POINTERS FOR REVIEW

Investing in Long-Term Assets: Capital Budgeting

 The Cost of Capital

-It is the rate of return that a firm must earn on the projects in which it invests to maintain its
market value and attract funds.

-it is an extremely important financial concept.

-it acts as major link between the firm’s long-term investment decisions and the wealth of the
owners as determined by investors in the market place.

-Cost of capital can also be defined as the rate of return required by the market suppliers of
capital to attract their fund to the firm.

 Business risk- the risk to the firm of being unable to cover operating cost- is assumed to
be unchanged. This means that the acceptance of a given project does not affect the
firm’s abilitiy to meet operating costs.
 Financial risk- the risk to the firm of being unable to cover required financial obligation-
is assumed to be unchanged. This means that the projects are financed in such a way
that the firm’s ability to meet financing costs is unchanged.

SPECIFIC SOURCES OF CAPITAL:

 The focus is on finding the costs of specific sources of capital and combining them to
determine the weighted average cost of capital
 We are concerned with the long term sources of funds available to a business firm,
because these sources supply the permanent financing.
 Long term financing supports the firm’s fixed asset investments.

FOUR BASIC SOURCES OF LONG-TERM FUNDS FOR THE BUSINESS FIRM:

1. Long-term debt
2. Preffered stock
3. Common stock
4. Retained earnings

Capital Budgeting- is the process of identifying, evaluating, planning, and financing capital
investment projects of an organization

Project Classification

1. Replacement: Maintenance of Business

2. Replacement: Cost Reduction
3. Expansion of Existing Products or market
4. Safety and Environmental Projects
5. Other projects (office buildings, parking lots, executive aircraft)

Study this

Capital Investment Projects

 Large commitments of resources

 Long-term commitments
 More difficult to reverse that short-term decisions
 Involve so much risk and uncertainty
A capital investment is a financial outlay made to support the long-term expansion of a
business.

The phrase is frequently used in reference to a business's purchase of long-term fixed assets like
property and machinery.

Cash on hand is one possible source of capital investment funding, but major projects are
typically financed by taking out loans or issuing stock.

Return on Investment (ROI)- A common profitability statistic used to assess how well an
investment has done is return on investment (ROI).

By dividing an investment's net profit (or loss) by its initial cost or outlay, ROI is expressed as a
percentage. ROI can be used to rate investments in various projects or assets and create apples-
to-apples comparisons.

ROI does not account for time passing or the holding duration, which means it may not account
for the opportunity costs of investing elsewhere.

Factors Affecting Long-term Decisions

1. Estimated CashFlows
2. Cost of Capital
3. Acceptance Criteria

ADVANTAGES

 Capital budgeting helps a company understand the various risks involved in an

investment opportunity. And how these risks affect the returns of the company.
 It helps the company to make long-term strategic investments.
 Capital budgeting presents whether an investment would increase the company’s value
or not
 It offers adequate control over expenditure for projects.

DISADVANTAGES

 Capital budgeting decisions are for the long-term and are majorly irreversible in nature.
 These techniques are mostly based on estimations and assumptions as the future will
always remain uncertain.
 A wrong capital budgeting decision can affect the company’s long-term durability. And
hence, it needs to be done judiciously by professionals who understand the project well.

Cash Flow Estimation and Risk Analysis

Cash flow (CF) is the change in the quantity of money that a company, institution, or person has.
The phrase is used in finance to refer to the volume of money (currency) produced or spent over
a specific period of time. There are numerous forms of CF, and they have numerous significant
applications in doing financial research and managing businesses.

Cash Inflow – Cash Outflow = CashFlow Balance

Working Capital Management

 Managing Current Assets

Working Capital, also known as net working capital (NWC), is the difference between a
company’s current assets— such as cash, accounts receivable/customers’ unpaid bills, and
inventories of raw materials and finished goods— and its current liabilities, such as accounts
payable and debts. It’s a commonly used measurement to gauge the short-term health of an
organization.

 Working capital also known as net working capital is the difference between a company’s
current assets and current liabilities

NET WORKING CAPITAL = CURRENT ASSETS – CURRENT LIABILITIES

Cash conversion cycle

The amount of time (measured in days) it takes for a business to convert its investments in
inventory and other resources into cash flows from sales is known as the cash conversion cycle
(CCC).

The CCC, also known as the net operating cycle or just the cash cycle, aims to quantify the
length of time that each net input dollar spends in the manufacturing and sales cycle before it is
turned into cash received.

Cash & Marketable Securities:

Cash: Peso Bills & Bank Deposits.

DEMAND DEPOSITS: Money in checking accounts that the firm can pay out immediately.

TIME DEPOSITS: Money in saving accounts that the firm can pay out only with a delay.

Marketable Securities: Commercial Paper & Treasury Bills

Cash budget

Cash Budgeting:

Three Common Steps to preparing Cash Budget

1. Forecast the sources of cash

2. Forecast the uses of cash
3. Calculate whether the firm is facing a cash shortage or plus

Forecasting future sources and uses of cash

SOURCES OF SHORT-TERM FINANCING

Secured Loans:

Accounts Receivables Financing

1. Some companies solve their financing problem by borrowing on the strength of their current
assets!...

When a loan is secured by receivables, the firm assigns the receivables to the bank.

The risk of default on the receivables is therefore borne by the firm

2. Others solve it by selling their current assets!...

An alternative procedure is to sell the receivables at a discount to a financial institution known

as FACTOR and let it collect the money.

Once the firm has sold receivables, the factor bears all the responsibility for collecting on the
accounts!...

THE COST OF BANK LOANS

1. Simple Interest: The interest rate on bank loans frequently is quoated on APR
2. Discount Interest : The interest rate on bank is often calculated on a discount basis.
3. Interest with Compensating Balances: Occasionally, bank loans require the firm to
maintain some amount on balance at the bank, which is called as Compensating Balance.

The reason is that borrower must pay interest on full amount borrowed but has access
only part of the funds.

In each case; the face value of the interest has to be converted to effective
interest rate in order to learn the actual burden on the loan.

Inventory Financing

Bank also lend on the security of inventory; but they are choosy about the inventory they will
accept.

Inventory Management

Inventory Period = Average Inventory / [Cost of Goods Sold / 365]

Receivable Management

ACCOUNTS RECEIVABLE MANAGEMENT- is the process of ensuring that customers pay their
dues on time. It helps the businesses to prevent themselves from running out of working capital
at any point of time. It also prevents overdue payment or non-payment of the pending amounts
of the customers.

What is AR?

- Any amount of money owed by customers for purchases made on credit is AR.
- Refers to the money a company’s customer owe for goods or services they have received
but not yet paid for.

Accounts Receivable:
arise because of companies do not usually expect customers to pay for their purchases
immediately.
These unpaid bills are a valuable asset that companies expect to be able to turn into cash in the
near future.

TRADE CREDIT : Unpaid bills from sales to other companies.

CONSUMER CREDIT : Sales of goods to the final customers

IMPORTANCE OF ACCOUNT RECEIVABLE

- AR management incorporates is all about ensuring that customers pay their invoices.
Good receivables management helps prevent overdue payment or non-payment. It is
therefore a quick and effective way to strengthen the company's financial or liquidity
position.
GOALS OF ACOUNTS RECEIVABLE MANAGEMENT

- The main objective in accounts receivable management is to minimize the Days Sales
Outstanding (DSO) and processing costs whilst maintaining good customer relations.
Accounts receivable is often the biggest current asset on the balance sheet.

The goal of effectie accounts receivable management is to optimize you billing, payments, and
collections process to minimize the time it takes to get paid and eliminate the risk of bad debt.

Receivables Period = Average Accounts Receivables / [Sales / 365]

Accounts Payable:

Unpaid Bills

Outstanding payments due to other companies

One firm’s credit is another firm’s debit

o AR Collection Period
 Dividend Policy
o Policy theory and arguments

o Factors affecting policy

o Types of policies
o Other forms of dividends

VII. Special Topics in Financial Management 8

 Merger and Acquisitions

https://www.slideshare.net/ravirockaditya/mergers-and-acquisition-ppt

Mergers and acquisitions, or M&A for short, involves the process of combining two
companies into one. The goal of combining two or more businesses is to try and achieve
synergy—where the whole (new company) is greater than the sum of its parts (the
former two separate entities).Nov 18, 2022
United Coconut Planters Bank (UCPB) has announced on its website that it will merge
with Land Bank of the Philippines (LANDBANK), with LANDBANK as the surviving entity.
This is in accordance with Executive Order No. 142 signed by President Rodrigo R.
Duterte on June 25, 2021.

Based on UCPB’s FAQ about the merger, all UCPB branches will continue to operate, but
later on, some LANDBANK and UCPB branches may be relocated or merged. Clients will
be advised prior to any location change. Reference: www.ucpb.com/inside-
mergernotice20211216/

The combined branch and ATM network will consist of 667 branches and 2,722 ATMs
nationwide. The merger will increase Landbank’s total assets to around three trillion
pesos and make Landbank the second biggest bank in the Philippines based on total
assets
 Reference: www.landbank.com/news/ucpb-stockholders-approve-landbank-merger-plan

Mergers & Acquisitions

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Mergers and acquisitions (M&A) is a practice area of the law, focused on domestic and
global transactions aimed at consolidating businesses of two or more companies
through legal operations such as mergers, purchase of assets, tender offers, hostile
takeovers, among others.

M&A deals vary in terms of the complexity and sophistication of the legal operation
implemented to carry them out. M&A deals are also used in a wide variety of industries
to enable strategic growth for businesses. Although each M&A deal is not the same,
there are usual stages implemented in many M&A transactions, as follows:

INTRODUCTION

Mergers and acquisitions are increasingly becoming strategic choice for organizational
growth, and achievement of business goals including profit, empire building, market
dominance and long-term survival. The ultimate goal of this is however maximization of
shareholders value. The phenomenon of rising M&A activity is observed world over
across various continents, although, it has commenced much earlier in developed
countries (as early as 1895 in US and 1920s in Europe), and is relatively recent in
developing countries.

WHAT IS MERGERS AND ACQUISITION?

- Mergers and acquisition (M&A) are defined as c=consolidation of companies.

WHAT IS MERGER?

- Mergers is the combination of two companies to form one new company.

- The combination of two companies involves a transfer of ownership.
- Both companies surrender their stock and issue new stock as a new company.

WAYS OF MERGER

A merger can take place in following way:

 By purchasing of assets
 By purchasing common shares
 By exchanging shares for assets
 By exchanging shares for shares

TYPES OF MERGERS

1. Horizontal mergers
2. Vertical mergers
3. Conglomerate mergers
4. Concentric mergers
1. HORIZONTAL MERGERS

A Horizontal merger is a merger between firms that produce and sell the same products, i.e.,
between competing firms. Horizontal mergers, if significant in size, can reduce competition in a
market and are often reviewed by competition
authorities.
 2. VERTICAL MERGERS

A Vertical merger is a merger between firms operating at different stages of production, e.g.,
from raw materials to finished products to distribution. An example would be a steel
manufacturer merging with an iron ore producer.

3. CONGLOMERATE MERGERS

A conglomerate merger is a merger between firms that are involved in totally unrelated business
activities. These mergers typically occur between firms within different industries or firms located
in different geographical locations.

There are two types of conglomerate mergers: pure and mixed. Pure conglomerate mergers
involve firms with nothing in common, while mixed conglomerate mergers involve firms that are
looking for product extensions or market extensions.

4. CONCENTRIC MERGERS

A concentric merger is a merger in which two companies from the same industry come together
to offer an extended range of products or services to customers. These companies often share
similar technology, marketing, and distribution channels, and look to the concentric merger to
create synergies.
WHAT IS ACQUISITION?

When one company takes over another and clearly established itself as a new owner, the
purchase is called an acquisition.

TYPES OF ACQUISITION

1. Friendly acquisition
2. Reverse aqcuisition
3. Back flip acquisition
4. Hostile acquisiton

A friendly takeover is a scenario in which a

target company is willingly acquired by
another company. Friendly takeovers are
subject to approval by the target company's
shareholders, who generally greenlight
deals only if they believe the price per share
offer is reasonable.

A reverse acquisition occurs when an

entity that issues securities (the legal
parent or the legal acquirer) is
identified as the accounting acquiree,
and accordingly, the legal subsidiary
(or the legal acquiree) is identified as
the accounting acquirer.

A backflip takeover is a rare type of

takeover that occurs when an acquirer
becomes a subsidiary of the company
it purchased. Upon completion of the
deal, the two entities join forces and
retain the name of the company that
was bought.
 A hostile takeover, in mergers and
acquisitions (M&A), is the acquisition of a
target company by another company
(referred to as the acquirer) by going
directly to the target company's
shareholders, either by making a tender
offer or through a proxy vote.

DIFFERENCES BETWEEN M&A

BASIS MERGERS ACQUISITION

Meaning
Formation of New Firm
Purpose
Size of business
No. of companies involved
Fusion of two or more When one entity purchases
companies voluntarily form a the business of other entity
new company
yes no
To decrease competition and For instantaneous growth
increase operational
efficiency
Size of merging companies is Size of the acqiuring
more or less same company is bigger than
acquired company
3 2

MERGERS: WHY AND WHY NOT?

WHY IS IT IMPORTANT PROBLEM WITH MERGERS

Increase market share Class of corporate cultures
Economies of scale Increased business complexity
Profit for research and development Employees may be resistant to change
Reduction of competition

ACQUISITION: WHY AND WHY NOT?

WHY IS IT IMPORTANT PROBLEM WITH ACQUISITION

Increase market share Inadequate valuation of target
Increased diversification Inability to achieve synergy
Excessive competition and cost maximization Finance by taking huge debt

MOTIVES FOR MERGERS AND ACQUISITION

 Economies of large scale business: enjoys both internal and external economies.
 Elimination of competition: it eliminates intense and wasteful expenditure by different
competing organization
  Desire to enjoy monopoly power: mergers and acquisition leads to monopolistic control in the
market.
 Adoption of modern technology: corporate organization require large resources.

BENEFITS OF MERGERS AND ACQUISITION

 Great value generation: mergers and acquisition generally succeed in generating cost efficiency
through the implementation of economies of sales
 Gaming cost efficiency: the joint companies benefit in terms of cost efficiency. As to firms for
new bigger company
 Increase in market share: an increase in market share is one of the possible benefits of M&A
 Gain higher competitiveness: the new firm is usually more cost-efficient and competitive as
compared to its financially with parent organization.

PROBLEMS OF MERGERS AND ACQUISITION

 Integration difficulties
 Large or extra ordinary debt
 Managers overly focused on acquisition
 Overly diversified

STRATEGIES OF MERGER AND ACQUISITION

 There is an important need to assess the market by deciding the growth factors through future
market opportunities.
 The integration process should be taken in line with consent of management from both the
companies venturing into the merger.
 Restructuring and future parameters should be decided with exchange of information and
knowledge from both ends.

DUE DILIGENCE

Due diligence: The financial and legal advisors of the buyer make a comprehensive revision of
the financial and legal matters of the target company or assets that will be purchased. The due
diligence phase's purpose is to identify any potential financial or legal contingencies that might
affect the transaction. The due diligence findings will be used as the primary source to prepare
the contract for the M&A deal.

The contract: The legal advisors of the parties prepare and negotiate a contract, which allocates
the risks between the buyer and the seller according to the findings made in the due diligence
phase. Among others, the contract may be in the form of a stock purchase agreement or an
asset purchase agreement.

The closing: The contract provides a detailed description of the actions both the buyer and the
seller will have to perform to close the M&A deal. Each closing is different in consideration of
the specifics of the transaction. For example, some closings may require that a governmental
authority grants its authorization. Other closings may only depend on each party's individual
actions (i.e., payment of the purchase price, delivery of stock certificates, etc.).

Post-closing: Even if the M&A deal has been closed, the parties may still have to comply with
post-closing obligations or actions, such as non-compete or non-solicitation obligations, among
others. However, some M&A deals might not have any post-closing obligations.
https://www.law.cornell.edu/wex/mergers_acquisitions

Strategic Planning and implementation

 Derivatives and Risk Management

 o Futures
o Options
o Forward contracts
o Hedging
o Swaps

 Hybrid Financing

Preferred stock

- A hybrid form of financing

- A type of stock that promises a (usually) fixed dividend but at a discretion of the board of
directors.
- It has preference over a common stock in the payment of dividends and claims on asset (but up
to a maximum of Par value of the stock)

Preferred stock and its FEATURES

 Cumulative dividends feature -a requirement that all cumulative unpaid dividends on the
preferred stock be paid before a dividend may be paid on the common stock
 Participating feature -allows preferred stockholders to participate in the increasing dividends if
the common stockholders receive increasing dividends.
 Voting rights (in special situations) -given usually if corporation is an able to pay preferred stock
dividends during a specified period.

ADVANTAGES OF PREFERRED STOCK

1. Passing a preferred dividend cannot force a firm into bankruptcy, whereas failure to pay interest on a
bond can lead to bankruptcy.

2. By issuing preferred stock, the firm avoids the dilution of common equity that occurs when common
stock is sold.

3. Since preferred stock sometimes has no maturity and since preferred sinking fund payments, if
present, are typically spread over a long period, preferred issues can reduce the cash flow drain from
repayment of principal that occurs with debt issues.

DISADVANTAGES OF PREFERRED STOCK

1. Preferred stock dividends are not deductible to the issuer; consequently, the after-tax cost of
preferred is typically higher than the after-tax cost of debt.

2. Although preferred dividends can be passed, investors expect them to be paid and firms intend to pay
the dividends if conditions permit. Thus, preferred dividends are considered a fixed cost. Therefore,
their use, like that of debt, increases the firm's financial risk and thus its cost of common equity.

COMMON STOCK VS. PREFERRED STOCK

CHARACTERISTIC COMMON STOCK PREFFERED STOCK

Ownership Yes No
Voting rights Yes No
Board representation Represented and in control Sometimes represented but
seldom in control
Company liquidation rights Paid back investment after Paid back invetsment after
debtors and Preferred Stock debtors but before Common
Holders Stock Holders
Return on capital (dividends) NOT guaranteed and paid Guaranteed by a coupon rate
only when company has that is similar to a bond
excess profits. Never paid interest payment. Paid before
before Preffered dividends. any distributions to Common
Stock Holders.
Sale of company Shares in return on sale Usually convertible to
common stock upon this type
of event and share in return
on sale.