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Finance & Financial Management

Managing Financial Resources

Hausarbeit 2003 28 Seiten

VWL - Finanzwissenschaft

Leseprobe

Contents

1. Q1: Capital Expenditure Decisions - Dichem PLC
1.a Net Present Value (NPV) & key assumptions
1.b Working Capital, Tax Implications & View of Finance Director
1.b.i Treatment of Working Capital
1.b.ii Tax Implications of the Investment in Equipment
1.b.iii Views of the Finance Director

2. Q2: Valuing Shares - Norbut Plc
2.a Valuing Shares
2.a.i Earnings, Dividends and Investment based on McDougall’s Expectations
2.a.ii Value of Norbut Plc
2.a.iii Value of Norbut Plc attributable to Future Investment
2.a.iv Norbut Plc’s Price Earning Ratio at Zero Growth
2.b Definition of the Price-Earnings Ratio (P/E) & Primary Determinant of a company’s P/E

3. Q3: Rights Issues - Novelty Paints Plc
3.a Rights Issue
3.a.i Terms of Issue, Ex-Rights Price & Value of a Right
3.a.ii Exercise of Rights vs. Selling of Rights
3.a.iii Timing of new Issues
3.a.iv Fall in Share Price Anticipated
3.b Rights Issue - Protects Shareholder’s Interest

4. Q4: Capital Structure Decisions - Gearless Plc
4.a Debt & Equity Financing
4.a.i Calculate Earnings per Share (EPS)
4.a.ii Break-even Point - same EPS for Two Options
4.a.iii EPS as a Function of Earnings
4.b Primary Advantages & Disadvantages of using Long-term Debt for Funding

5. References

1. Q1: Capital Expenditure Decisions - Dichem PLC

1.a Net Present Value (NPV) & key assumptions

Identification of parameters:

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Product

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Sales

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Overhead Allocation

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Key Assumptions -- In this calculation, we take the following assumption

- The initial investment on £10.0 mln. represents sunk cost and has no direct relevance to the current decision.
- No effect on working capital is visible because it is assumed that the increase in debtors as a result of introducing the product will be just about offset by the increase in creditors.
- Depreciate for machines starts from year 1.
- A residuals (sale of equipment) of £1.2 mln. in year 5 (C5) generating a positive cash flow and is considered in the P&L & CF statement.
- A straight line depreciation scheme is applied. Inflation is zero.
- Prices are constant at £ 5.00 over 5 years (no discount or any other reduction are considered).
- Cash flows are certain.
- The interest - & tax rate are constant over time.
- Tax payments are due in year 1. The tax constitutes a tax saving but it is assumed that the loss can be offset against the company’s profit in its other activities. Cash flows appears at the end of each period.
- Fixed costs are incremental costs.
- All manufactured items are sold except stock, which is sold the subsequent year
- No product cannibalisation

In order to calculate the difference in tax we set-up a profit & loss statement, which has an impact on the cash flow analysis of the project.

Profit & Loss (£000 000)

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Table 1.1 : Profit & Loss - Dichem plc

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Table 1.2 : Cash Flow - Dichem plc

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Recommendation

A positive NPV (Net Present Value) indicates a profitable and recommend project.

1.b Working Capital, Tax Implications & View of Finance Director

1.b.i Treatment of Working Capital

The management of working capital involves the relationship between a company's short-term (current) assets and its short-term (current) liabilities (It is challenge is to keep liquidity as low as possible and use the funds for projects - Return on liquidity is very low). Furthermore, the difference between current assets and the current liabilities is defined as net working capitali.

Most of any project needs some form of working capital, such as debtors, inventories, etci. The investment in working capital of any capital budgeting forms an important part of this. Depending on the company, current assets may or may not include cash and cash equivalents. Short term assets increase significantly because of a) investments in stock and “investment” in debtors. Liquidity may suffer. The net present value (NPV) and the internal rate of return (IRR) will be reduced at the inclusion of the investment.

The aim of working capital is to make certain that a company is able to continue its operations and that it has sufficient ability to satisfy both short-term debt and upcoming operational expenses. The management of working capital involves managing stocks, debtors and creditors and cash.

Working capital is a large and often overlooked component of the total capital employed (Mercer Mgmt Cons, 1998). The drivers for working capital are;

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Table: 3, Mercer Mgmt. Consulting, 1998ii

The aim for any company should be to stretch out creditors as long as possible and, in general, negotiate longer terms with vendors. The second goal is to turn debtors/receivables as quickly as possible, while turning stocks around as quickly as possible represents the third key target. Stocks may well be a substantial investment for a company, but they yield no interest. For this reason, a number of strategies including just-in-time stocking methods may be used to hold down a company's investment in stocks.

There is no difference between the requirement for a return on capital assets and the justification for a return on working capital. In both cases, at a given point in time, investors commit funds with the aim of having those funds returned at some time in the future. In the meantime, a return on those funds is expected to offset the opportunity cost. The difference between the treatment of working capital and, for example, capital costs is the length of time during which the funds are tied up within the regulated unit - whereas for working capital, funds may be tied up for a matter of days/weeks, this may be years for capital costs

A simple example of the investment in stocks of a raw material and difference in the level of stocks is illustrated below:

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Table 4 - Flow of Working Capital (Davis, 2002 iii )

An increase in net working capital (NWC) means a decrease in cash flow (CF) whereas a decrease in net working capital (NWC) entails an increase in cash flow (CF).

For a company, liquidity is needed in order to survive and form a basis for the overall aim of profitability - on the other hand, it is a profitability killer, if the level of liquidity is too high. Hence, aggressive working capital management is an important factor in driving competitive advantage - the CFO should think in scenarios (Best, medium, worst case). In real life, I experience that levels of stock remain high, while turnover decreases significantly. Consequently, stock becomes “old” on the shelf resulting in a negative impact of profitability.

1.b.ii Tax Implications of the Investment in Equipment

In general, the return on an investment will depend on the choice of investment and investments can be achieved in a variety of different ways with different impacts on taxes. A company could increase its long term debts or issue new equity capital.

A higher tax reduction (Ross, Westerfield, Jaffe, 2002iv ) is expected when financed through leasing or long term debt versus equipment financed through the companies own money, equity capital or retained earnings. In such a case the tax advantage is the annual depreciation of the equipment. The tax will be reduced because the depreciation reduces the profit.

Interest creates a tax deduction and borrowing a tax shield. The tax shield is nothing other than the

amount of taxes a company or individual may save from a tax deduction or tax credit that company or individual would otherwise pay without the deduction or credit.

To calculate the value of tax shield, VTS (Fernandez, 2002v ) the following formula is used:

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In the situation of Dichem Plc. the investment in equipment is £ 16.0 mln., depreciated for tax purposes on a straight-line basis over five years, carrying a residual value of £1.2 million at the end of the project. The corporate tax rate was given at 30% resulting in a value of tax shield calculated at £16.0 *30% = £4.8 mln.]

If a company is creating profits through sales, the losses caused by depreciation can be offset against the profits, in order to reduce the tax a company needs to pay. Any tax savings should be recognized in the cash flow statement as one of the benefits of investment.

1.b.iii Views of the Finance Director

Capital budgeting is an important element for small to medium-sized companies and should be used to improve the current expenses and short-term needs. Short term needs are usually at the forefront and sometimes cause a company to lose sight of its long-term objectives. Another goal is also to keep the debt low by borrowing sparingly and setting aside a cash reserve for current and emergency financial requirements.

Mistakes in forecasting might lower the cash flow, which in return would lead to a lower NPV.

The CEO should work together with the CFO set priorities for the financial objectives according to their importance, and time frame. This will help to keep things in perspective if other factors considered justify the investment, such as additional product know-how, which might be used for future products or the empty building, which is anyway on the cost side of the production site.

The financial management of a company takes on even greater significance when the economy and financial markets are struggling.

[...]


i Davis, D., Finance and Financial Management, The University of Strathclyde, 2002, Vol 1, pp. 158

ii Hodge K., Mercer Management Consulting Inc., London, UK, Improving returns and cash flow in process industries through aggressive working capital management, URL:

Hhttp://www.mercermc.com/defaultFlash.asp?section=PerspectivesH

iii Davis, D., Finance and Financial Management, The University of Strathclyde, 2002, Vol 1, pp. 158

iv Ross A. Stephen, Westerfield W. Randolph, Jaffe Jeffrey, Corporate Finance, McGraw-Hill, 2002, international, 6th edition, pp 601

v Fernandez, P., The value tax shields is not equal to the present value of tax shields, IESE Business School, University of Navarra, Madrid, Spain, 2002, pp 23

Details

Seiten
28
Jahr
2003
ISBN (eBook)
9783656004509
ISBN (Buch)
9783656005056
Dateigröße
502 KB
Sprache
Englisch
Katalognummer
v178459
Institution / Hochschule
University of Strathclyde
Note
1.2
Schlagworte
finance financial management managing resources

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Titel: Finance & Financial Management