Managerial Finance Essay

ASSIGNMENTBMMF5103MANAGERIAL FINANCE15 July 2013QUESTION 1a) Maximizing shopwornholder riches is a moral imperative for pecuniary double-decker instrument managers are supposed to work for shake byholders who are the echt confessers of a senior high society or connection. Shareholders elect participation directors who in acquire hire managers to run the f arrangernity on day to day priming with the view to sterilize addition for the ships company. Managers are remunerative for their services tryed to the company whereas the shareholders own the company. As much(prenominal) morally managers should pursue policies that enhance shareholder look upon with the primary objective foc hired on var.holder wealth maximization.b) Managers make key day-to-day decisions to maximize shareholder apprise. But how do the owners of a business organization know that managers are operating(a) to maximize shareholder pass judgment? This lack of information is known as the p rincipal-agent enigmas. The agent performs the tasks on shareholders behalf yet the shareholders cannot ensure that the agent performs precisely the way the shareholders would like.Agency be as link up to a corpo dimensionn refers to the costs of preventing agents (e.g. managers) pursuing their own recreates at the expense of shareholders. There might be conflicts between shareholders and the company managers. Shareholders who are owners want the managers to make decisions which ordain maturation the share value. Managers who receive salaries prefer to expand the business with the view to cast up their salaries which whitethorn not necessarily increase the share value. in that respectfrom, agency costs tend to go down the value of a corpo dimensionn beca employment the rising costs make the share price low when there is substantial debt involved. Costs of monitoring pass on increase and thus reduce wealth maximization of shareholders.c) Business ethical motive is the acc eptable go under of moral values and corpo valuate standards of conduct in running a business organization. It includes proper business policies and practices much(prenominal) as corporate governance, as a check against insider trading, bribery, discrimination and covers corporate societal responsibility and fiduciary responsibilities. Business morals is a basic textile providing proper conduct, it may be guided by law or put in placeso as to gain public confidence and acceptance.An face of business ethics is when an employee lie to a potential client to get him to sign for services or purchase the product offered.Business ethics is important to a corpo balancen because it will determine its reputation. It will entertain public confidence towards the corpo proportionalityn. It is essential for the long-term survival and success of the heap in business. Implementing an ethical program will foster a successful corporation culture, values and enhanced profit powerfulness. Busi ness ethics will overly influence the way the corporations conduct its business and affect all including customers, employees, suppliers, competitors, etc.d) Advantagesi) There is no maturity period in putting green stock. Thus, eliminating time to come re softenment obligation and enhances the desirability of harsh stock financing. ii) There is no obligation for hark backment of the currency. Instead, there are others to share the take chances of the business investment with. Since there is no debt obligation, there is no finance fee. iii) put out frequent stock can increase sozzleds get power.The more customary stock is change, the larger the plastereds paleness base. Therefore, the more easily and cheaply long-term debt financing can be obtained. iv) Once capital is raised through stock, the corporation is free to use the proceeds in any way it pleases.Disadvantagesi) Involves high cost.It may be the most expensive form of long-term financing. Dividends are not tax -deductible and common stock is a essayiersecurity than either debt or favored stock.ii) potential drop effects of dilution on earnings and voting power. When a company or corporation issues more shares, its financial results must be divided by a larger number of shares, causing dilution. This is because selling of shares of the company mode giving each investor a piece of ownership. Because they own the share of the company, the investors drive the right to demand explanations and justifications for business decisions.iii) Market perception that management think. solicitude issues involve examining perceptions about management and perceptions by management. It includes various judgments regarding the competence of on-line(prenominal) and future management team as well as issues related to insider buying such as future strategies to increase operations and mart share.When management makes large purchases of their own stock with private funds, investors may tincture that the company is undervalued or that a favorable company event will occur soon.e) The lead main users of ratio synopsisi) OwnersThe owners of a firm are mainly interested in the firms profitability, liquidness and hence survival. Therefore, they need financial ratios to test the performance of their company such as profitability ratios to receive outwhether management is able to convert gross sales dollars into profits and cash flow. The common ratios are gross leeway, operating tolerance and net income boundary line. The gross marge is the ratio of gross profits to sales. The operating margin is the ratio of operating profits to sales and net income margin is the ratio of net income to sales. The get-on-asset ratio, which is the ratio of net income to wide-cut assets, measures a companys effectiveness in deploying its assets to generate profits. The return-on-investment ratio, which is the ratio of net income to shareholders equity, indicates a companys ability to generate a r eturn for its owners. These ratios are useful to owners of companies.ii) CreditorsCreditors are interested in a firms ability to pay their debts over a short period of time.The ratio analysis will evaluate the firms liquidityposition. Creditors use liquidity ratio, which is the ratio of current assets to current liabilitiestogauge the ability of the company to pay its short-term bills. A ratio of greater than one is usually a minimum because anything less than one means the company has more liabilities than assets.iii) guidanceManagement team comprising financial managers regularly use ratio analysis to evaluate financial policies and decisions they get made. It is the overall responsibilities of the management team to make sure available resources are apply most effectively and efficiently and that the financial positions of the company is sound.Management uses profitability ratios to analyze the companys ability to convert sales dollars into profits and cash flow. For example, the return-on-investment ratio, which is the ratio of net income to shareholders equity, indicates a companys ability to generate a return for its owners.Examples of ratio formulaExample 1 utter(a) margin ratioGross allowance account =Gross Profit taxGross profit and tax income figures are obtained from the income statement of a business. Alternatively, gross profit can be figure by subtracting cost of goods interchange from revenue. Thus gross margin formula may be restated as Gross Margin =Revenue Cost of Goods SoldRevenueExample 2 Operating margin ratioOperating income is same as earnings before interest and tax. Operating income and revenue figures is available from the income statement of a company. Operating Margin =Operating IncomeRevenueQUESTION 2a) There are five-spot different categories of financial ratios. They arei) Liquidity ratio is used to measurecompanys ability to pay its short-term debt obligations. As such, they focus on the firms current assets and curre nt liabilities on the balance sheet.The most common liquidity ratios used is the current ratio mainly to give an caprice of the companys ability to pay back its short-term liabilities such as debt and account payables with its short-term assets such as cash, blood and receivables.ii) Debt ratio is used to measure companys ability to meet its long-term debt obligations. The ratio indicates what proportion of debt a company has relative to its assets. The measure gives an idea to the leverage of the company along with the potential risks the company faces in terms of its debt-load.iii) financial leverage ratio measure the extent to which a business or investor is using the borrowed cash. A company having high leverage is considered to be at risk of bankruptcy in the event the company is unable to repay the debts. The most common financial leverage ratio is the debt-to-equity ratio calculated as total debt divided by shareholders equityiv) Asset readiness or overturn ratios measu re the efficiency a company uses its assets to score sales. The most common asset efficiency ratios are the inventory turnover ratio, the receivables turnover ratio, the days sales in inventory ratio, the days sales in receivables ratio, the net working capital ratio, the fixed asset turnover ratio, and the total asset turnover ratio.v) The profitability ratios measure the companys ability to generate aprofit and an adequate return on assets and equity. The ratios measure how efficiently the firm uses its assets and how effectively it manages its operations. An example is the gain profit margin ratio is a ratio of profitability calculated as after-tax net income (net profits) divided by sales (revenue). It shows the nitty-gritty of each sales dollar left over after all expenses suck in been paid.Limitations of financial ratiosi) Although financial ratios can be effective tools for gauging financial performance and managerial effectiveness, they rarely provide answers. symmetrys will not say why something is exhalation wrong and what to do about a particular place they however pinpoint where a problem is.ii) There is no international standards on the use of financial ratios. Limitation of ratios interpretation emerges when a particular set of ratios of a company is compared to other company or business. For example, for calculating the inventory turnover one company may use the cost of goods sold as the numerator, small-arm another may use its sales figures. A company may use the operating profit to calculate its total assets turnover, while another may use the net income after taxes.iii) benchmark for assessing companys financial position is needed. Different operating methodologies may be employed to run a company may render the comparison of financial ratios irrelevant. Example, a company prefers to lease most of its assets while another company may own them. Thus, some of the ratios, such as debt to total assets, fixed-charge coverage, total assets turnover, and return on total assets, would be unrelated.iv) The swelling factor can make the ratio of a particular company look good or bad. Inventory turnover may have deteriorated over a three- form period the problem may not repayable to the increase in physical inventory, that rather, to increase in the cost of the goods.b) Effect of an increase in a companys debt ratio to its return on equity.An increase on debt-ratio will be increase in the return of equity. If a company finances itself through debt, the creditors lift the risk. If the debt results in increased earnings, the return on shareholder investment is exponential. match liabilities include both the current and non-current liabilities. The formula to calculate the debt ratio is Debt Ratio =Total LiabilitiesTotal AssetsReturn on Equity is expressed as a percentage and calculated asROE = Net Income/ earthy Equityc) Long-term interest rate = (RM13,000,000) (8/100) = RM1,040,000 Short-term interest rate = RM1,300,00 0 RM1,040,000 = RM260,000 Short-term interest rate = RM260,000/RM1,546,000 = 0.168Rate of interest on notes payable is 16.8%d) Changes in value of equity (in millions)(RM in millions)Shareholders beginning equity537Shareholders termination equity485Difference beginning & ending equity52Net income128Less Paid dividends57Difference71 business/shares purchased in the year (52+71)123Shares purchased throughout the year is RM123 millione) If the current ratio of corporation is 5.65 when industry average is 1.42, this disparity means that the corporation is havingi) an excess build-up in inventory. When the corporation holds a high level of inventory, it ties up business funds that could have been used in other areas such as in development or marketing. The cost of the inventory is not recovered by the corporation until it sells the inventory.ii) aged account receivables which is the totalitys owed to the company by its customers. The corporations account receivables reports will ident ify problems with receivables management process and identify accounts that remove collection action.QUESTION 3a) Although ownership of stock represents ownership in a company, not all stock is created equal. Therefore there are two basic types of stock common stock and preferred stock. preferred stock is sometimes referred to as a hybrid security because it has features of common stocks and trammel nets. A companys preferred stock trades independently of its common stock and offers preferred stockholders a different set of benefits. Preferred stocks paid amount of dividends just as fixed interest bond. It is not debt but equity like common stocks.b) Preferred stock par value of RM100 with annual dividend 10%. Annual rate of return is 11.5%. i) RM100 X10/100% = RM10. mother of 11.5%11.5%/100 = 0.115= RM86.96ii) As the risk-free rate increases, the mandatory rate of return will increase and the price will drop. When rates increase, the price of the preferred stock will likely fall . If price falls, the issuer will likely shout the preferred stock and replace it with a new preferred stock issue at a lower rate, conventional debt, or mayhap even common stockc) RM4.63(1+0.05)/(0.12-0.05) = 4.8615/0.07 = 69.46The value of the companys stock if the postulate rate of return is 12% is RM69.46d) Before change in price per share, r =5% + (8% -5%) beta 1.3 = 8.9%After change in price per share, r = 4% + (10% 4%) 1.5 = 13%Therefore, the change in price per share is RM4.87e) Formula for unvarying growth is rs = r RE + (rm rRE)b= 6% + 5% (1.4) = 13%2013 = RM0 dividen2015 = RM1.002016 = RM1.00 (1.2) = RM1.202017 = RM1.00 RM1.442018 = RM1.00 RM1.7282019 = RM1.00 RM1.849Calculate growth between constant rate=The price of the stock is RM20.16QUESTION 4a) Needs RM40,000/year during retirement periodn = 10 yrs, i = 9 %polyvinyl acetate = PMT (PVIFA) = RM40,000 (9.129) = RM365,160PV = RM365,160 (0.422) = RM154,097.52The Mirians should deposit RM154,097.52b) Model A PV = PMT (PVIFA) = RM5,000 (3.993) = RM19,965Model BYear earnings (RM)PVIFPV17,0000.9266,48226,0000.8575,14235,0000.7943,97044,0000.7352,94053,0000.6812,043Total20,577I would purchase/buy model A because it is cheaper by RM612 compared to model B.c) Which alternative to be chosen? plectrum 1PMT = RM3,500/2.487 = RM1,407,318.05Option 2PMT = RM3,500/3.102 = RM1,128,304.32Option 3PMT = RM3,500/3.605 = RM970,873.79The company should choose option 3 because lower by RM157,430.53 compared to option 2 which is second lowestd) Present value is have invest of the compound interest calculations. Applying compound interest calculation is to find the future value of a present amount. Using the present value calculation a present value amount is found to be received in future.e) Over certain period the principle amount increases as a result of the installment payments resulting in lower amount of interest that is charged by the bank.QUESTION 5a) When an investor buys a bond, the investor is impart mo ney to the bond issuer, which could be a government, corporation, etc. The issuer promises to pay a specified rate of interest during the life of the bond and to repay the principal, similarly known as face value or par value of the bond, when it matures, or comes due after a set period of time. Thus bonds provide interest payment and principal payment. Payment of interest is through annually or semi-annually. Coupon payments are paid periodically. When bond matures a principal sum is paid which is a lump sum payment.b) truss prices and interest rates are related. Interest rates and bond prices have inverse relationship, when one goes up, the other goes down. If interest rates is high enough, bond prices would fall. If interest rates is low, bond prices would rise. Prices of short-term bonds do not fluctuatemore often compared to long-term bond. Premium bond is sold when the stated rate of interests exceed the required rate of return.Example, if rates dropped to downstairs origin al coupon rate of 7% for RM1,000 bond, it would be priced at a premium since it would be carrying a higher interest rate than what was shortly available in the market. A bond will sell at a discount when the stated rate of interest is less than the required return. Bond is sold equal to the par value when the stated rate of interest is equal to the required return.c) Param does not have enough money to buy 10 bonds if the required rate of return is 9%. This is because the required rate of return which is 9% is less than the coupon rate of the bond which is 10%. The price of the bond is greater than the par value of RM1,000. Considering there are 10 bonds, the total price is greater than RM10,000. That is the reason why Param would not have enough money to buy the 10 bonds.d) FV = RM1,000PMT =clN = 10PV = RM1,2501/YR = 10.79%e) Interest rate risk is the risk of decline in bond values due to the increase in interest whereas reinvestment risk is the risk of an income decline due to a d rop in interest rates. Bond holders who bought long-term bond is greatly at risk to the interest rate risk.QUESTION 6a) (RM18+RM4+RM3+RM2-RM24)/24 X 100% = 12.5%.Therefore, Billie jeans realized rate of return during the three years holding period is 12.5%b) (i)Stock 18 + 0.8 (12 8) = 11.2%Stock 28 + 1.2 (12 8) = 12.8%Stock 38 + 0.6 (12 8) = 10.4%(ii) Stock 3 is undervalued due since E (R) RRc) Beta is the measurement for market risk which is non-diversifiable. The risk must be dealt with by the portfolio manager. Diversifiable risk should be diversified external by portfolio manager so that it would not pose a problem to the investment. As such all market risks is all relevant to the portfolio manager since it is his job and responsibility in balancing the likely risk and return.d) The situation suggest that investors are more risk adverse compared to before the release taking place. On the portfolio, a risk premium of 11% (16% 5%) is required whereas previously 10% (15% 5% ). If slope were to change downward, it means investors are less aversion to risk.e) Expected return 0.9(12%) + 0.1 (20%) = 12.8%Beta 0.9(1.2) + 0.1(2.0) = 1.28%