Unit 1: Strategic finance and risk management
Strategic Financial Management notes · PTU syllabus (MCOP302-18)
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Unit summary
Strategic financial management links finance to long-term value creation. This unit covers the meaning, nature and scope of SFM, financial and non-financial objectives, agency theory, the strategic decision-making framework, shareholder value creation and value drivers, corporate risk management with forwards, futures, options and swaps, financial planning models and Higgins' sustainable growth model.
After this unit you can
- Explain the nature, scope and objectives of strategic financial management
- Explain agency theory and shareholder value creation and its drivers
- Explain corporate risk management with derivatives
- Apply financial planning models and Higgins' sustainable growth rate
PTU syllabus topics
- Meaning
- nature and scope of SFM
- financial and non-financial objectives
- agency theory
- strategic decision-making framework
- shareholder value creation and value drivers
- corporate risk management using forwards/futures/options/swaps
- financial planning models and Higgins' sustainable growth model
Sustainable growth rate (Higgins)
g = ROE × retention ratio
Shareholder value
PV of future free cash flows − debt
Forward hedge
Locks today's rate for a future date
Put-call parity
C + PV(K) = P + S
Topic 1
Meaning, nature and scope of SFM
Strategic financial management is the application of financial techniques to strategic decisions so as to maximise long-term shareholder value — identifying, evaluating and implementing strategies with financial resources.
- Nature: long-term, value-focused, integrates investment, financing and dividend decisions with corporate strategy, considers risk and uncertainty, uses real options and scenario thinking.
- Scope: strategic investment (capacity expansion, M&A), financing strategy (capital structure, sources), dividend and payout strategy, risk management, performance measurement (EVA, MVA), restructuring.
Financial and non-financial objectives
| Financial objectives | Non-financial objectives |
|---|---|
| Maximise shareholder wealth (share price, TSR) | Customer satisfaction and quality |
| Growth in EPS and dividends | Employee welfare and development |
| Target ROCE, EVA | Environmental and social responsibility (ESG) |
| Maintain credit rating and gearing limits | Market leadership, innovation |
| Liquidity and solvency | Good governance and ethics |
Topic 2
Agency theory
An agency relationship exists when principals (shareholders) appoint agents (managers) to act for them.
Shareholders vs managers
Empire-building, perks, short-termism, risk avoidance
Shareholders vs debt holders
Risky projects, excessive dividends, asset substitution
Majority vs minority shareholders
Promoter-controlled firms in India
Company vs society
Externalities, pollution
- Agency costs: monitoring costs (audits, boards), bonding costs (manager's commitments), residual loss.
- Solutions: performance-linked pay, ESOPs, independent directors, audit committees, debt covenants, market for corporate control (takeover threat), shareholder activism, stewardship codes.
Topic 3
Strategic decision-making framework and value creation
- 1
Set corporate objectives
Value maximisation
- 2
Analyse environment and capabilities
- 3
Generate strategic options
Organic growth, M&A, divestment
- 4
Evaluate options
NPV, real options, strategic fit, risk
- 5
Choose and finance
Capital structure and funding plan
- 6
Implement and monitor
EVA, balanced scorecard
- Shareholder value creation: a firm creates value only when the return on invested capital exceeds the cost of capital (ROIC > WACC).
Sales growth rate
Operating profit margin
Income tax rate
Investment in working capital
Fixed capital investment
Cost of capital
Value growth duration
Period of competitive advantage
Topic 4
Corporate risk management with derivatives
- Risks: currency, interest rate, commodity price and equity risks.
Forwards
OTC contract fixing a future price
Exporter fixes rupee value of future dollar receipts
Futures
Exchange-traded, standardised, marked to market
Commodity and currency hedges on NSE/MCX
Options
Right without obligation; premium paid
Protection against adverse moves while keeping upside
Swaps
Exchange of cash-flow streams
Convert floating-rate loan to fixed (interest rate swap); currency swaps for foreign loans
Example
An Indian importer must pay US$ 1 million in 3 months. Spot ₹83, 3-month forward ₹83.60. Buying forward locks the cost at ₹8.36 crore — if the rupee falls to ₹85, the hedge saves ₹14 lakh.
- Risk management policy: identify exposures, set hedge ratios, choose instruments, limits, board oversight, hedge accounting (Ind AS 109).
Topic 5
Financial planning models and sustainable growth
- Financial planning models: percentage-of-sales method (forecasting balance sheet items as a percentage of sales to find additional funds needed — AFN), simulation and spreadsheet models, budgeting and pro-forma statements.
Additional funds needed
AFN = (A/S) × ΔS − (L/S) × ΔS − m × S1 × b
Higgins' sustainable growth rate
g* = ROE × b = Profit margin × Asset turnover × Equity multiplier × Retention ratio
Internal growth rate
ROA × b ÷ (1 − ROA × b)
- Higgins' model: the sustainable growth rate is the maximum sales growth a firm can achieve without issuing new equity or changing its financial policies (margin, asset turnover, leverage, payout).
Example
Profit margin 8%, asset turnover 1.5, equity multiplier 2, retention 60%: ROE = 0.08 × 1.5 × 2 = 24%; g* = 24% × 0.6 = 14.4%. If sales are planned to grow 20%, the firm must raise equity, increase leverage, cut payout or improve margins.
Key terms
- Strategic financial management
- Financial decision-making aimed at long-term value creation
- Agency cost
- Cost of conflicts between owners and managers
- Value driver
- Factor that determines shareholder value
- Hedging
- Reducing risk by taking an offsetting position
- Sustainable growth rate
- Maximum growth without new equity or policy change
Quick revision
- SFM: long-term, value-focused, integrates decisions with strategy.
- Agency problems and solutions.
- Value creation when ROIC > WACC; Rappaport's seven drivers.
- Hedging with forwards, futures, options, swaps.
- AFN by percentage of sales; g* = ROE × b (Higgins).
Important exam questions
Practice questions written to the PTU exam pattern for this unit's syllabus: short answers (Section A style) and long answers (Sections B and C style).
Short-answer questions
- Q1.Define strategic financial management.
- Q2.State two non-financial objectives of a firm.
- Q3.What is agency theory?
- Q4.Name Rappaport's value drivers.
- Q5.What is an interest rate swap?
- Q6.What is the sustainable growth rate?
Long-answer questions
- Q1.Explain the nature, scope and objectives of strategic financial management.
- Q2.Explain shareholder value creation and its drivers.
- Q3.Explain corporate risk management using derivatives.
- Q4.Explain financial planning models and Higgins' sustainable growth model.
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