Financial Management Issues - Coursework Example

work, Finance and Accounting Financial Management Question Answer (a). Option Cost of Equity Debt to Equity Ratio Debt = $ 500 Million Equity ratio = 1 billion Cost of Equity = (500000000 / 1000000000) = 0.5 * 100 = 50 % Option 2: Cost of Equity Debt to Equity Ratio = 1 Debt = 1 Billion Equity = 1 Billion Cost of Equity 1 Bn/ 1 Bn * 100 = 100 % Option 3: Cost of Equity Debt to Equity Ratio = 1 Debt = 3 Billion Equity = 3 Billion Cost of Equity = 3bn / 3 Bn * 100 = 100 % (b) After Tax Cost of Debt Option 3: After Tax Cost of Debt Cost of debt = $ 500 Million After tax Cost of debt = $ 500 Million * (100 – 40) /100 Cost of debt = 300 Million Option 2: After Tax Cost of Debt Debt to Equity Ratio = 1 Debt = 1 Billion Equity = 1 Billion After tax cost of debt = 1b * 60/100 = 600 Million. Option 3: After Tax Cost of Debt Debt to Equity Ratio = 1 Debt = 3 Billion Equity = 3 Billion After tax cost of debt = 3 Billion * 60/100 After tax = 180Million (c) Cost of capital Option 1 Capital = number of shares * the price per shares Capital = 50 * 80 = 4000 Million = 4 Billion Repurchasing half of the outstanding debt = 4Billion *1 / 2 = 2 Billion Cost of Capital = 2 Bn / 4 Bn * 100 = 50 % Option 2 Capital = amount of stock * the price of the stock Capital = 50 Million * 80 *1.2 = 4000 Million = 4 Billion After Buying Stock Capital = 4Billion *1.2 = 4.8 Billion Cost of Capital = 4.8 Bn / 4 Bn * 100 = 120 % Option 3 New debt = 3 Billion Capital = 50 Million * 80 *1.2 = 4 Billion After releasing new Debt Capital = 4Billion – 3 Billion = 1 Billion Cost of capital = 4 Bn / 1 Bn * 100 = 400 % (d) Best Option From the three costs of capital, the best alternatives are Option 3, because it has the highest cost of 400 %. This is because the higher the cost of capital, the greater is the expected return on capital investment. Question 2 (a) The decision as to whether the company should go ahead and borrow depends on the cost and benefit analysis. Cost The cost of capital is 100 Million Benefit Benefits of the investment = number of shares * the cost per share = 100 Million * 50 Benefit = 5000 Million After taxation Benefit = 5000 * (100 – 46)) / 100 Benefit = 5000 * 54 / 100 Benefit = 2700 Million Since the benefit outweighs the cost, the initiative is recommendable and the organization can go ahead. (b). Weighted average capital cost This is calculated as shown below: WACC with 100 million Borrowing WACC = ((D * Kd) / (D + E)) + ((E * Ke) / (D + E)) D = total debt = 200 Million E = Equity = $50 * 100Million) = 5000 Million Ke = Equity cost = 100Milion Kd = Debt cost = 1.5 * D = 1.5 * 200 Million WACC = ((200 * 200) / (200 + 5000)) + (5000 * 100) / (200 + 5000) WACC = (40000 / 1000000) + (500000 / 1000000) WACC = (4 / 100) + (5 / 10) = 4 / 100 + 50 / 100 = 54/100 WACC = 0.54 WACC without the 100 million borrowing: D = total debt = 200 Million - 100 Million = 100 Million E = Equity = $50 * 100Million) = 5000 Million Ke = Equity cost = 100Milion Kd = Debt cost = 1.5 * D = 1.5 * 200 Million WACC = ((100 * 200) / (100 + 5000)) + (5000 * 100) / (100 + 5000) WACC = 20000 / 500000 + 500000 / 5100 WACC = 2 / 50 + 5000 / 51 = 0.4 + 98 = 98.04 Question 3: a. Additional Debt The Earning from shares = 20 x 100000 = 2000000. Earning from bonds = 500000 x 10/100 = 50000 Earnings on T Bills = 500000 x 6 / 100 = 30000 Total = 80000 Marginal Tax = 80000 x 40 / 100 = 32000 Net earnings = 80000 – 32000 = 48, 000. Total = 500000 + 80000 = 580000 Additional debt = 580000 + (580000 * 1.15) Additional debt = 580000 + 667000 = 1247000 From the scale provided, additional debt = 1500000 Addition = ((1500000 – 1247000)/ 1247000) * 100 = 1253000 / 1247000 *100 = 100.4812 % b. Price per share Price per share = total debt / Number of shares 1247000 / 100000 Price per share = $ 12.47 per share c. Weighted Average Cost of Capital before additional Debt WACC = ((D * Kd) / (D + E)) + ((E * Ke) / (D + E)) D = total debt = 500000 E = Equity = 2000000 Ke = Equity cost = 1.15 * 2000000 = 2300000 Kd = Debt cost = 1.15 * 500000 = 575000 WACC = ((500000 + 575000) / (500000 + 2000000)) + (2000000 + 2300000) / (500000 + 2000000) WACC = 8.944851 d. Weighted Average Cost of Capital after additional Debt WACC = ((D * Kd) / (D + E)) + ((E * Ke) / (D + E)) D = total debt = 1500000 E = Equity = 2000000 Ke = Equity cost = 2300000 Kd = Debt cost = 575000 WACC = ((1500000 + 575000) / (1500000 + 2000000)) + (2000000 + 2300000) / (1500000 + 2000000) WACC = 1.821429 Question 4: a. Definition of Dependent variable and independent variable Dependent variable is the variable whose existence and behavior is influenced by another variable. It forms the subject of a mathematical model, such that when the values of the second variables change, dependent variables also change. Independent variable is the variable that affects the values of other variables but it is not changed. In the data provided, independent variables are: Firm Number Year Date of incorporation Account Currency In this exercise, we take the capital (C) as the dependent variable while long-term debts (LD) take the position on independent variables. The model created between the two is as shown below. C = LD* K, where K is a constant b. The summary for calculation of the variables is shown on the sheet 4 of the excel spreadsheet. The summary is as shown below. The results have been generated from SPSS, through the regression on multiple variables. Figure 1: Summary of Mean, Mode, Varience, Standard Deviation, maximum and Minimum Figure 2: Partial Correlation Analysis c. Comment The regression analysis shows the coefficient of linear relationship between the capital and the debt level to be a positive value of 0.988. This shows that indeed, the capital in the company largely depends on the debt level. The standard error is 1.8557. The statistical significance of the analysis is: Capital = 0.422 Long Term Debts: 0.399 d. The capital structure Comment: The analysis reveals the relationship between capital and the debt of the company. As the company debt grows, the capital amount also grows. Read More