Finance Management Test - Assignment Example

Explain why Virgen profits may not have been converted into cash reserves and describe what measures can betaken to improve this situation. This situation has got all to do with the firm’s dividend decision. As mentioned in the case study, share capital is one of the three finance sources for Virgen PLC. The dividend decision is a decision by a firm to either payout earnings, by way of dividends to shareholders, or retains the same for reinvestment purposes. Therefore, most of Virgen’s profits have been paid out as dividends and thus the small cash reserves. The dividend decision is an integrated portion of the financing decisions made in a firm and thus a payout influences to a high extent the amount that can be left as retained earnings as a source of internal equity. More specifically, the measures to be taken to see to it that this situation improves have to do with Virgen’s dividend policy. The policy should determine the amount of earnings payable to shareholders as dividends per financial year. These dividend payouts should be reduced. 2. State the formula for the gearing ratio and explain what the ratio is describing. State the advantages and disadvantages of Virgen being financed through share capital or issued bonds. Gearing ratio = long -term debt x 100 Equity +long-term debt This ratio is usually given as a percentage and it’s used to show how much of capital employed is from long-term debt and long-term sources of finance and thus, the higher the ratio the higher the given firm’s dependence upon long-term debt and finance. On the other hand, the lower the ratio, the higher the firm’s dependence upon equity finances. Share capital Advantages The funding is entirely committed to the business and the intended programs. Venture capitalists coming with the financing can bring with them contacts, skills and experience to the business. This can help in decision making and strategising The shareholders who happen to be the investor in the firm have a particularly vested interest in the success of its operations. Investors can also give a follow-up capital as the firm grows Disadvantages A lot of management time has to be invested in for the provision of regular information so that the shareholders can monitor the business’ progress. There are usually as well as legal issues that call for compliance while raising financing. Initially one can have a smaller business share in terms of the absolute value as well as in percentage terms. The mere function of raising share capital is costly, demanding and highly time consuming. Issued bonds Advantages A higher degree of flexibility in a firm’s capital structure is achieved through issued bonds. Due top this, a business is able to take timely measures when changes occur. It can serve as a tool to improve the company’s competitive edge. Issued bonds are utilised by businesses carrying out business in foreign countries to reach an optimal financial / capital structure. Also returns on corporate bonds can ensure a tax base as well as a business’ profitability due to interest tax shield. Investors or shareholders do not lose control of the business when they issue bonds. Disadvantages The creditor needs high levels of credibility from the business since interest returns have to be paid and the principal without consideration of the business’ profitability. Cost outlays arise due to bond emissions. This is due to the issue costs and lifecycle costs of bonds. Issuing businesses are faced with restrictions from the creditors originating from their right of opinions’ expression on predicament issues. The solution to these problems may impact on the claims’ setting up to the bonds. 3. Explain the main ways that issue bonds can be valued. Generally the value of issued bonds at maturity may differ in three ways. This is dependent on whether the bond is irredeemable, redeemable or even whether interest is an allowance expense to the business. Due to these three scenarios the cost of the bond to determine its value may differ. where the bond is redeemable, the cost of bond is kd= I +M-po n (m + po )/2 Where; I = Annual interest rate M =Maturity value of bond Po = Current market price of bond n = maturity period of bond Kd = cost of bond here the issued bond is irredeemable; Kd=I/po where we factor in the tax allowance factor Kd reduces to kd (1- T) where T = marginal corporate rate of tax. Generally, after the cost (kd) of bond has been determined the value of bond is determined as follows; M= po- It x (1+kd)n (1 +kd)t Where It= interest for the period t n= maturity period of the bond. 4. Describe which factors will need to be reviewed by the directors to decide which division to divest. Also, explain what any potential buyer will need to consider before they agree to buy the divisions. Before divesting, the Directors have to consider several factors like; Synergy – the economics that were being realised when the business was being operated as a combined course and how much would therefore be lost after the divestment. Taxation factors- whether the business made a profit or a loss- The amount of corporation tax that would be paid from the branch. If the taxes are unnecessarily high it should be done away with. Strategic factors- whether the divestment would lead to the expansion of the remaining business, the loss of customer base and the future implications in terms of performance. The buyer, on the other hand would consider similar reasons from a different perspective and additional others. These are:- Synergy- the economies of scale brought in by the new business and the addition to the already existing business in terms of marketing economies like distribution and marketing, financial economies and the efficiency in asset utilisation. Tax considerations- the amount of corporation tax payable by the new business. Where the new business might have made losses, this would lower the tax burden of the overall business. Asset backing- the new company may be having a substantial asset value that would help in building the business asset base Break–up value of Assets- the buyer may purchase a new business so as to break it up into smaller asset pieces and resell at a higher price realising capital gains. 5. Why may the current management be able to run virgin more efficiency if they succeeded in a management buy out of one of the divisions? Firstly, a management buy out ensure that the existing management save their jobs especially where such a division was set for sale to an outside buyer or for closure. The second benefit would be the fact that they would maximise on their financial benefits gotten from the division’s success where they take these earnings for themselves. It would also do away with outside potential acquire. 6. Explain the risks to Virgen of investing heavily in IT fixed assets. Investing heavily in IT fixed assets may be highly risky for virgin. The major risk associated with such an investment is that of obsolescence. This may occur where such assets are no longer needed despite their being in a good working order. This is due to the fact that new assets are frequently invented in IT and which come with more superior aspects and thus technical obsolescence in the virgin case is highly possible. 7. Describe the purpose of a due diligence exercise and what it will involve. Due diligence is an expression referring to the process of investigation of a given business with a specific standard care. In this case it may be a legal obligation. However, in most occurrences it is usually a voluntary exercise. More specifically, in this scenario it will involve the potential division’s buyer evaluating this division before acquisition. It may involve area like legal, financial, tax, labour, environment, information Technology as well as the market situation of the business. It may also involve personal and real property and intellectual property. 8. What are the potential advantages and disadvantages for a merger between Virgen and IBN for the following stakeholders: directors, employees, shareholders, customers, suppliers and the general public? Directors Advantages Since a public company’s reports are filed for all stakeholders to see, the directors can tell about the companies’ profitability and prospects. In terms of organization one head office is apt than many. Disadvantages Conflicts in objective differences and thus affecting the decision making process. There might be culture clashes in the two businesses due to the ways of operations. Some managers may be rendered redundant which may lower their motivation. Employees Advantages Redundancies may be advantageous if they are deployed more efficiently. Employees may borrow better skills from the more advanced company. Disadvantages Culture clash may occur due to the differences in the two businesses. Some employees may be rendered redundant negatively affecting their morale. Mergers may cause loss of jobs. Shareholders Advantages Shareholders of Virgen will own a small piece of the large IBN and this raises their total net worth. Since a public company’s reports are filed for all stakeholders to see, the shareholders can tell about the companies’ profitability and prospects. Disadvantages A merger may call for compromise where shareholders may be called on to give up some part of the company to the new shareholders. Mergers may bring in a new management that has a different motive other than profit maximisation. Customers Advantages The new company may bring with it a bigger variety of products. Better still there may be lowering of prices by the newly formed company. Disadvantages This may lead in to a reduction in consumer surplus and also lower quantity of production. This may lead to a monopoly and thus fewer consumer choices. Suppliers Advantages This may create a chance for suppliers to increase their supplies to the now bigger company. Suppliers may be called for to supply other products other than those they were supplying before. Disadvantages The newly formed firm may pay very low prices to the suppliers. The new company may bring with it suppliers who might substitute the existing suppliers. The general public Advantages Due to the requirements of disclosure for public companies it becomes a matter of the public to decide whether a company is worth investing in. It may create a better chance of investment in to the now bigger company. Disadvantages The new company may not put in to account the function of corporate social responsibility. It may lead to loss of jobs and they will negatively affect the general society. Read More