The new Economy

Objectives:

  1. trace economic history of what the digital economy means
  2. Look at link between new economy and digitisation
  3. impact of new economy on strategy, organisation and management processes

What is the ‘New Economy’

Compuserver forums

  • 1980s – personal computesr
    1990s – Internet launch
    1995 – e-commerce

Post-industrial services

  • Birth of e-commerce in the 1990’s
  • The Internet as a socio-economic & socio-technical environment
  • Convergence of technologies around the Internet & E-commerce

Clicks & Mortar

  • Application of e-commerce to traditional value chains (Bricks & Mortar: physical assets)
  • Addition of digital channels to physical channels using existing infrastructure
  • Creation of virtual aspects to physical organisations of digitalisation of certain processes

Pure-play

  • The emergence of organisations with mostly virtual value chains and limited physical aspects
  • Digital-Physical (Amazon and e-tailers retailing physical goods)
  • Digital-Digital: Digital services as well as digital channels. (iTunes, Google, eBay)

Digitalisation & 5 forces (1) 

  • Increased industry based competition and innovation (Core rivals)
  • Larger threat of substitutes (indirect competition especially in service based industries
  • Schumpeter’s concept of ‘Creative Destruction’

Digitalisation & 5 forces (Contd)

  • Reduced barriers to entry in certain industries
  • Direct marketing & disintermediation
  • CRM technologies & interactive marketing
  • Lower switching costs
  • Increased buyer power and consumer information

Value chain Impacts

  • ‘Accelerated Marketing’ (Chen 2005)
  • Increased outsourcing & disaggregation (Network Value Chains)
  • Increased emphasis on CRM
  • Customer Lifetime Value (CLV)
  • New Media Channels

New Media & Web 2.0

  • Blogs, social networks & Self-evolving content
  • Media fragmentation extended the digital and online environments
  • Competing online media: Yahoo, MSN, Google & of course Facebook!

Conclusions

  • Changing parameters in macro and meso environments
  • Changing strategic practices such as network value chains
  • Evolution in strategic marketing: Digital marketing, online marketing and interactive marketing strategies

Expected rate of return

Page 425 of Essentials of investment

13.
a.Computer stocks currently provide an expected rate of return of 16% MBI a large computer company, will pay a year-end dividend of $2 per share. if the stock is selling at $50 per share, what must be the market’s expectation of the growth rate of MBI dividends?

Po = D1 / K-g | $50 = $2 / 0.16 – g
(016-g) x 50 = 2 || g= 0.16 -2/50 = 0.12 or 12%

b) If dividend growth for case for MBI are revised downwards to 5% per year, what will happen to the price of MBI stock @ what qualitatively will happen to the company price-earnings ratio?
14. Even better products have come out with a new and improved product. as a result, the firm projects an ROE of 20%, and it will maintain a plowback ratio of .30. its earnings this year will be $2 per share. investors expect a 12% rate of return on the stock.

a) At what price and P/E ratio would you expect the firm to sell

Plowback ratio = Rentention ratio or 1 – Divident rayout ratio
G= ROE x b where b: plowback ratio
G= 0.2 x 0.3 = 0.06 or 6%

Po = D1 / K-g K is cost of equity or expected return
E1= $2
D1 = 0.70 x $2 = $1.40

Formula >> P0 = D1/K-g = D0(1+g)/K-g

P0 = 140/0.12-0.06 = $23.33

Po / E1 = 23.33/2 = 11.67

C. What would be the P/E ratio and the present value of growth opportunities if the first planned reinvest only 20% of its earnings?

P0 = 160/0.12-0.04 = $20

Po / E1 = 20/2 = 10

Page 431 CFA Exam

Q9 – Helen morgan, CFA. has been asked to use the DDM to determine the value of sun. morgan anticipated that sundanci’s earnings and dividends will grow at 32% for two years an 13% thereafter.

Calculate current value of a share of sundanci stock by using two stage dividend discount model and the data below

Formula Pt = Dt + 1 / K-g

T=1 D1 = D0 x (1+g1) = 0.286x (1.32) = 0.377
T2 = D2 = D1 x (1+g1) = o.377x(1.32)=0.497
P2= 0.497*(0.13 +1) / 0.14-0.13 = 56.31

R&D Expense as %
of Net Turnover
Personnel
Expenses
Average Number
Of Employees
Profit After Tax Net Turnover Personnel Expenses dvidided by Number of Employees Profits per Employee
0 £28,899,000 1,674 £7,583,000 £136,040,000 28,900,674 £4,529.87
0 £1,365,000 127 -£266,000 £3,350,000 1,365,127 -£2,094.49 NE vs NT 0.989833012
0 £2,641,000 211 £65,000 £13,645,000 2,641,211 £308.06 #emp vs Prof 0.107753812
0 £6,238,000 371 -£1,089,000 £15,345,000 6,238,371 -£2,935.31 P ex vs # emp 0.998357696
0 £8,536,000 666 -£1,261,000 £27,775,000 8,536,666 -£1,893.39 prof vs # emp 0.799340109
0 £20,077,000 790 £97,000 £71,988,000 20,077,790 £122.78
0 £57,979,000 2,781 £11,604,000 £138,511,000 57,981,781 £4,172.60
0 £10,160,000 549 £2,284,000 £31,531,000 10,160,549 £4,160.29
0 £44,034,000 2,117 -£5,890,000 £180,356,000 44,036,117 -£2,782.24
0 £46,635,000 2,351 £2,958,000 £221,137,000 46,637,351 £1,258.19
0 £8,751,000 575 -£914,000 £24,764,000 8,751,575 -£1,589.57
0 £5,185,000 276 £901,000 £16,848,000 5,185,276 £3,264.49
0 £44,518,000 2,309 £16,714,000 £253,347,000 44,520,309 £7,238.63
0 £1,189,000 69 £83,000 £4,298,000 1,189,069 £1,202.90
0 £17,375,000 1,087 £287,000 £60,424,000 17,376,087 £264.03
0 £22,596,000 1,699 £9,874,000 £95,796,000 22,597,699 £5,811.65
0 £30,100,000 1,338 £4,200,000 £110,600,000 30,101,338 £3,139.01
0 £30,100,000 1,338 £4,200,000 £110,600,000 30,101,338 £3,139.01
0 £8,716,000 488 £843,000 £28,438,000 8,716,488 £1,727.46
0 £5,791,000 243 £3,411,000 £22,878,000 5,791,243 £14,037.04
0 £139,200,000 6,649 -£30,900,000 £496,800,000 139,206,649 -£4,647.32
0 £24,214,000 1,462 £1,976,000 £79,245,000 24,215,462 £1,351.57
0 £6,683,000 361 £402,000 £18,933,000 6,683,361 £1,113.57
0 £14,839,000 678 -£5,927,000 £83,478,000 14,839,678 -£8,741.89
0.06 £13,482,000 729 £2,293,000 £61,940,000 13,482,729 £3,145.40
0.52 £138,117,000 6,551 £21,513,000 £470,688,000 138,123,551 £3,283.93
0.54 £6,461,000 458 £1,542,000 £26,316,000 6,461,458 £3,366.81
0.72 £24,843,000 895 -£2,868,000 £78,585,000 24,843,895 -£3,204.47
0.78 £214,050,000 9,515 £41,550,000 £745,936,000 214,059,515 £4,366.79
0.81 £216,400,000 10,805 £26,300,000 £934,000,000 216,410,805 £2,434.06
0.91 £8,636,000 573 -£235,000 £30,877,000 8,636,573 -£410.12
0.93 £59,186,000 2,773 £35,870,000 £203,917,000 59,188,773 £12,935.45
1.14 £21,799,000 949 £3,152,000 £130,217,000 21,799,949 £3,321.39
1.15 £255,500,000 11,414 £69,600,000 £1,180,100,000 255,511,414 £6,097.77
1.27 £18,677,000 1,046 £5,551,000 £98,683,000 18,678,046 £5,306.88
1.28 £389,400,000 18,303 £79,800,000 £1,501,800,000 389,418,303 £4,359.94
1.63 £5,185,000 267 £1,388,000 £27,549,000 5,185,267 £5,198.50
2.95 £6,505,000 289 £3,765,000 £25,835,000 6,505,289 £13,027.68

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Merger and Aquisitions

Learning Week 5 Seminar Questions

Question 1 (G. Arnold, Corporate Financial Management, Third edition, Financial Times Prentice Hall, 2005, Chapter 23, Questions and Problems: Question 1)

Large plc is considering the takeover of Small plc. Large is currently valued at £60m on the stock market while Small is valued at £30m. The economies of scale and other benefits of the merger are expected to produce a market value for the combined firm of £110m. A bid premium of £20m is expected to be needed to secure Small. Transaction costs (advisers’ fees, etc.) are estimated at £3m. Large has 30 million shares in issue and Small has 45 million. Assume the managers are shareholder-wealth maximisers.

Required

1. Does this merger create value for Large plc?

E (value of combined) = 110
Value of L (60)
Value of S (30)
Synergistic bought = 20
Less Transaction costs = (3) < Often investment banks
total 17
Less Bid overpayment = 20
synergistic benefit = (3) << its not worth it as it is a loss

2. If the purchase is made with cash what will be the price offered for each of Small’s shares?

Value = £30m
+ bid premium = £20m
Total = £50m

No g share to acquire £45m

Price g each = £50m / £45m = £1.11

3. What would be the value of each of Large’s shares after this merger?

Large acquires S for Cash
L has 30m shares outstanding
Value – £110 -3 – (130+20) = £57m of L alone
=£57m /30m shares = £1.90 per shares vs previous £2 per share

Question 2 (G. Arnold, Corporate Financial Management, Third edition, Financial Times Prentice Hall, 2005, Chapter 23, Questions and Problems: Question 3).

Box plc is considering the acquisition of Circle plc. The former is valued at £100m and the latter at £50m by the market. Economies of scale will result in savings of £2.5m annually in perpetuity. The required rate of return on both firms and the combination is 11 per cent. The transaction costs will amount to £1m.

Required:

1. What is the present value of the gain from the merger?

Combined value of firm:

100m B
50m C
150m
Plus synergy = 22.727
Less bid-pref = 0
Less transfer costs (1)
Value of combined firm = 150 + 21.727 = 171.727

2. If a cash offer of £70m is accepted by Circle’s shareholders what is the value created for Box’s shareholders

Cash offer accped for C = 70m

Bid = 70-50 = £20m premium
Value G = 150m + 21.7272m

3. If shares are offered in such a way that Circle’s shareholders would posses one-third of the merged entity, what is the value created for Box’s shareholders?

Cirle shares hold 1/3 of F B

Value B = 2/3 (100+50+21.7272) = 114

Question 3 (D. Watson and A. Head, Corporate Finance – Principles & Practice, Fourth edition, Financial Times Prentice Hall, 2007, Chapter 11, Questions for discussion: Question 1 / (a)).

The board of Hanging Valley plc wishes to take over Rattling Creek Ltd. Shown below are summarised financial data for the two companies.

Hanging Valley

Rattling Creek

Profit before interest and tax

£420,000

£200,000

Ordinary share dividends

6.9p

14.0p

Corporation tax rate

35%

35%

Balance sheet extracts:

Hanging Valley

Rattling Creek

Net fixed assets

1,750,000

800,000

Current assets

800,000

500,000

Current liabilities

(450,000)

(200,000)

Total assets less current liabilities

2,100,000

1,100,000

Long term debt at 10% per year
Long term liabilities

(200,000)

2,100,000

900,000

Financed by:
Ordinary shares, £1

1,500,000

500,000

reserves

600,000

400,000

2,100,000

900,000

Hanging Valley’s earnings and dividends have been increasing at approximately 15 per cent per year in recent times, while over the same period the earnings and dividends of Rattling Creek have remained static. The current market price of Hanging Valley’s ordinary shares is £1.60. The board of Hanging Valley considers that the shareholders of Rattling Creek will accept a share-for-share offer in the proportion of four shares in Hanging Valley for every five shares in Rattling Creek.

Required:

(a) Using three different valuation models[1], determine the effect on the wealth of Hanging Valley plc’s shareholders if Rattling Creek Ltd’s shareholders accept the proposed share exchange.

Net Assets Value = Fixed + current + sort term liability + long term liabilities
NAV based on book value

Value HV
Net assets 2.1m

Value RC
Net Assets 1.5m

Question 4 (D. Watson and A. Head, Corporate Finance – Principles & Practice, Fourth edition, Financial Times Prentice Hall, 2007, Chapter 11, Questions for discussion: Question 5).

It is 1 January 2012 and Magnet plc is in the process of divesting part of its operations via a proposed management buyout (MBO) The buyout team is currently looking for venture capital to finance the MBO. They have agreed a price of £25m with Magnet and have proposed that the financing will involve their putting up £5m of their personal funds to purchase an equity stake in the business with the remaining funds (£20m) coming from the venture capitalist in the form of long-term unsecured mezzanine debt finance.

The venture capitalist has indicated that it will require an interest rate on its debt investment of 11 per cent given that its finance will be unsecured. The four members of the MBO team have indicated that they intend to draw an annual salary of £150,000 each. The MBO team has just presented the venture capitalist company with the following five-year cash flow predictions (excluding directors’ salaries) which they consider to be on the pessimistic side:

Year ending

2012

2013

2014

2015

2016

Predicted sales

£6.78m

£6.82m

£7.23m

£7.51m

£8.02m

Cash outflows

£3.39m

£3.34m

£3.47m

£3.53m

£3.84m

Reinvestment

£1.5m

The new entity will pay corporation tax at a rate of 20 per cent in the year that profits arise. The reinvestment of £1.5m in 2014 will not qualify for capital allowances.

Required.

On the basis of this information, critically evaluate whether the proposed MBO is viable from a cash flow perspective in light of the two parties’ financial requirements and the predicted sales and costs. Support your answer with appropriate calculations.


[1] net asset valuation based on book values, capitalisation of earnings valuation (i.e. earnings yield valuation), and dividend yield method of share valuation

20120213-142627.jpg

Treasury management and working capital policy

The number one function of a Treasurer is

  • Corporate finance – capital markets, trading finance and risk
  • Equity management – investor relations, mergers and divestment

Financing

Most important source long-term financing is retained earnings
Advantages:
  • No dilution of existing shareholders or corporate control
  • avoids issuing costs
  • management may not have to explain to shareholders why dividend are not paid

Disadvantages:

  • limits firm profits
  • reduces divident payout
  • risk of not obtaining finance at a vital stage
  • managers may regard this essentially as free capital

Analysis of Assets:

  • Fixed Assets
  • Permanent current assets
  • Fluctuating current assets
  • Matching principle: long-term finance used for long-term assets, short-term finance used for short-term assets.

Methods of Financing:

  • short-term fluctuating current assets
  • long-term for permanent current assets and financing of fixed assets
  • increased use of longterm finance lowers risk

Financing: The currency of borrowing

Union Jack plc borrows £100m to invest in the USA.

Exchanges the £100m into $150m at the exchange rate of $1.5 to the pound.

Net cash flows in subsequent years are expected to be $30m per annum.

If the exchange rate remained constant Union Jack receives £20m per year.

If the rate of exchange moved to $2 for every pound the annual cash inflow would be £15m.

The risk attached to this project can be reduced by ensuring that the liabilities are in the same currency as the income flow.

Financing: The interest rate choice

Balance to be struck between fixed and floating interest-rate borrowings

Relationships with the financial community

A planned and sustained effort to maintain mutual understanding between shareholders and the organisation. Create a detailed and up-to-date picture of who the shareholders are. High-quality flow of information to enable shareholders to better appreciate the firm and its strategy in order to sustain their commitment.

Banking relationships.
Most firms make use of the services of more than one bank.
Any one bank may not have all the requisite skills and infrastructure. Banks have a tendency to join syndicates to make large loans to firms. Some companies operate in dozens of countries.

The treasurer at a strategic level    

Decision to merge with another firm or to purchase a major business (a trade purchase) will require some assessment of the ability of the organisation to finance such activity.

Treasurer will be able to advise on,

  • the sources of finance available;
  • the optimum mixture;
  • the willingness of the financial community to support the initiative.

Disposals of subsidiaries.

Advise on the course of interest rates and exchange rates and so decisions such as whether to establish a manufacturing facility or begin a marketing campaign in another country. Total amount of borrowing a firm should aim for.

Risk Management

Reasons firms sacrifice some potential profits in order to reduce the impact of adverse events:

-It helps financial planning;
-reduce the fear of financial distress;

-some risks are not rewarded

  • Liquidity risk; cash-flow risks
  • Credit risk; not being able to get capital
  • Market risk.
  • Risk retention;
  • Risk avoidance; only take risks that generate a profit, do not take risks for no return!
  • Risk reduction – Risk transfer:
-Diversify – don’t put your eggs all in one basket
-Insure – transfer the risk to other businesses
-Hedge – such as currency and derivatives ( forwards, futures, swaps and options)
Z-Score models

Discriminatory ratios – R1 to Rn will typically feature:

  • profitability;
  • asset turnover;
  • liquidity;
  • gearing.

They will frequently be ‘variants’ of more traditional financial ratios.
A score below a certain level indicates higher risk of corporate failure.

Relaxed strategy – liquidity is well addressed but taking less risks your return on capital employed will be low
Aggressive strategy – Taking more risks they are exposed to more liquidity risk but at the same time the company would be able to have a higher capital employed
This policy is reflected upon the managers risk exposure
Overtrading situations
  • Initial under-capitalisation of future operations, the company would not have sufficient funds to continue with the project.
  • Over-expansions – did not predict the higher demand from the market for your products and services
  • Poor utilisation of working capital resources – cash lying idle is a waist and has a very relaxed debtor policy and customers have the money which should be with the company or your paying your suppliers way to fast, always utilise any payment periods suppliers give you and utilise the capital for other low risk projects.
It could also be a combination of all three and have not used the capital and leads to overtrading.

Intangible Factors in Strategic Analysis

Intangible Factors in Strategic Analysis

  • The most intangible things can have the greatest impacts in reality

Model of organizational culture Goffee-Jones Matrix –

  • Sociability < — > Solidarity (how well diferent departments communicate together) – Networked, Fragmented, Mercenary, Communal
  • the intangibles of culture affect the tangible behaviour of businesses and individuals
Cultural Capabilties
  • Cultural type for inovation
  • willingness and ability to adapt to unforseen circumstances
Strategic management skols
Cultural Web – The Paradigm
  • Stories
  • Rituals & routines
  • Symbols
  • Control systems
  • Organisational structures
  • Power structures

Stakeholder theory:
Internal
  • Executive officers
  • Broad of directors
  • Stockholders
  • Employees
External – Customer, suppliers, creditors, governments, unions, competitors, general public
CSR and Reputation management are joined and are an application of CRS
Power-interest matrix
Brand Equity tables:
  • Brand image

>>CW – Apple can improve on there current possition as the best can get better, apple has a very strong after sale<< look at brand equity tables – look at there position and competitors and where they use to be and the direction they are going

//www.businessweek.com/magazine/toc/06_32/B399606globalbrands.htm

Corporate reputation

•The transmitted and perceived image of a corporation internally and externally
•Pertains to stakeholder management applications
•Incorporates PR, Corporate Governance and CSR
•Recognised in theory & practice: ‘Reputation Management’

:

Pulse: //www.reputationinstitute.com/

Fortune Reputation Index: //money.cnn.com/magazines/fortune/mostadmired/2009/index.html

FTSe4Good: //www.ftse.com/Indices/FTSE4Good_Index_Series/index.jsp

Dow Jones Sustainability Index: //www.sustainability-index.com/

See also : //www.iafinance.org/index.html

•Reputation is not just important for sales; it oils the wheels of dealings with government, suppliers, employees and other stakeholders The 32 companies that have qualified for Business in the Community’s (BITC) Corporate Responsibility Index throughout the seven years of its existence have outperformed their FTSE 350 peers by between 3.3 and 7.7 per cent each year. (www.allbusiness.com)
•Do not restrict judgement of companies to financial metrics
•Strategic resources & innovation
•Reputational impacts & corporate risk management
•Constituents of brand equity and CR are important too
•Evaluate intangible assets even if they are qualitative in nature
•Track intangible performance across key indices. If a smaller organisation look for key constituents where possible!

Time value of money (TMV) for level 1 CFA Exam

Securities usually have one or more type of risk

  • Default risk – risk of a borrower not make the payments on time
  • Liquidity Risk – cost of selling low liquid assets to transfer to cash (e.g. as with banks and day to day cash flows)
  • Maturity risk – The longer the maturity of a bond the risk as we are trying to determine things that are out of our view e.g. for 10 year bonds.
can be written as:
Required interest rate on a security = Nominal risk free rate + defat risk premium + Liquidity premium + maturity risk premium
A ” rate ” can also be interpreted as the ” discount rate ” and both are interchangeable.
Future value (compound value) of a single sum:
This is the amount a deposit will grow over a specific amount of time with interest being paid to the principal at n intervals.
formula:
DV = PV(1+I/Y)n
Where
  • PV = amount of money invested today (the present value
  • I/Y = rate of return per compounding period
  • N = total number of computing periods
Interest rates are our measure of the time value of money, although risk differences in financial securities lead to differences in their equilibrium interest rates . Equilibrium interest rate are the required rate of return for a particular investment.
Interest rate can also be views as the discount rate, it can also be seen as the opportunity cost of the current consumption.
Real risk-free rate of interest is a theoretical rate on a single period loan that has no expectation of inflation in it, it refers to an investor’s increase in purchasing powder (after adjusting for inflation).  since expected inflation in future periods is not zero, the rates we observe on U.S T-Bill are risk-free rates but not real rates of return, they are nominal risk free rates because they contain an inflation premium. the approximate relation here is.

Moninal Risk-free rate = Real risk-free rate + expected inflation rate

Universal Principal of Risk Management: Pooling and Hedging of Risk

Pulling and Hedging of Risk

Probability theory
First found in the 17th Century
$$P=Prob. 0≤P≤1$$

Independence theory
each event is independent from the next, an example of this would be throwing a coin in the air, every time you throw each event is independent from the other to calculate this probability

$$Prob (A and B) = Prob (A).(B)$$

Binomial Distribution:
The binomial distribution is the discrete probability distribution of the number of successes in a sequence of n independent yes/no experiments, each of which yields success with probability p. Such a success/failure experiment is also called a Bernoulli experiment or Bernoulli trial; when n = 1, the binomial distribution is a Bernoulli distribution. The Binomial distribution is an n times repeated Bernoulli trial. The binomial distribution is the basis for the popular binomial test of statistical significance. eg. x events in n tries:

Population measures

Random Variable = E(x)=Mx=

 Random Variable Sample
The Geographic Average is should be used to calculate a performance of an investor.

Variance and Covariance