ACCA 2016 BPP PASSCARD p4

1 The role and responsibility of senior 3a Conflicting stakeholder interests 17 3b Ethical issues in financial management 23 7a Impact of financing and APV method 51 8 International inve

Paper P4

Advanced Financial Management

Passcards for exams from

1 September 2015 – 31 August 2016

ACCA Passcards

Professional Paper P4 Advanced Financial Management

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Preface

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1 The role and responsibility of senior

3a Conflicting stakeholder interests 17

3b Ethical issues in financial management 23

7a Impact of financing and APV method 51

8 International investment decisions 73

Page

9 Acquisitions and mergers vs growth 81

10 Valuation for acquisitions and mergers 87

11 Regulatory framework and processes 99

12 Financing mergers and acquisitions 10513–14 Reconstruction and reorganisation 111

15 The treasury function in multinationals 119

18 Dividend policy in multinationals and

1: The role and responsibility

of senior financial executive

Financial objectives

The prime financial objective is to maximise the

market value of the company’s shares Primary

targets are profits and dividend growth Other targets

may be the level of gearing, profit retentions, operating

profitability and shareholder value indicators

 Risk and incertainty

Investment decisions include:

 Decide optimal fund allocation

Financial decisions include:

 Long-term capital structureNeed to determine source, costand risk of long-term finance

 Short-term working capitalmanagement

Balance between profitability andliquidity is crucial

Dividend decisions may affectviews of the company’s long-termprospects, and thus the shares’market values

Payment of dividends limits theamount of retained earningsavailable for re-investment

Investment

decisions Financing decisions decisions Dividend

The formulation, evaluation and selection of

strategies to prepare a long-term plan of action to

attain objectives Strategic decisions should be

suitable, feasible and acceptable.

 Long-term direction

 Matching activities to environment/resources

Key elements of financial planning

Planning involves a long horizon, uncertainties andcontingency plans

Consideration of which assets are essential andhow easily assets can be sold

 Long-term investment and short-term cash flow

 Surplus cash

 How finance raised

 Profitable

Strategic analysis means analysing the

organisation in its environment, its resources,

competences, mission and objectives

Strategic choice involves generating and evaluating

strategic options and selecting strategy

Strategic planning

Strategic cash flow management Strategic fund management

Growth v dividend payout

Scrip v cash dividends

Financing

Debt/equity mix

Lease v buy

Tactical planning and control

Conflict may arise between strategic planning (need

to invest in more expensive machinery, research and

development) and tactical planning (cost control)

Johnson and Scholes separate power groups into 'internal coalitions' and 'external stakeholder groups'.

Stakeholder goals Shareholders Providers of risk capital, aim to maximise

wealth

Suppliers To be paid full amount by date agreed,

and continue relationship (so may accept later payment)

Long-term lenders To receive payments of interest andcapital by due date

Employees To maximise salaries and benefits; also

prefer continuity in employment

Government Political objectives such as sustained

economic growth and high employment

Management Maximising their own rewards

2: Financial strategy formulation

Topic List

Assessing corporate performance

Financial strategy

Arbitrage

Risk and risk management

Formulating the correct financial strategy is crucial forbusiness success The four main areas of financialstrategy are capital structure policy, dividend policy, riskmanagement and capital investment monitoring

Debt and gearing

 Debt ratio (Total debts: Assets)

 Gearing (Proportion of debt in long-term capital)

Profitability and return

 Dividend yield  Interest yield

 Earnings per share  Dividend cover

 Price/earnings ratio

Stock market ratios

Comparisons with companies

in different industries

Investors aiming for diversifiedportfolios need to know differences between industrial sectors

 Changes in gearing ratio

 Changes in current/quick ratios

Economic Value Added (EVATM)

EVATM = NOPAT – (cost of capital × capital employed)

Add:

 Cumulative goodwill written off

 Cumulative depreciation written off

 Ownership stake

 Equity (full voting rights)

 Preference (prior right to dividends)

 All companies can use rights issues

 Listed companies can use offer for sale/placing

Debt/Bonds

 Fixed or floating rate

 Zero coupon (no interest)

 Convertible

 Bank loans

 Security over property may be required

When comparing different sources of finance, forexample different categories of debt, the followingfactors will generally be important:

 Certainty of raising amounts

 Time period available

Comparison of finance sources

 Costs

 Income to investors

 Tax

 Effect on control

Practicalities in issuing new shares

 Theoretical valuation models, eg Capital Asset

Pricing Model (CAPM) or Arbitrage Pricing

Theory (APT)

 Bond-yield-plus-premium approach: adds a

judgmental risk premium to the interest rate on

the firm’s own long-term debt

 Market-implied estimates using discounted cash

flow (DCF) approach (based on an assumption

on the growth rate of earnings of the company)

Estimating cost of equity

Financial strategy Arbitrage Risk and riskmanagement

Assessing corporate performance

Pecking order

 Retained earnings

 Debt

 Equity

 Whether lenders are prepared to lend (security)

 Availability of stock market funds

 Future trends

 Restrictions in loan agreements

 Maturity of current debt

Feasibility of capital structure

 Risk attitudes

 Loss of control by directors

 Excessive costs

 Too heavy commitments

Acceptability of capital structure

 Company financial position/ stability of earnings

 Need for a number of sources

 Time period of assets matched with funds

 Change in risk-return

 Cost and flexibility

 Tax relief

 Minimisation of cost of capital

Suitability of capital structure

Dividend policy

Dividend decisions determine the amount of, and

the way in which, a company’s profits are distributed

Financial strategy Risk and riskmanagement

Assessing corporate performance

CAPM exam formula Arbitrage pricing theory

The theory assumes that the return on each security

is based on a number of independent factors

E (rj) is expected return on security

B1is sensitivity to changes in Factor 1

F1is difference between Factor 1 actual andexpected values

e is a random term

Factor analysis

Analysis used to determine factors to which security

returns are sensitive Research indicates:

 Unanticipated inflation

 Changes in industrial production levels

 Changes in risk premiums on bonds

 Unanticipated changes in interest rate term

structure

r = E(rj) + B1F1 + B2F2 + eE(ri) = Rf+ βi(E(rm) – Rf)

Overriding reason for managing risk is to maximiseshareholder value.

 Systematic and unsystematic

The process of minimising the likelihood of a riskoccurring or the impact of that r isk if it does occur

Risk mitigation

3a: Conflicting stakeholder interests

Be prepared to answer questions on key concepts such

as agency theory or goal congruence, or developments

in corporate governance

Separation of ownership and management: ordinary

(equity) shareholders are owners of the company, but

the company is managed by its board of directors

Central source of stakeholder conflict: difference

between the interests of managers and those of o wners

Transaction costs economics

The transaction costs economics theory

postulates that the governance structure of acorporation is determined by transaction costs

 Short-termism

 Sales objective (instead of shareholder value)

 Overpriced acquisitions

 Resistance to takeovers

 Relationships with stakeholders may be difficult

Sources of stakeholder conflict

The transactions costs include search andinformation costs, bargaining costs and policingand enforcement costs

Corporate governance

Stakeholders

proposes that, whilst individual team members act

in their own self-interest, individual well-being

depends on the well-being of other individuals and

on the performance of the team

is accordance between the objectives of agentsacting within an organisation and the objectives ofthe organisation as a whole

Corporations are set of contracts between principals

(suppliers of finance) and agents (management)

The agency problem

Management incentives may enhance congruence:

 Profit-related pay

 Rights to subscribe at reduced price

 Executive share-option plans

BUT management may adopt creative accounting.

Sound corporate governance is another approach.

If managers don’t have significant shareholdings,

what stops them under-performing and

over-rewarding themselves?

UK Corporate Governance Code

Executive directors

Limits on service contracts,emoluments decided byremuneration committeeand fully disclosed

DIRECTORSresponsible for

 Don’t participate in options

 Appointed for specified term

Non executive directors

The Higgs Report stresses the importance of the board including a balance of e xecutive and non-executive

directors such that no individual or small g roup can dominate decision-making The report also lays down criteria for establishing the independence of non-executive directors, and stresses the need to separate theroles of Chairman and Chief Executive

 Audit committee of non-executive directors

 Consider need for internal audit function

 Accounts contain corporate governance statement

 Directors review and report on internal controls

Accountability and audit

 20 working days’ notice

 Separate resolutions on separate issues

 All committees answer questions

Annual general meeting

Stock market is less open, morelinks with banks than in UK.Policy boards (long-term)Functional boards (executive)Monocratic boards (symbolic)

In Germany, banks have term role, may have equity stake

longer-Separate supervisory board hasworkers’ and shareholders’

representatives

The US system is based on

control by legislation, regulation,

more rules on directors’ duties

than in UK Major creditors are

often on boards

USA

Management culture

By means of Stock Exchange

regulation, stringent reporting

Europe

By means of tax law Also two-tierboard system to protect shareholderinterests

Management culture comprises views on management and methods of doing b usiness Multinationals may haveparticular problems imposing the parent company’s culture overseas eg American practices in Europe

International comparisons

Ethics have become increasingly important in formulatingfinancial strategies Financial managers must remember

to build ethical considerations into the decision-makingprocess

3b: Ethical issues in financial management

Topic List

Ethical aspects

ethics

MarketingMarket behaviour Dominant position, treatment of

suppliers and customersSocial and cultural impact

Product development Animal testing, sensitivity toculture of different countries

and marketsHuman resource

Green issues and business practice

Sustainability

refers to the concept of balancing growth with

environmental, social and economic concerns

Company’s environmental policy

may include reduction/management of risk to thebusiness, motivating staff and enhancement ofcorporate reputation

Environmental reporting

Many companies produce an external report for externalstakeholders, covering:

 How business activity impacts on environment

 An environmental objective (eg use of 100%

recyclable materials within x years)

 The company's approach to achieving and

monitoring these objectives

 An assessment of its success towards achieving

the objectives

 An independent verification of claims made

Direct environmental impacts on business – eg:

 Changes affecting costs or resource

availability

 Impact on demand

 Effect on power balances between competitors

in a market

Indirect environmental impacts: eg, legislative

change; pressure from customers or staff as a

consequence of concern over environmental

problems

Triple bottom line reporting: a quantitative

summary of a company’s economic,

environmental and social performance over the

 Emissions to soil, water and air

 Water and energy use

Triple bottom line decision making

Financialcapital Manufacturedcapital Intellectualcapital

Humancapital relationshipSocial and

capital

Naturalcapital

Integrated reporting

Principles of integrated reporting

Integrated reports should be based on a number of

 Reliability and completeness

 Consistency and comparability

Integrated thinking involves consideration of the

interrelationships between operating and financial

units and the capitals the business uses

 Organisational overview and external environment

 Governance structure and value creation

 Business model

 Opportunities and risks

 Strategy and resource allocation

 Performance – achievement of strategic objectivesand impact on capitals

 Basis of preparation and presentation

Contents of integrated report

Carbon trading

UNFCCC

allows companies which emit less than their allowance to

sell the right to emit CO2to another company

obliged signatories to reduce total greenhouse gas emissions

by 2012, compared to 1990 levels EU15 reduction target: 8%

1997 Kyoto Protocol to the UNFCCC

Mission: to protect or enhance environment,

so as to promote the objective of achievingsustainable development

 Satisfies key stakeholder criteria

 Meets legal requirements

 Complies with British Standards or otherlocal regulations

United Nations Framework Convention on Climate Change

agreements:

 To develop programs to slow climate change

 To share technology and cooperate to reduce greenhouse

gas emissions

 To develop a greenhouse gas inventory listing national

sources and sinks

4: Trading and planning in a multinational environment

Topic List

Trade

Institutions

International financial markets

Global financial stability

Multinationals’ strategy

Risk

The growth of international trade brings benefits andrisks for the corporation The globalisation of internationalmarkets facilitates the flow of funds to emerging marketsbut may create instability

International trade

World output of goods and ser vices is increased if

countries specialise in the production of

goods/services in which they have a comparative

advantage and trade to obtain other goods and

services

Comparative advantage

Countries specialising in what they produce, even

if they are less efficient (in absolute ter ms) in

production of all types of good, is the compar ative

advantage justification of free trade, without

protectionism or trade barriers.

 Product differentiation barriers

 Absolute cost barriers

 Economy of scale barriers

 The level of fixed costs

 Legal/patent barriers

Barriers to market entry

 Tariffs or customs duties

European Union

The EU combines a free trade area with a customs union (mobility of factors of production).

 Mutually beneficial trade may be reduced

 There may be retaliation

 Economic growth prospects may be damaged

 Political ill-will may be created

What’s wrong with trade protection

 To combat imports of cheap goods

 To counter ‘dumping’

 Infant industries might need special treatment

 Declining industries might need specialtreatment

 Protection might reduce a trade deficit

Why protect trade?

World Trade Organisation and

International Monetary Fund

 Reduce existing barriers to free trade

 Eliminate discrimination in

international trade (in eg tariffs and

subsidies)

 Prevent growth of protection by

getting member countries to consult

with others first

 Act as a forum for assisting free trade,

and offering a disputes settlement

process

 Establish rules and guidelines to

make world trade more predictable

WTO aims

 Promote international monetary co-operation, and

establish code of conduct for international payments

 Provide financial support to countries with temporary

balance of payments deficits

 Provide for orderly growth of international liquidity

IMF aims

World Bank (IBRD)

supplements private finance and lends money on a commercial basis for capital projects, usually direct to governments or

government agencies

BIS

Bank for International Settlements: the banker for central banks.

Promotes co-operation between central banks Provides facilities for international co-operation

Risk Multinationals’

strategy

Global financial stability

International financial markets

Institutions Trade

 Loss of national control over economic policy

 The need to compensate for weaker economies

 Confusion in transition to EMU

 Lower confidence arising from loss of nationalpride

Arguments against EMU

 Economic policy stability

 Facilitation of trade

 Lower interest rates

 Preservation of the City’s position

Arguments for EMU

 To stabilise exchange rates between member

countries

 To promote economic convergence in Europe

 To develop European Economic and Monetary

Union (EMU)

European Monetary System (EMS)

Purposes

Globalisation of financial markets has contributed to

financial instability, despite facilitating the transfer of

funds to emerging markets