BEC 6
Process, Risk, Decisions
Business Process Management:
Business process reengineering - techniques to help org rethink how work is done do dramatically
improve.
Cost of quality:
Conformance - invest on front end
Prevention - prevent production of defective units
Appraisal - detecting before defect is shipped
Nonconformance - internal control - cost of failure - difficult to compute because
opportunity costs - external failure
Quality control:
Total quality management - please customers - emphases quality and we are never satisfied
Theory of constraints - maximize throughput by:
Constraints - anything that impedes the accomplishment of an objective
Internal constraints - people
External - market (exchange rates)
Six Sigma - emphasis is on cost reduction - uses rigorous metrics - improve processes but more
rigorous
Project risk - trade-off between risk and return.
Financial Risk Management
Interest rates ↑ value of fixed income assets ↓
Computation of return (yield) - also nominal interest rate is the rate of interest charged before any
adjustments for compounding.
Periodic rate - interest rate per period/net proceeds of the loan
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BEC 6
Process, Risk, Decisions
APR (non-compounded) - Multiply - effective periodic rate * # of compounding periods
Effecitve APR =
=
from example above
Simple interest = total interest over life of loan based only on original principal
Principal * annual rate * # of years
Compound interest = Raise = principal * (1+rate) ^ # years
Required rate of return - adding risk premium to risk free rate
Maturity risk premium (MRP) or interest rate risk - compensation investors demand for bearing
risk. Increases with term to maturity.
Inflation Premium - used to calculate nominal RF (example below)
Liquidity Risk Premium (LP) - Price concession for illiquid assets (real estate) to sell quickly
drop price
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BEC 6
Process, Risk, Decisions
Default Risk Premium -
International Risks:
Exchange rate risk - hedge to minimize risk
Factors influencing rates - trade and financial - currency with ↑ inflation loses value and demand for
currency ↓
Government controls vs freely fluctuating equilibrium - govt suppresses value
Financial - currency with ↑ interest rate attracts investment - demand ↑ value of currency ↑
Don’t need to memorize just reason through
Transaction exposure - calculate net A/R and A/P from foreign currency - estimate risk
Theory tested more than numbers if at all.
Economic exposure - same as above but for foreign currency (if euro ↑ what happens to A/R and A/P etc)
Financial Risk Management - transaction in a foreign currency - looking to mitigate (hedge) the loss. No
action taken on gain.
Measuring net transaction exposure - same as above - do we have a net A/R or net A/P
FC ↓ A/R ↓ Loss inflow ↓ FC ↑ A/P ↑ Loss outflow ↑
Hedging - acquire financial instrument that will profit if FC ↓ for A/R (flip for A/P)
Compute net impact to avoid over hedging
Techniques for hedging - acquire min amount necessary to hedge net transactions
Futures transactions - smaller transactions
AP - FC ↑ AP ↑ Loss - value ↑ buy - use profit on futures to offset loss
AR - FC ↓ AR ↓ Loss - value ↓ sell - use profit to offset loss
Forward hedge - similar to futures hedge private contract LARGE transactions
AP - FC ↑ AP ↑ buy contract
AR - FC ↓ AR ↓ sell contract
Money market hedge - use international money markets to meet future currency
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BEC 6
Process, Risk, Decisions
Buy a call if you believe FC ↑ buy a put if FC ↓
Currency option hedges - Buy option: CALL if AP and FC ↑ PUT if AR and FC ↓
Don’t need to memorize just understand concept
FC ↓ AR ↓ Loss - buy a put if FC < option price (strike price)
Understand concept
Translation exposure - foreign subsidiary
Revenue in US expenses in FC - if USD ↓ Revenue ↓ - FC ↑ expenses ↑
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BEC 6
Process, Risk, Decisions
Mitigation - restructure REV and EXP
↓ sales if sales in FC and that FC ↓ (just like AR)
↑ expenses if in FC and the FC ↑ (just like AP)
Restructure contract so EXP and REV are in the currency that is advantageous
Denominate sales in FC ↑ and exp in FC ↓ if possible
Transfer pricing between related parties - goal is to reduce taxable income
REV ↓ and EXP ↑ in order to ↓ taxable income to reduce taxes in that country (with higher taxes
usually)
FINANCIAL DECISIONS
Long term vs short term
Operating Lease - off BS (expense)
Capital lease - on BS - records asset and PV of obligation shown as liab
Debt covenants - promise - protect value of debt by protecting credit rating of debtor
FINANCIAL VALUATION
Annuity - equal cash flows
Per share valuation - dividend will never change:
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BEC 6
Process, Risk, Decisions
Dividend discount model
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BEC 6
Process, Risk, Decisions
Price multiples - focus on relationships that can be used to forecast share price
Price earnings ratio = P(0) / E(1)
PEG ratio - PE per unit of growth - a high PE = high growth rate
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BEC 6
Process, Risk, Decisions
Price to sales ratio
Price to Cash flow ratio
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