STRAT 5700 Chapter 1 Notes

Most important type of analysis

Industry Analysis

To calculate a firm's WACC, five pieces of information are required:

(1) a firm's debt rating, (2) its marginal tax rate, (3) its Beta, (4) the risk-free and market rates of return in the years a firm's WACC is being calculated, and (5) information about a firm's capital structure

WACC =

(Stockholders' Equity /Total Assets) Cost of Equity + (Debt/Total Assets) After· Tax Cost of Debt

Know formulas on page 14

.

Explain how the strategic management process begins and ends. 6 steps

1. A firm's mission 2. Objectives 3. External and Internal Analysis 4. Strategic Choice 5. Strategy Implementation 6. Competitive Advantage

Despite the very real challenges associated with measuring a firm's competitive advantage, two approaches have emerged. What are they?

1. Estimating a firms competitive advantage by examining its accounting performance. 2. the second examines the firms economic performance.

3 levels of external analysis

1. General Environment 2. Industry Environment (General Environment) 3. Industry structure (Porter's 5) - industry life cycle

Explain internal analysis

1. Helps a firm understand which of its resources and capabilities are likely to be sources of competitive advantage and which are less likely to be sources of such advantages 2. Can be used to identify areas of an organization that can be improved and changed.

Based on the strategic management process, the objective when making a strategic choice is to choose a strategy that? 4 things

1. Supports the firm's mission 2. is consistent with a firm's objectives 3. exploits opportunities in a firm's environment with a firm's strengths 4. neutralizes threats in a firm's environment while avoiding a firm's weaknesses

Explain External Analysis. 2 Main ideas

1. a firm identifies the critical threats and opportunities in its competitive environment. 2. examines how competition in this environment is likely to evolve and how this evolving will effect the threats and opportunities a firm is facing.

4 Types of accounting ratios

1. profitability ratios 2. liquidity ratios 3. leverage ratios 4. activity ratios

One way to use a firm's accounting statements to measure its competi· tive advantage is through the use of

Accounting Ratios

is a measure of how highly correlated the price of a firm's equity is to the overall stock market.

Beta

is the rate of return that a firm promises to pay its suppliers of capital to induce them to invest in the firm

Cost of Capital

is equal to the rate of return a firm must promise its equity holders in order to induce these individuals and institutions to invest in a firm

Cost of equity

Generally, there are two broad categories of sources of capital:

Debt and Equity

The strategic management process begins when a firm?

Defines its mission

How to calculate competitive advantage.

Economic value Firm 1 - Economic value Firm 2 = competitive advantage of firm 1 or competitive disadvantage to firm 2

are theories of how to gain competitive advantage in an industry that emerge over time or that have been radically reshaped once they are initially implemented

Emergent Strategies

what is a competitive advantage?

In general, a firm has a competitive advantage when it is able to create more economic value than rival firms.

Using ratio analysis, a firm earns above average accounting performance when its performance is greater than

Industry Average

the return investors would obtain if they purchased one share of each of the stocks traded on public exchanges.

Market rate of return

specific measurable targets a firm can use to evaluate the extent to which it is realizing its mission.

Objectives

How to do an external analysis

Porter's 5 forces

How do we do an industry analysis?

Porter's 5 forces model

Explain the types of ratios.

Profitability - some measure of profit in num and some measure of firm size in denominator Liquidity - focus on firms ability to meet short term obligations Leverage - focus on firms financial flexibility. Ability to obtain more debt activity - focus on level of activity

Cost of Equity =

Risk Free Rate of Return + (Market Rate of Return -Risk Free Rate of Return) Beta

Figuring out how iTunes has come to dominate the music download industry and what competitors can do about it will go a long way in determining a firm's performance in this industry. The process by which these kinds of questions are answered is the

Strategic Management Process

Armed with a mission, objectives, and completed external and internal analyses, a firm is ready to make its

Strategic choices. That is, a firm is ready to choose its "theory of how to gain competitive advantage.

A sequential set of analyses and choices that can increase the likelihood that a firm will choose a good strategy; that is, a strategy that will generate competitive advantages.

Strategic management process

occurs when a firm adopts organizational policies and practices that are consistent with its strategy

Strategy Implementation

temporary vs sustained competitive advantage

Temporary lasts for a very short period of time. Sustained can last much longer.

is equal to the interest that a firm must pay its debt holders (adjusted for taxes) in order to induce those debt holders to lend money to a firm.

The cost of debt

the rate the U.S. federal government has to pay on its long-term bonds to get investors to buy these bonds,

The risk free rate of return

How to calculate economic value?

Total Perceived Customer Benefit (the amount they pay) - Cost to Firm

Missions define both what a firm aspires to be in the long run and what it wants to avoid in the meantime?

True

How to do an internal analysis?

VRIO Framework

Explain business-level strategies

actions firms take to gain competitive advantage in a single market or industry

Explain corporate-level strategies.

actions firms take to gain competitive advantages by operating in multiple markets or industries simultaneously

The strategic choices available to firms fall into two large categories:

business level strategies and corporate level strategies

Of course, the ultimate objective of the strategic management process is to enable a firm to choose and implement a strategy that generates a

competitive advantage

Firms that create the same economic value as their rivals experience?

competitive parity

the 2 most common business-level strategies are

cost leadership and product differentiation

Competitive advantage can raise or lower based on what?

cost to firm and how much firm can sell it for (total perceived customer benefits)

Give example of an objective.

growth in earnings per share averaging 10 percent or better per year.

Define a Firms Strategy

its theory about how to gain competitive advantages. A good strategy actually generates such advantages

A firm's mission is its?

long-term purpose.

A firm's weighted average cost of capital (WACC) is simply the

percentage of a firm's total capital, which is debt times the cost of debt, plus the percentage of a firm's total capital; that is, equity times the cost of equity

What is economic value

the difference between the perceived benefits gained by a customer that purchases a firms products or services and the full economic cost of these products or services

Thus, the size of a firm's competitive advantage is the difference between

the economic value a firm is able to create and the economic value its rivals are able to create.'

High quality objectives are?

tightly connected to elements of a firm's mission and are relatively easy to measure and track over time

corporate level strategies include?

vertical integration strategies, diversification strategies, strategic alliance strategies, merger and acquisition strategies, and global strategies