Some Issues of Financial Management - Assignment Example

Financial management Students Name: Institutional Affiliation: Department Course: Date: Question 1 Cost of individual components of capital 1) Cost of debt Where I=interest T=tax bracket PV=par value Mv=market value kdt= 12%(1-0.4) + [(1000-880)\20] [(1000+880)\2 0.071*100 7.10% Cost of preference shares Where fe= floatation cost D= discount 2) Cost of ordinary shares Where do= earning expected to be paid Po= par value of shares Fe= flotation cost D= discount 5(1+8.92%) 83.33 0.06535+0.0892 15.46% Calculation of growth rate Where eps = earnings per share G= growth rate N= number of periods G= 4√4.63 1 3.29 8.92% 3) Cost of new ordinary shares Where do= earning expected to be paid Po= par value of shares Fe= flotation cost D= discount 5(1+8.92%) 73.33-5.40 0.08017+0.0892 0.16937*100 16.937 d) Assume that all ordinary share equity is from retained earnings; calculate the weighted average cost of capital using: Book value weights book value amount book weight cost wacc ordinary shares 2000000 0.53 15.46 8.19% total 3800000 Market value amount weight cost wacc market value 4000000 0.73 15.46 11.29% total 5500000 Target weights target weights cost wacc 0.5 15.46 7.73% e) Assume that all ordinary share equity is from new ordinary shares; calculate the weighted average cost of capital using: Book value weights book value amount book weight cost wacc ordinary shares 2000000 0.53 16.94 8.98% total 3800000 Market value amount weight cost wacc market value 4000000 0.73 16.94 12.37% total 5500000 Target weights target weights cost wacc 0.5 16.94 8.47% f. Review the answers in d and e. and report on your observations regarding Bee's weighted average cost of capital. WACC of d= book value 8.19% book value for e= 8.98% and market value = 12.37% This means that the cost of capital in d is constant when it comes to both market and book value but it changes in e as the cost increased from 8.98% to 12.37%. Moreover, the fact that the shares are issued from a new shares rather than using the available shares while that of d- are from all retained earnings. This shows that it’s expensive to use all retained earnings as source of capital the issue of new ordinary shares. Question 2 EPS= net income outstanding no. of shares debt ratio total debt equity ordinary EPS financing shares 0% 2000 0 2000 80000 3.75 10% 2000 200 1800 72000 3.92 20% 2000 400 1600 64000 4.09 30% 2000 600 1400 56000 4.29 40% 2000 800 1200 48000 4.33 50% 2000 1000 1000 40000 4 60% 2000 1200 800 32000 3 The best structure that will maximize EPS in the one with a debt ratio of 40% and EPS of 4.29 EPS = EBIT-INTEREST OUTSTANDING SHARES b. coefficient of variation = standard deviation expected return standard deviation = (eps*prob)+ (eps*prob2)….. Probability debt ratio EPS standard dev 20% 10% 3.92 0.885 40% 40% 4.33 1.32 40% 60% 3 0.346 0.2*3.92= 0.784 0.885 0.4*4.33= 1.732 1.32 0.4*3= 0.12 0.346 The eps of 40% is more risky to invest as the standard deviation is the most of 1.32 and beyond one. Question 3 Break points of weighted marginal cost of capital and ranges of financing The red line is the marginal cost of capital and the black is the break points. a. Marginal cost of capital(mcc) Long term debt (0.4*6.5)+ (0.4*7.5) + (0.4*9)\0.4 =23% Preference shares (0.1*9.5%) + (0.1*10%)\ 0.1 =19.5% Ordinary shares (0.5*11%) + (0.5*12.5%) + (14*0.5) \ 0.5 = 37.5% Marginal cost of capital= 8% Weighted average cost of capital b. Investment opportunity schedule c. Residual dividend policy This will articulate on the retained earnings then distribution of the remainder to shareholders. Retained earnings = $1,200,000\2 = $600,000 Question 4 a. Role of fisher model in corporate Fisher model has enabled firm make best investment decision. Fisher model has enabled investors to make the best investment using the model. The model has pragmatic details which has rekindled the hope of investors to accentuate on the best choice of investment. This has save more on the investment infrastructure and the money saved used in investment projects. The firm has been able to choice on the best productive opportunities presented as the firm will be able be capitalize on the net present value. The choice will be made out of owner preference as the model will depict on the best choice of investment. Achievement of the firm objectives The model has shaped way for the choice of best market for the firm. With the use of the model the firm can postulate on the getting the best market. With the market position presented the model can articulate on the best market position. Investment decision has been boosted by the use of the model as it gives more freedom on the required market. The investment can be funded through the borrowed money or internally generated money. The firm will achieve more optimally in terms of market segmentation and market ownership. This has enabled marketing and more generation of funds to aid in investment projects. b. Fisher model assumption The model has been faced by the following assumptions; 1. The information is received simultaneously by the agent’s accustomed bearing no cost attached to. The information is perceive to be on either being certain or risky. 2. The competition is the one of perfect on the securities and product in the market. 3. There is lack of direct transactions in costs, taxes and all asserts are perfectly divisible. 4. The agents possess different monotonous preferences, and exhibit a decreasing marginal utility[Abe07] 5. The agents and players in the economy have discretion of either making a choice to purchase stocks in a firm that has four investment options at its disposal. 6. All investors are coherent and risk-averse. 7. All investors have homogenous expectations c. Is it possible to draw the possibilities curve as an algebraic function? It’s possible because of the reason that the calculation of possibility curve uses the information obtained from the investment projects. The information obtained from the different investment proposals is used to calculate the possibility curve as this will be of great relevance. Using the information from the present values of investment proposal will be used to calculate the possible opportunity cost attached to the investment[Bri11]. The possibility curve can be drawn from the algebraic function. The mix of two products can be used to come up with possibility curve. The possibility curve is used in the economy to accentuate on the best production which will postulates on the best and effective investment in the economy. The possibility will dwell on the consumer preferences thus the possibility of accentuating on the possibility curve from the algebraic function. d. Separation Theorem The theory postulates on the key differences on the firm choice of investment and the owners attitudes towards to the investment[Abe07]. The theorem goes ahead and articulate on the firm’s decision in terms of financial status and the firm’s investment decisions. The separation theorem has great impact on the investment decisions made. The investment decision made will revolve on the firm’s attitude thus postulating on the firm making key investment decisions which will reflect in the success of the firm in business. The separation theorem will be of importance to shaping the attitudes of owners to reflect the kind of investment to be taken upon. The theorem has too kept alive the investment proposals of the firm. The firm will invest on the best investment option after critical evaluations and tremendous analysis[Bri11]. e. How does the Fisher Model relate to the ‘nexus of contracts’ idea in corporate decision-making? The nexus of contract explains that all companies and corporations are merely made up of contracts. The model fisher goes ahead to give that corporations owners have different attitude as oppose to the funding expectations. The model explains the interrelationship that co-exists between the many parties attached to the company. Nexus of contracts postulates the same idea and this has boosted decision making in corporate sense. Fisher model articulate on the human resource relationship as the nexus of contracts too having the same picture on corporations and companies. References Abe07: , (Abel, 2007), Bri11: , (Brigham, 2011), Read More