TERM LOAN AND WORKING CAPITAL. Seminar on Term Loan and Working Capital - December, 2010.

Transcription

1 TERM LOAN AND WORKING CAPITAL -STRATEGIES 1

2 INVESTMENT AND FINANCE POLICY 2

3 INVESTMENT POLICY Investment Policy selects an optimum portfolio of investment opportunities that maximize anticipated net cash inflows (ENPV) at minimum risk 3

4 FINANCE POLICY Financepolicy identifies potential fund sources (equity and debt, long or short) required to sustaininvestment, evaluates the risk adjusted returns expected by each and then selects the optimum mix that will minimisetheir overall weighted average cost of capital (WACC) 4

5 NORMATIVE OBJECTIVE The normative objectives of strategic financial management is the determination of a maximum inflow of cash profit and hence corporate value, subject to acceptable levels of riskassociated with investment opportunities, having acquired capital efficiently at minimum cost. 5

6 STRATEGIC FINANCIAL MANAGEMENT The Finance Decision (External) Capital Equity Debt Govt. Aid Acquisition of funds The Investment Decision (Internal) Disposition of funds Assets Fixed Current CAPITAL MARKET Objective Minimum Cost of Capital (WACC) Objective Maximum Cash Profit < (NPV) Corporate Objective MANAGEMENT POLICY Distributions Internal Maximum Economic Value Added (EVA) Retentions External Maximum Market Value Added (MVA) Capital Gains Corporate Wealth Maximization (Share price) 6

7 EVOLUTION OF FINANCE STRATEGY A Traditional Managerial Economic Systematic Behavioral Post Modern HISTORICAL PERSPECTIVE 7

8 POST-MODERNIST THEORY A FEW Non-Linear Theory POINTS TO PONDER Wealth Maximization delinked from Trading Fundamentals Crowd Behavior Market Sentiment Speculative Bubbles, Market Incoherence Catastrophe Theory 8

9 TERM LOAN AND WORKING CAPITAL -STRUCTURES 9

10 CAPITAL BUDGETING 10

11 CAPITAL BUDGETING MODELS PAY BACK METHOD ACCOUNTING RATE OF RETURN INTERNAL RATE OF RETURN NET PRESENT VALUE 11

12 CAPITAL BUDGETING MODELS COMPARATIVE CHART Model Wealth Maximisation Objective Investment Criteria Payback Rarely Miminise Payback (Maximise Liquidity) Time ARR Rarely Maximise ARR Profitability percentage IRR Rarely Maximise IRR Profitablity percentage NPV Likely Maximise NPV Absolute profits 12

13 IRR V/S NPV (Capital Cost of both projects is 10%) Project Year 0 Year 1 Year 2 Year 3 Year 4 Year 5 IRR (%) NPV 1 (135) % (100) %

14 RISK ANALYSIS 14

15 RISK ANALYSIS Total Risk = BusinessRisk + FinancialRisk Business Risk relates to the variabilityof future cash flows arising from an investment s fundamentalcharacteristics, as well as changing economic conditions Financial Risk is associated with a project s funding and how the earnings distributedto investors determine the company s cost of capital 15

16 TREATMENT OF BUSINESS RISK Modifications to the cut-off rate for investment that adds a risk premium to the discount rate Point estimates such as best, worst or most likely net cash inflow: Minimax, Laplace and Probability criteria 16

17 STANDARD DEVIATION THE MEAN-VARIANCE ANALYSIS Mean-Variance Analysis converts multi-valued outcomes to quasi-risk forecasts Is based on the classical probability theory Cash flows are assumed to be random variables which conform to a normal distribution with a symmetrical bell shaped curve 17

18 STANDARD DEVIATION IS DETERMINED AS FOLLOWS Calculate the mean of the distribution (EMV) by multiplying each variable s value by its probability of concurrence and adding the products Subtract the EMV from each possible value and square the result Multiply each squared deviation around the mean by its probability to determine cetainity equivalents and add them together. The sum is the variance Calculate the square root of the variance. This is the Standard Deviation THE LOWER THE STANDARD DEVIATION THE LOWER THE RISK AND VICE VERSA 18

19 FINANCE RISK WEIGHTED AVERAGE COST OF CAPITAL VARIOUS SOURCES AND THEIR RELATED COSTS Source of Finance Share Issue: Equity Preference Loan Issues: Secured and Unsecured Convertible Deferred payment to creditors Sale of excess or idle assets Sale and lease back of property Unallocated Overheads Capital Cost EPS or Dividends plus growth Fixed Dividend Interest plus repayment premium Interest plus future EPS (assuming conversion price above market price) Opportunity cost, administrative costs, loss of goodwill Alternative yield Leasing cost plus capital appreciation Opportunity Cost 19

20 WEIGHTED AVERAGE COST OF CAPITAL 20

21 WEIGHTED AVERAGE COST OF CAPITAL K = K(e) (V(E) + V(D)) + K(d) (V(D)/V(E)+ V(D)) Where: K = WACC K(e) = Cost of Equity K(d) = Cost of Debt V(E) = Market Value of Equity V(D) = Market Value of Debt 21

22 ASSUMPTIONS OF WACC Discount Rate New Projects have the same Risk-Return profile as the company s existing equity Each project is marginalto the scale of existing operations The company will retain its existing capital structure, leaving financial risk unchanged (IF A COMPANY ALTERS ITS CAPITAL STRUCTURE, THE WEIGHTS APPLIED TO THE COMPONENT COSTS IN THE WACC CALCULATIONS WOULD ALSO CHANGE, LEADING TO A NEW DISCOUNT RATE) 22

23 WACC BOOK VALUE: EXAMPLE Ordinary Shares Retained Earnings Prefence Shares CAPITAL STRUCTURE WEIGHT COMPONENT COST (%) WEIGHTED COST (%) Debentures Totals

24 WACC MARKET VALUE: EXAMPLE Ordinary Shares Retained Earnings Preference Shares CAPITAL STRUCTURE WEIGHT COMPONENT COST (%) WEIGHTED COST (%) Debentures Totals

25 RELEVANCE OF BUSINESS MODELS IN BOOT B2G B2C DETERMINING STRUCTURE GESTATION PERIODS CROSS BORDER BUSINESS TAX SENSITIVE BUSINESS CYCLES 25

26 TERM LOANS 26

27 TERM LOANS -TYPES TERM LOANS DOMESTIC V/S FOREIGN DEFERRED PAYMENT FACILITIES FCCBs Non Convertible Debentures Vendor Bill Discounting Stand By Letters of Credit 27

28 TERM LOANS DOMESTIC V/S FOREIGN End Use Interest Costs Hedging Costs Regulatory Considerations Accounting Considerations 28

29 FCCBs Investors Appetite Equity Linkage Coupon Rates Automatic Route Reset Clauses SEC Reg

30 Non Convertible Debentures Secured Debt Long Term Tenure Interest Rates Listed, Tradable Good Secondary Market Attached Warrants 30

31 WORKING CAPITAL 31

32 WORKING CAPITAL IMPORTANCE AND LONG TERM IMPLICATIONS Need for Proper Estimations: Error in Estimations have long term negative implications Sufficient Margins to be provided: Total reliance on debt not desirable Standard Ratios should not be applied: Business Model will determine Ratios Inventory, Receivables and Payables Management have become key features of Working Capital Management 32

33 WORKING CAPITAL TRADITIONAL CASH CREDIT OVERDRAFT BILL DISCOUNTING SOURCES WORKING CAPITAL TERM LOAN FOREIGN CURRENCY DENOMINATED LIMITS 33

34 WORKING CAPITAL NON-TRADITIONAL COMMERCIAL PAPER SOURCES NON CONVERTIBLE DEBENTURES STAND BY LETTERS OF CREDIT DISCOUNTING FUTURE CASH FLOWS 34

35 THANK YOU FOR YOUR PATIENCE TILL DEBT DO US PART 35