AFM Notes

Advanced Financial Management
Interest loan swaps (Risk management) and APV is important for this sitting
Investment Appraisal –
 To be mindful of the currency. Should be converted to country being invested in.

 Add back the carried forward tax loss, if any and tax allowable depreciation.
 Working capital only inflation amount (CY-PY) should be taken I respective years.
 Tax to be paid on additional income even though bilateral tax exists.
 Report compiled by: AN Accountant and Date: XX/XX/XXXX should be given. (format)
 Sunk cost should be ignored in NPV and BSOP model.
 BSOP (Real option) - Options to redeploy, sell, expand and cancel. (Technical terms -
delay/defer, switch/redeploy, expand/follow-on and abandon)
APV Steps – Only Tippletine and Amberle company are APV problems
 Calculate base NPV
 Calculate issue costs
 Calculate tax shield
 Subsidy benefit
 Tax benefit lost on subsidy (calculated same way as tax benefit)
 Add and deduct the costs and revenue to arrive at APV (Financing benefit)
A yield curve may be upward‐sloping because of –

 Future expectations
 Liquidity preference.
 Preferred habitat/market segmentation
Common assumptions – all the numbers are accurate. To perform sensitivity analysis. What happen
after given period of project life? Inflation and conversion is usually linear. WC is always recovered at
the end of project.
Factors to be considered before investing -

Political, cultural and ethical when investing in other country.
Real options – flexibility, need not start immediately and analyze risk and uncertainties. View risks and
uncertainties as opportunities, where upside outcomes can be exploited, and a company has the option
to disregard any downside impact. NPV captures only intrinsic value and but real option captures both
intrinsic and the time value.
Acquisitions and Mergers

 Types of synergy – finance, cost and revenue. Identifying undervalued companies, acquiring
companies which have strategic assets or product pipelines, Economies of scale.
 Free cash flow to firm (FCFF) = PBIT + non‐cash expenses – additional cash investment – tax FCFF
 Market value of company = Earnings * PE ratio (Using PE ratio method)
 Earnings per share * PE ratio = Market value per share
 While using constant growth formula, use discount factor even if question says foreseeable
future.
Steps –
 Calculate individual company value for both the acquirer and acquiree company (only equity
value of companies if required) using free to free cash flows or PE ratio
 Value of combined equity and value of synergy.
Acquisition ways and steps

Cash offer
 Calculate number of shares*cash paid for each share and calculate the gain % of each company.
Share for share offer
 Calculate number of shares offered by acquirer to acquiree by calculating synergy gain obtained
by each company and calculate the additional share value using the same. Finally, calculate the
gain %.
Mixed offer
 Cash and share price paid by acquirer to acquiree.
 Divide synergy between two companies as given in question and calculate the additional value
accordingly.
Take over regulations

 The principle of equal treatment - minority shareholders are offered the same level of benefits
 Squeeze-out rights - bidder to force minority shareholders to sell their stakes, at a fair price,
once. enable the acquirer to gain a 100% stake of the target company and prevent problems
arising from minority shareholders at a later date.
 The mandatory-bid condition through sell out rights - This allows remaining shareholders to exit
the company at a fair price once the bidder has accumulated a certain number of shares.
MBO and MBI - A management buy‐out (MBO) involves the purchase of a company by the management
running that company. management buy‐in (MBI) involves selling Co to a management team brought in
from outside the company.
Key concepts of behavioural finance

 Anchoring - e.g. investors are often attracted to buy shares whose price has fallen considerably
because they compare the current price to the previous high (but now irrelevant) price
 Gambler's fallacy - e.g. if the value of a share has risen for seven consecutive days, some
investors might sell the shares, believing that the share price is more likely to fall on the next
day.
 Herd behaviour - this is the tendency for individuals to mimic the actions (rational or irrational)
of a larger group
 Over-reaction and availability bias - For example, good news should raise a business' share price
accordingly. Reality, however, tends to contradict this theory.
 Confirmation bias - it can be difficult to encounter something or someone without having a
preconceived opinion.
 Formula
 Weighted average asset beta = Asset beta*acquirer (parent) market value of equity + Asset
beta*acquiree market value of equity / Total MV of parent and acquiree.
 To calculate combined company equity beta which will be used to calculate CAPM using these
details, calculate the Combined company cost of capital.
Reconstruction
 Alternative way of calculation cost of equity when Rf of risk premium details are not given is
using M and M formula and also for ungeared cost of equity = ke = kei + (1 – T) (kei – kd )(Vd /
Ve).
 Asset bets = Equity beta * Market Value of equity / Market Value of equity + Market Value of
debt (1-T)
 NOTE – Equity bets is always greater than asset beta
 IRR = L + NPVL / NPVL – NH × (H – L)
 Macualy Duration = first year PV*1 + second year PV*2 + third year PV*3 and so on divided by
total of present values before multiplication with number of years.
 Modified duration = Macualy Duration/1+gross redemption yield or cost of capital (discount rate
used to calculate NPV)
 Value at Risk(VaR) = return * root of number of years.
 Confidence level = Used when VaR is given
o 90% - 1.28
o 95% - 1.65
o 99% - 2.33
 The credit agency determines factors –
o Country,
o Industry,
o Management and
o Financial analysis (gearing and working capital management, relationship with its
bankers and its debt covenants, commitments to repay loans, reassurance about the
quality so audit report)
 When share price and earnings per share is no given, we use profit after tax*PE ratio to arrive at
value of the company.

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Advanced Financial Management

 To be mindful of the currency. Should be converted to country being invested in.

A yield curve may be upward‐sloping because of –

Factors to be considered before investing -

Acquisitions and Mergers

Acquisition ways and steps

Take over regulations

Key concepts of behavioural finance

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