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Managing Financial Resources and Decisions - Assignment Example

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(a) Sources and factors; Long term loan, leasing of property, new issue of equity shares, and the use retained earnings to fund projects, and factors consists of; cost of capital, status of the economy of operation and the nature of competition that exists in the industry.
(b)…
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Managing Financial Resources and Decisions
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Managing financial resources and decisions Task Part A (a) Sources and factors; Long term loan, leasing of property, new issue of equity shares, and the use retained earnings to fund projects, and factors consists of; cost of capital, status of the economy of operation and the nature of competition that exists in the industry. (b) Implications; Issuance of new shares changes the legal status and dilutes the earnings per share of the company thus increased tax bracket. Repurchase of new shares reduces dilution of earnings per share thus reducing dilution of control. The legal status does not change while tax bracket widens. Retained earnings have no effect on legal status and dilution of control but a wider tax base is felt. The operating leases have no effect on legal status and dilution of control but affect the tax expense of a company. (c) Appropriateness of the ‘pre-sales apartments’- The company will be in a position to execute its plans without interfering with its available resources. This alternative would be cheaper and convenient compared to other sources. The other four sources involves outsourcing or use of company’s assets which could have impacts of varied degrees on the financial position of the company. Task 1 Part B (a) Analysis of cost of debt and equity, the advantages of using either debt or equity to finance the Hotel project. The cost of debt is the required return by the equity shareholders since if the company fails to deliver these returns as expected, the equity holders will just sell their shares causing the prices of shares to fall. On the other hand, the cost of debt is the interests paid less the tax savings from tax-deductible interest payments. Advantages of using debt; Interest paid on debt is tax deductible hence a lower tax bill for the company. Debt is cheaper and safer in that debtors have prior claim in case of bankruptcy. It offers investors lower returns. Advantages of using equity; Dividends from equity is taxable thus a higher tax bill for the company. Equity offers higher rates of return to the investors. Equity is expensive and risky as it offers priority to creditors in case of bankruptcy. (b) Importance of financial planning and advice. Financial planning is of great importance to a company. It increases the cash flows by limiting expenditures on productive operations. It helps build the capital base, thus, shaping the future of the company. It helps identify relevant investment opportunities for a company. It helps a company to save effectively. Effective financial planning is executed using a budget. A budget expenditures acts as a financial roadmap for operations of the company. It can be used to limit the expenditure of company resources on wasteful investments. Used by companies for future plans for expansion and growth. Acts as decision making tool by the management since it outlines a precise and comprehensive analysis on how the company is expected to spend its cash in future periods. (c) Characteristics of information needs for decision making on the planned apartments. Relevance The information should be able give a predictable value of the project. It should be timely and have a feedback value for manager and the supervisor. Reliability The information should be verifiable, represent the facts about the proposed project with utmost good faith and be neutral. Comparability The information should be able to expose the similarities and differences between events and conditions. This will enable manager and the supervisor to make comparisons between projects and undertake appropriate resource allocations. Consistency – the information should be consistent between time periods to facilitate comparison of value of projects. (d) Impact on financial statements: Long term loan reduces after-tax earnings and the number of shares in an equity – debt swap scenario thus, increasing the earnings per share. In operating lease, no assets and liabilities related to the prevailing lease documented within the balance sheet. The company’s asset is mainly recorded at a relatively lower loss thus making return on the assets to be higher as compared to the corresponding capital lease demanding a relatively higher asset base. Moreover, it permits a company to demonstrate healthier solvency ratios encompassing debt-to-equity ratio. Operating leases create an off-balance sheet financing thus making no liability to be documented on the underlying balance sheet. This is because there were no assets documented. The result is that the company would display better debt ratios to its debt lenders. Classifying leases as operating possesses more incentives. Nevertheless, it possesses a few advantages in regard to utilization of the capitalization method. Moreover, the underlying lease expenses would lessen net income, which correspondingly reduces revenue tax expense and prevailing rates of a company. The prevailing operating cash flow is projected to be relatively higher when capital lease is utilized since it does not establish any operating lease expense. Equity shares – a share repurchase will the cash holdings and its total asset base by the amount expended in the payback on the statement of financial position of the company. The shareholders; equity on the liability side reduces by the payback. Consequently, the return on assets and the return on equity improve. Task 2 (a) Analysis of the opening and closing cash balances for each quarter. Quarter 1 Quarter 2 Quarter 3 Opening Cash Balance 5000 46000 110000 Expected cash Receipts: Cash revenue 90000 80000 60000 Receivables 54000 57000 20000 Loan 10000 5000 - Total Cash Available 154000 142000 80000 Disbursements Material 20000 30000 55000 Labor 30000 35000 40000 Administrative 2000 2000 3000 Machinery purchase 45000 - 90000 Income tax 11000 11000 12000 Total Disbursements 108000 78000 200000 Closing Cash Balance 46000 110000 (10000) Recommendations: The management should secure a credit to finance the shortfall. The management should reduce their expenditure to avoid the shortfall. The management should establish a cash reserve to cushion the shortfall. Task 3 Unit cost = Total Production Cost / Total Units Produced _____________________________________________________________________________ $ Variable production cost (1.20 x 8000) 9, 600 Fixed production cost 40, 000 Total production cost 49, 600 Unit cost (49, 600 / 8000) 1.20 Total production cost 49, 600 Variable selling cost (0.40 x 80000) 3,200 Fixed selling cost 20, 000 Total cost 72, 800 Least selling price (72, 800 / 8, 000) 9.10 Least value of purchase (9.10 x 15, 000) 136, 500 The least offer that Q Limited must accept is $ 136, 500 assuming that it breaks even. Task 4 HOTELS Payback period (PBP) Net Present Value Year NCF Cumulative NPV NPV = Amount per period PVIF 15%, n - Initial investment ‘Million’ ‘Million’ = [60/ (1+15%) 1 + 30/ (1+15%) 2 + 0 (100) (100) 40/ (1+15%) 3 + 80/ (1+15%) 4 + 1 60 (60) 10/ (1+15%) 4] - 100 2 30 (10) = (52.2+22.7+26.3+45.7+5.7)-100 3 40 30 = 158.9 - 100 4 80 110 = $ 58.9 million PBP = 2 + [(/ - $ 10/) / $ (110 – 10)] = 2 + 0.10 = 2.01 years HOUSING NPV = (Annuity x PVAF 15%, 4) + Payback period (PBP) (Residual value x PVIF 15%, 4) – Initial investment. PBP = Initial investment / Cash flow per period = {60 x [1-(1+15%) 4 ] 15% + 20/ (1+15%) 4 } – 150 = 150 / 60 = [60 x 2.85 + 11.4] – 150 = 2.5 years = 171.3 – 150 = $ 32.7 million Both projects are viable. They have positive net present values and shorter payback periods. Similarly, the two projects can generate their respective initial capital outlays within the shortest time possible. If they are to be implemented independently, both should be accepted. But, if they are mutually exclusive, then hotels project should be prioritized due to its higher net present and shorter payback period. IRR is used in the determination of profitability of a project before it can be implemented eliminating losses associated with new projects. 5 (a). Income statement: shows the profitability of a company during time interval. Shows how a company incurs expenses and generates revenues from its operating and non-operating activities. Statement of financial position: provides information regarding the financial position, performance and changes in position of a company that is significant to a wide range of users such as investors, shareholders etc. at a given date in making economic decisions (IASB Framework). 5(b). Sole trader- the financial statements are simple and may not have a statement of financial position and an income statement as it only serves the owner of the company. Partnership: the financial statements are aimed at an analyzing the profits and capital of the contributors of capital thus more complex than sole traders’. They include statement of financial position, income statement. They are not based on set standards. Limited company: the financial statements are more complex than for partnership and include statement of financial information, cash flow statement, statement of changes in equity and income statement. These statements are prepared in accordance with accounting standards. Task 6: MERLOT GRAPPA ROCE 19.4% 14.8% Net Asset Turnover X 2.3 X 1.2 Gross Profit Margin 12.2% 12.5% Operating Profit Margin 9.8% 10.5% Current Ratio 1.3 : 1 1.2 : 1 Closing Inventory Holding Period 73 days 70 days Trade receivables’ Collection Period 66 days 73 days Trade Payables’ Payment Period 77 days 108 days Gearing Ratio: Debt-Equity ratio 225% 87.3% Interest Cover X 6.67 X 6 Merlot Company has efficient net asset management than grappa as indicated by its higher net asset turnover. The operating profit margin of Grappa is higher than Merlot’s, an indicator that Merlot Company could be experiencing very high operating costs. Merlot has a better current ratio; both companies have the potential to pay off their short term obligations using their current resources comfortably when they fall due. Grappa has a better closing inventory holding period than Merlot. Merlot has a better trade receivables’ period. Merlot is able to re-invest these cash back to generate more profits. Grappa has better of trade payables’ payment period. This gives them an advantage of generating more cash flows, too late, they forego discounts they ought to have received for early payments. Both are profitable and have enough interest coverage to cover their interest expense. Grappa has more efficient and profitable investments, thus, more earnings to shareholders. Merlot has high risks. EPG Plc should acquire Merlo Company due to its more comparative better performance over Grappa. References BPP Learning Media (Firm). (2007). Managing financial resources and decisions: Course book. London: BPP Learning Media. Read More
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