Corporate Financial Strategy Chapter 8 Growth companies Corporate Financial Strategy 4th edition Dr Ruth Bender

Corporate Financial Strategy Growth companies: contents  Learning objectives  Financial strategy for a growth business  Growth companies require a marketing focus  Growth equity carries different risks to start-up equity  Capital asset pricing model  Dividend growth model  Project risk and return  Foregone low-risk opportunities  Rights issue  Bonus issue 2

Corporate Financial Strategy Learning objectives 1.Explain how the life cycle model relates to a company in the growth stages of its life. 2.Critique the financial strategy adopted by a growth company, making a decision as to which aspects of the life cycle model are relevant to its circumstances, and why. 3.Appreciate some of the assumptions behind the Capital Asset Pricing Model, and their flaws. 4.Calculate the theoretical impact of rights issues, bonus issues and share splits, and understand their likely effect on corporate value. 3

Corporate Financial Strategy Financial strategy for a growth business 4 Business risk High Financial risk Low Source of funding Growth equity investors Dividend policy Nominal payout ratio Future growth prospects High Price/earnings multiple High Current profitability (eps) Low Share price Growing but volatile

Corporate Financial Strategy Growth companies require a marketing focus 5 £ 0 Time Focus on building market share in order to be a major player by the time it starts to mature

Corporate Financial Strategy Growth equity carries different risks to start-up equity 6 Perceived risk Required return Start-up equity, provided by venture capital Growth equity, often provided by IPO

Corporate Financial Strategy Capital asset pricing model 7

Corporate Financial Strategy Dividend growth model 8 Ke is the shareholders’ required return D 1 is the next dividend to be paid P is the current share price G is the future compound growth in dividends

Corporate Financial Strategy Project risk and return 9 Project risk Project expected return Company overall risk factor A B Project A should be accepted, as it generates more return than its cost of capital. Project B should be rejected, as it generates less return than its cost of capital

Corporate Financial Strategy Foregone low-risk opportunities 10 Project riskCompany overall risk factor Minimum return Foregone low-risk opportunities

Corporate Financial Strategy Rights issue  In a rights issue, existing shareholder have the right to subscribe for new shares in proportion to their existing holding  For example, a 1 for 4 issue at 45p means that for every 4 shares held, the shareholder has the right to buy one extra share at 45p  If the shareholder chooses not to take up the rights, they are sold by the company in the market, and the shareholder receives the net proceeds  The theoretical post-rights price can be calculated. The actual post- rights price will differ from this due to investors’ views on the information released at the time of the issue 11 Theoretical post-rights price Market capitalisation before the rights issue + Proceeds of rights issue ÷ Total number of shares in issue post-rights

Corporate Financial Strategy Bonus issue  In a bonus issue, retained profits are capitalised to give new shares to the shareholders, in proportion to their existing holdings  The par value of the shares remains the same  No new cash is received by the company  The theoretical price after the bonus issue can be calculated. The actual price will differ from this due to investors’ views on the information released at the time of the issue 12 Theoretical price after the bonus issue Market capitalisation before the issue ÷ Total number of shares in issue after the bonus issue