Risk exposure

Political risk: Political action will affect the position and value of a company, governement may restrict the multinationals freedom by various political measure:

Measure: Negotiate with the host government, isurance, management structure, Production strategies and financing strategies.

Culture risk: affect the products and services produced and they way organisations are managed and staffed, i.e, different ways of doing business, media and distribution system,firm use its own natinal culture as a selling point etc.

Litigation risk: Anti-monopoly, internationa patenets, trademarks copyrights, promotion messages, methods, export and import controls

Economic risk: arises from change in economic policy in the host courntry that affact the macro-ecomonic environment in which the multinational company operated.

Stakeholders system(European)

This system relies on codified civil law designed to protect a broader group of stakeholders.

Other stakeholder effect: employees, credit rating agency, society, governemnt, mimority interest etc

External method-Over the couter (OCT)

Forward rate agreement (FRA); Lock the interest rate

Over the counter options

OCT collar

Swap

PPPT--claims that the rate of exchange between two currencies depends on the relative inflation rates within the respective countries.

The country with the higher inflatin will be subject to a depreciation of its currency.

If needing to estimate the expected future spot rates, the formula: Current sport rate*(1+inflation1)/(1+inflations2

IRPT--The interest rate parity theory claims that the difference between the spot and the forward exchange rates is equal to the differential betweene interest rates available in the two currencies.

Current spot rate*(1+interest 1st)/((1+interest 2nd)

Major Topics: Investment appraisal, Merger and acquisitioin,reconstrution and reorganization and risk management

Others: performance evaluation, corporate bonds and dividend policy

APV- When a new projects financial risk changing, it is possible to use adjusted WACC method to appraise a project acceptability. However, by using APV method, one can see clearly the effect of debt finance on NPV. Doestic APV proforma. 2steps:

a. Evaluate the project as if it was all equity finance, find out the Base case NPV

b. Make adjustments to allow for the effects of the method of financing that has been used

Financing cash flow effect=(-Issue cost+Tax shield on (normal loan +Subsidy loan)+post tax interest saving by subsidy loan)*DR@Kd

APV=Base case NPV+Financing cash flow effec

Ad:

APV may be prefereable to NPV is becuase by seperating different types of cash flows, the compnay managers will be able to see which part of the project generate what proportion of hte project's value

Allocating a specific discount rate to cash flow part helps determine the value added or destroyed

Investment related cash flows could be further distingushed by their constitent risk factors

Dis; Not take into account of" cost of financial distress, Possibly of tax exhaustion, and Anecy costs related to financing using debt"

Option- gives the holder the right (not obligation) to buy or sell an asset at a pre-greed price (exercise price)

Call option( buy), Put option(sell)

Value of an option=intrinsic value+time value

Intrisic value is the value of the option if it was exercised now. Time value: the difference between the market price of an option and its intrinsic value.

Real option--alternative or choices that may be available with a business investment opportunity. They usually relate to tangible assets. it prepresents either a form of insurance or a means to take advantage of a favourable situation.

Delay,expansion, redeplay option and abandon/withdraw option

Limitation of BSOP: 

it is for financial products and not physical products, on which real option applies

within perfect markets it assumes that a market exists to trade the underlying project or asset without restrictions

It assues a European syle iotin, which must be exercised on the expiry date

Risk management: Hedging ,Diversification, risk control, risk mitigation

benefit of CIMS:

ensure project meets its expected sales and cost, abvoid time delay, ebchmarking, can be used as communication toll, justify and authorise assumptions if external environment change.

financial analysis: Risk adjusted discount rate, sensitivity analysis, probability analysis(expected values), discounted payback, duration and VaR

Duration-it is a measure of the average time over which a project delivers its value. The lower hte project durationm the lower the risk of the project 

VaR- is the amount at risk to be lost from an invesetment under normal conditions over a given period at a particular confidence level. It is the potential loss of a project with a given probability.It can be calculated over more than one period by using standard deviation for the entire period.

Shoft capital rationing(internal)- issure more shares as it wil dilute control. Issure more share will dilute EPS. Issue debt finance will increase financial risk(i.e geraing and interest cover). Internal competition environment to find best projects. Control growth, pursue of organic growth.

Single period of capital rationing: divisible project --suing PI to rank projects. PI=PV of project / investment

Multi-period of capital rationing, using linear programming model

Step1: Define hte unknowns, step 2: formulate the objective ufnction, Step3: express the constraints in terms of inequalities including the non-begatives. Ste4: Interpret the results

Types of merger: Horizontal, Vertical, conglomerate

Ad: Speed, Lower cost, Acquisition of intangible asset, Quick access to the oversea market,Eliminate competition and over supply, Secure supply chain and diversify risk and synergies created

Dis: Exposure to business risk, exposure to disclosure risk, Acquisition premium high, managerial competence, Integration problem, possible refereal to the competition commission

Reverse takeover- a small listed company takes over a larger unquoted company by a share for share exchange. The larger company will then be the dominant partner in a listed company

The mandatory-bid rule, the principle of equal treatment, the squeeze-out rights,

Defense stategies for hostile takeover

Rejection of initial offer: it will send a signal to the predator that the target company will contest the takeover. In some case, it may scare the predator off.

poison pill: make hte company less attractive by giveing existing shareholders to buy shares at very low price

White knights, By inviting a firm to rescue the target firm from the unwanted bidder. The white knights would act a friendly counter-bidder

crown jewels, By seeling the mst valuable asset makes the ocmpany less attractive, to protect it from taken over by others

golden parachute, share buy-back , pacman defence, litigation or regulatory defence

FCFF done not less interest and discounted by WACC adn less market value of debt. FCFE less interest and discounted by Ke

Behavious finance -studies how phychological factors affect financial decision makeing. Some behaviour factors may help to explain the overvaluation problem it takeover.

over confidence: lead to the board over estimate their ability to turearound a firm and to produce a higher return than its previus management.

Confirmation bias: managers may pay more attention to the evedence that supports the potential logic of acquisition and ingnore those contradit to it.

Loss aversion bias: if there are manay companies bid for hte target, it is likely that hte price iwll be pushed higher, some manager may not iwlling to loss hte potential target, and pay a higher price.

Entrapment: If a manager believes that taking over another company will be crucial to helpin to turn around a higher price to ge thte rarget.

Anchoring: decision making may be affected by information available but not necessarily relevant 

Security taken offering(STO)- a new way to raise capital for an organization. Investors will receive a new type of coin or toten instead of shares. Payment is made in a cryptocurrency such as bitcoin or ehter 

AD：

Speed and ease of use as a source of finance, investor often based on a speculative expectatin of rapid and high return

Dis: Valuation risk, risk of moeny laundering, risk of regulation(some countries are banned)

Internal methods-Smoothing, matching, A& L management (netting)

External methods:

OTC tools (Tailor made): Forward rate agreement (FRA), Over the counter options, OCT collar, Swap

Exchange traded centre tools (standard): Interst rate futures, Options on interest rate futures, Exchange traded collar

 A2-5 FRA = in 2 months' time and ends in 5 months'time

Futures are traded on margin:

Initial margin: When bought or sold, the buyer or seller is required to deposit a sum of money with the exchange to avoic default risk

Mared to market: when INT change, the profit or loss on daily basis rather than the contract matures shall be calculated

Maintenance margin

Variation margin: Loss incurred/ profiti ncurred

External interest rate options-Interest rate option

Otions on interest rate futures:

Report to Jo co's board on the acquiction of F co

This report assesses a renewed proposal to acquire F by estimating the additional value created and impact on both companies's shareholder weralthm incluing the effect on dividend income. The report considers the validity of the assumptions used in the additional value calculations and discusses the conserns which are likely to be raised by both compaines shareholders. The appendices to the report provide detailed calculations in estimating the additional value created as well as the impact on shareholder wealth.

Summary of esults

Based on a free cahs flow valuationm J equity vale after the acquisition is 2. the acquisition threfore creates additionla value of 10. THe % change in equity value of F co is above the required premium of 35% and should be acceptable. Howevem the future dividend income is likely to reduce and may thereofre cause shareholders to quesiton the value of hte offer.

The comparison of shareholder wealth is as follows

Shareholder                                 J                           F

Equity values(%/change)            0.2%                    32%

Dividend income(% change)        2%                     30%

Shareholder concerns

J proposal to acquire F was previously rejected on the grounds that it failed to creat value for J HS. Both companies Shs are likely to be concerned about the credibility of hte revised calculations since very little time has passed from when that last decision was made. The board will need to communnicate what has change betwen now and then to jsutify the sudden improvement to the shareholder wearlth estimate. In additionm J share of hte additional value is positive but only by a samll margin. J sharehodls are unlike ly tto approve an offer where the bulk of hte additional value goes to the target shareholders. It would have been useful to have access to any previous calculations and / or board reports leading up to that last assessment to identify any changes to the key inputs so these could be investigated further.

There is no guarantee that F shs will accept an offer based on the same terms as the previous cash offer, For example, THe acquisition premium may nee dto be increased, which would reudce the share of hte additional value accruing to J shareholders. The previous offer was to be paid in cash rather tha though a share-for share exchange. so J board will need to communicate the strtegic benefits behind the acquisition since they are now asking

F shs to invest in the future of hte combined company. F shareholders are likely to expect board representation past-acquisition and the company's current directors may themselves have concerns for their own future. It would be useful to obtain more information about the previous negotiations betweemn the two companies to gain some insight into F reaction if another offer is made.

In addition, F founder and majoiirty shs is unlike ly to appove the proposed terms since it will lead to a reduction in dividend income. In addition, there does not seem to be a clear strategic objective behind the decision to make another takeover offer and this may need to be communicated more effectivvely if both companies shs are to garnt approval

Assumptions

THe following factors need to be considered before the board decides to proceed with an offer for F. It is assumed the imputs provided for the calculations are credible estimates. For example, it is assumed that the equity values, issedshares, asset beta coefficients, credit spread, profit before interest and tax, growth rates, incremeatal capital investment, tax rate and synergist cash flows are estimated accurately. It is also assumed that imputs suce as the tax and growth rates, asset betag, bet/equity ratio, credit spread, operating margin, risk free ratet, market risk premium adn maximum dividend restriction remain constant. MInor changes to any of hte key variables may have a materials impact on the final results, Thereofore J should conduct a sensitivity analysis to gain an understanding of hte risks associated with the proposal and identify critical varialbles.

It is assumed that J is justified in basing its post-acquisition asset beta on a weighted average of both companies pre-acquisition asset betas and that the current equity values are hte approprate weights. THere si no information provided regarding the debt/equity ratio or how J intedns to achieve this. However, J is already experiencing liquidity issues so it also questionable whether the credit spread on J debt will be unaffected by the acquisiton, particularly when the comppanis already highly geared.

THe free cash flow valuation assumes cash flows will grow in perpetuity even though this is unlikely and will therefore overstate teh additional value. THe post-acquisition growth rates are highly dependent on the level of incremental capital investment, so this imput will need to be assessed to ensure it is sufficient. tThe information provided also assumes that the acquisition will take palce immediately even though in relality there are likely to be significant delays whilst both companies negotiate terms and approve the deal.

THere is no basis provided for hte finance director's PBIT forecast or the growth estimates, all of which willneed to be substantiated. the same applies to the syneregies even though these make a significatn contribution to the additional value. Whilst there may be scope for achieving synergies, the estmate provided is highly materails to the final outcome and will therefore need to be investigated

Synergies: an acquisition creats synergies benefit when the value of hte combined entity is  more than the sum of the two companies' values. 3 types (cost /revenue / financial

Cost synergies:

Economies of scale--Cost per unit decreasing as the fixed costs will spread over a large production volume. and large company will be able to nogotiate better terms with supplier. i.e. bulk purchase discount

Economic of scope--bring benefit of joint advertising and common distruction channel

Elimination of duplication--As R&D and head office cost reduced

Revenue synergies: it exists when the acquition of the target company will result in higher revenues for the acquiring company, higher return on equity or a longer period of growth:
Increased market power

Marketing synergies: cross selling opportunities

Strategis cynergies, innovative products to market quicker

Financial synergy:
Surplus cash--

Tax benefit- if has unused tax relief because of making losses

Debt capcacity--size increased, debt capacity increase

Diversification--lead to risk diversifacation. the cash flows will be less volatile as the cash flow will come from different industry or market.

P/E ratio methods

Share price =P/E*EPS,  Total equity value=P/E*PAT, Total equity value (combined)=P/E*(PATa+PATb+SAT)

Assessing a given offer

Financial aspect:

Gain of target company's shareholder

Offered price per share-share price worth

Forward rate agreement: Noney arket --rate @ t date

Forwad market (gain or loss)

--Locket date

--Mart rate

Effective interest rate

Effective interest cash slow

Foward market(Locked rate) receipt or payment

Locked at T date rate

Which currecy is expensive( or / exchange rate)

Foreig deal with bank(use higher or lower rate)

Performance evaluation: Financial perfornace(Profitability+shareholders investment ratio)+Risk measurement (liquidity+Business risk+ financial risk)

APV and NPV

APVs method separate out a project cash flow and allocate specific rate to each type of cash flow, depend on the risk attribute to that particular type of cash flow. 

NPVs method discounts all cash flows by the average discont rate attributable to the aveage risk of a project

AD:

APV may be preferable to NPV is because by serperating different types of cash flows , the company managers will be able to see which part of hte project generate what proportion of the project;s value

Furthermore, allocating a specific discount rate to cash flow part helps determine the value added or destroyed

For compex projectsm investment related cash flows cound be further dictinguished by their constituent risk factors, where applicable.

Dis

If does not take into account of hte folloing by using large amount of debt finance:
cost of financial distress

possible of tax exhaustion

Anecy costs related to financing using debt

Incorporate real option into NPV-rol

Treaditional NPV assume decision is made now or not at allm once made, cannot be changed, while real option,recognize that many investments have some flexibility.

For example, some investment decisions can be delayed and some ca be abandoned if circustance change. These flexibility have value and it is known as time value

Rlate to casse and discuss the specific option in the case. Use BSOP to calculate the value of flexibility

Finallym a full value can be calculated by incorporate real ition into traditional NPV.

Limitations of Black Scholes Model

It is develoed for financial products and not physical products, on which real option applies.

It assues that a market exists to trade the underlying project or asset without restrictions, within perfect markets.

It assumes a European style optionm which must be exercised on the expiry date

  real optionm which is more likely an american sylem as it can be exercised before expiry dtae, So, it may under-estmate the value of the option.

Volatility of hte underlying asset can be determined accurately and readily.

This probably reasonalbe for financial productsm as theres is likely to be sufficient historical data available.

But for largem one off projectsm there would be little or no historical data abaiable.

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