Further Evaluation of Accounts

Dr. Clive Vlieland-Boddy FCA FCCA MBA 2009

Valuation of Businesses

Enterprise Value (EV) Net Asset Value. Earnings Multiple Values Discounted Net Present Value. EV/EBITDA = payback

Enterprise Value

Market Cap + Interest bearing debt Cash or Cash Equivalents

This is sometimes called the takeover value!

Net Asset Value

The net asset value is arrived at by: Total Current and Non Current Assets Less: Total Current and Non Current Liabilities.

The same can be arrived at by taking total shareholders funds,

Earnings Multiple

Often based on an adjusted P/E ratio or a standard market ratio.

Discounted NPV

Discounting the future expected cash flows to present value.

Remember

Valuation is one thing. But the real issue is to find a price that buyer and seller agree.

Linking Ratios

These are essentially expanding the items examined but essentially the basis equation still exists.

Dupont Analysis
Analysis of Return on Stockholders Equity (ROE)

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The Dupont Equation [Return on Equity (ROE)]

NI ROE Equity

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ROE just tells us the return!

This could be because of the: Profitability of the business. The gearing of the business so that the Equity Shareholders are benefiting or otherwise from changes in debt financing. Or could be from better or worse use of the NCA. Du Pont expands the basic Formula.
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The Dupont Equation [Return on Equity (ROE)]

NI Sales Assets ROE X X Sales Assets Equity ROE ( profitability) X (efficiency ) X (leverage)

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The Dupont Equation [Return on Equity (ROE)]

NI Sales Assets ROE X X Sales Assets Equity ROE ( profitability) X (efficiency ) X (leverage)

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The Dupont Equation [Return on Equity (ROE)]

NI Sales Assets NI ROE X X Sales Assets Equity Equity ROE ( profitability ) X (efficiency ) X (leverage)

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Betas = systematic risk

These are placed on enterprises by the market place. They normally range from 0-2 1 is standard. 0 means that the company is not affected by the general movement of the market. 2 means that the company is moves more sharply than the market. They can act as a general guide to the entity.
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Failure Prediction Models

These are useful tools to know about. They basically look at the liquidity of a company and create something called a z score. Altmans which is the most well known is worth knowing. At www.creditguru.com is an insolvency predictor which does the calculation for you.

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Altmans Z Score
Z Score = 1.2 A + 1.4 B + 3.3 C + 0.6 D + 1.0 E when: A = working capital/total assets B = retained earnings/total assets C = EBIT/total assets D = market value of equity/book value of debt E = sales/ total assets A score of 2.7 or more represents a strong company. A score of less than 1.8 indicates high risk of failure.

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Sustainable Growth

Internally by:

Improving Working Capital Management. (See 19.1.2) Improving Assets Utilization. Retaining Profits

Externally by:

Increasing Leverage. Increasing Share Capital

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Sustainable Growth
Financing Growth is essential. This can be done by several ways: Improving Cash Management. Improving Assets Utilisation. Increasing Leverage. Retained Earnings. Increasing Share Capital.
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Sustainable Growth Cont

Most companies fund growth by not paying all the net profit out as dividends. Thus the retained earnings fund the growth. But often this is insufficient. Some can fund the growth by effective working capital management. Lidl and Aldi. Generally additional capital, debt or equity is often required.
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Sustainable Growth Cont..

Pay Out Ratio ( dividend Ratio) is the % or net profit that is distributed as dividends. Plough Back Ratio is the % that is retained. Some say that the Plough Back Ratio is the sustainable growth rate. But this is not altogether fair.

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Sustainable Growth
Whilst this formula shows the internally generate profits will assist with growth, there are clearly other areas to achieve sustainable growth: Improving working capital management. (Aldi & Lidl) Access to debt and capital markets to generate funds on a regular basis.
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Good Readings

See 17.1.11

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Environmental Scanning

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Environmental Scanning
TOOLS AND METHODS

SWOT Strenghts, Weaknesses, Opportunities and Threats Analysis Economic Development Scenarios Other Tools

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Environmental Scanning
TOOLS AND METHODS

SWOT

PESTEL

Other Tools

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SWOT
The Company

Strengths Weaknesses Opportunities Threats

The Environment

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SWOT analysis

Popular method used for summarising of the innovation analysis results; Provides an overview of regional strengths and weaknesses as well as opportunities and threats the region is currently facing or may face in the future.

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Internal factors

A STRENGTH is a is a resource or capacity of the region that it can take advantage of to improve its innovation system and competitiveness, e.g.

Access to well-educated labour force; Good communication and infrastructure; Diversified regional economic structure; Well-functioning public services; Etc.
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Internal factors

WEAKNESS is a limitation, fault or defect in the region that will keep it from improving the innovation system, e.g.

Limited number of start ups in the region; Peripheral location and low population density; High degree of long-term unemployment; Lack of cooperation between companies; Etc.
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External factors

OPPORTUNITY is a favourable situation in the region's environment, e.g.

Availability of EU funds and programmes; New markets through increased internationalisation; New educational opportunities; Cross-border cooperation; Global increase for demand in tourism services; Etc.
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External factors

THREAT is an unfavourable situation in the region's environment that may potentially damage the strategy, e.g.

Increasing of energy prices; Termination of regional development funding; Decrease of population; Emigration of high-qualified labour force; Etc.
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SWOT Design

One SWOT strategy for the whole region; or A set of SWOT strategies

Relevant if different views of the parties involved in the SWOT process; E.g. a regional economic strength may be regarded as a weakness from environmental point of view; May be structured along different sectors (economic, environmental, social, etc) or target groups (companies, public agencies, R&D sector, etc).
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SWOT Analysis Main Steps

Strenghts 1 2 3 Weaknesses 1 2 3 OW Actions OxWx OxWx OxWx

Scaning of Regional Environment

Analysis of Strenghts and Weaknesss

Analysis of Opportunities and Threats

Opportunities 1 2 3

OS Actions OxSx OxSx OxSx

Threats 1 2 3

TS Actions TxSx TxSx TxSx

TW Actions TxWx TxWx TxWx

SWOT Matrix
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Using SWOT as a Basis for Development Strategy

The strategy shall define priorities and actions that
1.

Build on STRENGTHS;

2.
3.

Eliminate WEAKNESSES;
Exploit OPPORTUNITIES;

4.

Mitigate the effect of THREATS.

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SWOT Golden Rules

Be realistic about the strengths and weakness of your region when conducting the SWOT; Avoid general SWOT! It should always be specific; Distinguish between where your region is today and where it could be in the future;
Keep your SWOT short and simple.
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PEST or PEST(EL)
Environmental Scanning

Political Issues Economic Issues Social Issues Technical Issues Environmental Issues Legal Issues
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Development Scenarios

An alternative to SWOT analysis Development scenarios are not predictions or forecasts of the future!

They intend to explore a number of wideranging possible futures and access their implications for the region and its main actors

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Development Scenarios Main Steps

Identification of Regional Drivers and Regional Issues

Assessment of Regional Drivers and Dependency Analysis

Elaboration of Dependency Matrix

Development Scenario 1

Development Scenario 2

Development Scenario 3

Development Scenario 4

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Market Value Added

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MVA
Market Value Added (MVA) is the difference between the firms market value and the amount of capital supplied. MVA measures how well managers are doing at maximizing shareholders wealth.

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Market Value Added

Total market value

Premium

Market value added

Debt & equity capital

Investment

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Earnings Value Added

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EVA
Economic Value Added (EVA) is like MVA, but applied on an annual basis. EVA = Operating profit - (Total capital x Cost of capital). EVA represents economic profit, as opposed to accounting profit.

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EVA Drives MVA

Companies that consistently earn profits in excess of their required return ...
NOPAT EVA

Charge

Gain a premiums to book value.

Market Value
Capital
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MVA

Relationship of EVA to MVA MVA is the NPV of the EVAs

EVA Year 1 EVA Year 2 EVA EVA Year 3 .... Year n

Market Value Market value

MVA
EVA + EVA + 1+r (1 + r)2 Capital EVA + ... + EVA (1 + r)3 (1 + r)n

Market value is based on establishing the economic investment made in the company (capital), making a best guess about what economic profits (EVA) will happen in the future, and discounting those EVAs to the present to get market value added.
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Capital Structure Theory

Modligliani and Miller theory

Zero taxes Corporate taxes Corporate and personal taxes

Trade-off theory Signaling theory Debt financing as a managerial constraint

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MM Theory: Zero Taxes

Modligliani and Miller (MM) prove, under a very restrictive set of assumptions, that a firms value is unaffected by its financing mix:

VL = VU.

Therefore, capital structure is irrelevant.

Any increase in ROE resulting from financial leverage is exactly offset by the increase in risk (i.e., rs), so WACC is constant.

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MM Theory: Corporate Taxes

Corporate tax laws favour debt financing over equity financing. With corporate taxes, the benefits of financial leverage exceed the risks: More EBIT goes to investors and less to taxes when leverage is used.

MM show that: VL = VU + TD.

If T=40%, then every dollar of debt adds 40 cents of extra value to firm

Under MM with corporate taxes, the firms value 50 increases continuously as more and more debt is used.

Dividend Policy

There is an agreement that companies should not pay dividends as they should be able to generate a return far in excess of that an ordinary shareholder could do with the money. This argument that capital gains will accelerate faster with no dividend policy is an argument supported by many. In reality, shareholders need cash flow.
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Coffee Break

17.2.1

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Coffee Break

17.5.1

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Competitive Analysis and Marketing Strategy: A Review

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Structural Analysis of Industries

Michael Porter THREAT OF NEW ENTRANTS

BARGAINING POWER OF SUPPLIERS

RIVALRY AMONG COMPETITORS

BARGAINING POWER OF BUYERS

THREAT OF SUBSTITUTES
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Barriers to Entry

Economies of Scale Product Differentiation Capital Requirements Switching Costs Access to Distribution Channels Cost Disadvantages Independent of Scale Government Policy Experience Curves Expected Retaliation
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Factors Affecting Rivalry Among Existing Competitors

Numerous or Equally Balanced Competitors Slow Industry Growth High Fixed or Storage Costs Need to operate at capacity . Price cutting Lack of Differentiation Capacity Augmented in Large Increments Diverse Competitors High Strategic Stakes High Exit Barriers
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Bargaining Power of Buyers is High When....

Purchasing is concentrated or is in large volumes relative to sellers sales The product represents a large proportion of buyers costs There is little differentiation or there are low switching costs Backward integration is a credible threat Product performance / quality is unimportant to buyers performance

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Bargaining Power of Suppliers is High When....

Supplying industry is dominated by a few firms and is more concentrated than the customer industry The product has few substitutes The customer industry is not important to the supplier The supplier product is an important input, is differentiated, or has high switching costs The supplier group poses a credible threat of forward integration

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Barriers and Profitability

Low

Low, stable returns Low, risky returns

ENTRY BARRIERS
High High, stable returns High, risky returns

Low

High

EXIT BARRIERS

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Preparation for next session

Exercises 17,23 and 27

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The End

to be continued..

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