Key Valuation Concepts of Financial Decision Making - Essay Example

?Business Report Task Outline and evaluate different sources of long-term capital (both debt and equity). Long term funds refer to the funds that a business requires for buying assets that include buildings, land and machinery. This type of capital takes a long period to yield returns or be repaid in case it is borrowed (Droms & Wright, 2010). There are many sources of long term finance that are available for a business. The following are the major types of capital that are long term and their characteristics. 1. Shares These are forms of ownership that are issued to the public by joint corporations that deal in stocks. The company’s capital is divided into units with definite values and each of these units is referred to as a share. The people who hold this shares are called the shareholders. The major traits of shares is that they are the capital units for a company and each of them has a face value that is clear-cut. Certificates are issued to their holders for indicating the shares they hold against their values. All shares have unique numbers and their values indicate the significance of an investor in a company along with the degree of their liability (Melicher & Norton, 2010). These shares can be transferred from one person to another. There are several types of shares that a company can issue and these are the equity and preference shares. The preference shareholders receive dividends at a fixed rate and also receive their capital in case the company is winding up. They are quite a safe investment since their holders receive dividends regularly. On the other hand, the holders of equity shares receive their dividends only after the preference holders have been paid . They also do not receive dividend that is fixed. Their receiving of dividends depends on the profitability of the company. Their initial investments are only refunded once the preference share owners have been paid theirs (Droms & Wright, 2010). Shares are advantageous to their holders since they receive dividends on them when profits are high and their prices increase with an increase in profits. They are easily traded in their respective stock markets and their holders have voting rights within the company. The company experiences the advantages of easily raising capital and has no liability in the payment of their members dividends (Ferrel & Pride, 2006). This implies that if the company makes losses the management has no obligation to pay the owners their dividends. However, shares have disadvantages to their owners since the owners of equity are only paid their dividends when there are profits. The prices of the equity shares are not constant and vary with the company’s profitability. The company could raise a lot of money in the process of raising shares and this results in the shares having low values. The holders of the equity shares experience high degrees of threats and only own the company by name. The company has the disadvantage in that it cannot trade on the equity shares. The swaying of the owners of equity when voting for leaders by the management can lead to conflicting interests between them (Droms & Wright, 2010). 2. Debentures This is the money that a company borrows for a long period of time and pledges to repay within a constant period. The companies issues certificates to the providers of this loans known as debentures. It is given under the ordinary seal of an organization. It can be described as an acknowledgment that is put in writing for the amounts borrowed. It provides the conditions and terms on the money borrowed, their interest rates, repayment periods along with the securities offered (Rundell, 2008). The debenture holders are considered as creditors to the organization and are repaid after a constant time period. Their owners do not have the rights of voting and these amounts are normally secured. There are two types of these debentures which are the redeemable and irredeemable debentures along with the convertible and nonconvertible debentures. The redeemable ones are only repaid upon maturity while the irredeemable ones are not repayable in the organizations lifetime (Droms & Wright, 2010). On the other hand, the debentures that are convertible can be converted into shares at the option of their holders whereas the inconvertible ones cannot. The advantages of issuing debentures are that the organization raises funds without relinquishing control and is a reliable source of funds. In raising these funds a company saves in the amount of tax they pay on their incomes. This is because they get the same treatments as expenses are chargeable to the company’s profits (Ferrel & Pride, 2006). Their money is also repaid before all the other shareholders in the event of winding up a company. They are however disadvantageous in the fact that they become a burden to the company and have to be secured. They enable trading on capital but lower the returns of the shareholders and can be disastrous to a company in times of depression (Melicher & Norton, 2010). 3. Retained Earnings These are the profits that a company sets aside to meet the upcoming needs of additional capital. The reserving of funds can be vital for a company wanting to meet their financial needs in the future (Schroeder, Clark & Jack, 2010). This funds can be used to purchase additional assets or expanding their activities. Their advantages are that they offer cheaper sources of equity. They are also stable financially and useful in paying their shareholders money when the profits are low. They have the disadvantage in that they are only attainable in organizations that make high profits. They also bring dissatisfaction among their shareholders because they increase the company’s debt. This types of funds can also make a company establish itself as a monopoly since their financial positions are threatened. This funds also prompt the management to indulge in careless spending since they are not budgeted for (Melicher & Norton, 2010). 4. Obtaining loans through Commercial Banks. These are loans that a company can obtain from the monetary institutions to be repaid after a long period of time (Schroeder, Clark & Jack, 2010). The advantages that arise when organizations borrow from these institutions are numerous. This form of finance is flexible and can be repaid anytime. They are also not constant burdens for the organizations and these institutions keep their clients operations a secret. They spend minimal amount of time along with costs when compared to the issuing of shares or obtaining debentures. The borrowing business also manages to maintain control of the company despite the involvement of the monetary organization (Melicher & Norton, 2010). Another vital advantage is that loans are repayable in installments and their interest charges are low. However, they are disadvantageous since the monetary organizations require security for their money and cannot give out money if security is not given. This facility creates uncertainties for both the company and the investors if it becomes recurrent (Rundell, 2008). The formalities a business is required to comply with are plenty and this makes the process of attaining these funds tiresome. Task 2: Issues involved in seeking an appropriate balance between different types of long term finance, medium and short term finance A reduction in the amount of debts that a company owes their creditor results in low gearing levels among investors (Rundell, 2008). This makes the activities of expanding a company’s operations remain on hold for an indefinite period of time. This is due to the uncertainties in the economy. The withholding of funds by the investors enables them to invest when the economy stabilizes. During such periods most organizations are usually fond of concentrating on their financial strengths. This happens while they wait for an appropriate period to borrow funds for investment. This type of restraint applied by the organizations does harm their future visions of growth. For example, companies encountering depressions in the value of their shares take additional threats by investing further in these conditions. On the other hand, an increase in the debts owed by a company results in high gearing levels by the investors in the market (Schroeder, Clark & Jack, 2010). This augments the company’s efforts of expansion. This is because the creditors and investors are willing to provide more capital for investment purposes. The theorems by Modigliani and Miller suggest that certain market processes of price do not affect a firm’s value or its financing (Rundell, 2008). This happens with the deficiencies of taxes, costs of bankruptcy and agency along with the inadequate information operating in the capable markets. According to the proponents of this theorem, they suggest they do not consider whether the capital is raised through issuing shares of obtaining debts. The traditional theorem on the other hand suggests that companies have the abilities to plan their equity structures (Schroeder, Clark & Jack, 2010). The proponents of this theorem suggested that equity obtained through borrowing increases the threats on an organizations earnings. This move eventually decreases the prices of a company’s shares. They suggest that the capital borrowed by a company can lead to an increase in the returns the company gets. This eventually increases the prices of their shares in the market. They additionally suggest that capital can be gotten though fair play or obtaining debts (Rundell, 2008). The practical considerations that a company considers before searching for a source of equity are plenty. They include the return rates expected by the company and the company’s risk in their respective industries. This implies that companies in higher risk markets tend not to be favored by financial institutions giving loans. The company’s ability to raise these funds in unfavorable conditions is also put under consideration. The proponents of this theory suggested that companies have to reserve some of their funds to enable them face future uncertainties. This enables them to run smoothly despite the occurrences of hard fiscal periods. The industry variations that affect the choices made by a company in considering their source of funds in a company are numerous. They range from the interest rates charged, the duration the services will be provided and the risks involved in obtaining these funds. All this factors greatly affect the performances of a company once it has obtained the funds. The interest rates charged could affect the profitability of a business (Whittington, 2007). This happens if they raise their expenses above their income levels. The duration that the funds will be provided before they can start being repaid will also affect the sources of funds for an industry. The threats involved in obtaining certain sources of capital include the failure to repay in the stated durations and the misappropriation of the funds. Task 3: Explain and evaluate current thinking on the efficient market hypothesis. The secondary market is the monetary market where the buying and selling of securities and other instruments of finance for example bonds and futures takes place (Whittington, 2007). This secondary market is also used for selling loans by credit banks to shareholders. The concept can also be used to refer to bazaars where second hand commodities are dealt with. Examples of typical secondary markets that deal with stocks include the Nasdaq along with the New York stock exchange. It is in this markets that securities are transferred from an investor to another investor. It is very vital that this market remains greatly liquid. This is achievable by having a great number of shareholders in a certain market (Rundell, 2008). This augments its centralization and improves the liquidity of the marketplace. A lot of accuracy is required in the secondary market since the accuracy of prices reduces the companies management’s costs. This makes antagonistic takeovers a little bit of a threat moving equity into the hands of good managers. The act of pricing shares accurately assists in allocating debt finances efficiently whether they are debts or borrowings (Schroeder, Clark & Jack, 2010). The three forms of market efficiency include the strong, weak and semi-strong efficiencies. The strong efficiency which is the strongest description, implies that the whole information in a marketplace may it be private or community, is included in accounting for the prices of stock. An investor in this situation cannot get an advantage due to information from an insider of the company. The second type of efficiency which is the semi-strong one suggests that all societal information is considered when calculating the current price of a share. The use of the fundamental and technical analysis cannot be used to gain superior returns. The weak efficiencies suggest that the prices of past stocks get reflections in the current prices of stock. In these type of efficiency, a technical analysis may not be useful in predicting the trends of the market (Wilheim & Weber, 2010). The process of carrying out a fundamental analysis in a company involves the analysis of its statements of finance, competitors, their competitive advantages and their markets. In the stock market it involves considering the entire economies, the rates of interest, management, creation and the earnings involved. There are two approaches that are applicable when using this form of analysis. They include the bottom up and top down approaches. The goal of this form of analysis is to make fiscal forecasts after analysis of current and past data. A good example of the use of financial analysis in a company, is in conducting stock valuations for the purposes of predicting the evolution of their prices (Wilheim & Weber, 2010). On the other hand, a technical analysis involves analyzing past data in the markets along with their prices for the purpose of directing the prices. Behavioral finance studies the influences that psychology has on practitioners of finance and their effect on the markets. The field of financial economics makes assumptions that companies are governed with high rationality (Rundell, 2008). This is not true since the experience, strategies and skills of their management’s do defer. Learning Outcomes 1. Key strategic decisions that a business may have to make. Some of the key strategic decisions that a business will have to make include their reason for being in business, and the selection of their target customers (Schroeder, Clark & Jack, 2010). They will also consider the image they would like to present to the public along with their relationships with the suppliers. The strategic management of a business has to consider their roles along with their employees role. It involves deciding on how a business will differ from their competitors. It considers how technology, processes, the business commodities and equity will be used to attain the business objectives (Whittington, 2007). The business will have to make a strategic decision concerning the types of viewpoints, values and missions they will adopt. The business can also perform investment and performance appraisals on their activities to evaluate its profitability levels. 2. Explain how accounting and finance can assist in making and evaluating a decision. They provide reports that will be used by the external parties to the business in evaluating their performance. Examples of these external bodies include financial institutions, investors and the tax collection authorities. Some of the reports generated that assist in this processes are the profit and loss accounts, balance sheets and sales and purchases accounts. Management accounting provides vital information for decision the makers in a business (Wilheim & Weber, 2010). This information assists the managers in reducing costs, increasing sales and raising their profitability’s. They also aid in determining the most appropriate finance sources along with their duration of repayment. Accounting and financial documents assist in monitoring the costs the business incurs and can affect the implementation of different decisions. They also give a clear picture of how the business was performing in the past. This information aids an organization in determining which direction a business will take in future (Rundell, 2008). This is in terms of acquiring resources along with their utilization in efforts to meet the company’s objectives. 3. Analytical skills used in the key decision areas within finance and strategy. The analytical skills required for making vital decisions in finances and the strategies a business uses in their operations include the skills of solving problems, making decisions and communicating (Hinterseer, 2002). These skills enable the management in a business to create an advantage over their competitors. The use of their negotiation and interpretation skills will enable them to make appropriate decisions when faced by unfamiliar situations. The management’s ability to negotiate enables a business to attain quality and cost effective raw materials from their suppliers. The use of their problem solving capabilities ensures that the business overcomes difficulties. These are the difficulties they encounter in their finances and methods of strategizing (Hinterseer, 2002). The management’s ability to communicate effectively with their workers enables them to ease the implementation of their decisions. This also ensures that any changes in the organizational structures of a business are communicated early. This helps the business in countering the effects of resistances encountered in the operation of their routine business activities (Adkisson & Riser, 2006). 4. Limitations of the current state of financial theory in making strategic business decisions. There are several limitations of the financial theory in strategic decision making in a business. The principles that are in use in the field are ever changing and at a very high rate. There are also no uniform methods that are being used along with business procedures (Adkisson & Riser, 2006). This creates differences in the way we do things and brings about conflicts in the business. In order to avoid similar circumstances from occurring in the future, the regulatory bodies should come up with standards and other measures to assist in curbing conflicts. The current financial theory is also based on many estimations and principles (Rundell, 2008). The diverse principles being used by different businesses tend to mislead some of them. The financial theory is deficient since it does not offer details on cost information. This implies that an individual cannot have detailed information of the units at his disposal. The theory does not classify costs into their various categories for purposes of managing them easily. It offers no control on the costs a business will incur in their operations along with some helpful fixations of prices. Past costs of an item are given instead of their current costs (Adkisson & Riser, 2006). 5. Key valuation concepts and methodologies of financial decision making that contribute to the wider decision making of the organization. A business usually undergoes valuation in the event that it is being acquired by another business or is indulging in a merger. The methods that a business uses to perform valuations on its assets includes the method of discounting the flows of cash in a business and valuing their net assets (Adkisson & Riser, 2006). Discounting the cash flows involves estimating the values of an asset on the basis of the cash they will generate in future. This enables the business in determining the returns they expect from investing in certain assets. Valuation of the net assets on the other hand involves determining the value of the business assets after the payment of their expenses. It is widely used in the evaluation of assorted portfolio’s of business ventures. The use of this finance concept enables the determination of the current worth of a business. It enables another corporation that is interested in investing to know the exact worth of an entity. With this information the management is able to make the most appropriate decisions for their business (Gropelli & Nikbakht, 2010). Another method that is popularly used is the companies guideline methodology. This method is used in determining the worth of a business by evaluating the prices charged by other similar businesses in the industry. References Adkisson J., Riser C., 2006, Asset Protection, Concepts and Strategies for Protecting Your Wealth, McGraw-Hill Professional, New York. Droms W. G., Wright J,. O., 2010, Finance and Accounting for Nonfinancial Managers, All The Basics You Need To Know, Basic Books, Los Angeles. Gropelli A. A., Nikbakht E., 2006, Finance, Barron’s educational series, London. Hinterseer K., 2002, Criminal Finance, The Political Economy Of Money Laundering In A Comparative Legal Context, Kluwer Law International, Amsterdam. Melicher R. W., Norton E., A., 2010, introduction of finance, markets, investments and financial management, John Wiley and sons, New York. Pride W. M., & Ferrel O. C., 2006, Marketing, Concepts And Strategies, Cengage Learning, London. Rundell F. K. C., 2008, Finance For Engineers, Evaluation And Funding Of Capital Projects, Springer, New York. Schroeder R. G. & Clark., M.W., Cathey, J. 2010 Financial Accounting Theory And Analysis, Text Cases, John Wiley & Sons, New York. Weber B., & Wilheim H. 2010, Infrastructure as an Asset Class, Investment Strategies, Project Finance and PPP, John Wiley & Sons, New York. Whittington G. 2007, Profitability, Accounting Theory and Methodology, the Selected Essays of Geoffrey Whittington, Routledge, New York, 2007. Read More