Managerial Finance Essay

ASSIGNMENTBMMF5103MANAGERIAL FINANCE15 July 2013QUESTION 1a) Maximizing parenthoodholder wealth is a moral imperative for financial manager means managers atomic number 18 supposed to work for shargonholders who be the actual owners of a association or corpo dimensionn. Shareholders elect guild directors who in turn hire managers to run the corporation on day to day basis with the view to determine profit for the f regularizernity. Managers are paid for their services rendered to the company whereas the shareholders own the company. As such(prenominal) morally managers should pursue policies that enhance shareholder pass judgment with the primary objective focused on stockholder wealth maximization.b) Managers make key day-to-day decisions to maximise shareholder look on. But how do the owners of a backing know that managers are operating to maximize shareholder value? This lack of information is known as the head word-agent problems. The agent performs the tasks on shareholders behalf yet the shareholders canful non ensure that the agent performs precisely the way the shareholders would like.Agency be as related to a corporation refers to the costs of preventing agents (e.g. managers) pursuing their own touch ons at the expense of shareholders. There might be conflicts between shareholders and the company managers. Shareholders who are owners want the managers to make decisions which will addition the share value. Managers who receive salaries prefer to expand the business with the view to ontogenesis their salaries which may not necessarily increase the share value. Thus, agency costs tend to decrease the value of a corporation because the rising costs make the share set low when thither is substantial debt involved. Costs of monitoring will increase and thus reduce wealth maximization of shareholders.c) Business ethics is the acceptable set of moral determine and corpo set standards of conduct in running a business organization. It in cludes proper business policies and practices such as corporate g everyplacenance, as a check against insider trading, bribery, discrepancy and covers corporate social responsibility and fiduciary responsibilities. Business ethics is a basic framework providing proper conduct, it may be guided by integrity or put in placeso as to gain humanity confidence and acceptance.An example of business ethics is when an employee lie to a voltage client to form him to sign for services or purchase the product offered.Business ethics is important to a corporation because it will determine its reputation. It will give public confidence towards the corporation. It is essential for the long-term survival and success of the corporation in business. Implementing an ethical program will foster a successful corporation culture, set and enhanced profit susceptibility. Business ethics will also influence the way the corporations conduct its business and affect all including customers, employees, su ppliers, competitors, etc.d) Advantagesi) There is no matureness period in common stock. Thus, eliminating future repayment obligation and enhances the desir major power of common stock financing. ii) There is no obligation for repayment of the funds. Instead, there are others to share the risk of the business investment with. Since there is no debt obligation, there is no finance fee. iii) Issuing common stock can increase theatres borrowing power.The more than common stock is sell, the bigger the trus devilrthys equity base. Therefore, the more easily and cheaply long-term debt financing can be obtained. iv) Once capital is raised through stock, the corporation is free to use the proceeds in any way it pleases.Disadvantagesi) Involves exalted cost.It may be the most expensive form of long-term financing. Dividends are not tax-deductible and common stock is a riskiersecurity than either debt or preferred stock.ii) Potential effect of dilution on meshing and voting power. Whe n a company or corporation issues more shares, its financial results must be divided by a larger number of shares, causing dilution. This is because selling of shares of the company means giving each investor a piece of ownership. Because they own the share of the company, the investors have the right to demand explanations and justifications for business decisions.iii) Market perception that management think. Management issues involve examining perceptions about management and perceptions by management. It includes various judgments regarding the competence of current and future management team as well as issues related to insider buying such as future strategies to increase operations and trade share.When management makes large purchases of their own stock with private funds, investors may feel that the company is undervalued or that a favorable company event will occur soon.e) The three main users of ratio analysisi) OwnersThe owners of a firm are mainly interested in the firms profit cogency, liquidity and hence survival. Therefore, they need financial ratios to test the performance of their company such as profitability ratios to find outwhether management is able to win over gross sales dollars into profits and cash flow. The common ratios are gross margin, operating margin and salary income margin. The gross margin is the ratio of gross profits to sales. The operating margin is the ratio of operating profits to sales and top income margin is the ratio of net income to sales. The conk-on-asset ratio, which is the ratio of net income to total assets, measures a companys effectiveness in deploying its assets to generate profits. The return-on-investment ratio, which is the ratio of net income to shareholders equity, indicates a companys ability to generate a return for its owners. These ratios are useful to owners of companies.ii) CreditorsCreditors are interested in a firms ability to pay their debts over a short period of time.The ratio analysis w ill evaluate the firms liquidityposition. Creditors use liquidity ratio, which is the ratio of current assets to current liabilitiestogauge the ability of the company to pay its short-term bills. A ratio of great than one is usually a minimum because anything less(prenominal) than one means the company has more liabilities than assets.iii) ManagementManagement team comprising financial managers regularly use ratio analysis to evaluate financial policies and decisions they have made. It is the overall responsibilities of the management team to make sure available resources are used most effectively and efficiently and that the financial positions of the company is sound.Management uses profitability ratios to analyze the companys ability to convert sales dollars into profits and cash flow. For example, the return-on-investment ratio, which is the ratio of net income to shareholders equity, indicates a companys ability to generate a return for its owners. warnings of ratio formulaExa mple 1 Gross margin ratioGross Margin =Gross ProfitRevenueGross profit and revenue figures are obtained from the income statement of a business. Alternatively, gross profit can be calculated by subtracting cost of goods sold from revenue. Thus gross margin formula may be restated as Gross Margin =Revenue Cost of Goods SoldRevenueExample 2 Operating margin ratioOperating income is same as earnings before interest and tax. Operating income and revenue figures is available from the income statement of a company. Operating Margin =Operating IncomeRevenueQUESTION 2a) There are five different categories of financial ratios. They arei) Liquidity ratio is used to measurecompanys ability to pay its short-term debt obligations. As such, they focus on the firms current assets and current liabilities on the balance sheet.The most common liquidity ratios used is the current ratio mainly to give an idea of the companys ability to pay back its short-term liabilities such as debt and payables with its short-term assets such as cash, inventory and receivables.ii) Debt ratio is used to measure companys ability to meet its long-term debt obligations. The ratio indicates what proportion of debt a company has relative to its assets. The measure gives an idea to the leverage of the company along with the potential risks the company gifts in terms of its debt-load.iii) Financial leverage ratio measure the extent to which a business or investor is using the borrowed money. A company having high leverage is considered to be at risk of bankruptcy in the event the company is unable to repay the debts. The most common financial leverage ratio is the debt-to-equity ratio calculated as total debt divided by shareholders equityiv) Asset efficiency or turnover ratios measure the efficiency a company uses its assets to produce sales. The most common asset efficiency ratios are the inventory turnover ratio, the receivables turnover ratio, the days sales in inventory ratio, the days sales in receivables ratio, the net working capital ratio, the fixed asset turnover ratio, and the total asset turnover ratio.v) The profitability ratios measure the companys ability to generate aprofit and an adequate return on assets and equity. The ratios measure how efficiently the firm uses its assets and how effectively it manages its operations. An example is the Net profit margin ratio is a ratio of profitability calculated as after-tax net income (net profits) divided by sales (revenue). It shows the amount of each sales dollar left over after all expenses have been paid.Limitations of financial ratiosi) Although financial ratios can be effective tools for gauging financial performance and managerial effectiveness, they rarely provide answers. Ratios will not say why something is going wrong and what to do about a particular situation they only pinpoint where a problem is.ii) There is no international standards on the use of financial ratios. Limitation of ratios interpretation emer ges when a particular set of ratios of a company is compared to other company or business. For example, for sharp the inventory turnover one company may use the cost of goods sold as the numerator, while another may use its sales figures. A company may use the operating profit to calculate its total assets turnover, while another may use the net income after taxes.iii) Benchmark for assessing companys financial position is needed. Different operating methodologies may be employed to run a company may render the comparison of financial ratios irrelevant. Example, a company prefers to lease most of its assets while another company may own them. Thus, some of the ratios, such as debt to total assets, fixed-charge coverage, total assets turnover, and return on total assets, would be unrelated.iv) The inflation factor can make the ratio of a particular company look good or bad. instrument turnover may have deteriorated over a three-year period the problem may not due to the increase in physical inventory, but rather, to increase in the cost of the goods.b) Effect of an increase in a companys debt ratio to its return on equity.An increase on debt-ratio will be increase in the return of equity. If a company finances itself through debt, the creditors shoulder the risk. If the debt results in increased earnings, the return on shareholder investment is exponential. sum of money liabilities include both the current and non-current liabilities. The formula to calculate the debt ratio is Debt Ratio =Total LiabilitiesTotal AssetsReturn on Equity is expressed as a percentage and calculated asROE = Net Income/Common Equityc) Long-term interest rate = (RM13,000,000) (8/ nose candy) = RM1,040,000 Short-term interest rate = RM1,300,000 RM1,040,000 = RM260,000 Short-term interest rate = RM260,000/RM1,546,000 = 0.168Rate of interest on notes payable is 16.8%d) Changes in value of equity (in trillions)(RM in millions)Shareholders extraction equity537Shareholders ending equit y485Difference beginning & ending equity52Net income128Less Paid dividends57Difference71Stock/shares purchased in the year (52+71)123Shares purchased throughout the year is RM123 millione) If the current ratio of corporation is 5.65 when industry average is 1.42, this disparity means that the corporation is havingi) an excess build-up in inventory. When the corporation holds a high level of inventory, it ties up business funds that could have been used in other areas such as in development or marketing. The cost of the inventory is not vulcanised by the corporation until it sells the inventory.ii) aged account receivables which is the amounts owed to the company by its customers. The corporations account receivables reports will identify problems with receivables management process and identify accounts that contract collection action.QUESTION 3a) Although ownership of stock represents ownership in a company, not all stock is created equal. Therefore there are two basic types of s tock common stock and preferred stock. Preferred stock is sometimes referred to as a hybrid security because it has features of common stocks and vexs. A companys preferred stock trades independently of its common stock and offers preferred stockholders a different set of benefits. Preferred stocks paid amount of dividends just as fixed interest bond. It is not debt but equity like common stocks.b) Preferred stock par value of RM100 with annual dividend 10%. Annual rate of return is 11.5%. i) RM100 X10/100% = RM10.Yield of 11.5%11.5%/100 = 0.115= RM86.96ii) As the risk-free rate increases, the necessitate rate of return will increase and the price will drop. When pass judgment increase, the price of the preferred stock will likely fall. If price falls, the issuer will likely call the preferred stock and replace it with a new preferred stock issue at a lower rate, conventional debt, or perhaps even common stockc) RM4.63(1+0.05)/(0.12-0.05) = 4.8615/0.07 = 69.46The value of the com panys stock if the required rate of return is 12% is RM69.46d) Before change over in price per share, r =5% + (8% -5%) beta 1.3 = 8.9%After change in price per share, r = 4% + (10% 4%) 1.5 = 13%Therefore, the change in price per share is RM4.87e) Formula for constant growth is rs = r RE + (rm rRE)b= 6% + 5% (1.4) = 13%2013 = RM0 dividen2015 = RM1.002016 = RM1.00 (1.2) = RM1.202017 = RM1.00 RM1.442018 = RM1.00 RM1.7282019 = RM1.00 RM1.849Calculate growth between constant rate=The price of the stock is RM20.16QUESTION 4a) Needs RM40,000/year during retirement periodn = 10 yrs, i = 9 %PVA = PMT (PVIFA) = RM40,000 (9.129) = RM365,160PV = RM365,160 (0.422) = RM154,097.52The Mirians should deposit RM154,097.52b) Model A PV = PMT (PVIFA) = RM5,000 (3.993) = RM19,965Model BYearPayment (RM)PVIFPV17,0000.9266,48226,0000.8575,14235,0000.7943,97044,0000.7352,94053,0000.6812,043Total20,577I would purchase/buy model A because it is cheaper by RM612 compared to model B.c) Which option to be cho sen? pickax 1PMT = RM3,500/2.487 = RM1,407,318.05Option 2PMT = RM3,500/3.102 = RM1,128,304.32Option 3PMT = RM3,500/3.605 = RM970,873.79The company should choose option 3 because lower by RM157,430.53 compared to option 2 which is second lowestd) Present value is exact invest of the compound interest calculations. Applying compound interest calculation is to find the future value of a present amount. Using the present value calculation a present value amount is found to be received in future.e) Over certain period the principle amount increases as a result of the installment payments resulting in lower amount of interest that is charged by the bank.QUESTION 5a) When an investor buys a bond, the investor is lending money to the bond issuer, which could be a government, corporation, etc. The issuer promises to pay a specified rate of interest during the life of the bond and to repay the principal, also known as face value or par value of the bond, when it matures, or comes due after a set period of time. Thus bonds provide interest payment and principal payment. Payment of interest is done annually or semi-annually. Coupon payments are paid periodically. When bond matures a principal sum is paid which is a bulge sum payment.b) Bond prices and interest range are related. Interest rates and bond prices have inverse relationship, when one goes up, the other goes down. If interest rates is high enough, bond prices would fall. If interest rates is low, bond prices would rise. Prices of short-term bonds do not fluctuatemore often compared to long-term bond. Premium bond is sold when the stated rate of interests exceed the required rate of return.Example, if rates dropped to below original coupon rate of 7% for RM1,000 bond, it would be priced at a bounty since it would be carrying a higher interest rate than what was currently available in the market. A bond will sell at a discount when the stated rate of interest is less than the required return. Bond is sold equa l to the par value when the stated rate of interest is equal to the required return.c) Param does not have enough money to buy 10 bonds if the required rate of return is 9%. This is because the required rate of return which is 9% is less than the coupon rate of the bond which is 10%. The price of the bond is greater than the par value of RM1,000. Considering there are 10 bonds, the total price is greater than RM10,000. That is the reason why Param would not have enough money to buy the 10 bonds.d) FV = RM1,000PMT =150N = 10PV = RM1,2501/YR = 10.79%e) Interest rate risk is the risk of decline in bond values due to the increase in interest whereas reinvestment risk is the risk of an income decline due to a drop in interest rates. Bond holders who bought long-term bond is greatly at risk to the interest rate risk.QUESTION 6a) (RM18+RM4+RM3+RM2-RM24)/24 X 100% = 12.5%.Therefore, Billie jeans realized rate of return during the three years holding period is 12.5%b) (i)Stock 18 + 0.8 (12 8) = 11.2%Stock 28 + 1.2 (12 8) = 12.8%Stock 38 + 0.6 (12 8) = 10.4%(ii) Stock 3 is undervalued due since E (R) RRc) Beta is the measurement for market risk which is non-diversifiable. The risk must be dealt with by the portfolio manager. Diversifiable risk should be diversified away by portfolio manager so that it would not pose a problem to the investment. As such all market risks is all relevant to the portfolio manager since it is his job and responsibility in balancing the likely risk and return.d) The situation suggest that investors are more risk unfavorable compared to before the shift taking place. On the portfolio, a risk premium of 11% (16% 5%) is required whereas previously 10% (15% 5%). If slope were to change downward, it means investors are less aversion to risk.e) Expected return 0.9(12%) + 0.1 (20%) = 12.8%Beta 0.9(1.2) + 0.1(2.0) = 1.28%