Corporate Finance - Making Investment and Finance Decisions - Assignment Example

Running Head: Corporate Finance Name Course Lecturer Date Q1 The apparent conflict of interest between stockholders and mangers is because the stockholders want their investments in the company to be maximized for higher profits and consequently higher dividends. Burkart & Panunzi (2006) explains that managers want to maximize revenue so that they can have many sources of earning income for themselves. These disciplinary mechanisms may not work as expected because stockholders and managers have different objectives in running the company. Pache & Santos (2010) adds that stockholders wants hire the best managers but do not want to pay them more while managers set their remuneration once they are given the mandate. Stockholders do not have experience relevant in running the company and therefore may not understand the managers’ performance well. Morellec & Smith (2007) notes that managers view the company as a source of their salary, self esteem, perks and recognition as well as a way of creating value from their own human capital while managers wants managers to work diligently towards maximizing the value of their equity. Contrastingly managers examine the stock possession as one facet of their relation with the company. Stockholders lack information and are sometimes misinformed on control decisions which the managers are better informed. Though the board of directors represents the interest of the stockholders, they do not exercise sufficient control over the managers as they are typically handpicked by the insiders of the management who control the proxy process. His is the reasons why the disciplinary mechanisms might not work. Q2 a) 2012 % 2013 % Assets Current assets Cash 1482 2.2% 1553 2.2% Accounts receivable 3446 5.2% 4229 6.0% Inventory 8402 12.6% 8430 11.9% Total 13,330 14,212 Noncurrent assets Plant and equipments 53408 80% 56354 79.9% Total assets 66,738 70,566 Owner’s equity and liabilities Current liabilities Accounts payable 8885 13.3% 9003 12.7% Notes payable 7633 11.5% 8355 11.8% Total 16518 17358 Noncurrent liabilities Long term debt 6764 10.1% 4356 6.2% Owner’s equity Paid up capital 9000 13.5% 9000 12.8% Retained earnings 34456 51.6% 39852 56.5% Total 43456 48852 Total liabilities and owners equity 66,738 70,566 The largest use is in buying plant and equipment. This has consumed the biggest percentage of the funds for both years. The company as well is retaining a lot of profits that it generates. This consequently is the biggest source of cash. The company is keeping a lot of inventories. The inventories are many. This is not good as it is supposed to reduce them and maintain only necessary stocks to boost trade as White (2006) advises. The company does not have a lot of long term debt. It has reduced considerably from 2012 to 2013 meaning that the company has not made many investments for generating profits. b) Current ratio = Current asset/current liabilities 2012 = 13,330/16518 = 0.81 2013 =14,212/17358 = 0.82 Hennessy & Whited (2005) Current ratio examines the availability of the company's current assets to pay short term debt. It indicate the ability of the company to meet short current obligations with short the current assets. The company needs to ensure that it pays the current obligations failure to which it may limit its future access to credit and thereby inability to leverage growth and operations. The current ratio indicates liquidity issues as the ratio is less than one (1) for both years. This means that the company is using a lot of short term debt to finance its operations and doesn’t have short term assets to meet the obligations. Its far below the recommended ratio of between 1.2 and 2.0. It’s using more short term debt than it has current assets to pay them. Quick ratio = (current assets – inventory)/current liabilities 2012 = (13,330-8402)16518 = 0.30 2013 = (14212 -8430)/17358 = 0.33 The quick ratio indicates if the company has enough current assets without the inventory to cover its immediate liabilities. The ratios show that the company does not have enough current assets to meet its immediate liabilities as they are below 1.0 for both years. Consequently, it is has liquidity issues and it is highly geared. It cannot be able to pay its short term debts without selling the inventory. Debt/equity ratio = debt/equity 2012 = 6764/43456 = 0.16 2013 = 4356/ 48852 = 0.09 The debt to equity ratio indicates how the company is utilizing the borrowed funds. It cushions in cases of financial difficulties. These ratios shows that there is more equity and therefore the lender(s) are more likely to be repaid their funds plus interests. The company has too little debt and this may limit its potential as there is no leverage on investments to enhance profits as Byrd & Mizruchi (2005) notes. It has too little debt and may not have investments to generate revenues and increase profits. The debt has reduced considerably from 2012 to 2013. Q3 This scheme will make managers to be more responsive to stockholders. This is because it aligns the interest of the managers and stockholders as McAnally & Weaver (2008) quips. Managers will work to maximize their investment in the company and thereby maximize the stockholders wealth. They will be mindful of their equity in the company and they will work hard to maximize it. Bruce & Main (2005) explains that this is the stockholders objective and by this the stockholders and managers interests are aligned together. This makes them to work for the common good of the stockholders. Lenders of the firm will not be affected by this compensation schemes but they will welcome it because they want managers to be more responsive with their funds. Kuang (2008) asserts that managers usually do not want to go for borrowed funds to make investments for fear of nonperformance but when they have equity in the company they will be willing to take risks in order to make more investments and more profits as Byrd & Mizruchi (2005) states. Q4 b) The WES stocks are very volatile. This is because they have a lower average return. The other stocks are not volatile as they have high returns. Given an opportunity I would invest in All Ords as they have the best returns. c) There is no much difference in the betas of the two stocks. They are much relatively alike. Q5 The most important useful thing that I have learnt from the four topics is making investment decisions and finance decisions. This will help me to make decisions on the best possible way to make an investment. With capital and finances, I can invest in the most profitable investment as I know how to analyze and know which one is the best among many. It would as well help me make investment decisions once in a managerial level in corporate world. References Bruce, A Buck, T & Main, B (2005) Top executive remuneration: A view from Europe Journal of Management Studies. Burkart, M & Panunzi, F (2006) Agency conflicts, ownership concentration, and legal shareholder protection Journal of Financial Intermediation Byrd, D T & Mizruchi, M S (2005) Bankers on the Board and the Debt Ratio of Firms Journal of corporate finance Hennessy, C & Whited, T (2005) Debt dynamics The Journal of Finance Kuang, Y F (2008) Performance‐vested Stock Options and Earnings Management Journal of Business Finance & Accounting McAnally, M Srivastava, A & Weaver, C (2008) Executive stock options, missed earnings targets, and earnings management The Accounting Review. Morellec, E & Smith, C (2007) Agency conflicts and risk management Review of Finance. Pache, A & Santos, F (2010) when worlds collide: The internal dynamics of organizational responses to conflicting institutional demands Academy of Management Review. White, G (2006) the analysis and use of financial statements, (with cd) wiley.com Read More