.5)Total shareholder return (Working Insight 1.6)The value matrix (Figure 1.6)Stakeholders are importantAgency and double agency
2Slide3
Learning objectivesUnderstand what financial strategy is, and how it can add value.
Explain why shareholder value is created by investments with a positive net present value.
Appreciate how the relationship between perceived risk and required return governs companies and investors.
Differentiate the different models of measuring shareholder value.Explain why share price is not necessarily a good proxy for company value.Outline how agency theory is relevant to corporate finance.
3Slide4
Perceived
risk
Required
return
R
isk and return
4Slide5
The two-stage investment process
Shareholders
(and others)
invest in the company
Company invests
in a portfolio of projects
5Slide6
What does ‘good’ look like?6
Is it a good
Product
?Slide7
Reduce risk more than return
Increase return more than risk
Perceived
risk
Required
return
X
Value is created above the line
7Slide8
Perceived
risk
Required
return
Individuals have different risk appetites
Well-diversified institutional investor
Long-serving manager
Venture capital fund
8Slide9
The seven drivers of value
Rappaport,
Creating Shareholder Value,
1998
More
profit
Increase sales growth
Increase operating profit margin
Reduce cash tax rate
Out
of
fewer
assets
Reduce working capital as % of sales
Reduce fixed assets as % of sales
At
lower
risk
Reduce weighted average cost of capital
For
as
long
as
possible
Increase timescale of competitive advantage9Slide10
Economic profit10
Operating profit after tax 2,400
less cost of capital
(20,000 x 10%)
2,000
Economic profit 400
Operating profit after tax £2,400
Capital employed £20,000
Cost of capital
10%
Return on
capital employed
(2,400/20000)
12%
Spread 2%
Economic profit
(2% x 20,000)
400
Slide11
Total Shareholder Return (TSR)11
Share price at
1
January 100Share price at 31 December 110Capital gain in the year 10Dividend paid in the year 5Total
return 15
Total
shareholder return
(TSR) 15%Slide12
Figure 1.5 The value matrix
Economic profit
Value multiple
Market value
÷
Fair value
Negative
Positive
> 1.0
< 1.0
= 1.0
A
B
D
C
12Slide13
Stakeholders are important
Business and Financial strategy
Shareholders
Investment institutions, family members, prospective investors
Debt holders
Banks, investment institutions, individuals
Customers
Direct customers, end consumers, consumer groups
Managers
Board of directors, senior managers, other managers
Employees
Individuals, unions / staff associations, pensioners
Government and regulators
Tax authorities, trade department, employment department, governance regulators
Suppliers
Long term suppliers, raw material suppliers, sub-contractors
Community
Local community, environmental bodies, public at large
13Slide14
Agency and double agency14
Net assets
Fixed assets
Current assets less
current
liabilities
Non-operating assets
Debt
Equity
Fund managers
Individual
shareholders
and pensioners
Management
Employees