Understanding Companys Stock - Speech or Presentation Example

Business Finance Submitted by: XXXXXX Number: XXXXX of XXXXXX XXXXXXXX XXXXXX XXXXXX Submission: XX- XX- 2009 Question 1 - Nitrogen Plc: a. Ratios: i. Earnings per Share (EPS): EPS = (Net Profit after Taxes – Preference Dividend) / No. of Equity Shares Interest Expenses = 14 % of £ 1,500,000 = £ 210,000 Net Profit = £ 960,000 - £ 210,000 = £ 750,000 Net Profit after tax = £750,000 – (30% of 750,000) = £ 525,000 Preference Dividend = 12 % of £ 500,000 = £ 60,000 No. of Equity Shares = £ 2,000,000 / £ 0.50 = 4,000,000 EPS = (£ 525,000 - £ 60,000) / 4,000,000 = £ 0.11625 ii. Book Value per Share: Book Value per Share = (Shareholder’s Equity – Preference Equity) / Outstanding Shares = (£ 2,000,000 - £ 500,000) / 4,000,000 = £ 0.375 iii. Dividend Yield: Dividend Yield = Annual Dividend / Current Stock Price = (£ 0.06 * 4,000,000) / £ 1.50 = £ 160,000 iv. Interest Cover: Interest Expenses = £ 210,000 Interest Cover = £ 960,000 / £ 210,000 = 4.57 v. P/E Ratio: Price – Earnings Ratio = Market Value per Share / Earnings per Share = £ 1.50 / £ 0.11625 = 12.9 vi. Return on Equity: Return on Equity = (Net Profit after Taxes – Preference Dividend) / Shareholder Equity = (£ 525,000 - £ 60,000) / £ 2,000,000 = 23.25 % b. Describe the main features and purposes of a bonus issue of shares: Bonus shares are issued in order to bring the issued capital in line with the employed capital of a company. It is interesting to note that no additional funds are raised with this issue of bonus shares. Bonus shares are normally issued due to the following reasons: The company has made profits and thus increased its employed capital. Hence bonus shares are issued to bring a balance. Markets consider the bonus issue of shares as favourable. The Share capital is increased as per the bonus issue ratio. Earnings per share and book value per share are all reduced. Market price of the share automatically gets adjusted to take the bonus issue into account. (Hobson, 2007) Question 2: 1. Effects on the Earnings per Share: Earnings per Share = (Net profit after interest and taxes) / No. of shares a. Issue of 15% debentures at par: b. Issue of £ 1 ordinary shares at par: c. Issue of £ 250,000 of 15% debentures and same amount of £ 1 ordinary shares at par: The three alternative ways are analysed and the effect on the EPS are determined as follows: (£) Alternative a Alternative b Alternative c Ordinary Shares 2,000,000 2,500,000 2,250,000 15% Debentures 500,000 0 250,000         Increase in Profit 80,000 80,000 80,000 Interest on Debentures 75,000 0 37,500 Additional Profit 5,000 80,000 42,500 Additional Tax 1,250 20,000 10,625 Net effect on Profit 3,750 60,000 31,875         Effect on EPS 0.0019 0.0240 0.0142 Original EPS 0.12 0.12 0.12 Net EPS 0.1219 0.1440 0.1342 2. Important characteristics which distinguish debentures from preference shares: Preference shares refer to the capital of the company and carry a fixed rate dividend. The preference shares are normally belong to the owners of the company. Debentures are similar to long term loans and they carry a fixed interest and are normally issued in the form of bonds. They are an effective way to raise additional capital for the company. The payment of dividend to the preference shareholders is under the discretion of the board of directors of a company, whereas the interest payment for debentures is not under their control. Interests on debentures are tax deductible whereas dividend payments are not. In the case of a company going insolvent, debentures get preference over the preference shares (Harvard, 2009). Question 3: a. A Stock exchange placing: A stock exchange placing will enable the company to raise the additional funds very rapidly. However the company has to also satisfy the demands of the common shareholders and a number of changes have to be brought in terms of the management and policies. There is also a possibility of another company placing a bid to acquire the company through the stock exchange. A stock exchange placing can also act an effective marketing for the company, as the more people will become aware of the business (Hobson, 2007). b. A Rights issue of ordinary shares: A rights issue is offered to all exiting shareholders, as opposed to stock exchange placing where the stocks are open to common public. The shares are issued based on a ratio, for instance, every share qualifies to buy another four shares, for a specified period of time. The shareholders can either accept or reject the offering. There is a possibility that the required capital may not be raised, as the shareholders may not accept the offering. However, the company does not run the risk of adding more shareholders and also taking the risk of mergers and acquisitions (Hobson, 2007 and Keef, 1992). c. Cancelling the ordinary dividend for the year: The additional capital required can also be raised by not paying the dividends to the shareholders for the financial year. The main advantage of this method is that there are no additional costs involved in raising capital. However, it is to be noted that the shareholders may not be happy with this decision and it might have a negative effect on the potential investors (Frankfurter, Wood and Wansley, 2003). Question 4 – Halsten Plc: a. Payback Period: Initial Investment = £ 40,000 - £ 5,000 = £ 35,000 Year Savings Cumulative Savings 1 12,000 12,000 2 13,200 25,200 3 14,520 39,720 4 22,520 62,240 It is evident that the pay back period lies between the 2nd and 3rd year of operations. Payback period = 2 + (35,000 – 25,200) / 14,520 = 2.67 years b. Net Present Value: The net present value is computed by discounting the future savings to present values at the company’s cost of capital of 15 %. This value is then deducted from the initial investment of £ 35,000, to obtain the NPV. Year Savings Discount Factor Discounted Savings 1 12,000 0.87 10,440 2 13,200 0.76 10,032 3 14,520 0.66 9,583 4 22,520 0.57 12,836 Total 42,892 Net Present Value = £ 42,892 - £ 35,000 = £ 7,892 c. Internal Rate of Return: Internal rate of return indicates the discount rate at which the net present value becomes zero. This value can be computed by trial and error and using interpolation methods. In order to compute the internal rate of return, the net present value at 20% discount rate is computed. Using this value and the NPV computed at 15%, the Internal Rate of Return can be obtained by using interpolation (in case the NPV is negative at 20%) or extrapolation (in case the NPV is positive at 20%). Question 5 – Cameroon Plc: 1. Cash Budget from July to September: Month July (£) August (£) September (£) Opening Bank Balance 4,500 3,140 (520)         Cash received for Sales 9,000 10,500 12,000 Expenses       Raw Materials (2,940) (3,220) (3,500) Direct Labour (4,000) (3,440) (2,320) Variable Expenses (920) (1,000) (860) Fixed Expenses (2,500) (2,500) (2,500)         Machines - - (15,000) Dividend Payments - (4,000) -         Closing Bank Balance 3,140 (520) (12,700) 2. Summarize the distinguishing features of a bank overdraft as a source of short term finance: An overdraft is a facility that can be availed on a current account and can facilitate withdrawals exceeding the balance maintained in the account. There is usually a limit set for the overdraft by the Bank. This overdraft is a form of loan and carries an interest on the outstanding amount. The main advantages of bank overdrafts are that, they are flexible (only required amounts can be taken on loan) and the interest amounts are paid only on the amounts withdrawn (Stoltz and Viljoen, 2007). Question 6: a. Perpetual Inventory: Perpetual inventory, also known as continuous inventory, refers to the accounting system in which the goods in hand or stock are continuously updated after each and every transaction. This updated figure on the goods in hand will enable the company to identify the correct time to re – order materials from suppliers. b. Minimum Stock: The minimum level of stock indicates the level of stock that has to be maintained at all times in the inventory. This is also known as the safety stock. The company has to ensure that the stock level does not fall below this minimum stock. It is computed as difference between re – order level and the usage for a normal period. c. Re – Order Point: The re – order point refers to the level of stock at which order has to be placed for the supply of materials. Ideally, re – order point is zero, which is when the stocks are completely over. However, there is a time gap between placing the order and receiving the materials (lead time). Also a safety stock should be maintained. Hence the re – order point is when the stock reaches a level equivalent to the sum of consumption during lead time and the safety stock. d. Economic Order Quantity: The Economic Order Quantity indicates the optimum level of order that has to be placed so that minimum costs are incurred. It is based on the assumption that the ordering costs, rate of demand, lead time and purchase price are all constant. The economic order quantity reduces the total costs involved in ordering and holding the stocks. e. Lead Time: The lead time refers to the time period taken by the suppliers to deliver the goods, once the order is placed. The lead time gives an indication of the stock that is required by the company to run its daily activities during the time period. (Samuel et al, 2000 and Weston and Copeland, 1988) Question 7: 1. Working Capital Requirements: Sales per week = 23,400 / 52 = 450 units Total Sales = £ 234,000 Accounts Receivables = (450 units *6 weeks) * £ 10 = £ 27,000 Inventory = (450 units * 3 weeks) * £ 2.50 = £ 3,375 Accounts Payables: Suppliers = (450 units * 5 weeks) * £ 2.50 = £ 5,625 Salary = (450 units * 1 week) * £ 4 = £ 1,800 Accounts Payable = £ 7,425 From the above data, Collection Period = 6 weeks Inventory period: Cost of goods sold = 23,400 * £ 2.50 = £ 58,500 Cost of goods sold per week = £ 58,500 / 52 = £ 1,125 Inventory period = £ 3,375 / £ 1,125 = 3 weeks Payment Period: Raw Materials and Salaries = 23,400 * (£ 4 + £ 2.50) = £ 152,100 Expenses per week = £ 152,100 / 52 = £ 2,925 Payment Period = £ 7,425 / £ 2,925 = 2.54 weeks Hence Trading Cycle = (6 + 3 – 2.54) weeks = 6.46 weeks Total cash requirement = Sales – Profit = £ 234,000 - £ 35,100 = £ 198,900 for 52 weeks Hence for 6.46 weeks, cash required = (£ 198,900 / 52) * 6.46 = £ 24,709.5 Hence the working capital required is £ 24,709.50. 2. Main Objective of the Credit Control System: One of the main objectives of the credit control system is to ensure a healthy cash flow for the business and a strong liquidity position. The credit control system can be set up to identify defaulting payments from customers and can be followed up to ensure payments at the earliest. Another main objective is to minimize the potential bad debts. The credit control system helps identify potential fraudulent transactions and help reduce the risks involved (Samuel et al, 2000). Question 8: Describe the problems faced by small companies in attempting to raise finance and explain the role of venture finance companies in providing such finance: Considering the current situation of the economies and the credit crunch across the global financial markets, raising funds for a small company is not an easy process. Raising the initial capital for an emerging small business is one of the most difficult obstacles. Only investors with high risk tolerance will be willing to invest in the small business and taking chances on whether the business is viable in the markets. If companies plan to raise finances from private investors will face issues as the investors are most likely to need a part of the equity stake in the company. Finding investors without the need for equity are normally very difficult to find and these investors are generally known as ‘angels’. Also if the companies try receiving funds from banks, the businesses require having a well designed business plan which is documented. If the banks find the business idea viable only then would they be willing to invest in the business. In these case the best options for the small businesses is to generate funds from venture capitalist. Venture capitalists are individuals who are ready to invest in companies (Weston & Copeland, 1988). They also bring in the managerial as well as technical expertise into the companies to help the businesses run smoothly and also have a track of the investments made in the companies as well. Venture capitalist also provide for funding for companies which are new and have limited operational history in the markets. This is the best form of funding for new companies and small businesses as the companies are immature to receive bank loans or even to complete a debt offering (Petreski, 2006). Bibliography Frankfurter, G. M., Wood, B. G. and Wansley, J. W. (2003), Dividend Policy, Academic Press Harvard (2009), Understanding your Company’s Stock – Harvard Business Inc., 4 June 2009, Accessed on 1 June 2009, Available at https://www.delawareinc.com/101/index.cfm?pageid=10071 Hobson, R., (2007), Shares Made Simple: A Beginners Guide to the Stock Market, 1 November 2007, Harriman House Keef, S. P., (1992), Rights Issues, Management Research News, Volume 5, Issue 2, p 15 – 16 Petreski, M., (2006), ‘The Role of Venture Capital in Financing Small Businesses’, National Bank of the Republic of Macedonia, Journal of Entrepreneurship and Finance, Forthcoming, 7th August 2006 Samuels, J. M., Wilkes, F. M. and Brayshaw, R. E. (2000), Management of Company Finance, 6th edn, Thomson Learning, London Stoltz, A. and Viljoen, M. (2007), Financial Management – A Fresh Perspective, Pearson Publishers Weston, J. F. and Copeland, T. E. (1988), Managerial Finance, 2nd edn., Cassell Educational Ltd, London Read More