Course: Business Analysis (PF 608)

MPF Program
Department of Finance
July- December Session, 2021

Course Teacher: Dr. M. Masud Rahman

Professor, Department of Finance, DU
Course Description
Business analysis needs an understanding of the strategies of the firm that is unique in
nature and consistent to the culture of the firm. Different firms hold different strategies to
ensure a sustainable competitive edge. For the same aircrafts, for example, Singapore
Airlines charges 20% depreciation and American Airlines charges 5%. Plane fare of SA
increases but customers are still happy, as they are less price-conscious and more serious
about timely arrival and departure of flights. Another stakeholder is shareholders. The
shares of the firm are held by the Singapore government and so the owners do not mind
about the low margin. So the firm is successful with the assumption of 5 year life of the
commercial aircraft.

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 Course Description (Contd.)
• American Air assumes 20 years commercial life. It reduces cost and increases
profit margin. Customers are happy with low fares. They do not mind about
flight delay on technical reasons. Shares are spread out among different clients
who are happy with high profit margin even though flight delays and cancels
are quite common. These are apparently 2 different yet successful strategies
related to finance. This talks about organizational culture, philosophy, goals
and priorities. Another example of financial strategies is corporate
diversification. Nokia is more successful now when it is more concentrated on
cell phone manufacturing than before when it was a large conglomerate with
diversified products. On the other hand, when Singer was a leading sewing
machine producer, it was less appreciated by shareholders than today when it
is involved in widely diversified home appliances. [Link] a pioneer in
electronic commerce sector made its fortune by on line book selling. The firm
then became a bit too desperate in diversification of product line and started
to sell everything including medicine and drugs. Outcome was not very
encouraging as selling books is different from selling drugs.

1-2
 Course Description (Contd.)
• Use of off-balance sheet financing or lease financing is a popular financial
strategy to understate assets and overstates return on assets. Business analysis
is an evaluation of achievement and management of strategies. Strategic
management was traditionally regarded as a management course but overtime
it has now turned up as a discipline of integrated management rather than
functional management (like marketing management, personnel management
or financial management). Throughout the whole course we would be
interested to know the answer to the fundamental question like why some
firms are successful and some are not. Not that we would be capable of
answering them all but our approach would be more systematic with the
course than without the course.

• Text Book: Hill. Charles W.L and Gareth R. Jones: Theory of Strategic
Management With Cases, 9th Edition, 2010, South-Western, Canada, Third
Indian Reprint 2013,
•

Copyright © 2001 Houghton Mifflin Company. All rights reserved. 1-3

 Course Description (Contd.)
Course Contents:
 Introduction of strategy (Class lecture)
 Leadership, strategy & Competitive Advantage (Chapter 1). (Problem: Calculation of business risk of
levered and unlevered firm)
 Opportunities and Threats-Analyzing the External Environment (Chapter 2)
 Competencies and Profitability-Analyzing Internal Resources (Chapter 3) (Problem: Cash flow
analysis, Ratio analysis, Sustainable growth rate, Z-score, Correction of off-balance sheet financing
firm, NPV analysis in scenario analysis)
 Strategy at the Functional Level (Chapter 4)
 Strategy at Business Level (Chapter 5)
 Industry Environment at Business-Level Strategy (Chapter 6)
 Strategy at Corporate Level (Chapter 9)
 Corporate Diversification strategy (Chapter 10)
 Use of mathematics in business analysis: short term financing, working capital management, beta
belongingness, international repatriations.

Copyright © 2001 Houghton Mifflin Company. All rights reserved. 1-4

 Course Description (Contd.)

Assignment:
Students in a group of 3 students are supposed to submit
an assignment in the form of a case study on
Rationalization of market price of share through business
analysis of a listed company of Dhaka stock exchange.
The submission would accompany individual presentation
on the multi-media. The submission would take place just
after the 2nd midterm test.

Copyright © 2001 Houghton Mifflin Company. All rights reserved. 1-5

Chapter 1

The Strategic Management Process

Strategic Charles W. L. Hill

Management Gareth R. Jones

PowerPoint Presentation
An Integrated Approach by Charlie Cook

Fifth Edition

Copyright © 2001 Houghton Mifflin Company. All rights reserved.

 Competitive Advantage and Superior
Performance
• Wealth Maximization: Wealth means the share price in the secondary market and
maximization of that is the most fundamental goal of a firm. Shareholders are
important as they provide risk capital and they are the owners of the firm. They are
best served by wealth maximization. It is the best goal of the firm. Its beauty includes:
 It reflects accounting and non-accounting data

 Errors in financial statements corrected

 Future Potentials considered (PVGO)

 Non accounting data considered (CEO effect)

 Strategic strength considered

• Profitability (Traditional Goal)

 Growth

 Shares in industry sales

• Sales Promotion and Gaining Rival’s market share

• Diversification of products

Copyright © 2001 Houghton Mifflin Company. All rights reserved. 1-7

A graphical approach to
wealth maximization
S2
S1
Market Price of Shares

W2=P2
W1=P1

D2
D1

Q1 Quantity of stock
 Determinants of wealth


CF1 CF2 CF3 CF CFt
Po  1
 2
 3
 
 t
.
(1  k) (1  k) (1  k) (1  k) t 1 (1  k)

• CF means cash flow from the firm to the shareholder. This depends on
profit, EPS and dividend policy. Tax plays a role as the shareholder is
interested in after-tax income.
• k is the cost of capital required by the shareholders to leave the share price
unchanged. It is proportional to risk. If risk increases k increases and the
contribution of CF to Po goes down. So, Po is inversely related with risk.
• t or timing matters. A distant cash flow is less valuable than an immediate
cash flow.
 Other features of strategy:
Strategies are related to non-profit enterprises as well.
These can be Government agencies as well as NGOs.
Strategies helps a govt. agency to reduce child mortality
within a budget control. NGOs fight for scarce donations, and
a successful strategy gives a potential donors a compelling
massage about why they should contribute additional
donations..
Individual managers must take the responsibility of
strategic management rather than the abstract company. Two
types of managers are: general managers and functional
managers. Strategic management as done by the CEO is an
integration of the two levels, integration of department goals
with over all organizational goals, as well as integration of
goals of different stakeholders (like shareholders and
customers).

Copyright © 2001 Houghton Mifflin Company. All rights reserved. 1-10

 Business Model
• A Business Model is the managers’ conception of how the set of strategies
their company pursues should result in gaining the competitive advantages.
A business model encompasses the totality of how a company will:
 Select its customers
 Define and differentiate its product offerings
 Create value for its customers
 Acquire and keep customers
 Produce goods and services
 Lower costs
 Deliver those goods and services to the market
 Organize activities within the company
 Configure and arrange its resources (exposed as well as hidden)
 Achieve and sustain higher level of profitability
 Grow the business over time
 Relationship between Customer
Loyalty and Profit per Customer
Figure 4.6

The longer a company holds on to a customer the greater the volume of customer-
generated unit sales that offset fixed marketing costs and lowers the average cost of
each sale. Ex. The one time fixed cost of credit card is $50 per customers. This
business losesMifflin
Copyright © Houghton $50Company.
per customer in year 1, makes $44 in year 3 and $55 in year 6. 4 | 12
All rights reserved.
 Strategy-Making Process
Rational planning by top management?
Basic Strategic Planning Model

Defining the Mission and Setting Top-Level Goals

External Analysis of Opportunities and Threats

Internal Analysis of Strengths and Weaknesses

Selection of Appropriate Strategies

Implementation of Chosen Strategies

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 Strategic
Planning
Process

FIGURE 1.1

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 The first step of Mission statements includes 4 components:
1. Mission
 Sets out why the organization exists and what it should be doing. Kodak exists to
provide imaging solutions (like to capture, store, process, output, and
communicate images) of consumers, GM exists to satisfy needs for personal
mobility around the world. Thus, mission should be customer oriented rather
than product oriented. Products are exposed to the risk of technological
obsolesce.
2. Vision:
 Statement of some desired future state. The Nokia definition is classic: If it can
go mobile, it will. This includes future development of mobile services as well.
3. Values of the organization
 It states how managers and employees conduct themselves, how they should do
business, and what kind of organization they should build to help a company
achieve its mission. For example it states pay according to performances,
provide job security, fair treatment of employees, Remedy of unfair treatment.
Similar values can be defined with respect to other stakeholders (e.g.,
stockholders, bondholders, customers, suppliers, etc.)
4. Major goals
 Specify what the organization hopes to fulfill in the medium to long term. It
should be precise and measurable, realistic yet challenging, related with time
frame. Short run motive must not be overemphasized. There may be Secondary
goals or objectives to be attained that lead to superior performance.
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 Vision & Misson
Companies Title Language
Grameen Vision We exist to help our customers get the full benefit of communication
Phone services in their daily lives. (product and services focused)
Grameen Mission GP is the only reliable means of communication that brings the people of
Phone Bangladesh close to their love ones and important things in their lives
through unparallel network, relevant innovations & services. (people
focused)
Beximco Mission Each of our activities must benefit and add value to the common wealth
Pharma of our society. We firmly believe that, in the final analysis we are
accountable to each of the constituents with whom we interact, namely:
our employees, our customers, our business associates, our fellow
citizens and our shareholders. (Different Stakeholders (people) focused)
The Corporate Building growth by building a better world
Heidelberg image
Renata Mission To provide maximum value to our customer and communities where we
live (people focused)
Linde Vision We shall be recognized as the leader in all the business sectors in which
(BOC) we compete in Bangladesh (product oriented)
ACI Mission To enrich quality of the life through responsible application of
knowledge, skills and technology (people focused)
Copyright © 2001 Houghton Mifflin Company. All rights reserved. 1-16
 Components of Strategic Process:
Step 2. External Analysis (Chapter 2)
This deals with the analysis of external environment of the organization. This identify
strategic opportunities and threats in the operating environment outside the firm. An
example of external analysis in case of Time, sales went down in 2005 due to the growing
popularity of advertisements for web based publication where Time was indeed weak.

Immediate (Industry):
Rivalry, entry, exit, bargaining power
of customer and suppliers

Macroenvironment: National:
Inflation, unemployment, Inward vs. outward strategy,
growth rate, status of law, Membership to International
infrastructure organizations or custom union

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 Components of Strategic Process:
Step 3. Internal Analysis (Chapter 3)
Internal analysis focuses on reviewing of resources,
capabilities, and competencies of the company.
Identify strengths
 Quality and quantity of resources available, Example, Time Inc.
had strength like well-known brands (like Fortune, Money, Sports
Illustrated, and People)
 Company specific distinctive competencies, e.g., capabilities of
reporting and editorials of Time.
Identify weaknesses
 Inadequate resources, weakness of Time was undermining the
importance of online edition and in consequence, suffering from
inadequate bloggers needed for a strong online editions
 Managerial and organizational deficiencies, lack of commitment to
online publishing of Time
Copyright © 2001 Houghton Mifflin Company. All rights reserved. 1-18
 Components of Strategic Process:
Step 4 . SWOT and Strategic Choice

Based on the firm’s internal

strength and weaknesses, and its
external opportunities and threats
SWOT Analysis is done

Strategic Choice
Business level: competitive positioning
(Cost leadership and product differentiation)
Functional level: financial, HR, marketing
Global: outside expansion of production/sales
Corporate level: Diversification

Copyright © 2001 Houghton Mifflin Company. All rights reserved. 1-19

Components of Strategic Process
4. SWOT Analysis and Choice of Appropriate
Strategy

a. Functional-Level Strategy
 Financial
 Manufacturing
 Marketing
 Materials Management
 Research and Development
 Human Resources

Copyright ã 1998 by Houghton Mifflin Company. All rights reserved.

 4. SWOT and Strategic Choice (Continued)

• b. Business-Level Strategy
 Cost Leadership
 Differentiation
 Market Niche Focus

Copyright ã 1998 by Houghton Mifflin Company. All rights reserved.

 4. SWOT and Strategic Choice
(Continued)
[Link] achieve
Global Strategies
• A multi-domestic strategy is a strategy by which companies try
maximum local responsiveness by customizing both
their product offering and marketing strategy to match different
national conditions. Production, marketing and R&D activities
tend to be established in each major national market where
business is done.
• International companies are importers and exporters, they have
no investment outside of their home country.
• Multinational companies have investment in other countries,
but do not have coordinated product offerings in each country.
More focused on adapting their products and service to each
individual local market.
• Global companies have investment in many countries. They
market their products through the use of the same coordinated
image/brand in all markets. Generally one corporate office that
is responsible for global strategy. Emphasis on volume, cost
management and efficiency.
• Transnational companies are much more complex
organizations. They have invested in foreign operations, have a
central corporate facility but give decision-making, R&D and
marketing powers to each individual foreign market.
4. SWOT and Strategic Choice (Continued)

• d. Corporate-Level Strategy
 Vertical Integration
 Diversification
 Strategic Alliances
 Acquisitions
 New Ventures
 Business Portfolio
Restructuring

Copyright ã 1998 by Houghton Mifflin Company. All rights reserved.

 5. Strategy Implementation
Designing organizational structure
Structure
Designing control systems
 Market and output controls
 Bureaucratic controls
 Control through organizational culture
Controls
 Rewards and incentives

Matching strategy, structure,

and controls
 Congruence (fit) among strategy, Strategy
structure, and controls

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 Managing Strategic Change
The only constant in the business world is change. Success requires
adapting strategy and structure to a changing world.
The feedback loop in strategic planning. Once a strategy has been
implemented, its execution must be monitored to determine the extent to
which strategic goals and objectives are actually being achieved and to
what degree competitive advantage is being created and sustained. This
information and knowledge pass back to the corporate level through
feedback loops and become input for the next round of strategy
formulation and implementation.

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 Intended and Emergent
Strategies

FIGURE 1.3 Source: Reprinted from “Strategy Formation in an Adhocracy,”

by Henry Mintzberg and Alexandra McGugh, published in
Administrative Science Quarterly, Vol. 30, No. 2, June 1985, by
Copyright © 2001 Houghton Mifflin Company. All rights reserved. permission of Administrative Science Quarterly. 1-26
Strategy as an Emergent Process:
Criticism of conventional focus on strategic
management
Strategy making in an unpredictable world
 Creates the necessity for flexible strategic approaches.

Strategy making by lower-level managers

 Strategy evolves through autonomous action. Many important strategic decision at Intel
were initiated not by top managers but by the autonomous action of lower-level managers
deep within Intel who, on their own initiatives, formulated new strategies and worked to
persuade top level managers to alter strategic priorities of the firm (Intel p.22)
Serendipity and strategy
 Accidental discoveries and happenstances can have dramatic effects on strategic direction.
(Case: Starbuck’s music business: The company’s journey into music retailing started in late
1980s when Tim Jones, then the manager started to bring his own tapes of music
compilations into a store to play. Soon Jones was getting requests for copies for customers.
Starbucks now is a leading seller of CDs.)
Intended and emergent strategies
 Realized strategies are combinations of intended and emergent strategies.

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 Strategic Planning in Practice
How to plan strategies under uncertainty
 Scenario planning for dynamic environmental change
 Involve lower level managers against ivory tower planning
(Many of the GE direct recruit from top flight business schools
made the existing functional managers to think that they are not smart
enough to think through strategic problems themselves that created an
organization disharmony and non- cooperation).
Lesson to be taken:
 Enough contact with operational realities
 The importance of involving operating managers
 Procedural justice in the decision-making process in terms of engagement,
explanation, and expectations
Planning in a dynamic world of competitors: Strategic Intent
 Recognition of the static nature of the strategic fit model
 Stretch goals in case of ascent of competitors. Like Xerox ignored the rise of Canon and
Ricoh until it is too late, GM ignored the threat of Toyota and Honda, Caterpillar ignored
the rise of Komatsu. All these small firms had won over first mover due to a quest of
global leadership. Such an obsession is called strategic intent.

1-28
 Why good managers make bad
decisions
Cognitive biases systematically influence the rationality of decision makers. It is a
psychological biasness in the process of acquiring knowledge by reasoning, or by
intuition or through the senses. When making decisions, we tend to fall back on
certain rules of thumb, or heuristics (self developed method to solve problems), that
helps us to make sense out of a complex and uncertain world. It uses model to predict
human behaviors. Example, beliefs like “workers are in general opportunists (or
committed)” leads to formulate coercive strategy or (laissez-faire) strategy

FIGURE 1.5

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 Cognitive bias: sources
•Prior hypothesis bias: A preconceived functional relation among
variables even when the proofs go against that.
•Escalating commitment: decision makers increases commitment of
resources to a project even if they receive feedback that the project is
failing.
•Reasoning by analogy: Use of simple analogies to make sense out of
complex problems even when the analogy is wrong. Example, the
analogy of innovation is the outcome of freethinking might lead laissez-
faire.
•Representativeness bias: arriving decision on the basis of taking a small
sample under study.
•Illusion of control: The tendency to overestimate one’s ability to control
events. General manager or top management seem to be particularly
prone to this bias: having risen to the top management of an organization
they tend to be overconfident about their ability to succeed. Roll argues
that this a sources of too many wrong merging and acquisition.

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 Groupthink and Strategic Decisions
Most strategic decisions are group thinking, and often
biased
Pitfalls of groupthink
 Failing to question underlying assumptions (CBA
focuses on inflation rather than productivity while wage
increases).
 Coalescing (To come together) or forming around a
single person or policy (articulate, assertiveness bias)
 Ignores conflicting information (CBA ignores the
feedback of declining marginal productivity or ROI) .
 Developing after-the-fact rationalizations (ex-poste
rationalization rather than ex-ante rationalization due to
competitive dynamic).
 Having an emotional (nonobjective) commitment to an
action (example: sales versus profitability bias of
product diversification)

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 Features of successful Strategic Leadership
• Vision, eloquence (skillful use of language), and consistency
• Articulation of the business model (Dell computers and Michael Dell)
• Commitment of the leader to the vision (bail-out package spent out in plane fare)
• Being well informed: the leader develops a network of formal and informal sources who keep them
well informed about what is going on in the company.
• Willingness to delegate and empower: It empowers subordinates to make decisions which is a good
motivation tool and often results in decisions being made by those who must implement them.
• Astute use of power: In a classic article on leadership, Edward Wrapp noted that effective leaders
tend to be very shrewd in their use of power. He builds a consensus for their ideas rather than use
their authority to force ideas through, they must act as members of coalition or its democratic leaders
rather than dictators.
• Emotional intelligence (EI) as coined by Daniel Goldman describes a bundle of psychological
attributes that many leaders exhibit
• Self awareness- the ability to understand one’s own moods, emotions, and drives as well as
their effect on others.
• Self regulation- the ability to control and direct disruptive impulses or moods that is, to think
before acting
• Motivation-a passion for work that goes beyond money
• Empathy- the ability to understand subordinates
• Social skills-friendliness with a purpose

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 Financial Strategy
• Problem: Our firm has to make choice of technology and
leverage. The choice would be either labor intensive
technology or capital intensive technology. The other
choice is to take debt or not. For the labor intensive
technology fixed cost is $20,000 and variable cost is $1.50
per unit and for capital intensive technology fixed cost is
$60,000 and variable cost is $1.00 per unit. Sales price is
$2.00 per unit. Corporate tax rate is 40%. The firm at
present is an all equity firm of $1,75,000 but thinking to
introduce 50% debt @ 10% interest rate to replace equity.
Given the probability of sales information what would be
the choice?

Copyright © 2001 Houghton Mifflin Company. All rights reserved. 1-33

 Business Risk Depends on manufacturing
technology
$2 per Labor Intensive Manufacturing Capital Intensive Manufacturing
unit FC=$20,000; VC=$1.50 per unit FC=$60,000; VC=$1.00
units operating NI Operating NI
prob sold
sales costs EBIT (T=40%) ROE costs EBIT (T=40%) ROE
0.03 0 0 20000 -20000 -12000 -6.9 60000 -60000 -36000 -20.6
0.07 40,000 80000 80000 0 0 0.0 100000 -20000 -12000 -6.9
0.15 60,000 120000 110000 10000 6000 3.4 120000 0 0 0.0
0.5 110,000 220000 185000 35000 21000 12.0 170000 50000 30000 17.1
0.15 160,000 320000 260000 60000 36000 20.6 220000 100000 60000 34.3
0.07 180,000 360000 290000 70000 42000 24.0 240000 120000 72000 41.1
0.03 220,000 440000 350000 90000 54000 30.9 280000 160000 96000 54.9

Mean ΣROE*Pi =12 17.14

Risk σ √Σ(ROE-12) *(Pi) 2

=8.0 √(Σ(ROE-.17.14) 2)
*(Pi) 15.9
=

All Equity firm=$175,000

Copyright © 2001 Houghton Mifflin Company. All rights reserved.
 Risk –Return tradeoff of manufacturing
technology Technology Manual Automation
Mean ROE 12% 17%
Risk (σ) 8% 16%
Coefficient of 67% 94%
Variance

-15 -4 12 17 28 49

Copyright © 2001 Houghton Mifflin Company. All rights reserved. 1-35

 Calculation of risk (50% Debt of
$175,000)
$2 per
unit Labor Intensive Manufacturing Capital Intensive Manufacturing
Taxab
le Net ((ROE- Taxabl Net ((ROE
units operatin incom inco Mean)^2)* e incom ROE -.283)^
prob sold sales g costs EBIT e me ROE ROE*Pi Pi costs EBIT income e ROE *Pi 2)*Pi

0.03 0 0 20000 -20000 -28750 -17250 -0.20 -0.01 0.004 60000 -60000 -68750-41250 -0.47 -0.014 0.017

0.07 40,000 80000 80000 0 -8750 -5250 -0.06 0.00 0.004100000 -20000 -28750-17250 -0.20 -0.014 0.016

0.15 60,000 120000 110000 10000 1250 750 0.01 0.00 0.004120000 0 -8750 -5250 -0.06 -0.009 0.018

0.5 110,000 220000 185000 35000 26250 15750 0.18 0.09 0.000170000 50000 41250 24750 0.28 0.141 0.000
10000
0.15 160,000 320000 260000 60000 51250 30750 0.35 0.05 0.004220000 0 91250 54750 0.63 0.094 0.018
12000 11125
0.07 180,000 360000 290000 70000 61250 36750 0.42 0.03 0.004240000 0 0 66750 0.76 0.053 0.016
16000 15125
0.03 220,000 440000 350000 90000 81250 48750 0.56 0.02 0.004280000 0 0 90750 1.04 0.031 0.017
ΣROE*Pi= . ΣROE*Pi
sum/
Mean $35,000 18 0.025 =0.283 0.102

σROE= σROE=
Risk
(sigma) 0.16 0.32
89% 113%
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 Leverage increases ROE
Financial Leverage

New Leverage 50% All Equity (old)

Expected EBIT $35,000 $35,000
Interest $8,750 0
Taxable Income $26,250 $35,000
Net income 15750 21000
Expected ROE 0.18 0.12

Financial risk (Manual)= σROE(L)- σROE(U)=16%-8%=8%

Financial risk (Automation)= σROE(L)- σROE(U)=32%-16%=16%

The decision is to go for labor intensive technology with or

without leverage.
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