Questions Covering on Financial Management - Assignment Example

Running head: INTRODUCTION TO FINANCE Questions Covering on Financial Management Name Course Information Professor Information Date Due 1. Marco Boncordo Remainder require yearly deposit: 2. Choosing between investment options Depositing the money today yields yielding 8.2% semi-annually In the second option, $11,000 will be invested at 10% within a period of 8 yrs after waiting for 2 yrs. Investment should be made right now to earn returns at a rate of 8.2% semi-annually. The future value will be  compared with a value of  if investment is done after waiting for two years. 3. Saving money for investment purposes The starting point is to find the present value that will fund withdrawal of $100,000 annually for 25 years. We now proceed to find the amount of annual deposits in order to gather future value of $784,313.91. 4. Repayment of a loan Outstanding balance after 4 yrs: The balance is still very high because of interest and principal repayment. The cost of borrowing in this case is: . This interest payment contributes to the current high outstanding balance. 5. Carter limited Carter Limited Peer group Return on Equity 23.1% 23.1% Profit margin 4.9% 5.3% Asset turnover 2.6 times 3 times Financial leverage could have contributed to Carter’s ROE of 23.1%. As opposed to concentrating on equity, the company could have resorted to borrowing funds to raise finance, which eventually improves the return on equity (Khan, 2004). Carter’s profit margin and asset turnover is low compared with that of peer group hence the conclusion that the company could have used financial leverage to improve return on equity. Equity multiplier: Manipulating the above equation results in: Carter company 1.81 Peer company 1.45 Comparing the figure above, Carter has higher equity multiplier hence more leveraged compared with Peer Company. One of the benefits of financial leverage is retaining ownership. This would not be the case if the company were financed using equity. Equity will require decisions to be made by owners whereas in debt financing decision-making is retained and not distributed. Financial leverage also enables the owner to enjoy profits alone after clearing borrowed funds. This is different with equity because sharing of profits continues into the existence of a company. Thirdly, a company will capitalize on tax holidays because loan interest is subtracted before arriving at taxable profits. Despite the aforementioned advantages, financial leverage is not good because of financial risks involved. In the same vein, lending institutions would require high rates for companies that are highly geared. Ultimately, it becomes a huge cost to a company in the form of cost of equity. Contracts involved in debt financing will affect future financing because financiers often look at credit history of a borrower. 6. Profit maximization vs. value maximization In the past, businesses were concentrating meeting their expenses. Some companies have however moved to wealth maximization, which entails improving value of the business. While wealth maximization looks at long-term, profit maximization concentrates at the short-term goal (Shim and Siegel, 2008). This new approach is superior since it is sensitive to time value of money. In line with this approach, investment choices are made after subjecting future earnings to discount rates. The present values obtained from the operation gives a wider perspective of an investment because risks have been factored into the equation. A company can then proceed to raise capital bearing in mind that the projects have gone through a good appraisal. One of the internal factors affecting share price is dividends that have been declared. When a higher divided is declined in a financial year, share price would appreciate upwards. Dividends are declared because a company have cultivated profits. This increases value attached to shares of a company. Issuing shares instead of distributing cash also has the effect of reducing value and price of share. In the external environment, share price varies with demand and supply in the stock market. If demand for a stock increases, price of that share would appreciate. Similarly, stock price would decline with high supply of the stock in the stock market. Depending on social, economic, and political stability of a nation, investor confidence can be high or low. High investor confidence boosts the price of a share. Exchange rates as well affects share price. When exchange rate is high, price of a stock is expensive to an investor. This leads to low demand and deteriorating price of a share. High inflation and interest rates have the same inverse effect of reducing demand for a share. I think management decision can affect market value of the existing owners’ equity. This is because when management manipulates company accounts such that they appear to be profitable venture, market value of equity will improve. It is critical to note that value of equity varies with financial and operational position of a company. References Khan, M.Y. (2004). Financial Management: Text, Problems and Cases. New Delhi: Tata McGraw-Hill Education. Shim, J. K., & Siegel, J. G. (2008). Financial Management. New York: Barron's Educational Series. Read More