Revise Lecture 25

Just in time - JIT Advantages of JIT Management seek to eliminate waste at all stages of the manufacturing Stronger relationship between buyer and supplier. (Security to supplier who benefits from regular orders, continuing future business.) Buyer – lower holding costs, lower investment in stock & WIP, bulk discount

Just in time - JIT Advantages of JIT Emphasis on quality control in production reduces scrap, reworking and setup cost

4 key areas of AR (Debtors) 4 key areas of accounts receivable management are; Formulation of policy Assessment of creditworthiness Credit control Collection of amount due

4 key areas of AR (Debtors) Formulation of policy A framework needs to be established Terms of trade Period of credit offered Early settlement discounts Must consider whether to charge interest on over-due accounts

Factoring Factoring is the outsourcing of the credit control department to a third party Factoring is the way of speeding up the receipt of funds from accounts receivable

Factoring The company can choose some or all of the following three services offered by the factor; Debt collection and administration (recourse or non-recourse) Financing Credit Insurance

Factoring Non-recourse The client loses control over decisions about granting credit to its customers. Therefore some client prefer to retain the risk of irrecoverable debt and opt for a ‘with recourse’ factoring service. With this type of service the client decides whether extreme action (legal action) should be taken against a non payer.

Business Valuations Why we do valuations of company?

Business Valuations Valuation is described as ‘an art not a science’. The real worth of a company depends on the viewpoints of the various parties. Various methods of valuation will often give widely different results 10/31

Business Valuations Valuations of shares in both public & private companies are needed for several purposes by investors included; To establish terms of takeovers and mergers etc. To be able to make ‘buy and hold’ decisions in general.

Business Valuations To value companies entering the stock market To establish values of shares held by retiring directors, which the articles of a company specify must be sold For fiscal purpose (capital gain tax CGT) inheritance Divorce settlement

Business Valuations In making a bid for another company, it is important for the buyer to create a range of values within which a buyer would be prepared to negotiate. When deciding to float or sell the company again the seller must create a range of values within which to negotiate

Business Valuations Different methods Book value Assets basis Dividend basis Earnings basis Discounted cash flow basis

Business Valuations Book Value Also called balance sheet value but the book value of assets will differ from their market value

Business Valuations Assets basis If a business is difficult to sell, its owners may be prepared to accept a minimum bid that matched the value that they get from liquidation. There are 2 ways of assessing this Balance sheet value Realisable value

Business Valuations Realisable value – better but harder to calculate. Net realisable value (NRV) term used to define method of evaluating an assets worth. NRV is generally equal to the selling price of the stock goods less the selling costs (competition and disposal)

Business Valuations Weakness Asset based valuation Investors do not normally buy a company for its balance sheet assets but for the earnings / cash flows that all of its assets can produce in the future. We should value what is being purchased i.e. the future income / cash flows

Business Valuations Weakness Asset based valuation The asset approach also ignores non-balance sheet intangible assets e.g. Highly-skilled workforce Strong management team Competitive positioning of the company’s products

Business Valuations It is quite common that the non-balance sheet assets are more valuable than the balance sheet assets 20/31

Business Valuations Usefulness of Asset based valuation When asset based valuation are useful? For asset stripping (minimum acceptable to owners) To identify a minimum price in a takeover To value property investment companies

Business Valuations Dividend basis The value of a share is calculated as the present value of the future dividends being generated by the existing management team.

Business Valuations Value of a company P0 =

Business Valuations Problems or weaknesses It uses a set figure for G which assumes that dividends growth smoothly. In reality, dividend change according to the decisions made by managers who do not necessarily repeat historical trends. Therefore very difficult to accurately predict the future dividend growth rate.

Business Valuations Business risk (Weakness) Dividend growth model does not explicitly consider risk, particularly business risk. The company may change its area of business operations and economic environment is notoriously uncertain. Therefore share price will however fall as risk increases, leading to an increased cost of capital 25/31

Business Valuations Model also ignores the effects of taxation and assumes there is no issue costs for new shares

Business Valuations Capital Assets pricing Model – CAPM CAPM = Required return = Rf (Rm – Rf) beta Rf = risk-free rate Rm = average return on the market (Rm- Rf) = average market risk premium Beta = systematic risk of the investment compared to market and therefore amount of the premium needed 27/31

Business Valuations Capital Assets pricing Model – CAPM This model assumes that investors have a broad range of investments and are worried how fall in the stock market as a whole would affect their investments. Main advantage CAPM over the DVM is that it does explicity consider risk. Particularly systematic risk of individual investments. 28/31

Business Valuations Disadvantage of CAPM Formula does require estimates to be made of Excess return , The risk-free rate and Beta values. All of these can be difficult to estimates, but are more reliable than dividend growth used in dividend valuation model (DVM) 29/31

Business Valuations Earnings Basis Income-based methods of valuation are of particular use when valuing a majority shareholding; Ownership bestows additional benefits of control not reflected in the DVM model Majority shareholders can influence dividend policy and therefore are more interested in earnings. 30

Business Valuations Market value = P / E * Earnings P / E = shows the market’s view of the growth prospects / risk of a company Earnings = shows the current profitability of the company