CORPORATE FINANCE. A South African Perspective EDITEDBY GIDEON ELS

Transcription

1 CORPORATE FINANCE A South African Perspective EDITEDBY GIDEON ELS ELDA DU TOIT I PIERRE ERASMUS I LIEZEL KOTZE I SAM NGWENYA KEVIN THOMAS I SUZETTE VIVIERS OXFORD UNIVERSITY PRESS SOUTHERN AFRICA

2 Table of Contents Introduction to~cqr^5 a^e_fjnaincial management Introduction ~:~re:~:=..:::.:s..:.: What is corporate finance? The role of corporate financial management The financial manager Corporate financial-management decisions The goals of financial management Shareholders'wealth maximisation The corporate forms of business Sole proprietorship 'Partnership Companies Close corporation The agency problem Agency costs Managerial versus shareholder goals Managerial compensation Financial markets and institutions Financial markets Financial institutions Flow of funds Corporate governance and ethics Corporate governance Business ethics Conclusion '. 20 Part l: Measurement 27 2 Financial statements Introduction The objectives of financial statements : Who are the users of financial statements? Requirements for financial statements The standardisation of financial statements Statement of financial position Assets '. : Total equity Liabilities Statement of comprehensive income Statement of cash flows Cash flow from operating activities Cash flow from investing activities Cash flow from financing activities Conclusion 48

3 Ratio analysis Introduction Requirements for financial ratios Norms of comparison Types of ratios Profitability ratios Return on assets Return on equity Return on shareholders' equity Return on ordinary shareholders' equity :: Profit margins : Gross profit margin Operating profit margin Earnings before interest and tax margin Net profit margin Turnover ratios Total asset turnover ratio Property, plant and equipment turnover ratio Current asset turnover ratio Trade receivables turnover ratio Inventory turnover ratio Trade payables turnover ratio : Liquidity ratios Current ratio Quick ratio Cash ratio Trade receivables turnover time Inventory turnover time Trade payables turnover time Cash conversion cycle :' Solvency ratios Debt:assets ratio Debt:equity ratio Financial leverage ratio Finance cost coverage Fixed payments coverage ratio Preference dividend coverage ratio : Cash flow ratios : Cash flow to turnover ratio Cash return on assets ratio Cash return on shareholders' equity ratio Cash flow to operating profit ratio Finance and dividend cost coverage ratios Other cash coverage ratios Investment ratios Earnings per share ratio Dividend per share ratio Price-earnings ratio Dividend payout ratio 75

4 3.H.5 Ordinary dividend coverage ratio Market-to-book value ratio Financial gearing DuPont Analysis Conclusion 80 Part 2: Investment decisions 89 4 The time value of money. :': Introduction Interest rates Future value and compounding of lump sums Investing for a single period : Investing for more than one period Compounding interest more frequently than annually Semi-annual, quarterly and monthly compounding Continuous compounding Nominal and effective interest rates Present value and discounting More on present and future values Determining an interest rate Calculating the number of periods Valuing annuities Future value of an ordinary annuity Future value of an annuity due : Present value of an ordinary annuity Present value of an annuity due : Ordinary deferred annuities Mixed streams of cash flows : Retirement funding Perpetuities Amortising a loan ii Sinking funds Conclusion 127 Appendix Investment appraisal methods Introduction The importance of efficient investment appraisal -. : Types of investment projects Replacement projects Expansion projects Independent projects Mutually exclusive projects Complementary projects Substitute projects Conventional projects Unconventional projects : 145

5 5.3.9 Other types of projects : The average return method The payback period method The discounted payback period method The net present value method The internal rate of return method -. : Comparing the net present value and internal rate of return methods Net present value profile Discussion of the NPV profile Evaluating mutually exclusive projects by means of the IRR method Modified internal rate of return The profitability index Conclusion Estimating relevant cash flows Introduction The difference between profit and cash flow Estimating relevant cash flows Sunk costs : Opportunity costs Finance costs Inflation and tax : The components of project cash flows v Calculating the initial investment Initial investment for an expansion project, Initial investment for a replacement project Calculating the operating cash flows Operating cash flows of an expansion project Operating cash flows of a replacement project. : Calculating the terminal cash flow...:.:' : Capital gains tax : Conclusion Appraising investment risk Introduction What are uncertainty and risk and why do they need to be assessed? Uncertainty and risk : : Risk vs return Approaches to risk in investment appraisal Types of risk in investment projects Probability distributions and expected values Probability distribution : Expected value Using scenario analysis, sensitivity analysis and simulation analysis to assess risk Scenario analysis, Sensitivity analysis Simulation analysis Break-even analysis as a measure of dealing with risk Accounting break-even analysis 212

6 7.6.2 Accounting break-even analysis and operating cash flow Cash break-even analysis Financial break-even analysis Conclusion 216 Bond valuation and interest rates Introduction : What is a bond? Characteristics of bonds How to value a bond ; The different types of bonds Government bonds Municipal bonds Corporate bonds Convertible bonds Junk bonds Zero-coupon bonds Extendable and retractable bonds Foreign-currency bonds Inflation-linked bonds Bond markets and bond ratings Bond markets and reporting Bond ratings What determines bond returns? Real interest rate and expected inflation rate Interest rate risk and time to maturity Default risk Lack of liquidity. : The influence of interest and inflation/rates on bonds The difference between nominal and'real interest rates The Fisher Effect Conclusion 244 Share valuation Introduction Ordinary shares and preference shares, The development of stock exchanges Defining value Par value Market value : Book value Economic/intrinsic value Share valuation Discounted cash flow techniques Relative valuation techniques Expected return and required return Market efficiency Conclusion 268

7 Part 3: Financing decisions Risk and return Introduction Assessing the return and risk characteristics of a single security Evaluating historic returns Evaluating expected returns Evaluating historic risk Evaluating expected risk : Coefficient of variation!" Summary-single security return and risk Assessing the return and risk characteristics of a portfolio Assessing expected portfolio returns Assessing expected portfolio risk Portfolio risk: A closer look Summary: Portfolio return and risk The security market line Conclusion Cost of capital 309 n.i Introduction 310 n.2 Pooling of funds 311 n.3 Cost of capital 312 n.3.1 Cost of ordinary shareholders' equity 313 n.3.2 Cost of preference shares 318 n.3.3 Cost of debt 319 n.4 Weighted average cost of capital 322 n.4.1 Calculating weighted average cost of capital 322 n.4.2 Assumptions of weighted average cost of capital 325 n.5 Using weighted average cost of capital in investment decisions 326 n.6 Marginal cost of capital 327 ii.7 Conclusion Capital structure Introduction The different types of equity finance External sources of equity finance Internal sources of equity finance - reserves and retained earnings The different types of non-current debt finance Bonds and debentures Mortgage bonds Other non-current loans Debt versus equity Medium-term finance Term loans Leases Finance leases Operating leases 343

8 Sale and leaseback The borrow and buy versus lease decision Discount rate Assessed losses Factoring Invoice discounting.'." H Other sources of medium-term finance Gearing Capital structure Optimal capital structure,: Modigliani and Miller's theory of gearing Traditional theory of gearing Conclusion 355 Part 4: Dividends Dividend policy Introduction Dividend policy issues Information content Clientele effect Homemade dividends Is it important to have a dividend policy? Dividend irrelevance Dividend relevance The level of dividend payout Deciding on the dividend level The residual distribution model Fixed dividend cover.<' Constant growth The dividend payment process Payout policy options Cash dividend Share dividend Share repurchase Stock splits and consolidations Conclusion 379 Part 5 : Working-capital management Working-capital management Introduction What is working capital? Current assets and current liabilities Net working capital Why is it important to manage working capital? Liquidity 394

9 The risks of liquid assets The cash conversion cycle The elements of the cash conversion cycle Calculating the cash conversion cycle Managing cash Cash budgeting Managing inventory The importance of inventory management Methods of managing inventory Managing accounts receivable (debtors) ṿ " The importance of accounts receivable management Establishing a credit policy 403 i4.8> Managing accounts payable (creditors) Conclusion : 406 Solutions : 415 Index 475