Advanced Accounting Concepts

8/8/2019 Advanced Accounting Concepts

1/25

Advanced Accounting concepts


2/25

Value Based Management

Creating value for shareholders is accepted as acorporate objective in todays times

Many VBM approaches have been developed tomeasure and create value. These are synergiesof various disciplines

Finance DCF and shareholder value maximisationBusiness strategy Value creation through exploitation of

business oppurtunitiesAccounting Structure of financial statements with modificationsOrganisational Behaviour - Incentive plans for creating value


3/25

Principal methods ofVBM

1.Free cash flow Mckinsey and Alcar

2.EVA / MVA Stern Stewart

3.Cash flow return on investment / Cash value added

( CFROI /CVA ) BCG

Common threads

1. Value of any company = PV of future cash flows

2. Firms should use value metrics and employ themacross all management functions

3. A well designed incentive structure will motivateemployees to create shareholder value.


4/25

Economic Value AddedEVA

EVA as a concept was developed byStern Stewart & Co. EVA is the surplusover and above the cost of capital.

A company which gives a return morethan the cost of capital creates wealthor adds shareholder value whereas a

company earning a return less than thecost of capital destroys value.


5/25

EVA = PAT cost of equity

= PAT cost of equity rate * equity capital

EVA = Capital * ( return on capital cost of

capital )

EVA = NOPAT cost of capital

(PAT + INT(1-t)) (Capital * WACC)


6/25

Illustration

Net sales 300

COGS 258PBIT 42

Interest 12

PBT 30

Tax @30% 9

P AT 21

Cost of equity = 18%Cost of debt = 12%

Debt Equity ratio = 1

Equity = 100 , Debt = 100


7/25

Components of EVA

NOPAT

Cost of capital

Capital employed


8/25

Value creating strategies using EVA

Capital = 10000, NOPAT =2000, c = 15%, r=20%

EVA = 10000* ( 20-15) = 500

I. Improvement of operating performance to 2250

II . Profitable investment of 10000 at a return of 18%

III. Withdrawal of unproductive capital of 1000 therebyreducing return by 50.

IV. Reduction in cost of capital by altering capitalstructure.


9/25

EVA and firm valuation

Firm value = economic book value ofassets +PV of EVA associated with it.

Ideally firm value using EVA will be moreor less similar to firm value using DCF


10/25

Global Ltd. is interested in acquiring the food

division of Regional Ltd. They have forecastedthe free cash flow on the basis of followingassumptions :

1. Growth rates in assets, revenues and profitsafter tax will be 20% for the first 3 years,12% for the next 3 years and 8% thereafter.

2. The ratio ofPAT to net assets would be 0.12

3. The oppurtunity cost of capital is 11%


11/25

1 2 3 4 5 6

Asset value 50.00 60.00 72.00 86.40 96.77 108.38

NOP AT 6.00 7.20 8.64 10.37 11.61 13.00

Net Invt. 10.00 12.00 14.40 10.37 11.61 8.67

FCF (4.00) (4.80) (5.76) nil nil 4.33

Terminal value 4.33 ( 1+0.8) =156

0.11 -0.08

PV ( FCF+TV) = (9.39 ) + 83.46 = 74.07


12/25

EVA projection

1 2 3 4 5 6

Op. capital 50.00 60.00 72.00 86.40 96.77 108.38

NOP AT 6.00 7.20 8.64 10.37 11.61 13.00

Cost of capital 11% 11% 11% 11% 11% 11%

Capital charge 5.50 6.60 7.92 9.50 10.64 11.92

EV A 0.50 0.60 0.72 0.87 0.97 1.08

TV 1.08 * 1.08 = 1.17 = 39

0.11-0.08 0.03Firm value = 50 + PV ( EVA + TV )

= 50 + 24.05 = 74.05


13/25

Mergers and Acquisitions


14/25

Economic rationale of a merger is that thevalue of the combined entity will be more

than that of individual entities.

Realistic reasons in favour of mergers

1. Strategic benefit

2. Economies of scale

3. Economies of scope4. Economies of vertical integration

5. Complementary resources

6. Tax shields


15/25

Mechanics of a mergerI. Legal Procedure Sec 391-394 of the

Companies Act 1956

Examination of object clause Intimation to stock exchanges Approval of draft amalgamation proposal by the

Boards Application to High courts Notice to shareholders and creditors

Meetings of shareholders and creditors Passing of High court orders Filing the order with Registrar Transfer of assets and liabilities Issue of shares and debentures


16/25

II . Tax aspects

Tax concessions are available to amalgamated company only ifthe amalgamating company is a Indian company.

Following deductions remaining unabsorbed by theamalgamating company will be allowed to the amalgamated

company.

Capital expenditure on scientific research

Expenditure on acquisition of patents / knowhow etc.

Expenditure for obtaining license to operate telecom servicesAmortisation of preliminary expenses

Carry forward of losses and unabsorbed depreciation


17/25

Accounting for amalgamations AS -14

Pooling method - merger

Purchase method - acquisition


18/25

Illustration

Beta Ltd. has agreed to merge with Alpha Ltd.The swap ratio of 3:5 has been fixed. The facevalue per share of both companies is Rs.10/-.The assets & liabilities of Beta Ltd. are

revalued as :

Net fixed assets 3200

Investments 400Current assets 2900

Current liabilities 1600

Loan funds 2400


19/25

Before merger After merger

Pooling Purchase

Liabilities A Ltd. B Ltd. Alpha Ltd. Alpha

Ltd.Share capital 4000 1000 4600 4600

Capital reserve - - 4001900

Share premium 2000 500 2500 2000

G. Reserve 6000 1500 7500 6000

Loan funds 4000 2500 6500 6400

C.Liab & Prov. 2000 1500 3500 3600

18000 7000 25000 24500

AssetsNet fixed assets 7000 3000 10000 10200

Investments 3000 500 3500 3400

Current assets 7000 3000 10000 9900

Misc. expenses 1000 500 1500 1000


20/25

Exchange ratio in a merger

Basis

Book value per shareEarnings per share

Dividend discounted value per share

Discounted cash flow value per share


21/25

Book value per share

If BV per share of acquiring company is Rs.25and that of target company is Rs.15, theexchange ratio will be 15/25 = 3/5

for every 5 shares in target company 3 shares inacquiring company.

Drawback of this method Book values do not reflect economic

values


22/25

Earnings per share : If the EPS of the target companyis Rs. 5.00 and the EPS of acquiring company is Rs.5exchange ratio = 2/5

Drawbacks of this method

This method is based on current earning per share. It

fails to take into account :

The growth rate of the companies Improvement in earnings due to merger Risks associated with the earnings of the two companies.


23/25

Market price per share

The exchange ratio is based on the relative marketprice of the shares of the company.

If the shares of the company are actively traded thenthe market prices indicate current earnings, growthprospects and risks. If the shares are not activelytraded market price may not be a realistic indicator

Share prices may be manipulated by vested interests.


24/25

Dividend discounted value per share

The dividend discounted value is the presentvalue of expected dividends

This method is useful only if the dividendstreams can be predicted with reasonablesurety


25/25

Discounted cash flow value per share

DCF value per share

= Firm value by DCF method debt value

Number of equity shares

This method is useful if the companiesbusiness plans and cash flow projections areavailable for 5 10 years.

Advanced Accounting Concepts

Documents

Transcript of Advanced Accounting Concepts