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Table of Contents
1 FMV Overview..................................................................................................................... 1 2 Financial Forecasting........................................................................................................1
2.1 Projected IS & BS (Long Term)........................................................................................... 1 2.2 Cash flow forecasting (Short Term).....................................................................................1
4 Dividend Policy.................................................................................................................. 6
4.1 Factors in determining dividend policy.................................................................................6 4.2 Modigliani- Miller approach.................................................................................................. 6 4.3 Alternatives to cash dividends............................................................................................. 7
4.3.1 Share dividends................................................................................................................... 7 4.3.2 Share repurchase................................................................................................................ 7
Date: 03/12/2006
1 FMV Overview
3 key decisions: Investment decision (higher NPV more value of firm) Financing decision (capital structure decision) o MM approach: doesnt matter how firm financed assets side of BS determines value of company not financing (liab + equity) Dividend decision Tips: Look at questions before reading case
2 Financial Forecasting
Purpose of financial plan is to ensure sufficient funds (cash) available for mgmt to achieve objectives.
o Bring both to same time span (i.e. Proj1 = 2 yrs, Proj2 = 3 yrs, NPV over 6 years) or o Bring both to 1 year (equivalent annual annuity) NPV = C1 + + Cn - Coutflow 1 n (1 + K) (1 + K)
Where: Cn = free cash flow at end of year n K = required rate of return If same amount (C) every year (perpetuity) can use limit: PV = C/K
Advantages: o Managers get better understanding of risk o Identify most sensitive variables Disadvantages: o Judgement required o Static analysis (variables are usually interlinked)
3.2.3 Simulations
Step1: identify the key variables and their interrelations Step 2: specify the possible values for each variable Step 3: carry out repeated trials to get prob. Distribution for project cash flows Advantages: o Managers are forced to build a model o Distribution of project outcomes Disadvantages: o Costly and time consuming o More complex (modelling relationships)
Get NPV and subtract initial investment to get ENPV Disadvantages: o Not good indicator of risk
Figure 5.10 Probability distribution of two projects with the same expected value
The figure shows the probability distribution for two projects which have the same expected value. We can see, the distribution for each project around the expected value is quite different. Project A has a much tighter distribution than Project B. This means that Project A has less 'downside' risk but also has less 'upside' potential.
4 Dividend Policy
Objective of financial mgmt is to max. shareholder weather (i.e. share price) empire building mgmt engage in activities rather that whats best for the company (SH value maximization) o Retained earnings are sometimes used for empire building (dont have to convince SH to raise capital) Dividend cover = (Profit after tax) / (Dividend) OR (EPS) / (DPS) o High DC indicates profits would have to drop a lot before you lost your dividend o DC < 1 means earnings cannot cover dividend o Inverse is dividend payout ration proportion of profits paid out as dividends Dividend per share and Dividend payout ratio measures of dividend patterns Pick a dividend policy and stick with it (predictable, no surprises, no unwanted signals) Dividend increases should keep with inflation
o In theory, whether a company pays a dividend or not the SH wealth does not change o If the company didnt issue a dividend but he wanted to receive one he could sell a portion of shares. Change the # of shares of SH but not SH wealth o If the company issued a dividend and issued more shares to compensate, the SH wealth would not change Assumptions: o No share issue costs o No transaction costs for: Selling proportion of shares Selling shares in unlisted companies (dont have to worry about finding buying or discounting price) o No tax