1. Structuring Corporate Financial Policy Diagnosis of Problems and Evaluation of Strategies

2. I. Goal:
To understand how to diagnosis of problems and evaluate strategies

3. 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

4. The Elements of Financial Policy
Every financial structure reveals underlying financial policies.
The following seven elements reveals underlying financial policy
1. Mix of Classes of Capital
Example- Debt & Equity / Common Stocks & Retained Earnings
Some firms exhibit a pecking order of Financing : Internal Cash Flows, Debt and finally Equity.

5. The Elements of Financial Policy, Cont.
2. Maturity Structure
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

6. The Elements of Financial Policy, Cont.
4. Currency
- Level of Exposure to Exchange Rate Risks
- Capital Sources
5. Exotica
- Financial Innovation
6. External Control
- Fear & Expectation

7. The Elements of Financial Policy, Cont.
7. Distribution
These elements become a basis for developing a broad, detailed picture of firm’s financial policies

8. C. Comparative Illustration
Financial Polices for Eli’ s and Genentech

9. 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.

10. II. Framework for Diagnosing Financial Policy Opportunities and Problems.
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

11. 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

12. 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

13. IV. Analyzing Financial Policy From a Competitive Perspective
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

14. IV. Analyzing Financial Policy From a Competitive Perspective
Financial flexibility: debt, coverage ratios, cost of capitals
Industrial Issues: R&D, Unfunded pension liabilities or medical benefit obligation…

15. V. Diagnosing Financial Policy From an Internal Perspective.
3 Major concerns:
Financial Flexibility
Sustainability of financial policy
Feasibility of strategic goals

16. 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)

17. 1) Financial Flexibility:
- 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.

18. 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.

19. 2) Self-sustainable Growth & Feasibility
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
This model provide no guarantee that a strategy will maximize value

20. VI. What is best?
The following framework is a way of identifying the tradeoffs among “good” and “bad”
Flexibility- ability to meet unforeseen financing requirement as they arise.
Predictable Risk in business
Income measures such as DCF value, projected ROE, EPS and cost of capital.
Control- percentage of share distributions of the company and debt structure
Timing- Is the current capital market environment is the right moment to implment any alternative financial structure.

21. VII Conclusion
Final decision for alternative structures remain for CFO and adviser.
Good Luck.