The Decision-Making in Corporate Finance - Coursework Example

Name of the student Name of the institution Name of the tutor Executive summary This paper examines the decision making in corporate finance. It has three major parts which has been discussed into details here. The first part discusses sales forecasting; its states that accurate sales generally forecast helps Company to escape stock run out and stop clientele from leaving to competitors. Secondly, the second part discusses the dividend theory. The share price divided model theory is one of the theories that can be used to explain earnings for shareholders and discussed in the paper. Lastly, the paper discusses cost of capital that can be amorphous as cost of obtaining money to fund asset purchase in the corporation. The paper concludes with giving a summary for the whole paper. Introduction One major function of management that most companies do not recognize is sales forecasting and it is an essential contributor to the organization success. The top management is assisted to make accurate decisions using sales forecast and it also gives the management chance to serve the customer better (Madura 2012). In case there can be accurate demand prediction, meeting customer expectation in time and efficient delivery of goods helps in maintaining their confidence. Accurate sales generally forecast helps Company to escape stock run out and stop clientele from leaving to competitors (Brigham & Daves 2012) at the baseline, the result of precise forecast can be very much profound. Raw resources and part that can purchase more effectively when last minute, sports market purchase can be avoided by the company. Unnecessary expenses should be eliminated through accurate forecasting the creation needs. Similarly, services of logistic that can be obtained at a more abridged cost through long term contracts rather than through sport market preparations. The effect of accurate sales forecast can be drastic and some of the key factors to be considered during forecasting include; Proper understanding of the meaning and concepts of forecasting by the management Good forecasting of demand and supply capabilities of the company Administration should be in a place to correctly manage corporate objectives more collaborate The administration should be in a place to eliminate Islands analysis This paper gives sales forecast for Carter Dicks Company giving five-year sales forecast and plan. This paper gives sales forecast for Carter Dicks Company giving five-year sales forecast and plan. Sales forecast Year 2014 2015 2016 2017 2018 2019 Sales 10 10.6 11.4 20.4 13.6 15 Expenses 9 9.54 10.26 18.36 12.24 13.5 PAT (10%) 1 1.06 1.14 2.04 1.36 1.5 Capital employed 12.5 12.5 12.5 12.5 12.5 12.5 Sales asset turnover 0.8 0.848 0.912 1.632 1.088 1.2 Dividends payout ratio 50% 50% 50% 50% 50% 50% Debt ratio 30% 30% 30% 30% 30% 30% Five Year financial planning Year 1 $ (millions) Year 2 $ (millions) Year 3 $ (millions) Year 4 $ (millions) Year 5 $ (millions) Revenue 10.6 11.4 20.4 13.6 15 Cost of Sales (4.77) (5.13) (9.18) (6.12) (6.75) Gross Profit 5.83 6.27 11.22 7.48 8.25 S, G&A Expenses (4.24) (4.56) (8.16) (5.44) (6) EBIT 1.59 1.71 3.06 2.04 2.25 Tax (0.318) (0.342) (0.612) (0.408) (0.45) Interest (0.212) (0.228) (0.408) (0.272) (0.30) PIT 1.06 1.14 2.04 1.36 1.5 Assumption in calculation of forecast Cost of sales is 45% of the total sales General and administration expenses are 40% of the total sales Graphically, the result can be shown as follows From the graph, there is s steady increase in profit from year one to year three reaching the highest level of 2.04 million. The profit declines in year four but further picks up again in year five. The forecast shows good business as the company will be making high profits compared to previous years hence the forecast shows business worth investing. Ratio of sales turnover Year 2014 Year 1 Year 2 Year 3 Year 4 Year 5 Sales asset turnover 0.8 0.848 0.912 1.632 1.088 1.2 The ratios explain how efficient the company is using its assets. From the thumb rule, in case the ratio is higher, it shows that the company is getting a higher return (Madura 2012). The comparison is made difficult as a result of variations of ratios from one industry to another. The comparison makes meaningful only if compared to industries in a similar sector or the same year. From the analysis, the sales asset turnover ratio increases every year signaling an improvement in the company utilization of its resources (Brigham & Daves 2012). The debt ratio has remained constant throughout the period indicating good management of trade debtors. Therefore, the company should continue reducing the number of trade debtors throughout the period. Task two Company dividend decisions concern with the decisions about the allocation of business earnings between payments to the shareholders and retained earnings (Deshmukh, Goel, & Howe 2013). The retained earnings constitute one of the most potent sources of funds for financing corporate growth; on the other hand, dividends constitute the cash flows that accrue to the equity investors. Although both the growth and dividends are desirable, these two goals are conflicting. A higher dividend rate shows that less retained earnings and consequently, a slower rate of growth in earnings and stock prices (Deshmukh Goel & Howe 2013). The earnings that are retained constitute the most important source of capital to finance company growth. On the other hand, dividends constitute the cash flows that accrue to the equity investors. Although both the growth and dividends are desirable, these two goals are conflicting. A higher dividend rate shows that less retained earnings and consequently, a slower rate of growth in earnings and stock prices (Deshmukh, Goel, & Howe 2013). The finance executive always has to strike a satisfactory compromise between the two in such a way that shareholders wealth in the company is maximized, prudent finance executive takes dividend decision in the light of investor's preference, liquidity position of the company, stability of earnings of the company need to repay debt restriction in debt contract access to capital markets, control and other similar factors (Hussainey, Oscar, & Chijoke-Mgbame 2011). Dividends Policy In most cases dividend policy relies on the characteristics of the firm, the characteristics of shareholders and the profitability of the company. Dividend declaration methods give another method of policy classification. They include; Regular dividend policy Stable dividend policy Irregular dividend policy No dividend policy The policy of dividend helps to determine the division of earnings between stockholders payments and reinvestment in the firm. The work of managers is to allocate the earnings to dividends or withhold earnings. Retained earnings are one of the most important sources of fund within an organization and for the growth of the corporation. Corporate expansion finally makes it possible to get additional dividends. Dividend theories The share price divided model theory is one of the common theories that can be used to explain earnings for shareholders. Discounted earnings is the basis of this theory and states that the return rate of shareholdings earnings changes with outside factors. Personal investors should be in a position to buy future dividends when the value of the shares is the only price they can get. The market establishes the stream of share prices through discounted future dividends. The model is based on that particular assumption. The discounted dividends assume that investors know the streams of future dividends, and so they are supposed to have perfect knowledge. The white beck- kisord model (1963) argues that share prices are not based on their discounted dividends but on their dividend models. Deshmukh, Goel, & Howe (2013) built a dividend signal model for the dissipative signal type. Madura (2012) examined further examined security evaluation theory and synthesized the multiple dates settling with quite uncertainty. The result of the theory in the formation of the determinants formula of the security values as the main function of the predictable dividend attuned for the discounted of dividend structure risk and the free risk rates. The CAP models are in most cases seen as one of the special cases in the free risk rates dividends. In cases like this, the security payoff are seen as the variation on the information as the main security determinant of the dividend plus price. Madura (2012) stipulates that only predictable dividends which can also be used as valid capitalization of the current value, which is attributed to security. Lasher (2013) further studies the ability of the dividends results to assist in predicting ling horizon return on the stock. Two series results were used and the result shows that dividend yields only show trivial ability to forecast supply market returns in either country. However, other scholars not sure of dividend theories, initially, studying the market price shares theory depends on the corporation proceeds. There is no dividends result on the share prices and the shareholders are supposed to be so cultural such that, when the corporate maintained the profits and fails to pay dividends as they waits for the company to spend its initial fund so that can quote their expected return, while on the other hand, dividend policy does not influence the market price of the shares (Deshmukh, Goel, & Howe 2013). Sources of finance A business can source finances either internally, that is within the business or externally that is outside the business. Internal sources include Owners own investment like start up capital Retained profit Sale of stock Sale of fixed asset and lastly Debt collected Retained profit can act as a long source of fund for business. This was when the profits made normally ploughed back into the business. It can serve as both long and medium source of fiancé (Deshmukh, Goel, & Howe 2013). The advantages of retained profits are that it does not have to be repaid, and it attracts no interest. The demerits include lack of availability to new business and business may not make enough profit to plough back. External sources of finance include Bank loan overdraft Additional partner Leasing Share issue Higher purchase Trade credit Government grants Except higher purchase, bank overdraft, and trade credit, all other sources are long term sources of business finance (Brigham & Daves 2012). Issue of shares, for instance, is a source of finance suitable for limited company, and it involves issuing more shares. The merit of share issues is that it does not have to be repaid and attract no interest (Brigham & Daves 2012). However, this kind of sourcing funds increasing the number of shareholders making dividends be paid to more shareholders while at the same time the company ownership is being diluted. Some of the factors that affect the source of finances include Purpose- that is what the management intends to do with the finance Period- the time frame through which the finance will be returned is an important factor Amount how much money the business needs and lastly The business ownership Advice to the management From the above discussion and current company policies of increasing the dividends with increase of profit, the company needs to change this kind of policy as it reduces the most vital internal source of finance. The 50% dividend payout and increase with an increase in profit should be charged in a business in order for it to raise more funds internally. The theory of security assessment for manifold dates settling with indecision explains the important of retained earning further supporting the theory of retained earning in the business. Therefore, that company needs to reconsider their dividend policy and long-term sources of finance. The ratio of debt to long-term funds (debt plus equity) should be kept at the current industry average of 30% that happens to be the current gearing level of the company should be reduced further while issuing out new shares should be the last resort as it is in the company current as further issuance of shares would dilute the company ownership. Task three Cost of capital can be amorphous as cost of obtain money to fund asset purchase in the corporation (Wegener & Eiben 2013). Use of approximation of r (Discount rate) if we can earn more than the cost of capital (r) from the project than the company should undertake. The rule accept the project if actual return > cost of capital (r) reject if the actual return < capital cost. Therefore the cost of capital (r) is maximum return that any investor can accept (Wegener & Eiben, 2013). Use average sources of fund Sources include Debt (rd) Preferred stock (rp) Common stock -Retained earnings (rs) New issue of common stock (re) Cost of debt (rd) = 30% Cost preferred stock Rp = DP/ (VP (1- fp) Again fp = floatation cost = 0.8* 100 = 80% Cost of long-term borrowing = 6% Weighted Average Cost of Capital WACC = ra = wdrd (1-t) + wprp + wsrs 0.3 (1-0.8) + 0.3 +0.06 = 0.42 42% The value of delivered to shareholders due to managers ability to grow the earnings, dividends and share prices is the shareholder's value. In other words, shareholders value can be defined as a sum of all planned decision that influences the companies’ ability to efficiently increase the amount of free cash flow over time (Wegener, & Eiben 2013). The two main drivers of the shareholder's value are the wise investment decisions and healthy returns on capital. Value-based management (VBM) is a concept used to describe the management in which management are expected to maximize the shareholder's value (Madura 2012). It can also be described as a management approach whereby the company overall ambition, logical technique and organization process are all aligned to help the company maximize its value by focusing management decision making process on the key drivers of the value (Madura 2012). The value based management argues that the company profit should be measured in a way that takes into consideration the cost of capital employed to generate revenue. From the analysis, 30% debt to equity ratio is high indicating that most of the capital invested in public companies has come from nonissue share capital and retained earnings (Brigham, & Daves 2012). The investors who purchase shares will only have to pay part of the cash on a promise of higher return on them. From this point of view, the company’s shares capital is being utilized and generates enough returns since returns are greater that the cost of capital invested (Madura 2012). Shareholder's value is created by generating future returns for equity investors that exceed the returns that those investors could expect to earn elsewhere (Wegener, & Eiben 2013). The belief is that these excess returns will be reflected in the share price of the company (Brigham, & Daves 2012). The returns are normally measured in terms of cash flow and consists of resources is used to accuse of the use of the capital invested. In essence, the idea is that if you manage your business to add to your business to add to shareholder's value, then one need to prove the value of shareholders investment and this is consistent with the objective of the company to maximize the shareholder's wealth (Brigham, & Daves 2012). In this analysis, the shareholder's value has been calculated using the present value of economic profits of the company into the future rather than the free cash flows. Shareholder value analysis is normally used in estimating the value of shareholders in a company and business unit. From the analysis, the shareholder's value is 30% compared to WAAC of 42% Free cash flow reflects the cash flow from the operations of the business for a given period before considering any financing related cash flows, such as those relating to shares or debt. These include dividends, interest payments among others (Wegener, & Eiben 2013). From the company; Sales 432 Less Operating costs (8) Operating profit 416 Tax (30) Op after tax 386 Investment capital (234) Free cash flow from operation 148 Technically, in order for the value of the business to be accurately determined free cash flow for all future times. The advantages and disadvantages of SVA As can be seen from the analysis SVA can be used to worth a business. It can also be used to assess option strategic decision in an organization by comparing the pre and post plan value of a company (Wegener, & Eiben 2013). Moreover, the simplified approach, which emphasizes the seven key value drivers, lends itself to the sensitivity analysis. Sensitivity analysis involves assessing the effect or changes in assumption on the value of a business or a strategy. This strategy can be particularly useful way of identifying the critical variables that affect shareholder's value (Wegener, & Eiben 2013). Shareholders value analysis can also have relevance in an operational context. The seven key value drivers can be broken down into more detailed and practical performance measures and targets, so that managers are normally confident to act in a manner that are consistency with the ultimate objective of creating shareholder's wealth (Madura 2012). The most significant problem with this technique is predicting the variables that are necessary for the analysis (Madura 2012). Summary Shareholder's value has become one of the issues in most boardrooms not only in United Kingdom but the whole world. However, in the case with management ideas, the concept of the shareholders value around for several years. In terms of organizational objectives, it is consistent with maximizing shareholders wealth. It differs from the traditional approaches to measuring performance in the way in which it is calculated and reports that wealth. It has been suggested that merely adopting the terminology may result to increase in the company share value owing to an improvement in modern company objectives. For the companies to continue reaping the actual intrinsic benefits from these measures, it cannot be enough simply to calculate and report the measures. For an ongoing and sustainable increase in shareholder's value to be achieved, organizational changes must be undertaken to shift the focus of the management away from he profit and towards value drivers. Bibliography Brigham, E., & Daves, P. 2012. Intermediate financial management. Cengage Learning. Deshmukh, S., Goel, A. M., & Howe, K. M. 2013. CEO overconfidence and dividend policy. Journal of Financial Intermediation, 22(3), 440-463. Hussainey, K., Oscar Mgbame, C., & Chijoke-Mgbame, A. M. 2011. Dividend policy and share price volatility: UK evidence. the journal of risk finance, 12(1), 57-68. Lasher, W. R. 2013. Practical financial management. Cengage Learning. Madura, J. 2012. International financial management. Cengage Learning. Wegener, M., & Eiben, J. 2013. Dividend Policy 19B-Deanna Perez Fashions. Read More