Finance and Resource Management - Essay Example

Finance and Resource Management Cost analysis: The case under consideration is the patrol car and its associated expenses. The car was bought about seven years back and the cost of vehicle was $5000. The life time of the vehicle was estimated as 10 years. A new vehicle, of course with improved facilities for patrolling and so on, but having the same engine capacity and dimension would cost around $9000. As advised by the auditors, the vehicle was to be depreciated by following straight line method. This would mean that value of vehicle would go down by $500. Thus, this year the vehicle would be depreciated by $500. On the other hand new vehicle would be depreciated by $900 if the same technique were to be followed. The vehicle would be used, on an average 80 kilometers. The fuel efficiency is 8 kms per litre of petrol. Thus, there is a requirement to use 10 liters petrol. Each litre is costing about $2 and so petrol cost would be $20 per day and for 355 days, it would be $7100. The new vehicle has better fuel efficiency giving 10 kms per litre. It would thus require 8 litres per day and with the same cost of petrol, the yearly requirement would be $5680 (that is, 8 litre * $2 * 355 days). Cost of maintenance has gone up in the recent time. As the vehicle has been subject to severe wear and tear, the maintenance cost is estimated in the order of 20 percent of the car. That is, $1000 this year. But maintenance cost for the new car would be very low. It would not exceed 2 percent of its actual cost. This would be therefore $180 per year. Based on the information provided as above, the budget for operating the old vehicle has been mapped below. This has been juxtaposed against the possible cost that will be incurred for operating a new vehicle for similar purpose. Cost of operating old patrol car as against new car Sl no Cost Old car New Car 1 Fuel 7100 5680 2 Maintenance cost 1000 180 3 Depreciation 500 900 Based on the above consideration, operating old vehicle is costlier than the new one. For instance, the annual cost of running the old patrol car is $8600, whereas that of new car would be $6760. There is a difference of $ 1840. For the above estimation, the salary payable to driver has not been considered, as it will involve employment of a driver irrespective of the fact that the car is new or old. 2. Budget prepared: In one of the company meeting, it was decided to have annual gathering under the pretext of a training program. The participants included middle level manager numbering about 25 from the United States. The department conducted basically a training program involving talk by about eight invited guests, who had to be given mementos. As these experts were drawn from best performers’ list working for our organization, it was decided that no honorarium would be paid. These participants were asked to stay in a hotel for 2 days. Hotel room tariff was $ 400 per day on twin sharing basis and thus per participant it worked out to be $200. The hotel had conference room for which they charged $600 per day. Hotel also provided food and served tea and coffee during the intervals time. They were charged separately and so they had to be included. It was decided to give away conference kits to all the participants, which would have lots of papers and other documents relevant for the training program. Printing certificates and other charges were also considered. It was also decided to have contingency amounting to 10 percent of sum of all other expenses. Based on these, the following budget were prepared. Budget for organzing 2 day training program   Sl No. Major Heads of Expenditure Basis for Estimate Amount in US$ 1 Accommodation for participants 25 No. x $. 200 x 2 Days 10000 2 Rent for Venue 2 days * $ 600 1200 3 Mementos 8 No. x $ 50 400 4 Bouquets & Flowers 25 No. x $4 100 5 Catering 80 No. x $ 60 x 3 times 14400 6 Tea, Coffee etc 80 No. x $10 x 5 times 4000 7 Training kits 35 No. x $ 40 1400 8 Printing and stationary 35 No. x $ 15 525 9 Contingencies 10% of 1-8 items 3202   Total   35227 Based on the above information and calculation, the expected cost of conducting the training program worked out to be $35,227. As many as 25 participants were targeted and so per participant it is $1410 for two days; and $ 705 per day. The expected outcome is an increase in the productivity level of workers, which is expected to go up by 20 percent. At the moment, these employees are drawing, on an average, monthly salary of $5000. Matching 20 percent increase works out to be $1000. In other words, the organization is likely to have a net increase in the value in the order of $1000 per month, whereas the one time training expenditure is $1410 per employee. Assuming that at least 80 percent of trainees will stay back, additional income to the organization would be close to $240000 in the first year. When the cost of training program, that is $ 35227 is subtracted, the net increase would be close to $205000. Considering this, it makes lots of sense to go ahead with the proposal to conduct the training and incur the expenses as per what has been budgeted against each of the headings. 3. Financial proposal: The global business environment is undergoing a sea change in the wake of many countries acceding to provisions of World Trade Organization. Due to increased degree of opening up and removals of controls over flow of goods and services, there has been a high degree of economic integration. There are many leading multinational companies, who would like to benefit from this increased globalization. There are still many domestic companies who also intend to exploit business opportunities emerging from such globalization. Ensuring success of new ventures would require constant traveling of business executives of different background. Concomitant to globalization, there is an increase in the income of many economies. This has lead to the emergence of a section of population who seek out to spend their leisure time on traveling to tourists’ center of other economies. Increased business activities and the rise of leisurely section have given rise to a new demand for two major businesses, namely, hospitality and airlines. The proposed business aims to exploit business opportunities in the hospitality industry. This has been with a view to capture the business potentials offered by China, a newly emerging manufacturing hub of the globe resulting in ballooning of economic activities within the country, supported by Hong Kong, which has well established business centers. Given these well knitting of these economies through international trade, opening up of hotels in these countries is very likely to succeed. The proposed hotels would have a capacity of 350 beds, aimed at attracting business travelers. It has been proved that hotels aimed at these customers would have at any time an occupancy rate of 90 per cent. In Hong Kong as well as in Shanghai, it has been noted that the room tariff rate could be of USD 45. This has been calculated as follows. Typical apartments that would provide comfortable accommodation in Harbor City of Hong Kong would be available for a monthly rent of Hong Kong Dollar (HKD) 10800 (“Hong Kong Apartments - Serviced Apartments – Accommodation”). The average exchange rate of HKD for United States Dollar (USD) is USD 1 = UKD 7.8. With this, the monthly rent works out to be USD 1385. Since cost of living is quite high in Hong Kong, only 3.25 per cent of monthly rent of an apartment is charged as room tariff, which works out to be USD 45. Comfortable accommodation in HuangPu District of Central Shanghai would be available for USD 900 (“Apartments For Rent.”). It is important to note that this is somewhat on the lower side, which could be suitable for the targeted. Since cost of living is under control within the city, five percent of monthly rent of an apartment is considered as ideally rate for the targeted customers to stay; and this would give a figure of USD 45 as daily tariff. Using this information, the size of business expected for hotel is worked out as follows. The proposed hotel will provide only double bed rooms; and there is no reduction in tariff even if only a single bed is occupied. It would charge moderately one-third rent for every extra bed sought after. This gives the following data Period Tariff (USD) Tariff for extra bed (USD) April 1 to Sep 30 Oct 1 to Nov 15 Nov 16 to March 31 45 90 45 15 30 15 The period as mentioned in above table reflects two normal season and one peak season. That is, between October 1 and November 15 of every year is considered as peak season and the remaining period as normal season. Since it is customary to charge differential charge for these two seasons, the proposed venture would double the room tariff during peak period as given in the above table. Thus, there would be 320 days falling under normal period, and remaining 45 days under peak season. It is assumed that there would be 80 per cent occupancy rate at any time. And, one third of clients would seek for extra beds. Based on this information, the following financial figures were worked out: Total size of business is worked out as follows: Total number of beds = 700 (350 in Hong Kong + 350 in Central Shanghai) Effective occupation (at 90 % average occupancy rate) = 630 Daily requirements of Extra beds: 1/3 of 630 = 210 Expected revenue: Tariff at the rate of USD 45 for 320 days (normal period) = ­90,72,000 USD (630 beds * USD 45 * 320 days) Tariff at the rate of USD 90 for 45days (peak period) = ­25,51,500 USD (630 beds * USD 90 * 45 days) Tariff for extra beds at USD 15 for 320 days = 10,08,000 USD (210 beds * USD 15 * 320 days) Tariff for extra beds at USD 30 for 45days (peak period) = ­2,83,500 USD (210 beds * USD 30 * 45 days) Total = 129,15,000 USD Thus the total size of business per year with the proposed capacity works out to be USD 129,15,000. This is taking into account only the proposed business at Hong Kong and Shanghai city. Three Financing Options: Various financing options have been explored within the framework of capital structure theories (Rose, Westerfield and Jordan, 2003 pp.567-574). The required fund for financing building-up of the hotel requires long-term fund, as there is a gestation period involved. The estimated fund requirement is $50,00,000. Totally 700 rooms will have to be build up. Assuming the average dimension of each room will be 150 square feet, the total square feet will be 105000. Since it is hotel, lots of other facilities such as restaurant and bar, laundary, staff room, recreation facilities, conference hall, reception place, parking area and so on. Allowing for all this, the super built up area will be in the order of 210000 square feet. It is assumed that average cost of construction cost per square foot is $ 24 and so the the long term fund required will come close to $50,00,000. Rising of long-term fund has their cost. The following options are available. a. Issue common stock: It is assumed that company has about 10 million shares with the face value of $1 each. The market price of each share is $2.5, which is also the average price for the last six months. If $50,00,000 were to be raised through fresh issue of common stock, it would mean that the company would have to issue about 2million shares. Once these stocks are issued, the total number of shares would increase to 12 million. b. Issue of bonds: Second option is the company can mobilize $ 50,00,000 by issue of 5 per cent bonds. As the interest rate offered is 2 percentage points higher than federal rate, they would be attractive for the common investors. The current market yield of the company’s existing bonds is assumed as 4.9 per cent. If bonds were to be issued, the proportion of bonds in total liabilities, that is, debt component of capital structure, would increase. c. Issue of preferred stock: As of now, the company does not have preferred stock liability (assumed). This can, however, be issued at the rate of 3.0 percentage points higher than federal rate. Each preferred stock can be priced at the rate of $2. This would mean new issue of 6 per cent 25 million preferred stock. Of these options, issue of bond is preferable, as the cost works out to be lower than preferred stock. It is also preferred because with some leverage, equity holders will benefit more from the investment in new hotel facilities both in Hong Kong and Shanghai. Implementing the options: These three different options can be implemented by taking the help of merchant bankers. There is no private placement with any institutional investors. All issues are directly offered to public and hence the issue cost would be somewhat higher. The market valuation is found to be good and so the company need not incur any expense towards underwriting. Going by the experiences of many companies that recently went for public issues, the company would have to incur very close to 1.5 per cent of total value of issues. This is applicable to all forms of financing. Issue of common stock and preferred stock require compliance with the regulatory and procedural aspects of Securities and Exchange Commission’s. Merchant banker would meet the issue requirements and the company has to provide the banker with all necessary information. Given the good documentation and system of process within the company, supply of information to the merchant banker would not be a difficult task. Since there has not been much change in the market price for quite some time, the prevailing price for last six months can be considered as the issue price. Issue of bonds is somewhat difficult. Standard and Poor has rated the company’s existing bonds to BBB. It is very much within the bracket of investments category. The rating agency has to be approached to get the new bonds rated. It is, however, feared that rating might fall to BB or B because the additional issue would take the debt proportion to more than one half of total liabilities. To overcome this, the company needs to convene a meeting of existing bondholders and explain to them that debt servicing would be done on time. This is to thwart the likelihood of bonds being down rated or issue going under subscribed. Here again, the service of a merchant banker would be resorted, who would also take care of all issue related requirements. 4. Cost estimation and learning curve: An important function of cost accounting is to estimate cost of goods manufactured and services rendered. Once product-wise costing is ascertained, pricing the product becomes easy. Unless the company knows the variable costs and fixed costs, it would not be able to determine break-even point, which is crucial to decide whether or not continuing a product would help company to achieve the objective of making profit. Moreover, cost analysis helps decision-making process. If cost related information have been classified and presented, it helps informed judgment by all decision makers and takers within an organization. For instance, cost data helps a company to deal effectively with details required for deciding which line of production is more profitable and so on. Controlling cost is an essential ingredient of every decision. Every dollar saved is a dollar earned, and hence it adds to the income. A company would be better positioned to control cost if it has detailed information. Fixed costs are incurred and often they add and enhance the productive capacity of the company and its control is only when the company commits itself. The variable cost is routine and concerns with the day-to-day business of the company. Thus, every attempt to control cost has to have a detailed analysis of variable cost. . Another important reason why costs are to be estimated is because the organization wants to know if they are moving up in the learning curve. This can be gauged by comparing the cost incurred for producing the first unit, with the cost incurred for producing the nth unit. In simple terms it means whether the organization has to have same level of input for all units throughout. For instance, if the 10 man hours are spent for producing the first unit, whereas it takes only 5 man hours to produce the nth unit, then it is equivalent to saying that the organization has move up in the learning curve. References “Apartments For Rent” at the http://shanghairealty.com/apartments_for_r.htm Barry J. Brinker (eds) Handbook of Cost Management. Boston: Warren Gorham Lamont. 1992. Brealey, R.A., and Myers, S.C. Principles of Corporate Finance, (7th edn) Boston: McGraw-Hill. 2003. Brimson, JA. Activity Accounting: An Activity-Based Costing Approach. New York: John Wiley. 1991. Burgh, JG. Cost and Management Accounting A Modern Approach. New York: West Publishing Company. 1994 “Hong Kong Apartments-Serviced Apartments–Accommodation” at http://moveandstay.com/hongkong Rose, Westerfield and Jordan. Fundamentals of Corporate Finance. New York: McGraw-Hill. 2003. VanHorne, C.J. Financial Management & Policy. (12th edn), Essex: Pearson. 2001. Read More