Chapter 5 Financial strategies over the life cycle

1. Corporate Financial Strategy4th edition Dr Ruth Bender Chapter 5Financial strategies over the life cycle

2. Financial strategies over the life cycle: contents • Learning objectives • Life cycle model • Shake-out period • Portfolio matrix incorporating product life cycle [with names] • Portfolio matrix incorporating product life cycle [with pictures] • Unknowns decrease over the life cycle • Net cash flows at different stages of development • Modified Ansoff matrix • Financial strategy changes over the life cycle • Cost of capital in a divisional structure

3. Learning objectives • Understand what financial strategy is, and how it can add value. • Explain why shareholder value is created by investments with a positive net present value. • Appreciate how the relationship between perceived risk and required return governs companies and investors. • Differentiate the different models of measuring shareholder value. • Explain why share price is not necessarily a good proxy for company value. • Outline how agency theory is relevant to corporate finance.

4. Maturity Launch Growth Decline £ Sales 0 Time Profits Cash flows Life cycle model

5. Shake-out period Anticipated sales forecast used to justify capacity increases Sales / capacity Overcapacity position Actual sales level Historical fast growth in sales Time

6. Portfolio matrix incorporating product life cycle High Star ? Rate of market growth Funding Cash cow Dog Low/negative High Low Relative market share Based on Boston Consulting Group

7. Portfolio matrix incorporating product life cycle  High Rate of market growth Funding Low/negative High Low Relative market share Based on Boston Consulting Group

8. Unknowns decrease over the life cycle • DECLINE • Rate of eventual decline • LAUNCH • Product risk • Market acceptance • Market share • Size of market at maturity • Length of maturity period • Maintenance of market share • Rate of eventual decline • GROWTH • Market share • Size of market at maturity • Length of maturity period • Maintenance of market share • Rate of eventual decline • MATURITY • Length of maturity period • Maintenance of market share • Rate of eventual decline

9. Net cash flows at different stages of development GROWTH Cash inflow Sales High Cash outflow Marketing, fixed assets, Working capital, etc. High Net cash flow ? Cash flow starts negative, becoming neutral or positive LAUNCH Cash inflow Sales Low Cash outflow R&D, launch Marketing, fixed assets, etc. High Net cash flow Negative MATURE Cash inflow Sales High Cash outflow Ongoing cost base Low Net cash flow Positive DECLINE Cash inflow Sales Low Cash outflow Maintenance Low Net cash flow Negative • Cash flow starts positive, becoming neutral

10. Modified Ansoff matrix Products Existing Related New Core business growth strategy Existing Customer-led growth strategy Markets Product-led growth strategy Related Diversification strategy New

11. GROWTH Business risk high Financial risk low Funding equity (float) Dividend payout nominal Growth high P/E high Eps low Share price growing & volatile LAUNCH Business risk very high Financial risk very low Funding equity (venture capital) Dividend payout nil Growth very high P/E very high Eps nominal Share price growing & highly volatile MATURITY Business risk medium Financial risk medium Funding debt Dividend payout high Growth medium / low P/E medium Eps high Share price stable with limited volatility DECLINE Business risk low Financial risk high Funding debt Dividend payout total Growth negative P/E low Eps declining Share price declining & volatile Financial strategy changes over the life cycle

12. Cost of capital in a divisional structure This extract from the financial report of Henkel shows that divisions with different risk profiles are given different WACCs Source: Henkel 2012 financial statements, page 54 www.henkel.com