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;

1. Formulation of policy2. Assessment of creditworthiness3. Credit control4. Collection of amount due

4 key areas of AR (Debtors)

Formulation of policyA framework needs to be establishedTerms 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;

1. Debt collection and administration (recourse or non-recourse)

2. Financing3. 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 methods1. Book value2. Assets basis3. Dividend basis4. Earnings basis5. 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 basisIf 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 this1. Balance sheet value2. 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 valuationInvestors 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 valuationThe asset approach also ignores non-balance sheet intangible assets e.g.1. Highly-skilled workforce2. Strong management team3. 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?

1. For asset stripping (minimum acceptable to owners)

2. To identify a minimum price in a takeover3. 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 BasisIncome-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