The Modigliani-Miller Theorem Is a Cornerstone of Modern Corporate Finance - Coursework Example

?Assignment #5 and number Respond to each of the questions completely. Discussion Discussion Topic A The Modigliani-Miller Theorem isa cornerstone of modern corporate finance. Its heart, the theorem is an irrelevance proposition. The Modigliani-Miller Theorem comprises four distinct results from a series of papers the first proposition establishes that under certain conditions, a firm’s debt-equity ratio does not affect its market value. The second proposition establishes that a firm’s advantage has no effect on its weighted average cost of capital (i.e., the cost of equity capital is a linear function of the debt-equity ratio). The third proposition establishes that firm market value is independent of its dividend policy. The fourth proposition establishes that equity-holders are indifferent about the firm’s financial policy (Gitman, 2009). Given a fixed amount of total capital, the allocation of capital between debt and equity is irrelevant because the weighted average of the two costs of capital to the firm is the same for all possible combinations of the two. In the context of the modern theory of finance, it represents one of the first formal uses of a no arbitrage argument though the “law of one price” is longstanding. It structured the debate on why irrelevance fails around the Theorem’s assumptions: by neutral taxes; by no capital market frictions (i.e., no transaction costs, asset trade restrictions or bankruptcy costs); by symmetric access to credit markets (i.e., firms and investors can borrow or lend at the same rate); and by the firm financial policy reveals no information (Eiteman, 2007). Discuss the different ways in which a corporation can distribute cash to its shareholders. Dividends and stock repurchases are the two major ways that corporations can distribute cash to their shareholders. Dividends may also be distributed in the form of stock (stock dividends and stock splits), scrip (a promise to pay at a future date), or property (typically commodities or goods from inventory). By law, dividends paid with profits; dividends may not be paid from a corporation's capital. This law, designed to protect the corporation's creditors, we call the impairment of capital rule. This law stipulates that dividend payments may not exceed the corporation's retained earnings as shown on its balance sheet (Eiteman, 2007). Companies usually pay dividends on a quarterly basis. When the company is about to pay a dividend, the company's board of directors makes a dividend announcement that includes the amount of the dividend, the date of record, and the date of payment. The date, on which the dividend announcement is declared, we call the declaration date (Eiteman, 2009). Discussion 1 Topic B Discuss the importance and goals of long-term financial planning. Elaborate on the advantages and disadvantages of different methods of forecasting. Management in both private and public organizations typically operates under conditions of uncertainty or risk. Probably the most important function of business is forecasting, which is a starting point for planning and budgeting. The objective of forecasting is to reduce risk in decision-making. In business, forecasts form the basis for planning capacity, production and inventory, work force, sales and market share, finances and budgeting, research and development, and top management’s strategy. Sales forecasts are especially crucial aspects of many financial management activities, including budgets, profit planning, capital expenditure analysis, and acquisition and merger analysis. The advantage of this approach is; that the forecasting completed quickly and easily, without need of elaborate statistics. The jury of executive opinions may be the only means of forecasting feasible in the absence of adequate data. The disadvantage: however, is that of “group think?” Problems become inherent to those whom meet as a group. Foremost among these are high cohesiveness, strong leadership, and insulation of the group. With high cohesiveness, the group becomes increasingly conforming through group pressure that helps stifle dissension and critical thought. Strong leadership fosters group pressure for unanimous opinion. Insulation of the group tends to separate the group from outside opinions, if given (wise geeks). Discuss the concept of sustainable growth rate and its importance in financial analysis. The sustainable growth rate (SGR) of a firm is the maximum rate of growth in sales that they achieved, given the firm's profitability, asset utilization, and desired dividend payout and debt financial advantage ratios. Variables typically include the net profit margin on new and existing revenues; the asset turnover ratio, which is the ratio of sales revenues to total assets; the assets to beginning of period equity ratio; and the retention rate, which we define as the fraction of earnings retained in the business. Economists and business researchers contend that achieving sustainable growth is not possible without paying heed to twin cornerstones: growth strategy and growth capability. Companies that pay inadequate attention to one aspect or the other are doomed to failure in their efforts to establish practices of sustainable growth (though short-term realized gains). When a company has an excellent growth strategy in place, but has not put the necessary infrastructure in place to execute that strategy, long-term growth is impossible. The reverse is true as well. The concept of sustainable growth can be helpful for planning healthy corporate growth (wisegeeks.com) Discussion 2 Discussion 2 Topic A Discuss the avenues to improve working capital management. Working capital management is an important yardstick to measure a company's operational and financial efficiency. This aspect must form part of the company's strategic and operational thinking. Continuing efforts, consistently to make and improve the working capital position. This will yield greater efficiency and improve customer satisfaction (Gitman, 2009). Discuss the importance and main avenues of cash management. Discuss the company’s cash cycle. How does it differ from its operating cycle? Cash flows in a cycle into, around and out of a business. It is the business's lifeblood and every manager's primary task is to help cash flow and to use the cash flow to generate profits. If a business is operating profitably, this will generate cash surpluses. If it does not generate surpluses, the business will eventually run out of cash and expire. The faster a business expands the more cash it will need for working capital and investment. The cheapest and best sources of cash exist as working capital right within business. Good management of working capital will generate cash will help improve profits and reduce risks. Bear in mind that the cost of providing credit to customers and holding stocks can represent a substantial proportion of a firm's total profits (Gitman, 2009). Two elements in the business cycle that absorb cash, one called inventory and the other denoted as receivables. The main sources of cash are the payables, equity, and loans. Each component of working capital (namely inventory, receivables and payables) has two dimensions time and money. When it comes to managing working capital time is money. When someone can get money to move faster around the cycle (e.g. collect monies due from debtors more quickly) or reduce the amount of money tied up (e.g. reduce inventory levels relative to sales), the business will generate more cash or it will need to borrow less money to fund working capital. This will help the company to reduce the cost of bank interest and/or will have additional free money available to support additional sales growth or investment. Another alternative is to negotiate improved terms with suppliers, get longer credit or an increased credit limit; creates effectively free finance to help fund future sales (Eiteman, 2007). Discussion 2 Topic B List and discuss the main objectives of short-term financial planning. The terms "short term" and "long term" are relative. Thus, it is difficult to put an exact definition on short-term financial planning. However, many people use either 24 months or 36 months as the length of time at which short-term financial planning ends. Short-term financial planning provides a roadmap toward achieving financial goals. A good short-term financial plan addresses factors like how much money needs to be saved, how much interest any savings need to earn, and how best to achieve both. An excellent short-term financial plan explores how the plan affects long-term goals. Short-term financial planning, identified by specific strategies to achieve or help achieve goals that are to be met in the near future, typically 2 to 3 years out (Gitman, 2009). Discuss the methods of short-term financing. Short-term financing, designed with a repayment within a one-year period. Further, they design it so it will meet the various needs of companies. Five types of short-term financing listed below Purchase Order Financing is a technique where resellers identified as unusually large or unique purchase orders they receive from their customers. It is necessary to finance these specific transactions, thereby reserving their company's credit line for more typical transactions. Extended Terms financing, used to permit resellers or end users to extend standard 30-day payment terms on their credit line for specific transactions to manage their company's cash flow. E-Rate Financing is a vehicle that provides financing for resellers who have an E-Rate financed contract with an educational institution. This assists in matching the E-Rate grant payment from the government with the purchase payment to the vendor. Distribution Financing is a vehicle available for qualified resellers and distributors to extend interest-free 45- and 60-day payments terms to manage cash flow and company growth. Accounts Receivable Financing uses authorized resellers to establish a secured, revolving line of credit with advance rates up to 85% to assist in managing cash flow and company growth (Eiteman, 2007). References: Eiteman, D.K. (2007). Multinational Business Finance. (11th. ed.). Pearson Education Inc. Gitman, L.J. (2009). Principals of Managerial Finance. (12th. ed.). Pearson, Prentice Hall. SRB (2011). Retrieved May 5, 2011. From website. http://wwwwisegeeks.com Read More