CFA_Level 1_04_Corporate Issures_2023

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Corporate Issures

01 Corporate Structures and Ownership

Classification ofbusiness structures

common forms

Sole proprietorship

General partnership

Limited partnership

Limited companies

Comparison

Types

For-Profits

Nonprofits

no shareholders

not distribute dividends

do not pay taxes

compare

same

board of directors

paid employees

difference

non-profit

no shareholders

no dividends

not pay taxes

profiit must be reinvested

Public and Private Corporations

Differences

Exchange listing and share ownership transfer

Registration and disclosure requirements

Share issuance

Private to public

Initial public offering (IPO)

Direct listing (DL)

Acquisition SPAC

Public to private

Leveraged buyout (LBO)

Management buyout (MBO)

Trends in public and private companies

emerging economies: public is rising

developed market: public is declining

mergers and acquisitions

LBOs and MBOs

choose remain private

Lenders and Owners

Differences

Risk-return

Investor perspective

Issuer perspective

02 Corporate Governance and ESG

Corporate Governance

Concepts

Shareholder theory

Stakeholder theory

Interest Conflicts

Principal-agent

Shareholder vs. Management/Board

risk tolerance

Board vs.Management

Controlling shareholder vs. Minority shareholder

Shareholder vs. Creditor

Stakeholder Management

Shareholder mechanisms

Shareholder meetings

Reporting and transparency

Shareholder activism

Shareholder derivative lawsuits

Corporate takeovers

Creditor mechanisms

Board of director and management mechanisms

Board committees

audit commitee

governance committee

director excluded from voting on relate-party transaction

Remuneration plans

nomination committee

risk committee

investment committe

Government mechanisms

common law better than civil law

Impact to corporate

Poor corporate governance

Effective corporate governance

ESG

Concepts

Environmental

stranded assets, toxic emissions & waste

Social

data privacy

Governance

ownership structure

Approach

value-based

incorporate, traditional

values-based

moral or faith-based belief

Investing

Responsible investing

broadest (umbrella) term

sustainable investing

socially responsible investing (SRI)

Methodology

Negative screening

Positive screening

ESG integration

Thematic investing

Engagement/active ownership

Impact investing

03 Business Models & Risks

Business model

Features

Value proposition

who

customer, market

what

firm offering

where

channel

how much

pricing

Value chain

calue chain

within a firm

single firm

supply chain

both within and external a firm

all steps

Profitability and unit economics

operating margin

operating income / revenue

unit cost

(total fixed costs + total variable costs) / produced units

unit economics

unit revenue - unit cost

contribution margin

selling price per unit - variable cost per unit

break-even point

fixed cost / contribution margin

Types

Business model variations

complex, specialized

E-Commerce business models

Network Effects and Platform business models

increase in value, more users join

Crowd sourcing business models

Hybrid business models

Financial implication

External factors

marcoeconomic variables, i.e. GDP growth

Firm-specific factors

wide moat: strong barriers to competition, low business & financial risk

Risks

Marco risk

political, economic, legal

Business risk

operating result different from expectation

Industry risks

Company-specific risks

Financial risk

Financial leverage

Total leverage

04 Capital Investments

Concept

Project Types

Business maintenance

Going concern projects

Regulatory projects

Business Growth

Expansion projects

Other projects

Definition & Steps

Capital allocation process

to make capital investment decisions

4 steps

Step 1: Generating ideas

Step 2: Investment analysis

Step 3: Capital allocation planning

Step 4: Monitoring and post-audit

Basic Principles

After tax incremental cash flows

3 includes

Opportunity costs

Externalities

Synergy (positive effect)

Cannibalization (negative effect)

2 excludes

Sunk costs

Financing costs

interest

Cash flow pattern

conventional

nonconventional

Investment Decision Criteria

Single project estimation

NPV

Formula

based on opportunity COC

Criteria

Pros & Cons

IRR

Mutually Exclusive Investment Decision

NPV & IRR conflict

Reason

Decision (NPV)

Project interaction

Independent

Mutually exclusive

Sequencing

Capital allocation methods

ROIC

Common capital allocation pitfalls

Real Options

Types of real options

Evaluate approaches

05 Working Capital & Liquidity

Financing options

Internal

Operating cash flow

usable captial

= after-tax operating cash flows - interest - dividend

= net income + depreciation - dividend

working capital

accounts payable

1/10, net 40: 1% discount if paid within 10 days; or full amount by 40 days

accounts receivable

inventory

liquid assets

External

Financial intermediaries

Capital markets

Working capital management

Conservative

Aggressive

Moderate

Liquidity & short-term funding

Source

Primary source

Secondary source

Liquidity Issues

Drags on liquidity

Pulls on liquidity

Measurement

Liquidity Ratio

Current ratio

current assets / current liabilities

Quick ration

(cash + short-term marketable securities + receivables ) / current liabilities

Cash ratio

(cash + short-term marketable securities ) / current liabilities

activity ratios

receivable turnover

credit sales / average receivables

No, of days receivable

365 / receivable turnover

inventory turnover

cost of goods sold / average inventory

No. of days inventory

365 / inventory turnover

Payables turnover

purchase / average trrade payable

purchase = inventory1 - inventory0 + COGS

No, of days payable

365 / payables turnover ratio

cash conversion cycle

days of inventory + days of receivable - days of payable

Turnover/Turnover Days

Receivables/lnventory/Payables

Cycle

Operating cycle = Inventory Turnover Days + Accounts Receivable Turnover Days

Cash conversion cvcle = Operating cycle - Accounts Payable Turnover Days

Evaluating short-term financing choices

Financing objectives

Other relevant factors

06 Cost of Capital-Foundational Topics

WACC

Calculate

Cost of the various sources of capital

Cost of debt

YTM approach

hold until maturity

Debt-rating approach

comparably rated of similar maturities

matrix pricing

Cost of preferred stock

Cost of equity

CAPM

DDM

Bond yield plus risk premium

lssues in cost of capital

Public company beta

Adjusted beta = 2/3 (unadjusted beta) + 1/3

Nonpublic company beta

step 1: deleverage, asset beta

step 2: leverage, equity beta

Flotation Cost

07 Capital Structure

Modigliani-Miller propositions

Assumption

Modigliani and Miller theory

Without tax

MM I

capital structure not affect MV

investment and capital structure decisions are independent

WACC not affected by capital structure

MM II

Higher financial leverage raise cost of equity

With tax

MM I

MM II

As debt increase, WACC decreasees and CV increases

static trade-off theory

Optimal capital structure

CV is maximized, WACC is minimized

value-enhancing effects from tax deductibility of interest

value-reducing impact of costs of financial distress

Factors affecting capitalstructure decision

Internal factors

Business model characteristics

existing leverage

corporate tax rate

capital structure policies / guidelines

third-party debt ratings

External factors

market conditions / business cycle

regulatory constraints

industry /peer firm leverage

Company life cylce

Costs of financial distress

Static trade-off theory

Information asymmetry

Pecking order theory

internal funds -> debt -> public equity offerings

Agency costs

MJ's free cash flow hypothesis

determine weights in WACC

target capital structure, or raise capital with this target, use this target

if target not known

market value

examine trends

averages of comparable companies' capital structures

08 Measures of Leverage

Risk

Business risk

Sales risk

Operating risk

variable cost

fixed cost

Financial risk

Leverage

Degree of financial leverage

Degree of operating leverage

Degree of total leverage

Breakeven point

Breakeven point

Operating breakeven point