Corporate Financial Strategy

Exploration of a FEW* Issues From This Week’s Assigned Readings

MSIN3017 (MSINM013) – Week 1, Lecture 2 of 2

*To repeat from ‘Orientation’ lecture slides: It is only possible to explore a few (2 or 3)
issues from each week’s assigned readings in depth at each week’s lecture session. That is
ONE of the reasons why you should NOT presume topics that from assigned readings
which are not covered in class sessions are not important, or less likely to appear as exam
questions.
 In class questions– PARTICIPATE*!

Demonstrate that you have completed

today’s assigned reading by
answering some spot questions about
Reading in the CFS text assigned for
today– Chapter 1.

*To ENSURE that you are called upon in class, do one or more of the following: contribute nothing,
converse in class, web surf. WE WILL FIND YOU (For movie buffs: The Paper Chase)
2
1
Financial Theories of (a) Value and (b) Economic Profit (EP)

2
Various, including from the CFS course text,
Assigned reading for completion prior to today’s lecture session

3
 1
Financial Theories of Value and
Of Economic Profit (EP)

4
Shareholder Value / Financial Theory

1.  What does the phrase “creating value” mean? How is that phrase
sometimes mis-interpreted in other parts of the organisation? Why?

2.  To what does the phrase “Financial Theory of Value” refer?

3.  What has happened to use of accrual accounting-based methods of

valuing companies (e.g., dividend-based methods) in companies
overall since the emergence of CF based concepts in the mid 1970s?

4.  What is the difference between Economic Profit (EP) and Economic
Value Added (EVATM)?

Q: If other functional parts and groups in the company insist on their own, bespoke
interpretations of what ‘added value’ represents, that’s OK right? After all, every one has
a right to their own opinion, correct? 5
NO!! “Value” is not some financial PR buzzword nor self-assigned (by
individual or department) attribute, but rather, objectively determined by
forward operating performance, expressed in financial terms…

6
Worth of a Company is Mostly a Function of the Effectiveness of Asset
(Investment) Deployment x NEXT CF Returns From Same

The 1956 Gordon Formula (aka Continuous Value Formula) was first designed for
dividends. But while dividend distributions per se may effect ST share price,
dividends exert no causal effect on worth (value). GF is now used mostly in DCF:

7
 EP: Temporary Excess Returns on Capital Employed

TOTAL RETURNS ON
CAPITAL INVESTED 1.  Why do some FD’s claim
Economic that EP is superior to
Profit: Present Value of FCF*s?
Difference What are some opposing
Between Total arguments?
Returns on
Cap. Invested
2. Why does the EP amount
and Capital
Charge usually £, tend to decrease over
some- time?
times %

Capital 3.) How might EP statistics

Charge: temporarily be distorted?
Capital
Invested x
Weighed
Average Cost
of Capital *CF = NOPAT + Non Cash Items + Certain
Deferables

elapsed time *FCF = CF minus period Investment (i)

8
 Market Value Added (MVA)

1.  Is Market Capitalisation

(MC) the price (market
value (MV) that you could
MV buy up all of the
Present Debt
Value of company’s debt and
Future EPs equity?

2. Is MVA primarily useful as

Market a dynamic (period-by-
MV period) or instead, a static
Capital-
Equity (one time view) of the
isation
financial performance of
Book Value of
the Business the company?

3. How might the MVE

component be distorted
during a stock market
bubble period (e.g.
2005-7, 1998-2000,
1987-89)? 9
? ‘Financial Management’

? ‘Profit Improvement’

10
‘Financial Management’

Financial management is concerned with improving

the use of financial resources… for the objective of
increasing company profitability and value, on a
continuing basis

? What’s included, what isn’t?

? What are examples of superior performance in this domain…

or the opposite?

11
‘Profit improvement’

As customarily applied and perceived across the

financial community, short-term actions primarily
designed to fortify reported EPS.

? EPS objective (Stern paper, Wk 6)

? When desirable- corporate examples?

? Longer-term implications

? CFOs/FDs customary role

12
 2
Various, Including Points
From Reading You Completed
Prior to Today’s Lecture in
the CFS core text

13
Other Roles and Responsibilities in the Office of the Financial
Director, Agency

1.  How do the typical roles and responsibilities of the TREASURER, the
CONTROLLER and the CHIEF FINANCIAL OFFICER (CFO) differ?

2.  Who reports to whom? Type of coordination exercised by FD?

3.  Given the diversity of roles, what skill sets / backgrounds does the CFO/FD
typically exhibit.

- Variability based on relative size of the company?

- Variations by geography (UK versus US)

- Does brinkmanship leverage / lingering recession change the likely key

competencies of the CFO/FD?

14
What tends to be the primary reason for CFO dismissal, and
how does that relate to the FD’s essential responsibilities?

What is the primary criteria that the CEO and the Board
consider in making its decision?

In walking this evaluative tightrope, what are the FD’s primary

challenges in terms of:

- Near term expectations v longer term performance

- Established ‘core’ activities v future key areas
- ‘Super shareholders’ v best interests of the firm

15
Integration of Company Business Plan With Financing Plan

What Arnold says (p. 2):

Without clarity (on objective of the corporation) it is very difficult to run a business in a
purposeful and effective manner.

But in FD-relevant terms, isn’t this what he means?

- No financial plan can save a fatally flawed business plan. Vivendi, Zynga, Groupon or a
criminal one Worldcom, Exxon

- (1) Fads are not plans (2) Continually changing BP means suboptimal FP. H-P, MSFT, A&F

- The basic TYPE of financing plan varies considerably based on the type of business and its
future prospects

- Start-up: emphasis on growth-development financing to secure firm’s future Twitter

- Midlife (plateau): incremental capital for investment to hold off growing number of
competitors, selective acquisitions P&G, Samsung
16
- ‘Fully mature’– SOLVENCY RIM, Nokia, HMV
MUCH Easier Expressed Than Actually Achieved

Arnold’s Case 1.1 re Cadbury: (now Kraft)

Balanced delivery of strong growth in revenues and margins

Implications

- Cadbury management are asserting that they can juggle two sometimes conflicting
objectives in its business-financing plan– (1) EQUIVALENT UNIT VOLUME GROWTH
Why isn’t this simply turnover (revenue)? (2) MARGIN MANAGEMENT Gross or net?

- Why is it not as easy to achieve both as Cadbury seems to imply in its statement?

- What are the FD/CFO’s primary roles in advancing each of the two different
objectives?

17
MUCH Easier Expressed Than Actually Achieved
Fill in the quadrants
(representative
companies)

EQUIV,
UNIT
GROWTH

L
H
MARGIN MANAGEMENT

18
- Arnold eventually acknowledges the primacy of MSV, for both
the FD and the corporation overall

-  But how do each of the following potentially complicate the FD/CFO’s MSV
mission?

  Continuing versus speculative (ST) investors

  Activists self-serving (and not necessarily accurate) interpretation of ‘improvement’

  Financial exotic theory, accepted until it crashes, e.g., MTM, ‘valuation’ by revenue
multiple, tranches of deadbeat mortgages, bitcoin?

Time permitting:

- Other questions to judge the completeness of your reading of today’s assignment

- Why is solvency (WC) topic first for Week 2 work shop and assignment?
19