INSTITUTE OF CERTIFIED PUBLIC ACCOUNTANTS OF RWANDA CPA A2.1 STRATEGIC CORPORATE FINANCE Study Manual 2nd edition February 2020, © ICPAR All copy right reserved All rights reserved. No part of this publication may be reproduced, stored in a retrieval system or transmitted in any form or by any means, electronic, mechanical, photocopying, recording or otherwise, without the prior written permission of ICPAR. Acknowledgement We wish to officially recognize all parties who contributed to revising and updating this Manual, Our thanks are extended to all tutors and lecturers from various training institutions who actively provided their input toward completion of this exercise and especially the Ministry of Finance and Economic Planning (MINECOFIN) through its PFM Basket Fund which supported financially the execution of this assignment INSTITUTE OF CERTIFIED PUBLIC ACCOUNTANTS OF RWANDA Advanced Level A2.1 STRATEGIC CORPORATE FINANCE 2nd Edition February 2020 This Manual has been fully revised and updated in accordance with the current syllabus/ curriculum. It has been developed in consultation with experienced tutors and lecturers. TABLE OF CONTENTS Unit Title Page Introduction to the course 5 1. Financial environment 6 Introduction 7 Ageny theory 8 Nationalised industries/public sector 13 Corporate social responsibility (csr) 14 Conclusion 16 Impact of government on activities 16 Composition of shareholders 16 Corporate governance 16 Rationale for corporate governance 16 Best practice 17 Efficient markert hypothesis ( emh) 17 Types of efficiency 17 A. Allocative efficiency 17 B. Operational efficiency 18 C. Information efficiency 18 Forms of information efficiency 18 A. Weak form level of efficiency 18 B. Semi-strong form level of efficiency 18 C. Strong form level of efficiency 19 Implications of emh for financial decision makers 19 A. The timing of financial policy 19 B. Project evaluation based upon npv 19 C. Creative accounting 19 D. Mergers and takeovers 20 E. Validity of the current market price 20 2. Mergers and acquisitions 21 Introduction 22 2 A2.1 STRATEGIC CPA EXAMINATION CORPORATE FINANCE STUDY MANUAL Types of combinations 22 Arguments for mergers and acquisition ( reasons for mergers and acquisition) 22 Arguments against mergers and acquisition reasons behind failed Mergers and acquisition 23 Impact of acquisition 24 The overall merger & acquisition process 24 Phase 3 - investigate & value the target: 25 Phase 4 - acquire through negotiation: 25 Phase 5 - post merger integration: 26 Methods of financing mergers and takeovers ( purchase consideration) 26 Financial terms of exchange 27 Valuing the target firm 30 Due diligence 32 Management buyout ( mbo) 33 How to finance a management buyout 34 Funding the purchase 34 Funding operations 35 Management buy-in (mbi) 36 Post - acquisition issues 38 Ethical considerations 38 3. Corporate failure 39 Financial distress 40 Corporate failure 40 4. Sources of finance 46 Short -term sources of finance 47 Venture capital 57 Introduction 57 Case study 59 Financial & operational gearing 66 Financial gearing 66 Illustration 66 5. Financial risk management 73 Introduction 74 CPA EXAMINATION A2.1 STRATEGIC 3 STUDY MANUAL CORPORATE FINANCE The internal technique 86 Risk management - main techniques/instruments 89 Financial futures 96 6. Portfolio theory 99 Introduction 100 Arbitrage pricing theory ( apt) 106 7. Financial analysis and business planning 111 Business plans 112 Introduction 112 Contents of business plan 112 8. International managerial finance 154 Introduction 155 9. Sundry definitions 170 Introduction 171 Sundry definitions 171 4 A2.1 STRATEGIC CPA EXAMINATION CORPORATE FINANCE STUDY MANUAL INTRODUCTION TO THE COURSE Stage: Advanced Level 2 Subject Title: A2.1 Strategic Corporate Finance Aim The aim of this subject is to enable students to understand the key responsibilities and financing decisions facing today’s strategic financial manager. Students should be able to develop detailed business plans, to assess the potential financial risks and to advise on suitable risk management strategies for entrepreneurial activities and established organisations. Strategic Corporate Finance as an Integral Part of the Syllabus Strategic Corporate Finance develops the financial management skills acquired by students in Managerial Finance Intermediate and other disciplines acquired in the earlier examination stages. Strategic Corporate Finance requires students to integrate and expand that knowledge so as to provide a framework for strategic financial management analysis and decisions. Learning Outcomes On successful completion of this subject students should be able to: • Evaluate the financial objectives of an organisation, explain how they are determined and interrelate with the non-financial objectives and stakeholder interests. • Discuss the legal regulations, the professional and ethical considerations facing financial managers. • Value shares / businesses in the context of a proposed merger, acquisition or management buyout. • Analyse reasons for and advise on actions to prevent corporate failure. • Evaluate and advise as to the optimum capital gearing structure, term structure and dividend policy for an organisation. • Advise as to appropriate exchange risk and interest rate risk management strategies and • discuss the use of derivatives in long term risk management. • Discuss the relevance of portfolio theory and the Capital Asset Pricing Model to financial managers. • Prepare a business plan for an organisation given prescribed information. • Evaluate the financial management of an organisation over a period of time and/or relative to competitors / industry norms. CPA EXAMINATION A2.1 STRATEGIC 5 STUDY MANUAL CORPORATE FINANCE Study Unit 1 FINANCIAL ENVIRONMENT Contents • Determining financial objectives within the strategic planning process. • Identify key stakeholders of organizations and the interests of each stakeholder group. • Corporate Social Responsibility, its relationship to the objective of organisation • Maximising shareholder wealth. • Agency theory and its relevance to financial managers. • The professional, regulatory and legal framework relevant to financial requirements, money laundering, directors’ responsibilities. • Monetary regulation and its effect on Capital Markets. • The key activities undertaken by treasury managers. • Centralized treasury management and the arguments for and against. • The efficient market hypothesis 6 A2.1 STRATEGIC CPA EXAMINATION CORPORATE FINANCE STUDY MANUAL INTRODUCTION Corporate finance is the field of finance dealing with financial decisions that business enterprises make and the tools and analysis used to make these decisions. The primary goal of corporate finance is to maximize corporate value while managing the firm's financial risks a. Corporate Finance and the Finance Manager ie what do you as the financial manager what do? • Identify Long term investment ; identify investment opportunities with value for money • Decide on a financial mix (debt and equity) which maximizes value • Manage working capital , for the benefit of the organization • Other goals of a firm may exist like survive, maximize market share, maximize profits etc, all these are in line with maximizing shareholder interest b. Corporate Finance and the different business forms • Liability – Unlimited and Limited » Unlimited liability – Sole proprietorship & partnerships » Limited liability - incorporated bodies • Considerations on the business form include cost, continuity, control, liability & tax issues It is often assumed that the single objective of commercial entities is: To Maximise the Value of the Firm Or To Maximise the Wealth of the Shareholders In reality, firms have multiple, and often conflicting, objectives and will seek to optimise among those. The modern corporation is a complex entity which is responsible not only to shareholders but to all stakeholders. The main stakeholders are: 1. Shareholders 2. Loan Creditors – seek security, repayment of loan interest and principal. 3. Employees – seek fair wages, promotional opportunities, welfare & social facilities => improved motivation. 4. Management - job security; fair reward; job satisfaction. 5. Trade Creditors - payment within credit terms. 6. The Community - sponsorship; charities; install environmental measures. 7. The Government - payment of taxes, rates, provide employment. 8. Customers - provision of service/goods at fair price; quality; on time etc. The relative importance of the various groups may differ, possibly depending on company size and management style. Management will be concerned with the value of the firm as it satisfies one of the important stakeholders (shareholders). A low valuation may increase the possibility of an unwanted takeover bid. Also, finance must be adequately rewarded and its market value maintained, so that further finance is obtainable when required. CPA EXAMINATION A2.1 STRATEGIC 7 STUDY MANUAL CORPORATE FINANCE Non-financial objectives may conflict with financial objectives – e.g. provision of staff recreational facilities; modern, safe working environment etc. AGENCY THEORY The managers/directors act as agents for the shareholders (owners) in running the company. This separation of ownership from control may lead to certain problems if managers are not monitored or constrained - e.g. management working inefficiently; adopting risk averse policies such as ‘safe’ short-term investments and low gearing; empire building for power/status; rewarding