MAC3702 STUDY NOTES COMPLETE

MAC3702 STUDY NOTES COMPLETE TABLE OF CONTENTS TOPIC 1 – ADVANCED ANALYSIS OF INFORMATION ................................................................................... 5 LEARNING OUTCOMES............................................................................................................................. 5 STUDY UNIT 1 ADVANCED ANALYSIS OF INFORMATION ............................................................................ 6 Financial management............................................................................................................................. 6 Goal of an entity ...................................................................................................................................... 6 Business model or value creation model of an entity .................................................................................. 6 Stakeholders of an entity.......................................................................................................................... 7 Risk and return of investors ...................................................................................................................... 8 Key aspects of financial management ..................................................................................................... 11 Strategy and Risk .................................................................................................................................. 12 Strategy and the business environment................................................................................................... 12 Financial analysis .................................................................................................................................. 13 Users of financial and non-financial ........................................................................................................ 14 Tools or techniques of financial statement analysis .................................................................................. 15 Financial analysis .................................................................................................................................. 16 TOPIC 2 – REQUIRED RETURNS ................................................................................................................ 23 LEARNING OUTCOMES........................................................................................................................... 23 STUDY UNIT 2 RISK AND RETURN ............................................................................................................. 24 Return: ................................................................................................................................................. 24 Debt and financial leverage .................................................................................................................... 24 Capital structure theory .......................................................................................................................... 28 The arbitrage process ............................................................................................................................ 33 Portfolio management............................................................................................................................ 39 Diversification........................................................................................................................................ 45 STUDY UNIT 3 SOURCES AND FORMS OF LONG-TERM FINANCE ............................................................ 48 Deciding on the form of finance .............................................................................................................. 48 Classification of different forms of finance ............................................................................................... 48 Sources of finance ................................................................................................................................. 48 Forms of finance.................................................................................................................................... 48 Criteria applied by providers of finance/investors ..................................................................................... 51 Deciding on the best financing option...................................................................................................... 52 Cost-effective form of finance ................................................................................................................. 53 Leases.................................................................................................................................................. 53 TOPIC 3 – WEIGHTED AVERAGE COST OF CAPITAL ................................................................................. 58 LEARNING OUTCOMES........................................................................................................................... 58 STUDY UNIT 4 WEIGHTED AVERAGE COST OF CAPITAL (WACC) ............................................................. 59 The cost of capital ................................................................................................................................. 59 WACC .................................................................................................................................................. 59 Capital structure components ................................................................................................................. 60 The Weighted Average Cost of Capital ................................................................................................... 63 Calculating the growth rate..................................................................................................................... 67 TOPIC 4 – ORGANIC GROWTH (CAPITAL BUDGETING) ............................................................................. 69 LEARNING OUTCOMES........................................................................................................................... 69 STUDY UNIT 5 ADVANCED CAPITAL BUDGETING ...................................................................................... 70 Capital budgeting .................................................................................................................................. 70 Advanced techniques in capital budgeting ............................................................................................... 73 Advanced investment evaluation techniques ........................................................................................... 76 Inflation, taxation, relevant/opportunity costs and revenues ...................................................................... 79 TOPIC 5 – MERGERS AND ACQUISITIONS ................................................................................................. 81 LEARNING OUTCOMES........................................................................................................................... 81 STUDY UNIT 6 BUSINESS AND LEGAL ASPECTS ....................................................................................... 82 Forms of mergers and acquisitions ......................................................................................................... 82 Three types of acquisitions ..................................................................................................................... 82 Reasons for takeovers and mergers ....................................................................................................... 83 Reasons why mergers fail ...................................................................................................................... 83 Legal implications .................................................................................................................................. 83 STUDY UNIT 7 ELEMENTARY PRICING (VALUATION) AND FINANCING ISSUES ........................................ 85 Valuation model based on free cash flow ................................................................................................ 85 Models based on Free Cash Flow........................................................................................................... 87 Exit multiples......................................................................................................................................... 90 The McKinsey Convergence Value-Driver Formula .................................................................................. 91 M&A valuation considerations ................................................................................................................ 91 Maximum share valuation ...................................................................................................................... 92 Fair share valuation ............................................................................................................................... 92 Operational synergies ............................................................................................................................ 93 Financial effects of acquisition ................................................................................................................ 93 Earnings growth .................................................................................................................................... 94 Funding for mergers and acquisitions...................................................................................................... 96 TOPIC 6 – CASH MANAGEMENT ................................................................................................................101 LEARNING OUTCOMES..........................................................................................................................101 STUDY UNIT 8 TREASURY FUNCTION.......................................................................................................102 The role of the treasury function ............................................................................................................102 Treasury policy .....................................................................................................................................103 Decision to centralise the treasury function or department .......................................................................103 Working capital management policy and financing ..................................................................................105 Levels of working capital .......................................................................................................................106 Cash management ...............................................................................................................................107 Functions of Cash Management ............................................................................................................107 Cash operating cycle ............................................................................................................................108 The Baumol model for cash management ..............................................................................................110 The Miller-Orr model .............................................................................................................................112 Debtors' management...........................................................................................................................114 Credit policies ......................................................................................................................................114 Collection policy ...................................................................................................................................115 Debtor factoring....................................................................................................................................118 The dividend decision ...........................................................................................................................119 TOPIC 7 – CURRENCY AND INTEREST RATE RISK MANAGEMENT ..........................................................120 LEARNING OUTCOMES..........................................................................................................................120 STUDY UNIT 9 MANAGING CURRENCY AND INTEREST RATE RISKS .......................................................121 Currency risk defined ............................................................................................................................121 Categories of currency risk....................................................................................................................121 Different currency quotes in the currency market ....................................................................................123 Theories and factors determining exchange rates ...................................................................................127 Factors influencing exchange rates ........................................................................................................131 Hedging currency risk ...........................................................................................................................132 Interest Rate Risk .................................................................................................................................135 Treasury Bills .......................................................................................................................................138 Bankers’ Acceptances ..........................................................................................................................138 Negotiable Certificates of Deposit ..........................................................................................................138 Forward rate agreements ......................................................................................................................138 TOPIC 1 – ADVANCED ANALYSIS OF INFORMATION LEARNING OUTCOMES After studying this topic, you should be able to:  perform financial analysis and interpret results  analyses and interpret non-financial information  describe the limitations of accounting data  the limitations of ratio analysis  key non-financial indicators, including environmental, social and governance (ESG) aspects that can be used to identify and monitor business risks