Managing Financial Resoures and Decisions 4. Answer 13 questions.No more than 2500 words allowed - Assignment Example

?1A The four important sources of finance can be the following Bank Loan 2) Issuing Equity 3) Lease 4) Hire-Purchase Bank Loans are used when acompany needs to borrow a large amount of money. The cost of this money is interest being charged by the banks. The repayment schedule includes repayment of both principle and interest and usually this type of loan is collateralized. The collateral in this case will be the equipment itself. In other words, if the company fails to clear of its loan and interest, the bank will have the option of selling the equipment that was brought against loan in the open market. This process is called hypothecation and saves the bank against the risk of default. Issuing Equity is another smart option that can be used by the company. This involves issuing shares to investors at a price determined by the company and using them to raise finance for the equipment needed by the scientists Lease is when the other company or financing organization buys the equipment and let our company use it against monthly charges known as rentals. The benefit of this option is that the company will not have to bear the entire cost of equipment upfront and in case the company does not need equipment in the future it won’t have to pay the rental and will not have to invest huge amount into buying the product. Hire-Purchase is like a loan to the company. The difference here is that instead of lending you the money, the bank or other financial institution buys you an asset and charges a mark-up against this assets which is amortized by the monthly payments which includes payment of both principal and the mark-up. 1b) Bank Loan is usually the most expensive option for the company. However, it is most easy to obtain against collateral. The benefit here is that the company does not lose control of the business by obtaining this loan as can happen in issuing equity. Issuing equity can be dangerous for owners or original investor as if they issue too much equity, they may lose out their control of the business and other shareholders may collude to form a holding company. This is the downside of issuing equity. However, the benefits of issuing equity are also great. First of all, unlike interest bearing loans or instruments, here the dividends are only paid in the profitable years, whereas in case of loans, lease and hire purchase interest has to be paid every period regardless of the fact the company makes a profit or loss. Hence obtaining credit loans, lease and hire purchase is burden on the company’s resources as creditors have a right to sell of company’s assets if they are not paid. Keeping in mind the company is young and does not have enough resources or plowed back profits, it is the best option for the company to raise finance by issuing equity. However, the company should make sure that it floats as much shares in the market so as they will not lose the control of the business or not third party investors will be able to collude to form a holding company. 1c) There will be a different set of requirements and documents that different funds providers will ask from the company before expending them a loan. Banks would ask for collateral and a business plan before deciding on whether it would lend the company or not. Bank would also ask for projected cash flows and income statement in order to make sure that the funds that the bank is obtaining are yielding the required return in order to pay the bank. Similarly, a bank would also ask for the balance sheet to make sure that in the event of default, the company has enough assets and the bank could sell them to recover its lending. Equity investors would want a prospectus which will have to be published in the newspaper. Other than equity investors would be interested in knowing the future plans of the company, the growth rate and name of directors and people running the company. Leasing company would need to know how long the company intends to use the assets, what will be the cash flow generation of the assets and what are the resources that the company has in case it is unable to pay for the use of the assets to pay the leasing company. Hire-purchase would require least amount of documentation. Since, the assets won’t be transferred to the company until it has been completely amortized, hence the hire purchase company has no risk and if the company fails to pay or use the asset, it can be sold in the open market and receipts from the company during the year in which it was used by the business would be extra profit for the hire purchase company. 1d) The best option is hire purchase because of the least requirement from the credit organization and because of the fact that no absurd cash outflows would take place which is going to improve the company’s cash conditions. 1e) It is very important for the organization to indulge in financial planning process at this point in time. The reason why is important I because they are trying something new and are adopting new business idea. If at this stage they are unsure about the future than they are more likely to fail than if they plan ahead. Task 2: Bank loans will increase company’s long term liability and cash column in the balance sheet. Since no interest is due in the next twelve months, there would be no short-term liability created since short-term liability only occurs when a company has a debt obligation falling within a year. Other impact of a bank loan on the balance sheet would be that it will increase the gearing of the company. Gearing tells the investors that how much of the company’s total financing has come from debt. In the long-run it would help reduce the taxes as tax is charged on income after interest expenses have been subtracted. Issuing equity would increase the cash column in the balance sheet under current assets and also the equity section under capital section. Leasing wouldn’t have any impact on the balance sheet apart from any periodic obligation due to them. Similarly, hire purchase will not have any impact on the balance sheet also apart from the periodic obligation. However, after the hire purchase has been fully amortized the equipment would become part of the company’s assets and would be added in the fixed assets column. Hence, from the long term point of view hire purchase is a good financing option as it does not impact balance sheet in any way in the short term and suddenly increases the assets of a company, after hire purchase has been fully amortized. From this discussion, we can see that hire purchase is the most feasible option for the company as it does not have any impact on the company’s resources in the short term which is a good thing for a new company like ours. Other than that, hire purchase allows the company not to make huge investment of purchasing an equipment at once, but the company has an opportunity to pay only small periodic payments that covers both interest and principal and once the hire purchase financing has been fully amortized, the hire purchase become part of a company’s assets. This is different from operational lease as despite the rentals being paid, the ownership of the asset remains with the leasing company. Hence, it is better for the company not to opt for leasing and instead choose hire purchasing option because it is going to increase the assets of the company in the long run and would stabilize the financial condition of the company. Hire purchase is also superior to other modes of financing as it leads to asset building, lower interest rate and there is no risk that the company’s original investors will lose control of the business by issuing too much stake for obtaining much needed funds for the company. In the end of this email, I believe that we should go with the hire purchase financing for the all the reasons discussed above and for the fact that it is much more beneficial for the company than any other source of financing. Task 3: 3a) Plan A Selling Price 65 Variable Cost 38 Contribution 27 Fixed Costs: R & D 300,000 Marketing 75000 Part Time Person 13,000 Total Fixed Costs 388,000 Break Even 14370 Units Break Even in Terms of Sales ?934,074.07 Plan B: Selling Price 100 Varialbe Cost 38 Contribution 62 Fixed Costs 388,000 Break Even 6258 Units Break Even in Sales ?625,806 3b) Since the contribution is higher in the plan B hence it takes less units and less amount to break even. Hence, the second plan looks more feasible as time has value and immediate payment can be invested into other projects yielding returns. Also the less number of units that have be produced to breakeven means that the company’s electricity and other savings in real term. In theoretical terms, the company’s fixed costs remain the same, but in real terms they can be decreased using innovation and street smart approaches. Hence, increase in contribution in plan B has reduced the breakeven point for the company. Coupled with other things and time value of money it is best for the company to choose plan B. 3c) At 65 Y1 Y2 Y3 Cash Inflow: Units 2500 2500 2500 Payment 35 35 35 Price 65 65 65 Total Cash Inflow 5687500 5687500 5687500 Cash Outflow Variable Costs 1140000 1140000 1140000 Fixed Cost 375,000 75,000 75,000 Part Time Person 13000 13000 13000 Total Cash Outflow 1528000 1228000 1228000 Net Cash Flow 4159500 4459500 4459500 Y0 -90,000 y1 4159500 y2 4459500 y3 4459500 NPV @ 10 $29,849.29 NPV @ 15 $11,779.84 NPV @ 20 $5,650.72 NPV @ 25 $2,955.05 NPV @ 30 $1,579.60 NPV @ 35 $807.73 NPV @ 40 $345.58 NPV @ 50 ($131.24) NPV is between 40 and 50 At 100 Y1 Y2 Y3 Cash Inflow: Units 20,000 20,000 20,000 Payment 1 1 1 Price 100 100 100 Total Cash Inflow 2000000 2000000 2000000 Cash Outflow Variable Costs 1140000 1140000 1140000 Fixed Cost 375,000 75,000 75,000 Part Time Person 13000 13000 13000 Total Cash Outflow 1528000 1228000 1228000 Net Cash Flow 472000 772000 772000 Y0 -90,000 y1 472000 y2 772000 y3 772000 NPV @ 30 ($2,385.32) NPV @ 40 ($1,902.86) NPV @ 50 ($1,577.30) NPV @ 70 ($1,171.79) NPV @ 100 ($844.06) NPV @ 150 ($575.10) NPV @ 200 ($435.98) More than 200% At 65 Payback 7.89758384 In Almost 8 days At 100 Payback 69.597458 In 70 days 3d) The best option considering the tools used at appraise the project is using the suggested marketing plan and pricing plan B. The return in this plan is greater than 200% as revealed by the NPV figure. Hence, it is best for the company to use the marketing and pricing plan B to maximize the wealth. The payback period is insignificant in this case because investment is getting covered in less than one year for both plans. In fact the investment is being covered in just few days. All of this shows that both the plans are feasible but the marketing plan B is yielding amazing result as the return in this plan is higher than 200%. 3e) i) Done in Excel ii) If my recommendation is accepted, the cash flow would increase by 90,000 upfront in the form of bank loan. Similarly, there will be period outflow of let’s say 9000 for every year in the form of interest. Then after three years there will be another big outflow of 90,000 as the loan will be paid off in three years time. This would add an extra cash outflow of 90,000 + 27000 = €117,000. Hence the firm would lose than amount if my recommendation is chosen. Hence it is better for the company and management to continue with the current method of financing and ignore my recommendation as the return s in the methods chosen by the company are as high as 200%. The plan B is the winner plan for the company. The returns are increasingly high in this plan and there are no absurd or sudden cash outflow as happening in my recommendation. Hence, the company should continue with the current plan for the profitability of the company. Conclusion: It can be safely concluded from the case that the business model adopted by the company is extremely profitable. The company should go ahead with it even if it involves obtaining expensive loans because the return on the company’s project are exceeding 200 percent and nowhere in the world the loans can be as high as that. Hence, the company should green signal to its finance people for the project even it involves aggressive borrowing. References: Calabrese, G. 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