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Definition of SFM “ the identification of the possible strategies capable of maximizing an organization’s net present value, the allocation of scarce capital resources among the competing opportunities and the implementation and monitoring of the chosen strategy , so as to achieve stated objectives.”
Financial Objectives of a Company • Maximizing the wealth of the share holders. • How is a company Financed ?
Value Enhancement in the Business Parlance. • The price of a company’s share goes up when the company is expected to make attractive profits, which it plans to pay as dividends to its shareholders or re-invest in the business to achieve future profit growth and dividend growth.
AGENCY THEORY • Relationship between the various interested parties. • Duties and conflicts.
Goal Congruence The situation when the goals of different interest groups coincide. A way of helping to achieve goal congruence between shareholders & managers is by the introduction of carefully designed remuneration packages for managers which would motivate managers to take decisions in consistent with the objectives of the shareholders.
1. Pay or bonuses related to the size of profits termed as Profit related pay. 2. Rewarding Managers with shares. 3. Rewarding Managers with share options.
OBJECTIVE ? :- • Which of the following is not included in strategic Management? a. Providing and organising the resources required. b. Analyzing Company’s options by matching its resources with the external environment. c. Setting long term objectives. d. Developing a company profit that reflects its internal with the external environment.
When Interest Rates are Higher • Reduce the amount of its debt Finance. • Company might opt to raise Finance by borrowing short-term funds and debt at a variable interest rate. eg:- Overdraft, rather than long term funds at fixed rates interest. • A company which has a surplus of Cash and liquid funds to invest might switch some of its short term investments out of equities and into interest bearing securities.
Strategic Planning Approach. SP is a systematic approach to decisions about basic directions and purpose of a business and the development of plans to achieve that purpose. It involves….. • Interpretation of policy • Applying strategies • Establishing Corporate objectives • Company develops in a planned manner.
Strategic Planning Steps:- • Business review and Assessment. • Establishment of Objectives. • Choice of Strategy and their Evaluation. • Detailed evaluation of the Strategic Plan. • Establishment of Annual or other short term budgets. • Implementing the plan and monitoring the results.
Relationship between Short term and Long term planning. Financial Planning must begin at the strategic level. Forecast must be made • Future Changes in sales. • Profitability. • Capital Employed.
Senior Mgt must negotiate with Middle Mgt, until a single strategic plan is agreed. Tactical plans must be drawn on, 1. Pricing Policies. 2. Personnel Requirements. 3. Production Methods. And a medium term plan established. This is then made into a series of short term financial plans at a later point of time
Planning Systems Top-Down system. Bottom-up system.
Objective? The objective of Decision-Making in corporate finance :- • To maximize firm value/Stock prices. • Ensure it earns more profit. • To ensure more in retained earnings. • All of the above.
Benefits Of Strategic Planning:- • Financial Benefits. • Enhanced capability of problem solving. • Improved quality of strategic decisions through group interaction. • Greater Employee Motivation. • Reduction in resistance to Change.
Estimating Financial requirements:- 1. Simple Traditional Method. Forecasting Financial requirements in terms of the number of days for which sales are tied up. 2. Engineering Analysis. Combination Of technical Know how and Judgement. 3. Operation Analysis. Based on various kinds of operations which a firm is engaged.( Not of technical Basis)
Factors to be considered while estimating Financial Requirements.1. Cost 2. Repayment Date. 3. Liquidity. 4. Interest Payment. 5. Claim on Assets. 6. Control. 7. Risk. 8. Availability. 9. Seasonality. 10. Requirements.
11. Cost Initial Promotional Outlays. 12. Fixed Asset Needs. 13. Current Assets. 14. Distribution Outlays. 15. Gestation Period. 16. Margin Of Safety. 17. Need For additional Funds.
RISK AND UNCETAINITY Which one of these is more Risky ?................. Research And Development….. Expansion………. Replacement…………….
SOURCES OF RISK……… 1. Size of the investment. • Re-investment of Cash Flows. • Variability of Cash Flows. • Life of the Project.
Risk and return on a single Asset:- Risk and return may be defined for a single asset, Or a portfolio of Assets. Rate of return:- Annual income + Ending price-Beginning Price. Beginning Price.
Rate of return split into Two components. Annual Income + End price-Beginning Price Beginning Price Beginning Price. Current Yield Capital Gain Yields.
Certainty Equivalent Approach This method considers adjusting cash inflows rather than adjusting the discount rate compensates risk element. The expected uncertain cash flow of each year are modified by multiplying them with what is known as Certainity Equivalent co-efficient, to remove the element of uncertainty.
A firm with a10% required rate of return is considering building new research Facilities with an expected life of 5 years. The initial Outlay associated with this project involves a certain cash outflow of Rs 1,20,000. The expected cash inflows and certainty coefficients are as follows:- Year Expected Certainty Cash Flow Equivalent Coefficient. • 10,000 0.95 • 20,000 0.90 • 40,000 0.85 • 80,000 0.75 • 80,000 0.65
CASE STUDY • In the context of the present business environment, risk management has become a critical activity for most of the firms. In the light of the above discuss the different approaches to managing risk?
GENERIC APPROACHES TO MANAGING RISK • Risk avoidance • Loss control • Combination • Separation • Risk transfer • Risk retention • Risk sharing
RISK AVOIDANCE • An extreme way of managing risk is to avoid it altogether. This can be done by not undertaking the activity that entails risk.
LOSS CONTROL • Loss control refers to the attempt to reduce either the possibility of a loss or the quantum of loss. This is done by making adjustments in the day-to-day business activities.
COMBINATION • Combination refers to the technique of combining more than 1 business activities in order to reduce the overall risk of the firm. It is also referred to as aggregation or diversification.
SEPARATION • Separation is a technique of reducing risk through separating parts of businesses or assets or liablities.
RISK TRANSFER • Risk is transferred when the firm originally exposed to a risk transfers it to another party which is willing to bear the risk. This may be done in three ways.
RISK RETENTION • Risk is retained when nothing is done to avoid, reduce, or transfer it. Risk may be retained consciously because the other techniques of managing risk are too costly or because it is not possible to employ other techniques.
RISK SHARING • This technique is a combination of risk retention and risk transfer. Under this technique, a particular risk is managed by retaining a part of it and transferring the rest to a party willing to bear it.
Decision Tree Analysis • A firm is ready for production which is estimated to cost Rs 8 Crore and takes one year. • If the results of pilot production are encouraging the next step would be to test market the product. That would cost Rs 3crore, and take two months.
Based on the outcome of the test marketing, manufacturing decision has to be taken. • The firm may skip the test marketing phase and take a decision whether to manufacture or not. • If the firm wants to manufacture the product commercially it has two options, a small plant or a big plant. This decision lies mainly on the size of the market.
Demand in the short run is purely on results of the test market. • Demand in the long run would depend on how satisfied the initial users are. • If the firm builds a large plant initially it can cater to the needs of the market when demand growth is favourable.
If demand turns out to be weak the plant would operate at a low level of Capacity utilization. • If the market turns out to be strong it will have to build another plant soon(incur higher total outlay) in order to save from competitive encroachment.
Steps in Decision tree analysis. • Identifying the problem and Alternatives. • Delineating the Decision Tree. • Specifying Probabilities and monetary outcomes. • Evaluating various decision alternatives.
It was once thought that states too sophisticated to fight each other would make war through sport. They do not. The real international battle ground these days is the board room. THE WEAPON IS TAKEOVER
Reasons for Merger. • Economies of scale. Utilization of production Capacities. Distribution Networks. Engineering services. Research and Development. Data processing systems.
Strategic Benefit • As A pre-emptive measure it can prevent a competitor from establishing a similar position in the industry. • It offers a special Timing advantage because the merger alternative enables a firm to ‘Leap Frog’ several stages in the process of expansion. • It may entail less risk and even less cost. • In a saturated market simultaneous expansion and replacement makes more sense than creation of additional capacity through internal expansion.
Complementary resources. • If two firms have complementary resources it makes sense for them to merge. A small firm with an innovative product may need the engineering capability and marketing reach of a big firm.
Tax shields • When a firm with accumulated losses and /Or unabsorbed depreciation merges with a profit –making firm, tax shields are utilized better.
Utilization of surplus Funds • A firm in a mature industry may generate a lot of cash but may not have opportunities for profitable investment.
Managerial Effectiveness. • This may occur if the existing management team , which is performing poorly, is replaced by amore effective management team.
Restructuring • Financial restructuring- Involves a significant change in the financial structure of the firm and / or the pattern of ownership and control. Two types 1. Aimed at bringing relief from the burden of debt. 2. Aimed at concentrating equity in few hands with the help of debt.
Relief from Debt burden. Convert Debt into equity. Write of a portion or whole of accumulated interest. Reduce interest rate. Make accumulated interest payable in stalement without interest.
What does debt Do? • A leveraged Buyout entails considerable dependence on debt. • Debt spurs management to perform, Equity lull management to relax and take things easy. • Debt is hard , Equity is soft. • Debt is a sword , Equity is a pillow.
Risk and rewards. The sponsors of a leveraged buyout are lured by the prospect of wholly owning a company or a division thereof with the help of substantial debt finance. They assume considerable risks in the hope of reaping handsome rewards. The success of the entire operation depends on their ability to improve performance of the unit, contain its business risk, exersice cost control and liquidate disposable Assets.
Organisational restructuring:- • To cope with heightened competition. • Regrouping of business. • Decentralization. • Downsizing. • Outsourcing. • Business process engineering. • Enterprise Resource Planning. • Total Quality Management.
