S@R Examples Application Areas
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Transcript of S@R Examples Application Areas
1© Copyright 2006 Strategy@Risk Ltd. All rights reserved
S@R Examples and Overview application areas
Value based Strategic Risk and Performance Management achieves a sustainable increase in enterprise value over time.It represents an important tool for planning as well as for performance measurement and for controlling purposes .
“S@R has set out to create models that boost income and save our clients time and money. Our models can give answers to both deterministic and stochastic questions, by linking dedicated ebitda models to holistic balance simulation taking into account all important factors describing the company. The basis is a real balance simulation model – not a simple cash flow forecast model.”
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Examples Application Areas
I. BudgetingII. Strategic Risk and Performance
ManagementIII. Valuation under UncertaintyIV. InvestmentsV. Mergers & AcquisitionsVI. Working Capital StrategyVII.Selecting strategy (or M&A candidate)VIII. Overview application areas
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Budget to low, but relatively small deviation
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EBITDA (NOK mill.)
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EBIT (SEK 1000)
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Budget to high and large absolute deviation
Budget and simulation forecast are they close or far off the actual result, and do you know what is your realistic window of opportunity?
Example: The EBITDA model used for BudgetingStress testing – creating better budget targets
Location will give an absolute ranking of Alternatives. Shape will give important informationon risk and opportunities – and show cost of increasing sales targets
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Risk awareness gives better predictabilityThe learning effect – Steeper curve: decrease in
uncertainty
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Normalized Budget Uncertainty
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Well organized enterprise risk management enables running the business at a higher risk level in a controlled manner with a higher company value as result.
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ii. Strategic Risk and Performance Management
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S@R gives you the capability to achieve results through your ERM
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Value creation with S@R – Guide to why SRM should be on top managements agenda
Placing SRM in the corporate risk and finance lancscape can be tricky. S@R has developed the necessary methods and tools for securing better decision making, revealing total risk and increasing shareholder value towards corporate goals.
The figure depicts the relations between risk tolerance, the board’s risk indifference curves, risk appetite, risk capacity and the risk efficiency frontier.
The risk efficiency frontier is found as the locus of upside potential ratios where all unwanted risk/uncertainty have been mitigated. What is left is residual risk, assuming that the mitigation is effective.
The enterprise utility function gives the board’s preferences between risk and value.
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Downside Risk(Lower partial moment LPM2)
Shareh
olde
r value up
side
(Upper partia
l mom
ent U
PM1)
The Board's riskindifference curves
(Risk aversion)U1
Strategi
c RM
U2
Risk reduction Risk appetite
U3
ERM
EnterpriseRisk efficiency frontier
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Enterprise risk exposure are used to define risk appetite
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Risk appetite and Risk appetite is not always the same …..
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lity
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eigh
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VaR
Extended Tail Loss = -82,8Average value of the area
ETLSR
Spectral Risk = -86,2Risk aversion weighted risk
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Benchmarking of sales channels
After simulations the result could look like this:
1. The blue curve is like a “cash cow” doing good income
2. Green and brown curves are challenging. By identifying the critical success factors there are great challenges to improve businesses, but great uncertainty1. Green from 100 up to 350
2. Brown from 50 up to 350
3. Light blue is bad business and may need a decision to go further or not to go
Cash cowDog ‘Problem’ children
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Total income pr channel
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Ch #1Ch #2Ch #3Ch #4
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Benchmarking EBITDA profiles
We are finding that our clients are increasingly addressing operational riskIssues:
What is the future cash‐flow volatility of my company and the individual BU’s?What are the drivers of operational volatility (Ebitda) and which drivers can we actively manage and how?Which operational options should I pursue/prioritize?
Economic i.e. hedge commodity prices, contract product price, etc.?Operational i.e. product/production and single points of failure, etc.?
and strategic risk issues:What are the expected value volatility of my company (equity/entity)?What are the drivers of value volatility and which drivers should we actively manage and how?Which strategic options should I pursue/prioritize?Should I hedge exchange rates, commodity prices, etc.?What are the expected effects of translation hedges?In which BU’s should I continue to invest?What Cost of Capital should I charge to the BU’s?What financial leverage is most appropriate for my firm?
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Country # 1Country # 2Country # 3Country # 4Country # 5
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NPV distribution of Equity Transactions
NPV distribution of Debt Transactions
The uncertainty of Debt and Equity
The cumulative Debt and Equity transactions and their yearly probability distributions over the simulated time period forms the foundation for financial planning
They will give confidence intervals for future capital requirements for both Debt and Equity
They will also form the basis for contingency planning – if series of probable but not likely events should manifest capital requirements in the right tail of the distributions
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Uncertainty of Currency Rates , Tax and Translation Risk
Agio /Disagio from Operations:Currency effects On CostAgio /Disagio on CostCurrency effects On SalesAgio /Disagio on Sales
Financial Agio /Disagio:On Debt BalanceOn Debt Interest PaymentsOn Debt RepaymentTax Effects of Agio /Disagioon Interest Payments
Balance Sheet Effects:Domestic or Functional CurrencyTranslation EffectsValuation Variation on Debt and AssetsTranslation Hedges
Currency Effects analyzed
Tax Effects analyzed:Tax effects on cost of debt and equityTax effects on Exchange rate forecasts Tax shields effects on debt Tax effects on enterpriseCurrent and deferred taxes
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Translation Risk Four methods for Translation Hedging are provided:1. Fixed Gearing, 2. Proportional Debt to Assets,3. All Debt in one Currency and Base or
functional currency and4. All Debt in one Currency,
Given the Hedge ratio (0‐100 %)This gives a number of different possible strategies. Each strategy will have different probabilities for Loss/Gain:
… adding further uncertainty to the distribution for equity value
Each strategy will then change the probability distribution for equity value:
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iii. Valuation under Uncertainty
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Valuation2008 2009 2010 2011 2012
Invested Capital at Beg. of Period 14.339,6 16.714,9 18.719,4 20.650,6 22.411,9Excess Marketable Securities ,0 ,0 ,0 ,0 ,0OB - Excess Marketable Securities 925,1 ,0 ,0 ,0 ,0Capital Charge 988,5 1.012,6 1.045,9 1.097,1 1.284,5NPV of Translation Gain/(Loss) ,0 ,0 ,0 ,0 ,0NPV of Forecasted EP (2.651,1) (2.802,5) (3.156,1) (3.437,2) (3.749,5)NPV of Continuing Value (2.814,3) (2.984,8) (3.151,6) (3.319,0) (3.509,2)--- -- ---------- ----- --------- --------- --------- --------- ---------Value of Entity by EP 10.787,8 11.940,2 13.457,7 14.991,5 16.437,7
Book Value of Debt (7.860,7) (9.680,0)(11.681,8)(13.488,2)(13.829,6)--- ----- -- ---- --------- ---------------------------------------Value of Equity by EP 2.927,1 2.260,2 1.775,9 1.503,3 2.608,1===== == ====== == == ======= ======= ======= ======= =======
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USD
Prob
abili
ty Value of EntityValue of Debt
Value of Equity
And the corresponding probability distributions:
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Pricing of Capital Correct estimation of WACC is essential
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Wacc
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Relative Cum
ulative Freq
uency
Mean 5,08S.D. 1,43Minimum 1,44Maximum 9,26Lower Confidence Limit of Mean 4,90Upper Confidence Limit of Mean 5,25
Wacc is a stochastic variable thru volatility in earnings, interest rates, exchange rates, expected return to equity etc:
Most WACC calculations uses book values for debt and equity and fixed WACC for the next 3‐5 years. Correct WACC can only be found thru simulation, solving for market value weightsgiving changes in WACC from period to period.
S@R: http://www.strategy‐at‐risk.com/2010/02/08/wacc‐and‐infrastructure‐regulation/http://www.strategy‐at‐risk.com/2008/09/08/the‐weighted‐average‐cost‐of‐capital/
This is a by product from the S&R simulation model
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Uncertainty simulations and Sensitivity analysis
• Since the range (and their probabilities) are given for all variables in the uncertainty analysis, the need for sensitivity analysis is greatly reduced.
• By stopping the simulation and print a complete set of reports when set criteria's has been exceeded the combined and simultaneous effect of all variables can be studied.
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iv. Investments
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Enterprise Value (mill. USD)
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Probability Distribution for Enterprise Value of (mill USD)Current operations, +Alt#1, +Alt#2 and +Alt#3
+Alt#1
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Analyze and compare strategic Investments
1. Location will give an absolute ranking of alternatives
2. Shape will give important information on risk and opportunities
3. Together the give all necessary information for selecting1 the dominant alternative
If you are looking at investing alternatives or contemplating possible M&A, the Equity Value distribution’s:
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What is the probability of a strategy giving Loss?
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Value of Equity
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ability
Probability distribution for Added value byStrategic Project and the Value of Commitments
Value added by Strategic Project
Cost of Commitments
Value of EquityProb
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Probability for Gain and Loss by Strategic Project
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Area of Probable Gain
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tyProbability distribution for Value of Equity at Current Operations
and with Strategic Project Added
Current Operation +Strategic Project
CurrentOperations
The important part now is the area below at the point of intersection:
• Is it lower or above the company's accepted risk level ?• Large potential, but – there is a probability of 60% for loss – is it a sound strategy ?
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v. Mergers & Acquisitions
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Enterprise Value
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Probability Distribution for Value of Company
Expected Value = 153,42
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Expected value‐Price
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Acquisitions
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If you have the distribution for Enterpriseor Equity value you can calculate the Probability of loss from the acquisitionOR The bid price given the probability of gain.
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Driving value through integrationDoes synergies exist and do they have a value?
The more risk averse the less should be paid as merger premium
The more risk averse the more can be paid as merger premium
Revenue increasing synergies: Cost decreasing synergies:
… the company rated the likelihood of achieving each of the synergies at this point as “unproven,” “possible” or “probable.” By updating its progress against its full set of synergies — and the potential value of each synergy — the company was able to better prioritize its efforts going forward.
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vi. Working Capital Strategy
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Working CapitalI
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Different working capital strategieswill give different return on investedcapital and thus on company value.
It is however not straight forward to find the best strategy since many considerations regarding suppliers and customers must be taken into account and since most of those arestochastic.
vii. Selecting strategy (or M&A candidate)
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Selecting strategy (or M&A candidate)I
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Selecting between strategies can beSimple when the choices look s like this:
… but the choices can be difficult:
And you will need both theory andmethods to discern between them
iiiv. Overview Application Areas
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Strategy@RiskY O U R C O N S U L T I N G P A R T N E R I N R I S K
Services Application area Use Results
Financial Planning and testing
Budgeting Stress‐testingCost and capital savings. Stabilize results. Align budgets and results better.Get an organization that better hits targets, reveal over‐or under achievements.Make correct market/outlet choices.Communicate better with the investors and financial market.Know your expected multi‐period investments necessary to increase sales.Reveal market/product potential.Evaluate financial hedging strategies.Understand the future cash‐flow volatility of company and the individual BU’s.Find the financial leverage that is most appropriate for the firm.
Upside/downside potential and risk
Multi period uncertainties
Financial planningEvaluate your market position and potential for growth
Financial modeling
Balance simulation, holistic Risk/opportunity models
Analyzing Financial risk:1. Currency risk2. Transaction risk3. Translation risk4. Interest rate risk5. Credit risk6. Financing risk
Making the company capable to perform detailed strategic planning. Executing earlier and more apt actions against risk factors.Make the right and most profitable strategic choices in line with company risk appetite and tolerance. Get precise and correct multi‐period market weighted cost of capital.
Analyzing Operational risk:1. Implementation risk2. Country risk3. Repatriation of funds risk
Balance risk:1. Liquidity2. Solvency3. Equity/entity value
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Strategy@RiskY O U R C O N S U L T I N G P A R T N E R I N R I S K
Services Application area Use Results
Business Development
Production processesCompare strategic choices.
Estimate necessary capital and investment requirements.
Make the right investment choice.Compare investments, M&A actions, their individual value, necessary commitments and impact on companyGet todays and future capital requirements right.
Plant location and plant sizing
Business Strategy
Investments Comparing business units, country units or product lines – decide allocation and need for resources.
Compare risk, opportunity and expected profitability.
Carry out professional demand modeling.
Be able to analyze and incorporate markets uncertainties.
Be able to compare effectiveness, robustness and results from different sales channels and suppliers.Be able to chose focus and invest resources in the right products, countries and production by understanding their requirements and contribution to the group.Be able to make better investment/divestment decisions.Boost results by analyzing and acting on revealed and transparent risk and opportunity simulations.Risk priced transactions ‐ Improved allocation ‐Optimized costs and efficiencies
Choice of sales channel
Choice of supplier
Markets uncertainty
Demand modeling
Decision support
Product pricing – asset pricing
Valuations, capital cost and requirements, individually and effect on company
Due Diligence
Benchmark M&A candidates profiles, M&A initial and future estimated capital requirements Identify and benchmark an investment portfolio and/or individual business units’ risk profilesImprove predictability in operating earnings at risk that may impact corporate financial position and performance
M&A
Contracts
Divestments/ Asset sales
Risk/ Opportunity Management
Strategic Risk And Performance ManagementERM quantification
Act on and plan based on your whole Risk‐opportunity situation
Plan and act according to risk strategyEstablish risk tolerance and risk appetiteDevelop risk mitigating strategies
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