Financial Policy and Corporate Strategy
Paper 14 tests whether you can connect a company's financial policy choices - capital structure, dividend, investment and liquidity - to its competitive strategy and to value creation, rather than treating them as isolated computations.
Where financial policy sits
Corporate strategy sets the portfolio (which businesses to be in); business strategy sets competitive positioning; financial policy is the functional-level translation into funding, payout and investment rules. A coherent policy states a target debt/equity range, a dividend payout band, a hurdle rate and a liquidity buffer, each traceable to strategy. A growth strategy justifies low payout and higher leverage only if ROIC exceeds WACC.
Value-based tests
EVA = NOPAT − (WACC × invested capital), equivalently (ROIC − WACC) × capital. MVA = market value − capital employed. Proposals should be screened on the spread, not on accounting profit growth. On dividends, MM irrelevance holds only with perfect markets; signalling, clientele, agency and tax effects matter in practice, and the residual dividend model ties payout to the funding of positive-NPV investment.
Worked example
NOPAT ₹120 crore, capital employed ₹800 crore, WACC 12%: EVA = 120 − 96 = ₹24 crore (ROIC 15%). A ₹200 crore project adds NOPAT ₹26 crore, so ROIC is 13% and incremental EVA ₹2 crore - accept. A rival proposal adds ₹22 crore (11%) - reject, even though it raises absolute profit by ₹22 crore.
Traps
Using book weights instead of market weights in WACC; celebrating EPS growth from acquisitions that destroy value; treating MM irrelevance as practical guidance; ignoring that financial slack has option value; confusing accounting profit with economic profit.