Strategy Chapter 8: Implementing Strategies: Finance and Accounting Issues

A sampling of issues that may require finance and accounting policies, decisions, analyses, and
actions in implementing strategies include the following: 1. To raise capital with short- or long-term
debt, a bond issuance, divestiture, or a preferred or common stock issuance 2. To lease or buy fixed
assets 3. To determine an appropriate dividend payout ratio 4. To use last-in-first-out (LIFO), first-in-
first-out (FIFO), or a market-value accounting approach 5. To extend the time of accounts receivable
or not 6. To establish a certain percentage discount on accounts within a specified period of time 7.
To determine the amount of cash to be kept on hand 8. To purchase additional treasury stock or not
9. To determine whether to accept a merger offer 10. To determine how much to ask (or pay) for a
division of the firm to be divested Five especially important finance and accounting activities central
to strategy implementation are listed and discussed sequentially in this chapter: 1. Determine capital
structure: acquire needed capital to implement strategies; perform EPS/ EBIT analysis. 2. Develop
projected financial statements: show expected impact of recommendations. 3. Perform corporate
valuation: in the event an offer is received, or a rival firm is to be acquired. 4. Analyze financial ratios.
5. Manage initial public offerings (IPOs), cash levels, and corporate bonds.

Capital Structure:

A firm must determine the most profitable means for raising needed capital. Occasionally cash on
hand can finance small projects, but much of the cash on a firm’s balance sheet may not be readily
accessible without incurring taxes depending on what country the cash resides. Another way to raise
the capital for new projects is to divest existing businesses. The proportion of debt to equity on a
balance sheet is often referred to as a firm’s capital structure; performing an EPS/EBIT analysis is a
common way to determine the appropriate capital structure needed.

 EPS is earnings per share, which is net income / number of shares outstanding. EBIT is
earnings before interest and taxes, or as it is sometimes called, operating income. 3. Shares
outstanding are similar to shares issued except shares issued also includes shares of stock
that a firm has repurchased (treasury stock). The denominator of EPS is shares outstanding;
Shares authorized are the number of shares a firm has approval to issue in total, EBT is
earnings before tax; EAT is earnings after tax.
- EPS/EBIT analysis is a widely used technique for determining whether debt, stock, or a
combination of the two is the best alternative for raising capital to implement strategies. This
technique involves an examination of the impact that debt versus stock financing has on EPS
under various expectations for EBIT, given specific recommendations. An enterprise should
carry enough debt in its capital structure to boost its return on investment in projects earning
more than the cost of the debt.
 EPS is perhaps the best measure of success of a company, so it is widely used in making the
capital acquisition decision. EPS reflects the common “maximizing shareholders’ wealth”
overarching corporate objective, in contrast to maximizing profits in the short run. If profit
maximization is the primary objective of the firm, then in performing an EPS/EBIT analysis,
you may focus more on the EAT rather than EPS.

EPS/EBIT Analysis: Steps to Complete: Gather data, set up cmputataion table, insert numbers (For
the EBIT row, select a pessimistic (low), realistic (medium), and optimistic (high)), EBT = row2 – row1,

Taxes = row3*tax%, EAT = row4 – row3, EPS = 5/6, Graph Your EPS/EBIT Analysis Simply place the top
row ($ EBIT) on the x-axis and place the bottom row ($ EPS) on the y-axis.
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aralığı 10 ile 18 milyon dolar arası olduğu için en düşük orta ve en yüksek şekilde 10 15 18 olacak
şekilde seçiliyor interest için 0 koyduğumuzda e b t 10 milyon - 0'dan 10.000 15 milyon eksi sıfırdan
15.000 gibi devam ediyor vergiler için 10.000 x %23 yapıyoruz. EAT için EBT- Taxes yapıyoruz. EPS için
EAT/Shares yapıyoruz. Debt financingte ınterest = capital/ı[Link]=5 mill/0.05.

Shares= (capital needed/ stockprice)+ shares outstanding = 5000/94.17= 53.1+2550 = 2603

Shares in debt financing = (capital needed*60%/ stockprice)+ shares outstanding =

5000*0.6=3000/94.17 = 31.9+2550=2582

Limitations/Considerations Associated with EPS/EBIT Analysis 1. Flexibility. As a firm’s capital

structure changes, so does its flexibility for considering future capital needs. Using all debt or all stock
to raise capital today may impose fixed obligations, restrictive covenants, or other constraints
tomorrow that could reduce or enhance a firm’s ability to raise additional capital. 2. Dilution of
Ownership. When additional stock is issued to finance strategy imple mentation, ownership and
control of the enterprise are diluted. This can be a serious concern in today’s business environment of
hostile takeovers, mergers, and acquisitions. If dilution of ownership is a concern, then debt could be
more attractive than stock, even if EPS values are higher with stock. 3. Timing. If interest rates are
expected to rise, then debt may be more attractive than stock (assuming a fixed rate is locked in),
even if EPS values are higher with stock. In times of high stock prices, stock may more attractive than
debt. 4. Leveraged Situation. If the firm is currently too highly leveraged versus industry av erage
ratios, then financing through stock may be more attractive than debt, even if EPS values are higher
for debt. 5. Continuity. The analysis assumes stock price, tax rate, and interest rates stay constant
across pessimistic, realistic, and optimistic conditions. 6. EBIT Ranges. The EBIT values are estimated
based on the prior year, plus the impact of strategies to be implemented. 7. Dividends. If EPS values
are highest for all stock, and if the firm pays dividends, then more funds will leave the firm as per
dividends if all-stock financing is selected.
Projected Financial Statements: Projected financial statements are income statements and balance
sheets developed for future years to forecast the potential impacts of various recommendations
proposed for implementation.

Steps to Develop Projected Financial Statements: Prepare the projected income statement before
the balance sheet, Start by forecasting sales (revenues); Use the percentage-of-sales method to
project cost of goods sold (COGS) and the Operating Expenses in the income statement, Calculate the
projected net income (NI), Subtract from the NI any dividends to be paid. The remaining NI is retained
earnings (RE). Bring the RE amount over to the balance sheet by adding it to the prior year’s RE
amount on the balance sheet. Project the balance sheet items working from the bottom to the top;
begin with the RE row; if using the template, the RE number is calculated automatically based on the
amount of dividends paid; then forecast the remaining equity items, followed by forecasting the long-
term liabilities, current liabilities, long-term assets, and current assets (in that order), Use cash as the
plug figure—that is, project every line item on the projected balance except cash (and RE); use the
cash account to make the assets equal to the sum of the liabilities and shareholders’ equity. Then
make appropriate adjustments, List commentary or notes below the projected statements to clarify
for the reader why significant changes were made on particular items or rows in one year versus the
next. Notes are essential for a reader to understand the changes made in certain rows.

Corporate Valuation Evaluating the worth of a business is central to strategy implementation because
firms acquire other firms, divisions of other firms, or even divest part of their own firm. Thus,
thousands of transactions occur each year in which businesses are bought or sold for some dollar
amount.

Corporate valuation is not an exact science; value is sometimes in the eye of the beholder. Companies
desire to sell high and buy low, and negotiation normally takes place in both situations. The valuation
of a firm’s worth is based on financial facts, but common sense and good judgment enter into the
process because it is difficult to assign a monetary value to some factors—such as a loyal customer
base, a history of growth, legal suits pending, dedicated employees, a favorable lease, a bad credit
rating, or valuable patents—that may not be fully reflected in a firm’s financial statements. Also,
different valuation methods will yield different totals for a firm’s worth. Evaluating the worth of a
business truly requires both qualitative and quantitative skills.

Methods of Corporate
Valuation:

The Net Worth Method =

Shareholders’ Equity (SE) -
(Goodwill + Intangibles)

The Net Income Method =

Net Income * Five

Price-Earnings Ratio Method

= (Stock Price / EPS) * NI

Outstanding Shares Method = Number of Shares Outstanding * Stock Price

Manage Financial Ratios, IPOs, and Bonds

Financial Ratio Analyses: Financial ratios are examined based on (1) how they change over time, (2)
how they compare to industry norms, and (3) how they compare with key competitors. Financial
ratios based on actual financial statements reveal strengths and weaknesses of the firm; ratios based
on projected financial statements reveal potential problems and successes likely to occur if a
particular set of recommendations is implemented.

Go Public with an IPO?: Hundreds of companies annually hold initial public offerings (IPOs) to move
from being private to being public. “Going public” means selling off a percentage of a company to
others to raise capital; this action dilutes the owners’ control of the firm.

Issue Bonds to Raise Capital?: Another popular way for a company to raise capital is to issue
corporate bonds, which is analogous to going to the bank and borrowing money, except that with
bonds, the company obtains the funds from investors rather than banks. On a balance sheet, bonds
are included in the long-term debt row. Especially when a company’s balance sheet is strong and its
credit rating excellent, issuing bonds can be an effective way to raise needed capital.