Measuring and Managing Values of Companies - Assignment Example

Q1. CALCULATING THE WACC OF A COMPANY IS THE EASIEST THING IN THE WORLD weighted average cost of capital is an expression used to evaluate whether taking a certain course of action would be worth, this is because a company creates value of its share holders by adding value on there capital beyond their original contribution therefore necessitating the calculation of WACC. WACC is usually in most cases expressed as percentage in form of an interest rate, if a company works with a WACC of ten percent, it's usually interpreted that it cannot invest in projects or investments paying with returns less than that percentage. This can be in other words be the opportunity cost of capital, this is the cost on returns of investing capital in a company or else where. Calculation of WACC is not a simple task as many would think, this is because the only part which is simple is calculation of the debt a firm has, these debt include the bank loan and other borrowing, however this is usually the beginning of the hard task since it known that the equity finance is usually more expensive than cost debt finance, this is due to the fact that equity finance has complex computation of the risk premium making computation of WACC complex. This computation of WACC is made more complex when determining which debts or equity should be used to increase the returns on capital of the share holders. The inclusion of corporate tax- rate in this computation adds more trouble while calculating WACC in view of the fact that interest payment is taxable. Below is a formula for calculation of WACC; WACC=Debt/total finance (cost of the debt) (1-tax) + equity/total cost (cost of the equity) From the above facts, I would not agree with the statement that calculation of the WACC is the easiest thing in the world because even though the formulae appears simple it cannot be interpreted in lay mans language, e.g. the total finance includes all the trade credits and current liabilities which are reflected in the balance sheet of a company, but for the accountants who calculate the investments alternatives and evaluate critically the account of a company whose objective is to maximize the investment returns, it may not be a hard thing. But I would conclude by disagreeing with the statement. Q2. Determining the replacement of maximus limited machinery using equivalent annual cost: year capital investment running cost scrap value gross value present value factor present value 1 9999 0 9999 9999 1 9999 0 2985 5040 2055 0.909091 1868.182 present value 11867.18 2 9999 0 9999 9999 1 9999 0 4015 3100 -915 0.909091 -831.818 0 4015 3100 -915 0.826446 -756.198 present value 8410.983 3 9999 0 9999 9999 1 9999 0 8970 1080 -7890 0.909091 -7172.73 0 8970 1080 -7890 0.826446 -6520.66 0 8970 1080 -7890 0.751315 -5927.87 present value -9622.26 From the above calculations the machines should be replaced on the third year, this is because the net present value of the machine in the third year is negative (-9622.26) as compared to the other years where the net present value is positive. A negative present value means that the machine has negative value. This is a good measure of investment because it considers the time value of money and particularly useful for selection of a mutually exclusive investment and instrumental in achieving the objective of financial management, however one major factor that needs to be considered while selecting the better investment project is that, this is an absolute measure in that it favors the investment with higher NPV but it is likely that this project has a higher investment cost therefore, its doesn't give best results. Another factor to be considered is the whether the machines have different lives. 3. MARKET EFFICIENCY AND SHAREHOLDER WEALTH MAXIMISATION ARE TWO SIDE OF THE SAME COIN. Market efficiencies is defined as a market in which all the participants have all the information in the market, that is, all buyer and seller have know the prices concerning all the products whereas the investors are competing fairly without any irregularities such as barriers to entry whereas they only can earn normal profits as the consumers get a good value of their money. An efficient market implies that new investor cannot easily use the common strategies to gain entry even though there are no barriers to entry. In an efficient market both the production efficient and allocative efficiencies occur. In the long run, the market efficiency is achieved and the diagram below shows a situation where by the equilibrium price equals the marginal cost and equal to marginal revenue. This is case of a pure competitive market in which we can say that market efficiency and shareholder wealth maximization are same and the same side of a coin, this is because at the point of equilibrium; P=MR=MC, is point of wealth maximization and where the market efficiency is achieved. Share holder wealth maximization also means profit maximization, this means a situation where by the firm be in command of the output and the prices in order to reap the highest profits. This can be approached from a simple perspective that the profit equals the revenues minus the costs or profits are achieved when the marginal cost equals the marginal revenue. For firms operating in competitive markets this profit maximization is achieved when the marginal revenue equals marginal cost but in case of monopolistic competition, the marginal revenue is always higher than marginal cost because they control the market and are the price makers and therefore it makes profit maximization not equal to market efficiency because the monopoly price is always higher than market price as explained in the diagram below; To conclude my argument I would disagree with the statement because in most case the market efficiency is never realistic but the wealth maximization is usually achieved. Q4. Grantley Ltd working capital calculation: Working capital = current assets - current liabilities Gross profit = 50% Turnover = 36 million Gross profit = 36 X 50% = 18 million Current assets of the company include: Cash Debtors Current liabilities of the company include: Stocks Creditors Therefore the calculation of working capital for the company will be as follows: Working capital = current assets - current liabilities Working capital = (cash + debtors) - (stocks + creditors) Working capital for the company after the contract will be as follows: Working capital = (cash + debtors + 3.59) - (stocks + creditors) Therefore working capital will increase by 3.59 million pounds. The company can get its extra funding from the sales of its stocks in the market; the stocks to be traded should be increased so that the extra funding can be achieved as required by the new contract attained, also the current working capital could be achieved through the increase of credit supplies into the company. Q5.EVALUATE THE ISSUES THAT THE DIRECTORS SHOULD CONSIDER IN CHANGING THE DIVIDEND POLICY OF THE FIRM Decision making on changes of the dividend policy are made by board of directors, this is vital because it can have an effect on the stock price and the capital structure of a corporation. This decision is usually to pay the share holders of a company to pay them for having invested in the company. There are three main factors which should be considered when changing the dividend policy of a firm these are; The free flow is cash theory of dividend; this is where the firms pay dividend when there is surplus fund after investing al the feasible investment alternatives. Dividend clienteles theory; this is where a firm may have many different type of dividend patterns for share holders with different objectives, in such a situation a change in the dividend decision must consider all of them. Information signalling theory; this is where the investors tend to associate the increase of or decrease of the dividend to convey some message about the future of the firm since they cannot get the books of account of the firm to investigate about the future of the firm The firm managers should critically evaluate these factors because its likely to affect the investors and also have to consider how much excess/ surplus is available not forgetting the interest of its share holders. Q6.THE FAILURE OF A BUSINESS CAN OFTEN BE SAID TO BE A FAILURE OF STRATEGY A business strategy can be defined as a plan undertaking which is set of interrelated activities designed to achieve specific objective within a given budget and a period of time. This further means that a business can be a strategy by its self hence if it fails, the strategy can be said to have failed. Taking business as a strategy, its failure can result to have occurred due to a mistake in one of the stages of the strategy cycle. These stages of the strategy cycle are; strategy identification, formulation, appraisal, implementation, completion and evaluation. From the above argument, it can be agreed that the fail of a business can be said to be failure of strategy. On the other hand many businesses fail because failure of control of the resources, lack of enough resources, ignoring the customer needs, lack of proper record keeping, poor marketing, ignoring competition, lack of proper insurance cover and lack of training of the employees. A combination or one of these factors leads to business failure To conclude the above statement, I would agree with the statement since the business its self is a strategy, therefore which ever force can lead to its failure, and then the strategy will have failed. REFERENCES: Thomas E (2000) Valuation: Measuring and managing values of companies, John Wiley and Sons, UK George M and G Woods (2003) Divided policy: theory and Practice, Elsevier press, US Wikipedia the free encyclopaedia (2007) Markets, retrieved on 26th June, available at www.en.wikipedia.org Read More