Case 32 structuring corporate financial policy diagnosis of problems and evaluation of strategies
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Case 32. Structuring Corporate Financial Policy Diagnosis of Problems and Evaluation of Strategies. I. Goal:. To understand how to diagnosis of problems and evaluate strategies. II. Steps. 1. Identifying corporate financial policy: Elements of its design

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Case 32 structuring corporate financial policy diagnosis of problems and evaluation of strategies

Case 32. Structuring Corporate Financial Policy Diagnosis of Problems and Evaluation of Strategies


I goal

I. Goal:

  • To understand how to diagnosis of problems and evaluate strategies


Ii steps

II. Steps

1. Identifying corporate financial policy: Elements of its design

A. Concept of Corporate Financial Policy

- Financial policy: a set of broad guideline or preferred style to guide the raising of capital and distribution of value


Case 32 structuring corporate financial policy diagnosis of problems and evaluation of strategies

B. 7 elements revealing underlying financial policy

1. Mix of Classes of Capital

Ex) Debt & Equity / Common Stocks & Retained Earnings

Ex) A Pecking order of Financing : Profit

-> Debt -> Equity

2. Maturity Structure


Case 32 structuring corporate financial policy diagnosis of problems and evaluation of strategies

- Firm’s judgment about future financing opportunities and taking risk

- Neutral: Maturity of Asset = Maturity of Liability

- Managers’ bet about refinancing and interest rate risks

3. Coupon and Dividend Payment

- Managers’ bets


Case 32 structuring corporate financial policy diagnosis of problems and evaluation of strategies

4. Currency

- Level of Exposure to Exchange Rate Risks

- Capital Sources

5. Exotica

- Financial Innovation

6. External Control

- Fear & Expectation


Case 32 structuring corporate financial policy diagnosis of problems and evaluation of strategies

7. Distribution

These elements become a basis for developing a broad, detailed picture of firm’s financial policies

C. Comparative Illustration

Eli’ s and Genentech’ s Example:


Case 32 structuring corporate financial policy diagnosis of problems and evaluation of strategies

II. Framework for Diagnosing Financial Policy Opportunities and Problems.

- It is based on the perspective of competitors, investors and senior corporate managers

1) Investor View: Does financial policy create value?

- Maximizing shareholder’s wealth

- Minimizing risks

2) Competitor View: Does the financial policy create competitive advantage?

- Competitors’ F/S is an indicator or benchmark.


Case 32 structuring corporate financial policy diagnosis of problems and evaluation of strategies

3) Internal View: Does the financial policy sustain the vision of senior management?

- Funds the growth goals and dividend payouts of the firm without severely diluting the firm’s current equity owners

Investor View: Value Creation +

Competitor View: Competitive Advantage +

Internal View: Survival

Financial Structure: Mix, Maturity, Basis, Currency, Exotica, External Control, Distribution


Case 32 structuring corporate financial policy diagnosis of problems and evaluation of strategies

III. Analyzing Financial Policy (FP) From the Investors’ Viewpoint

1) Is the FP Increasing the firm value?

  • Cost of Debt

  • Cost of Equity

  • Debt/Equity Mix: WACC

  • P/E, Market/Book Multiples: Compared to Benchmark

  • Bond Rating: Financial Ratio

  • Ownership: Individual, Institution, Blockholders

  • Short Position on the Stocks


Case 32 structuring corporate financial policy diagnosis of problems and evaluation of strategies

  • IV. Analyzing Financial Policy From a Competitive Perspective

    1) Why it matters?

  • Standard Practice in the Industry and Strategic Position

  • Strategic Competitive Instrument

    2) Steps:

  • Define the universe of competitors

  • “Spread” the data and financial ratios on the firm and its competitors in comparative fashion


Case 32 structuring corporate financial policy diagnosis of problems and evaluation of strategies

  • Identify similarities and difference.

  • Add more information such as foreign competitor, another ratios.

  • Discuss with CFO or Industry experts.

    3) Plausible quantitative measures

  • Size: sales, market value, # of employee

  • Asset Productivity: ROA

  • Shareholder wealth: P/E

  • Predictability: Beta, Historical trends

  • Growth: 1 to 10 year compound growth


Case 32 structuring corporate financial policy diagnosis of problems and evaluation of strategies

  • Financial flexibility: debt, coverage ratios, cost of capitals

  • Industrial Issues: R&D, Unfunded pension liabilities or medical benefit obligation…

    V. Diagnosing Financial Policy From an Internal Perspective.

  • 3 Major concerns:

  • Financial Flexibility

  • Sustainability of financial policy

  • Feasibility of strategic goals


Case 32 structuring corporate financial policy diagnosis of problems and evaluation of strategies

  • 1) Financial Flexibility:

  • Simply represented as the excess cash and unused debt capability.

  • All reserves that could be mobilized should be reflected

    Financial flexibility =

    excess cash + (debt at minimum rating – current debt outstanding)


Case 32 structuring corporate financial policy diagnosis of problems and evaluation of strategies

- How to measure the debt at minimum rating?

(1) Select a target minimum debt rating acceptable to the firm.

(2) Determine the book value debt/equity mix consistent with the minimum rating

(3) Determine the book value of debt consistent with (2).

Financial flexibility indicates the financial reserves on which the firm can call to exploit unusual surprising opportunities.


Case 32 structuring corporate financial policy diagnosis of problems and evaluation of strategies

  • 2) Self-sustainable Growth & Feasibility

  • Self sustain growth model:

  • Growth rate =ROE*(1 - dividend payout ratio)

  • An assumption: over the forecast period, the firm sells no new shares of stock. As long as the firm does not change its mix of debt and equity, the model implies that assets can grow only as fast as equity and dividend payout ratio.


Case 32 structuring corporate financial policy diagnosis of problems and evaluation of strategies

  • Test of feasibility of a plan:

    Compare the growth rate from the model to the targeted growth rate dictated by the plan.

  • Enriching the model, using DuPont Analysis or Financial Leverage Equation (FLE)

  • Ex)

  • DuPont: ROE=P/S*S/A*A/E

  • FLE: ROE=ROTC+((ROTC-Kd)*(D/E))

  • ROTC=return on capital, Kd; cost of debt


Case 32 structuring corporate financial policy diagnosis of problems and evaluation of strategies

  • This model provide no guarantee that a strategy will maximize value

    VI. What is best?

    A way of identifying the tradeoffs among “good” and “bads”

  • Flexibility

  • Predictable Risk

  • Income

  • Control

  • Timing


Case 32 structuring corporate financial policy diagnosis of problems and evaluation of strategies

  • Final decision for alternative structures remain for CFO and adviser.

  • Good Luck.


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