1. Chapter 1 Corporate financial strategy: setting the context
Corporate Financial Strategy 4th edition
Dr Ruth Bender
Chapter 1 Corporate financial strategy: setting the context

2. Setting the context: contents
Learning objectives
Risk and return
The two-stage investment process
What does ‘good’ look like?
NPV illustration (Working Insight 1.3)
Value is created ‘above the line’ (Figure 1.4)
Individuals have different risk appetites (Figure 1.5)
The seven drivers of value
Economic profit (Working Insight 1.5)
Total shareholder return (Working Insight 1.6)
The value matrix (Figure 1.6)
Stakeholders are important
Agency and double agency

3. Learning objectives
Understand what financial strategy is, and how it can add value.
Explain why shareholder value is created by investments with a positive net present value.
Appreciate how the relationship between perceived risk and required return governs companies and investors.
Differentiate the different models of measuring shareholder value.
Explain why share price is not necessarily a good proxy for company value.
Outline how agency theory is relevant to corporate finance.

4. Risk and return
Required
return
Perceived risk

5. The two-stage investment process
Shareholders
(and others)
invest in the company
Company invests in a portfolio of projects

6. What does ‘good’ look like?
Is it a good Product?
Is it a good Business?
Is it a good Company?
Is it a good Investment?
Is it a good Product?

7. Value is created above the line
Required
return
Increase return more than risk X
Reduce risk more than return
Perceived risk

8. Individuals have different risk appetites
Long-serving manager
Venture capital fund
Required
return
Well-diversified institutional investor
Perceived risk

9. The seven drivers of value
More profit
Increase sales growth
Increase operating profit margin
Reduce cash tax rate
Out of fewer assets
Reduce working capital as % of sales
Reduce fixed assets as % of sales
At lower risk
Reduce weighted average cost of capital
For as long as possible
Increase timescale of competitive advantage
Rappaport, Creating Shareholder Value, 1998

10. Economic profit Operating profit after tax £2,400
Capital employed £20,000
Cost of capital %
Operating profit after tax ,400
less cost of capital (20,000 x 10%) ,000
Economic profit
Return on capital employed (2,400/20000) %
Spread %
Economic profit (2% x 20,000)

11. Total Shareholder Return (TSR)
Share price at 1 January
Share price at 31 December 110
Capital gain in the year
Dividend paid in the year
Total return
Total shareholder return (TSR) %

12. Figure 1.5 The value matrix
> 1.0 A B
Value multiple
Market value ÷
Fair value
= 1.0 D C
< 1.0
Negative
Positive
Economic profit

13. Stakeholders are important
Shareholders
Investment institutions, family members, prospective investors
Community
Local community, environmental bodies, public at large
Debt holders
Banks, investment institutions, individuals
Business and Financial strategy
Suppliers
Long term suppliers, raw material suppliers, sub-contractors
Customers
Direct customers, end consumers, consumer groups
Managers
Board of directors, senior managers, other managers
Government and regulators
Tax authorities, trade department, employment department, governance regulators
Employees
Individuals, unions / staff associations, pensioners

14. Agency and double agency
Net assets
Fixed assets
Current assets less current liabilities
Non-operating assets
Debt
Fund managers
Individual shareholders and pensioners
Equity
Management
Employees