Approaches to Financial Management - Assignment Example

Financial management assignment Name Institutional Affiliation Question 1 Financial management Introduction Financial management is a discipline that is concerned with the generation and allocation of scarce resources such as funds so as the most efficient users within the company through a market pricing system which is usually the required rate of return. Financial management approach usually measures its scope in a diverse field that basically comprises of the fundamental part of the finance (Brigham & Houston, 2012). Theoretically, financial management approach is widely divided into two parts. Approaches to the financial management Traditional Approach Traditional approach is considered to be the first stage of financial management that was utilized in the 20th century. This approach is based on the earlier period experience and the customarily accepted techniques because the key part of this approach is usually to raise funds for the business concerns. Traditional approaches usually comprise of vital areas such as the arrangement for funds from the lending body, arrangements of funds via diverse financial instruments and funding out the various sources. The prominence in the traditional approach is basically on the procurement of funds by the corporate firms that were woven around the viewpoint of the suppliers of funds as investors (Finkler, Smith, Calabrese, & Purtell, 2016). The aspect implies that the traditional approach was the outsider looking approach. Modern approach Modern approach is considered to be a methodical approach of looking into the company financial problems. According to this approach, the finance functions cover both acquisitions of funds in addition to funds allocation to diverse other uses. Basically, financial management is apprehensive with the aspects implicated in raising funds, efficiency and proper allocation of funds. The modern approach is considered to be more balanced as it articulates that financing is mostly concerned with funds procurements and funds application as it offers equal weights to both utilization and procurement of funds. Question 2 Differences between fund flow and cash flow According to financial management, cash flow statement is considered to be a report that depicts the alterations in the cash position that is outflows and inflows of a company. Cash flow is a methodical reconciliation statement that enlightens the main purposes for the variation between the closing and opening cash balances over the period (Madura, 2011). On the other hand, fund flow statement is considered to be a statement that shows the financial position ups and down or the variation in working capital of the firm between two financial periods. Question 3 Basing on the question, the PV of an ordinary annuity of $100 per year in perpetuity at the 7% rate of interest is $1,428.57. Present Value $100 0.07 $1,428.57 Present Value $100 0.14 $714.29 The PV of an ordinary annuity of $100 for every year in perpetuity at an interest rate of 14% is $714.29. The PV of the perpetuity will decline because of the higher rate of discount (Brigham & Houston, 2012). Question 3 (b) Amortization $1,000,000 = PMT (PVIFA 15%^-5) PMT = $1,000,000/3.3522 = $298,316 Loan amortization table Year Beginning Bal. Payment Interest Principal End Bal 1 $1,000,000 $298,316 $150,000 $148,316 $851,684 2 $851,684 298,316 127,753 170,563 681,122 The principal is $170,563/$298,316 = 57%. Question 4 (a) Equity shares Equity shares are considered to be the share that is not preference shares as the dividends on this particular type of shares is usually paid after the fixed dividends rate have been paid on preference shares. Usually, the dividends rates on the equity shares are usually not fixed and largely depend upon the available revenue and the board intention (Madura, 2011). Equity shares holders usually enjoy voting rights on all aspects that relates to the company business. Advantages of equity shares No fixed burden: as compared to preference shares, the equity shares have a set burden on the firm funds since the dividends on these particular shares are a question to profits availability and the board of directors’ intentions. Creditworthiness: basically, the offering of the equity shares does not change anything on the company assets because a firm can raise extra finances on the stability of its fixed assets. Disadvantages of equity shares Dilution in management control because any sale of equity stocks weakens the voting right of the current equity investors and broaden the power of control to the new shareholder and the transferred share might bring about power centralization in few hands. It can lead to over-capitalization because an excessive utilization of equity shares my results in over capitalization. A dividend for each share is low that it adversely impacts the investors’ psychology which is hard to cure. Question 4 b Internal sources of finance Internal sources of finance usually imply the nature of finance since it is the capital or finance that is created internally by the company unlike funds like loans that are externally arranged from financial institutions and banks. They include, the sale of assets, retained profits, and a decrease in working capital since the aspect of finance is considered to be a steady necessity for each growing company (Chandra, 2011). A firm can distribute its dividend from the surplus but according to the prescribed rules by the state. Surplus is usually accumulated from other diverse sources, moreover the remainder of earned revenues that are known as surplus capital arising from assets revaluation. The internal source of finance is used in the industrial concern by; Achieving a suitable dividend guidelines and enlisting the sustenance of the public Helping internal finance of projects exclusive of borrowings resumption It is used for retiring debentures or bonds for building up sinking funds for debt redemption. Question 5 (a) Based on the question, it is true that both investors must be enthusiastic to pay the similar price for General Electric’s shares. The stock share price is the present value of its projected dividends. If both shareholders expect the similar future dividends and they concur on the riskiness of the stock, then they must arrive at the same value of stock with the dividend discount approach that usually marks down the dividends and utilizes the rate of growth and the required rate of return that both investors have (Finkler et al. 2016). The time period is not relevant since both investors will discount all the prospect dividends so as obtain the cost currently and thus both will reach the similar cost. The price of the stock is the present value of a stream of cash flows which is the dividends. Both the shareholders are buying stocks in the similar period, and both shareholders agree at growth rate, D1, and at risk. The constant growth rate of the stock is calculated as follows Whether the investor holds stocks for either two or ten years, the stock value in the current year is considered to be similar. When the first shareholder sells his or her shares after the first two years, the stock value will be different from P0 due to the dividends growth. Correspondingly, when the second shareholder sells his or her shares after ten years, the stock prices will be different that is P2. Question 5 b Forecast of growth (g) Total required rate of return = Required rate of return* Current stock price Total required rate of return = 14% * $80 $11.20 Required appreciation in stock price = Total required return - Return in form of dividend $11.20 - $4 = $7.20 Growth rate (g) = Required appreciation in stock price Current stock price Growth rate (g) = $7.20/$80 9% Question 6 (a) Yield to maturity Time to maturity = 12 years Bond Par Value = $1,000 Coupon interest rate = 10% ($100) Bond selling price = $850 Year to maturity =? Price of Bond = 0.1*1000 + 1000 1+850 1+850 100 + (1000-850) 12/1000 + 850/2 112.5/925 0.1216 12.16% Question 6 (b) Based on the question, this particular statement is false because short-term bonds are obtainable for a short period of time which is far less probable that the going interest rate will heavily differ during the bond’s short life (Finkler et al. 2016). In several cases, the 1-year bonds will exist under the same going interest rate that their whole lives because of interest rates apt to take more period to change in a significant manner. Longer term bonds, conversely, apt to be more responsive to the rate of interest changes since interest rates are almost guaranteed to vary over the bonds longer life. In most cases, longer term bonds end up varying a number of times driving up and down the price bond frequently during its life. Example Let us presume a 1-year bond that is issued at 7% interest. This interest rate would be set by the ongoing market rate so we can also assume that it is 7%. Often, the market usually takes more time to react and shift so it might take approximately 1-2 years for any considerable change to happen at that interest rate. Thus, by the time it shifts, the bond will have already matured, and it is no longer in the flow (Chandra, 2011). If there is a 12-year bond offered at 7% in the similar market, it will be affected more by the fluctuation of the interest rate. Even if it takes 1-2 years for a shift, the bond will still be on the market so its value will shift consequently. A number of these 1-2 years cycles can happen during its 12-year life, so this particular bond is probable to see the swinging of its value over the years. References Brigham, E. F., & Houston, J. F. (2012). Fundamentals of financial management. Cengage Learning. Chandra, P. (2011). Financial management. Tata McGraw-Hill Education. Finkler, S. A., Smith, D. L., Calabrese, T. D., & Purtell, R. M. (2016). Financial management for public, health, and not-for-profit organizations. CQ Press. Madura, J. (2011). International financial management. Cengage Learning. Read More