Research Articles Base: Capital Budgeting

WHAT IS MEANT BY FINANCIAL INTERMEDIATION? GIVE EXAMPLES

Financial Intermediation   Introduction               The flow of capital is important in the business world. Entrepreneurs are constantly in need of capital to start new businesses or to keep the flow of current operations moving. This means that the demand of capital is also constant. Unfortunately, it is a fact that current business operations are not also up to the challenge of supplying the capital needed to support the continuation of the business endeavors.  This means that entrepreneurs are always on the lookout for sources of capital.               Banks and other financial firms are usually on the rescue to businesses that are in need of capital. They offer loans that would allow businesses to get the capital they need. Banks and other financial institutions that offer loans to businesses are important. This is the case since money borrowing is an integral part of business and economic life. It is the case that almost everyone has experienced borrowing money at one point or another.               The activity of bowing money brings about the subject of financial intermediation. However, this business activity occurs without people recognizing it by name. With this, it is the objective of this paper to define financial intermediation and provide examples to better illustrate how this business activity takes place. The following discussions in the paper will be focusing on the process of financial intermediation in the hopes of making people aware about the nature of the activity.   Financial Intermediation                         As stated earlier, financial intermediation occurs without people recognizing it by name. Therefore, there is a need to provide a clear definition of the term financial intermediation as well as provide examples of the business activity to illustrate its clockwork. This section of the paper will be discussing views about financial intermediation to be able to adequately define the term.               Views regarding financial intermediation is divided there are those who believe that it is important in the success of the business world in general, while there are some who believes that it does not have any real affects on businesses. According to (2001), financial intermediaries can ignored since it do not have a significant effect. Allen supported this claim by stating that the Journal of Finance’s millennium issue surveyed corporate finance, asset pricing and continuous time finance but not financial intermediation.               On the other hand, there are those who believe that financial intermediation is pervasive, which makes it a crucial part of business life, but what exactly is financial intermediation and what makes it important? Financial intermediation is the process of using existing money in a bank to serve as loan for others. For example, client A deposited a certain amount of money in bank A and client B asks bank A for a loan, it can be the case that bank will loan client B the money deposited by client A. Since the bank do many transactions in a day client A will not have to worry about his or her money since the bank can provide him or her with money in case he or she decides to withdraw them.   The premise of financial intermediation is borrowing the money of other people to loan to other people. Banks serve as the intermediaries between the person whom the money was borrowed and the person who borrowed the money. However, the two clients do not negotiate with each other. The borrower and the lender both transact with the bank and thus the term intermediary.   Financial intermediation takes place since money being deposited in banks will be any good just sitting in vaults. Therefore, it would be more beneficial if they were used as capital to start or maintain business operations. As such, banks and financial institutions can profit form financial intermediations through interest rates that add to the payment of the loans. In addition, other bank clients can also benefit from financial intermediation through interest rates that will be added to their savings.   This means that financial intermediation is crucial in the business world.  (1990) supports this, stating that every dollar financed outwardly comes form banks. Financial intermediation is the root of savings-investment process. As such, being able to get a loan is crucial in the growth of business as well as the expansion of existing ones. As first glance, it may seem that the risks involved in lending other people’s money to too great, the utilization of loans to produce more business helps in stimulating the economy.   Conclusion               In conclusion, financial intermediation helps business to pursue their business objectives. In addition, it also helps in boosting the economy o a country. The risks of lending other people’s money it off-set by the potentials of the new businesses or business expansions on the country’s economy. Furthermore, the loans are secured by contract so banks are confident that they will be able to regain the loaned amounts of money in times that they need to be regained.               The circulation of cold cash ensures that there will be much more to circulate in the future. This means that financial intermediation contributes to the creation of wealth by capitalizing on exiting ones and attempting to make them profitable.         Reference   Credit:ivythesis.typepad.com

WHAT IS MEANT BY FINANCIAL INTERMEDIATION? GIVE EXAMPLES

Financial Intermediation Introduction The flow of capital is important in the business world. Entrepreneurs are consta...

Finance and Growth Strategies

Net Present Value             End of the Year Cash Flow CF Discount Rate DR* Present Value     at 9% CF/DR 0 -10,950,000 1.00 (10,950,000.00) 1 4,500,000 1.09 4,128,440.37 2 4,500,000 1.19 3,787,559.97 3 4,500,000 1.30 3,474,825.66 4 4,500,000 1.41 3,187,913.45 5 4,500,000 1.54 2,924,691.24 6 4,500,000 1.68 2,683,202.97 7 4,500,000 1.83 2,461,654.10         11,698,287.76                                         NPV= 11,698,287.76 – 10,950,000     =            748,287.76                       *Equal to Required Rate of Return               Internal Rate of Return (Trial-and-Error)             End of the Year Cash Flow Discount Rate DR Present Value     CF at 12% CF/DR 0   -10,950,000 1.00 -10950000.00 1   4,500,000 1.12 4017857.14 2   4,500,000 1.25 3587372.45 3   4,500,000 1.40 3203011.12 4   4,500,000 1.57 2859831.35 5   4,500,000 1.76 2553420.85 6   4,500,000 1.97 2279840.05 7   4,500,000 2.21 2035571.47                9,586,904.42           NPV=  9,586,904.42 – 10,950,000     =   (1,363,095.58)                                                                               Computation 1   Computation 2   Using Interpolation                                     0.35 Computation 1       1.06 Computation 1 multiplied by Computation 2   10.06 Add to r1       Approximately the IRR is 10%                               1.  Since the NPV has positive value (L 748,287.76), the expansion of product line of Fijisawa tends to increase investors wealth, thus, should be a worth while strategy.  In the same manner, the IRR is greater than the required rate of return at approximately 10% versus 9% supporting the profitability of the expansion.  However, as the NPV value is a mere 6.8% of the initial investment and there is only 1% difference between the rates of return of the expansion relative to the requirement of investors, the figure suggests minimal return for investors despite seven years waiting to recoup and profit from their investments.  Aside from minimal compensation to adhere the time value of money, the investment also failed to sufficiently compensate investors from the risk of the new product line being eaten by competition or ignored by customers.  Due to this, it is concluded that other investment alternatives should be sought and make this option the last resort.       2.  Capital budgeting directly affects the long-term investment decisions of the firm (see appendix 1) to remain consistent to its goals (2002 ).  It embodies the intention of the firm and sustains the relationship its culture affords to offer to its stakeholders.  Thus, when capital budgeting has erred to protect its intentions and fails to derive its culture planted to (say) debtors, it may not receive the previous support from their financing.  This can be in the case when the firm fails to accurately forecast its cash inflows that tell the profitability of an engagement.  As it is strategic in nature, the capital budgets should be flawless when prepared and translated to a project.  As an example, Airbus and Boeing had committed substantial resources to build A380 and Sonic Cruiser respectively (2003 ).  If their capital budgeting has flaws, it is difficult to reverse the strategy due to the substantial costs of initial outlay or some outstanding contracts with suppliers as well as customer expectations for improved technology.  And when Airbus or Boeing continued overturn their budget loopholes, they would suffer from stakeholder doubts that can result to reduce share attractiveness, broken supplier relationship, cancelled orders and lost opportunity in the airline industry.   3.  Payback period method is advantageous when a firm tightly adheres to the time value of money concept, that is, the money to be received in the future has higher risks and lower value than the same amount of money on-hand today.  This becomes crucial when a firm is bound to be acquired in which its objective is not to maximize profits rather minimize the time required to recoup investments (say) for a period of two years in which it is also bound to be formally acquired.  Alternatively, its computation (see appendix 2) ignores time value of money due to the absence of discounting cash inflows to find their present values (1999) unlike NPV or IRR.  Nonetheless, it is used frequently because it is the most popular and easily understood investment appraisal techniques (p. 357).  Easy it is because it is internally-driven from the view and subjectivity of the firm preventing technical calculations and market research in favor of the “fastest way to recover investment” rule.  .         4.  From the period 1960 to 1992, Africa remained the region with the highest expropriation activity ( 1994).  There are several options to consider such risk in view of my investment there.  First, I can deploy foreign direct investments (FDI) provided that the government assures their investors protection through just compensation (Brownsville v. Pavazos) whenever a local bill is passed to exercise certain rights that only expropriation can obtain.  Second, I can opt to rely on research findings to rationalize my decision to the risk of my business as an FDI.  If my business is on agriculture, oil exploration or other natural resource utilizing or depleting, I would not dare to enter the region since they are the most active expropriation areas (1994).  Considering that there are countries in Africa that uses selection rather mass expropriation, in the contrary, such could serve as a fair destination.  Lastly, I can get out of my optimal dream of the region’s abundant resources and have practical and less risky portfolio investments in the South African stock exchange ().  This can be a sub-optimal substitute but coupled with fixed, continuous and less anxious returns suitable for risk-averse, unrelated firms.            5.  Mergers and acquisitions seldom results to added value expected can be suspected from over expectation of the acquirer.  News Corporation expected to finally have its legacy after Direct TV acquisition ( 2004).  However, with the post-merger outcome wherein the acquirer only have at most 30% stake in the latter (Direct TV website), the added value may not be suffice to call the acquisition successful.  As a matter of fact, there was no acquisition but merely portfolio investment.  In effect, there was a lack of accurate evaluation of the target response and necessary adjustments in the earlier pronouncement of acquisition goals to react to it.  Thus, expected value is overvalued and is likely to be assessed as failure unless there emerge untoward developments like stock market bubble in the post-merger/ acquisition.  Freezing this hypothesis, the primary factor would also be found within human specific characteristics since it is only the part of an organization that derives motivation for optimal performance.   There are different reasons for merger and acquisitions and examples can illustrate these.  HP acquired Compaq to not overly rely on its well-known businesses of printers and computer accessories but to intensely compete on the PC industry; consequently, the merged firm overtook IBM in terms of market and revenues ().  On the other hand, Merck & Company was trailed by its competitors replacing the former in the number 1 spot in pharmaceutical industry as it resisted acquiring a successful firm and minimizing the cost and time spent on internal drug research and development ().  Lastly, the Australian-based News Corporation, the owner of Twentieth Century Fox and other international media firms, acknowledged its offered acquisition to satellite pay television leader in the US market, Direct TV, would make its ultimate objective of being the world’s largest media company (2004).                      Such citations have different causes and implications.  HP wanted to increase market power and reshape its competitive scope, Merck & Company is bounded to significantly spend and wait for new-product development, and News Corporation aspired to overcome entry barriers, reduce risk of developing new products and increase diversification ().  On the other extreme, not all acquisitions are successful particularly in delivering the expected added value for the merged firm ().  The acquirer may have conducted inadequate evaluation of target leading to too much diversification or large extraordinary debt.  The merged firm also may have integration difficulties that result to inability to achieve synergy, being large without substance and managers overly focused in acquisition disregarding managerial functions for sustainable growth.               In 1989, HP acquired Apollo workstation business.  HP had succeeded to integrate the compensation, engineering and marketing aspects of the merged firm (1998).  However, the last aspect they have intricacy to deal with is the different work philosophies of each firm employee.  HP environment foster cooperation while Apollo allows competition between teams.  Another, the former is customer-focused while the latter is technology-focused.  This example is basically a submission that intangible resources are unique to a firm and is difficult to imitate unlike tangible assets.  As a result, the pre-merger goals of HP and Apollo of increased market power and generate cash flow respectively is not easily attained.  In this case, the human-side dictated the major post-acquisition problem.  And since organizational culture is the social energy that drives or fails to drive a (merged) firm towards its goal (), resolving the behavioral conflict was also the major focus of the new firm.               The expectation not only on added value per se but also considering the period in which they can be obtained and integrated by people is a function of three merger effects: namely, looking over one’s shoulder, win-loss game and feeling of isolation ( 2000).  They are demoralizing effect of post-merger downsizing, inconvenience and adaptation of/to the new firm.  Ultimately, as what happened in HP-Apollo case, the integration of physical, financial and technological resources were completed faster than organizational resources and culture.  This is because culture grows over time.  And since humans are the foundation of capabilities (), core competencies cannot be simply obtained from resources.  They are also subjected to behavioral adjustments of integration.                  In a different case, there are acquisitions that did not submerge the culture of the acquired into the acquirer.  AT&T let McCraw Communications preserve its entrepreneurial, philanthropic and casual culture ().  Similarly, IBM did the same when it acquired Lotus.  The former let the latter to price their unit products and even mimic some of Lotus work style like attending meeting in non-formal clothes.  The preservation of cultural identities is crucial particularly when the acquired firm has business that is new or unfamiliar with the acquirer.  This idea gives the acquirer bigger bargaining power to retain its philosophies and business strategies.  Otherwise, the advantages of the acquired firm skills and knowledge cannot be exploited by the acquirer.               In cross-border acquisitions, a research was conducted to study the reasons of underperformance of two firms since the acquisition: one is a UK company and German subsidiary and the other is A German company and UK subsidiary (2003).  For the former case, the study showed that cultural differences of firms blemish acquisition strategy because of homogeneity of control system particularly in accounting methods.  The UK company underestimated the finance function of Germany and showed uncompromising approach to German’s precise accounting models.  In effect, the added value of vertical integration it aspires with the acquisition has yet to be obtained at the time of the study.  On the other hand, the German company do not see this as success barrier instead the lack of control system that focus on strategic objectives.                Price leadership strategy is undermined in both cases in favor of product differentiation and innovation.  In both cases, the firms obtained their own accounting method that undermines the value of currency exchange fluctuations to overall profit but continued their entrepreneurial skills.  Also, there are merely special visits to assess proper controls on subsidiaries deepening the problem of financial integration.  Seemingly, there were substantial looses on efficiency and economies of scale hindered by language barriers and local knowledge.  And so, not only the firm-specific culture was hampering the value added expectation by mother companies but also country specific.  This communication, coordination, integration and adaptation difficulties all sum-up to make sense with the underperforming post-acquisition scenario.   Appendix 1: Corporate Goal, Financial Management and Capital Budgeting             Appendix 2: Payback Period Method Example   Turbo charge is considering one of the following two investments.     Machine X Machine Y Net cash flow (after tax): £ £ Year 1 4,000 15,000 Year 2 5,000 6,000 Year 3 16,000 4,000 Total cash flow 25,000 25,000 Initial investment (cash outlay) 25,000 25,000 Payback Period (PBP) 3 Years 3 Years                                                                                                           Credit:ivythesis.typepad.com

Finance and Growth Strategies

Net Present Value End of the Year Cash Flow CF Discount Rate DR* Present ...

Capital adequacy requirement impedes lending in banks

Problem Statement Capital adequacy regulation for banks may reinforce macroeconomic fluctuations: If negative shocks to aggregate demand reduce the ability of firms to service their debts to banks, reduction in debt service lowers bank equity because of capital adequacy requirements and may in turn reduces bank lending and industry investment. There looks at banking crises in the developing world including macroeconomic and supervisory factors. It discusses policy options, drawing on actual experience in developing and developed economies. Thus, testing how active management of bank credit risk exposure through the loan sales market affects capital structure, lending, profits as banks that rebalance their loan portfolio exposures by both buying and selling loans that is, banks that use the loan sales market for risk management purposes rather than to alter their holdings of loans hold less capital than other banks; they also make more risky loans as a percentage of total assets than other banks. Holding size, leverage and lending activities constant, banks active in the loan sales market have lower risk and higher profits than other banks. Aside, banks that improve their ability to manage credit risk may operate with greater leverage and may lend more of their assets to risky borrower, benefits of advances in risk management in banking may be greater credit availability, rather than reduced risk in the banking system. The merit of international convergence of bank capital requirements in the presence of divergent closure policies of different central banks can be examined. The lack of complementary variation between minimum bank capital requirements and regulatory forbearance leads to spillover from more forbearing to less forbearing economies and reduces the competitive advantage of banks in less forbearing economies. Linking the central bank’s forbearance to its alignment with domestic bank owners, it is shown that in equilibrium; regression toward the worst closure policy may result: The bank of initially less forbearing economies adopt greater forbearance, adjustments might have been made by partial recognition of unrealized stock losses and expected loan losses, efforts to increase capital in ways that effectively reduced risk exposure seemed to dominate the response to strengthened capital requirements. The analysis may suggest the advisability of supplementing risk-based capital requirements with leverage restrictions raises the question of whether percent minimum ratio of capital accord is sufficient for banks. Such impact does not obtain with either risk-based capital requirements or nonbinding deposit rate ceilings, but only the former are always effective in controlling risk-shifting incentives. Persuading those who think that capital requirements are worth studying that it is important to pause a moment, abstracting from all that has been done, to delineate a set of fundamental principles for future work on capital requirements. It seems important, at least from time to time, to expand the focus of the analysis of bank capital. If only narrow technical questions were ever posed, it would be difficult to address the broader issues with a satisfactory level of confidence in the results. Thus, the methodology will be somewhat unusual in the context of standard economics. The approach is empirical and deductive, but is not based explicitly on hypothetical microeconomic modeling, which is readily available, identifying useful features of capital requirements, past and present, as means of establishing criteria that researchers would find desirable in subsequent capital regimes. The minimum capital requirements have been successful to the extent that they have reflected these sorts of large first-order exposure. The concept of exposure is distinct from that of risk. Exposure is not defined as corresponding to any particular type of risk, but rather as a measure of the aggregate value that is subject to risks in general. For instance, the face value of a debt instrument may provide good basic measure of exposure. Nevertheless, range of values involved in those differences is frequently of second order as compared with the basic exposure of the instrument. Exposure is calculated by means of well defined rules that are straightforward and represent overall level of risk. Poorly functioning banking systems impede economic progress, exacerbate poverty and destabilize economies. Furthermore, there have been an unprecedented number of disruptive banking crises in recent decades. There is no evidence that successful practices in the United States, for example, will succeed in countries with different institutional and political environments. There is no evidence that each regulatory and supervisory practice can be considered as part of an extensive checklist of desirable best practices in which more checks are better than fewer as opposed to considering regulation and supervision as reflecting broad views about the role of government in society. Credit:ivythesis.typepad.com

Capital adequacy requirement impedes lending in banks

Problem Statement Capital adequacy regulation for banks may reinforce macroeconomic fluctuations: If negative shocks to aggregate demand ...

DIVIDEND AND CAPITAL STRUCTURE

Dividend Policy Considerations Risk is not only a source of randomness on the return of investment but also a measure of this variability because the probabilities of various outcomes are known ( & 1997 ;  2001 ).  Contrary to uncertainty, risk is more predictable and measurable because outcome probabilities need not to be estimated rather given.  The probability of having tail or head (i.e. 50/50) in a toss coin is an example of risk while the probability of winning or loosing in a legal trial is an example of uncertainty.  In addition, there are three fallacies about risks; namely, risk is always bad, risk should be eliminated at all costs and playing it safe is the safest thing to do ( 2001 ).  Risks are either threat or opportunity depending on the stance of entities involved.  For example, a hurricane is a disaster for homeowners in a certain community but some people like sellers of lumber, weather radios and other emergency equipments/ tools may view the disaster as earning opportunity.    Elimination of risks to avoid untoward results should address initially two questions; namely, is it complete elimination and what is the cost of any reduction?  For example, there is a chance that an asteroid could hit the earth according to some experts but would the probability of the event (i.e. 1 in 1 billion) can be substantial enough to create the need to create homes in caves and underground which have monetary and non-monetary costs ( 2001 ).  Lastly, preferring zero risk is equated to a risk-averse person.  For example, even though the probability of wining a ,400 raffles ticket at a cost 0 is 50%, a risk-averse person will not bet his 0 due to the adversity on having nothing.  This despite the expected value of buying the raffle ticket and betting is 0 (i.e. ½ () + ½ (,400) = 0) which means there is an equal probability of doubling his money ( 2001 ).       I. Total Risks             Consistent with a rational market, individuals and other entities expect and are promised with higher (lower) returns if they engaged in investments with higher (lower) risks.  Shareholders are concern with total risk because it is a measure of the risk of an exposure of business portfolio that is comprised by the sum of market and firm-specific risks.  Due to this, investors can reduce their total risk through diversification without altering their expected return ( 1993 ).  However, this incentive is less attractive to contemporary investors because firm-specific risks are automatically considered when they hold a certain number of securities.  As a result, firm specific risk becomes irrelevant to investment motivation because investors do not have to bear the firm-specific risk and therefore do not have to be compensated ( 1993 ).      II. Unsystematic Risk Business risk is related to operating features of a firm while financial risk is related to the strategies behind the capital structure of a firm ( 1999).  The former is a type of risk that is outside the control of firms and hardly affected by certain tactics and strategies because business risk is very dynamic and uncertain.  On the other hand, the latter involves factors within the scope of managerial control because it arises from borrowed funds the company is bound to pay unlike equity funds.  However, they are both under the definition of systematic risk or inherent risks of companies that cannot be reduced by diversification strategies.  Business risks includes example such as the sensitivity of competitive structure of an industry to changes in macroeconomic variables such as inflation and interest rates.  On the other hand, the more debt a firm has a greater level of financial risk or inability to meet such obligation.   III. Systematic Risk For example, every stock in London Stock Exchange is uncorrelated with every stock; the beta coefficient is zero ( 2006).  In this case, it will be possible to hold a portfolio in LSE that has risk-free.  Investors would be acting like a casino owner having to only wait at the end of the day to receive fees from the players.  The owner will accumulate earnings without any risks in playing rather only responsible for maintaining the venue.  With zero betas, game theory will not hold and stock markets will never exist as correlated risk is the source of all risk in the diversified portfolio.  On individual assets, beta represents volatility and liquidity of the market place while on portfolio perspective it refers to investor’s level of risk adversity.  Beta is estimated through times series analysis and linear regression models ( 2006) like estimating ninety trading days of simple returns used as estimators for covariance and variance.  Negative betas can be derived by holding securities that move against the market, shorting stocks and putting on options.    IV. Agency Problem Problems of agency relationship focus on the conflict between principal (i.e. shareholders/ clients) and agent (i.e. the managers/ consultants).  It states that as much as principals would like to maximize their investments and minimizing costs, agents have a conflicting goal of maximizing compensation and providing less-effort service ( &  1976).  The former can only speculate about the tendency of the latter to exemplify such agent behavior because agents can misinterpret skills and knowledge to the attention of the principals.  Due to speculation, principals implement monitoring systems and reduction in asymmetrical information to prevent any possible opportunistic behaviors from the agents.  In effect, the relationship implies that highly-preferred agents are those who can minimize such agency costs leaking from the pockets of principals.             Managers can work for shareholders yet they themselves are significant shareholders.  This happens when managers exercise their rights for employee stock options.  Due to lack of transparency, managers may have conflict interest in the onset especially if their shares have significant voting rights to direct the corporate strategy in the future.  Agency and principal compact should be guarded by corporations to prevent adverse scenarios of diluting agent’s (e.g. managers) responsibilities by giving them the probability to be principals (e.g. stockholders).  When this happens, managers can have sub-optimal effort in managing the company because part of his time, strategic contribution and money are diverted to being a stockholder.  As a general rule, stockholders are the risk-takers while managers are the agents that will assure the former from being under success.    Write-off applied to stock option-related expenses that loosen the pressure of costs being deducted to revenues.  As a result, the profit of the company especially the whole income statement has the incentive to mitigate any losses or even look as profitable.  Due to this, Dunlap’s previous use of writing-off option-related costs enables its losses to be minimized in terms of revenue reduction.  The argument of Dunlap against Sun Beam also gained ground because writing-off mitigated the loss.    The hiring of auditors and bond companies to evaluate corporation’s financial statements can have negative and positive effects for the public.  The former can induce collusion in which other auditing functions can be affected by the profit being derived from the additional work.  As a result, corporations can collude to minimize reporting standards or favor few misapplications of required disclosures.  Also, this situation can give corporations unnecessary incentive to model their financial statements according to the liking of auditors and bond companies.  In effect, they can lead to getting their positive thinking of the corporation and then submit the real intention of getting funds or colluding to by-pass financial statement requirements.  On the contrary, such situation is positive when the relationship blooms in minimizing transaction costs of auditing because at the planning stage of designing the reports intervention is already applied.  Financial markets can have efficiency in managing resources and capital.   In view of the positive and negative side of this ideal, it is suggested that potential clients should be applied with restrictions regarding the extent of opinions that auditing offices and bond agencies can apply.  Those accounts that relating to additional income of the contractors should not be communicated and the design or content per se of the statements should be focused.  Auditors should not also have relatives in the client’s company to avoid personal biases in evaluating the financial statements.  Government standards may also include additional disclosures in the financial statements about the extent of preview and opinion that auditing and bond agencies have been made.  In these recommendations, the public may be assured that negative collusion will ensue and their best interests are protected in both investing and evaluation areas.   On extreme cases, agency problem leads to more problematic scenario in which publicly-listed companies are grounded.  Auditing services which when degraded can impact the reputation of stock exchanges and listed companies.  This is usually the case in some countries.  Non-audit services create economic benefits which are complemented by direct payment of clients to auditing firms ( 2001).  The lucrative effects of the transaction are eminent like evasion of corporate/ income taxes, productivity demands from top-level management of the auditing company (e.g. in case of individual employee) and relative ease (perhaps comfort) of performing profession and public responsibilities.  Connivance is often used to speed-up economic and regulated dealings in the absence of relevant authorities and other stakeholders.   Importance             For the stock price, an increase in expected dollar earnings of a firm with unchanged risk will increase its value while an increase in expected dollar earnings with lower risks will “significantly” increase its value ( 2000 ).  Due to this scenario, higher-ranked common stocks are more preferred than lower-ranked stocks and the latter tends to be sold in favor of the former.  The former is defined as those stocks with highest expected rate of return for the risk or the lowest risk for an expected rate of return.  As earnings per share (EPS) indicates the dollar return for every stock an investor purchased, it is one of the most items in the firm’s financial information that receives highest interests.  For its part, the firm should solidify its claim of having high-ranked stocks to be able to compete for the limited available capital in the economy.  As debt financing is more risky than equity financing (since the firm is obligated to pay debts even minimal or no profits is obtained), this task of the firm should be convincing.                       Although corporate earnings have positive relationship with stock price ( 2000 ) such as the greater earnings the higher stock price will be, external forces both political and economic in nature would barred the firm from optimal realization of such relationship.  In effect, being inclined or parallel with economic indicators is as crucial as internally generated earnings.  One indication of this is that expected earnings should exceed interest rate of government bond to be able to be competitive.  Another is that it should flow consistently with changes in interest rate, inflation and economic activity.  This will make the firm’s investors to avoid unguided speculation when making investment decisions.  It is a well-known dogma that no participant in a stock exchange can control the entire trend of stocks and so the consensus counts.  And where will a rational firm/ investor/ government base their decisions?  Of course, on what is really happening to the economy with small number of them speculating for short-term gains, that is, a mere buy and sell strategy.          Too much inflation (e.g. hyperinflation) has negative effect on stock price which can either be stimulated by pull and/or push consumer/ producer effects.  To dispute this, common stocks are viewed as inflation hedgers ( 2000 ) as they can easily maneuver the cost of firm’s goods to follow inflation in the cost of production.  Generally, the adverse inflationary effects on stock price is rather of short-term basis while the long-run inflationary functions of common stocks can be derived by an investor who is willing to place his investment longer in the hands of the firm.        There are at least three types of traders/ investors in the stock market ( 1964).  This will serve as a guide for every trading/ investment strategy.  For portfolio managers, one profitable trading strategy especially for portfolio managers is top-down stock strategy wherein the economic and market environments are analyzed before making a decision.  Bottom-up approach emphasizes financial analysis of a firm’s data including comparison of stock performance against its competitors.  For technical traders, there is also a technique to forecasts stock price movements by using previous charts to identify trends and there signals of actually happening including their impact.  Hedging and arbitraging strategies are also used to aid in analysis.  For sales traders, another is the strategy that aims to determine the best price by having knowledge of trading partners and relative prices to identify who is liquid in the market and exploit such identification.   Capital Structure Considerations I. Modigliani and Miller (Without Tax)             This argument is opposite of the traditional view.  It argues that the value of the firm is independent of its capital structure that can be proved by simply capitalizing the expected return appropriate to each risk class ( 1999).  For example, two different firms have a capital structure or debt-to-equity ratio of 90:10 and 10:90 respectively.  With this argument, the value of the firm is reflected by its earnings before interest and taxes (EBIT) and the variability or risk of the EBIT while the average cost of capital serves as the discount rate that will capitalize EBIT.  As a result, the cost of capital of the un-geared firm will also be equal to the geared firm because the cost of debt capital is eliminated.  In this proposition, cost of equity capital is a linear function of capital structure that cancels the yield in equity due to capitalization rate and financial risk premiums.  As a result, increases in gearing also increases the risk of equity capital that will positively push the required rate of return upwards.  In addition, the use of cheaper debt is trade-off by increasing the cost of equity   II. Modigliani and Miller (With Tax)             This argument is a refined version of “without taxes” because it adapts to real corporate situations.  It posits that tax shields that benefit a highly geared firm is misleading and with questionable effects ( 1999).  The benefits are initially apparent because the highly geared firm has tax allowable interest payments to creditors that will make their earnings after interest and taxes (EAIT) greater than un-geared firm.  When capitalizing method in “without tax” version is applied, appropriate discount rate will be applicable to interest payments on debt which produces the tax shield making interest and tax shield on the same class of risk.  In this regard, the value of the geared company and the un-geared company plus the present value of the tax shield will be equal.  Finally, as debt-equity ratio increase, the firm’s financial risk is also increased which cause its cost of equity to rise.  In contrast, the impact of corporate taxes cancels the cost of debt and therefore cost of equity where trade-off is the obvious situation.             III. The Traditional View Weighted average cost of capital (WACC) aids the firm to select the most efficient combination of capital structure by reflecting in the computation both equity and debt financing options.  It is posted that high equity capital structure is less risky than debt financing because the firm should pay banks even though there is no profits.  However, too much equity financing can destruct the ownership structure of the firm which can be harmful for major stakeholders.  Therefore, capital structure must be managed by combining financing alternatives in order to optimize a firm’s cost of capital that can contribute to increase in firm’s value.      Traditional model believes that capital structure is related to the value of the company wherein it is possible to reduce WACC ( 1999).  The model held by following assumptions; namely, all earnings are distributed as dividends, earnings are expected to remain constant indefinitely, all investors have identical expectations about future earnings, taxation is ignored, business risk remains constant, capital structure can be altered immediately by exchanging debt for equity or vice versa and there is no transaction cost.  The traditional model theorizes that the WACC of the firm is a source of useful information or signal to achieve an optimal capital structure.   IV. Capital Structure Analysis Using the gearing ratio, the level of a firm’s financial risk is assessable which means that the firm can identify if financial resources are able to pay planned or on-going financial commitments or not ( 1999).  In this way, the firm can make decisions and implement strategies according to its financing ability.  This upper hand is worthy not only because it places the firm in a safer stance but more importantly it is able to control one side of the general risk confronting a business (financial side) which relaxes problems emerging from the uncontrollable business/ environmental risks.    With this, the survival of the firm is protected by capital structure (CS) as internal consequences of a firm’s strategy are detected.  Questions such as “Do we have enough money for the project?”, “Is there a need to borrow or issue shares?” and “What is the gearing ratio to be adopted to maximize the potential of the project?”  This facility has also its implications on corporate ability to forecast, exploit and mitigate environmental changes and even apply influence over its gradual evolution.  This can achieve merit by using the resource-based model of above average returns wherein core competencies are matched against the changing environment (,  &  2003 ).               Using CS as the basis for project planning and implementation, the firm can enjoy the computed future earnings without interference from pending obligations to creditors or shareholders.  This is important for project cash flows to be obtained all throughout its life span because creditors can sue a company when debt contract or shareholders’ expectation are not met.  As an example, in the early years of US operations of News Corporation (the owner of Twentieth Century Fox), its CEO and financial officers faced difficulty to calm its creditors and defer lawsuit that can substantially disrupt its corporate life in the US (,  &  2004 ).    The company’s debt came from its huge acquisition costs on most American-owned media companies where some are unsuccessful to meet their expected earnings.  This case shows how lack of financial planning can provide a big headache for (expanding) firms.  However, through CS, this highly-owned family company may have give-up some of its control in favor of equity financing.  Thus, it may have prevented the last minute plead and risky confrontations to its creditors.                         In general, debt financing is cheaper than equity financing because it is a tax allowable expense ( 1999 ).  However, it is also more committed (thus, risky) because repaying includes the principal and interest and it is mandatory even if the company results to a loss.  In addition, too much debt can discourage shareholder and their funds from entering the firm’s coffers because ordinary shareholder is only awarded with the profit residual after the creditors are paid ().  In the contrary, focus on equity financing can be unacceptable (in the case of News Corporation) or not strategic because the firm can loose its identity as it also looses control to major corporate decisions.  When company’s shares are concentrated to one entity on the market, it may also face hostile takeover.  This literally is one way to say that the original company has already perished.    Bibliography Books   Electronic Sources       Credit:ivythesis.typepad.com

DIVIDEND AND CAPITAL STRUCTURE

Dividend Policy Considerations Risk is not only a source of randomness on the return of investment but also a measure of this variabilit...

Working Capital Management of ACCRA Brewery limited

WORKING CAPITAL MANAGEMENT        We may define working capital simply as cash that are available to the company or organization. Therefore managing the cash at hand depends entirely on utilization of funds and useful expenditure by whoever owns it. Working capital management who’s primary function is to ensure that the company will continuously have sufficient funds for allocation. For a company’s success can be evaluated extensively through its financial position, not only on a company asset but also in their liability. So if you are going to invest such as stocks in any company you should investigate on their financial position before investing.       We are not going into a detail and in and out of this stuff but we are going to view real examples of businesses who are expert in this field of working capital and how they have been so successful in working capital management to further understand its variable importance.         ACCRA Brewery limited – Is one of the largest brewing industry in Accra, Ghana shows their financial reports to the public in 2009, and how they have managed to control their working capital effectively. Their financial statement shows continuous flow of smooth and steady income, the financial report is in accordance with Financial Reports Standard using critical accounting estimation. Acquisition and liquidation of reports have been properly declared to the public to show transparency among its stock holders. Their property evaluation stated at cost less depreciation. Inventories of stocks including all expenses incurred in bringing them into safest location.   To make sure they have been performing well, all taxes are paid and declared so that the government will not sue them for evasion.         The company has been exposed to financial risk including credit risk and foreign currencies and exchange rate. Risk management is carried out by the board of directors that provides written principles for overall financial risk. Credit sales are strategically used to take advantage of market opportunities.  In Capital management they reported that they will ensure that the company will meet its debt before it’s due to maximize shareholders value because the company’s capital depends on the shareholders equity. This is how they allocate and manage their working capital. Dr. Charles Mensa Chairman thanks the public for their continuous support.          Ashanti Goldfield Company Limited (AGC) – An International gold mining company located in African nations: Ghana, Guinea, Tanzania and Zimbabwe. This Company has experience downfall and unexpected significant effect in working capital management. It was when the Group of 15 Central bank limits their order of gold into the market, this has brought financial crisis to the company. Some competitors find their way to decrease their price that overtaken Ashanti’s market dominance.       Thereafter there has not been any solution that the company has undertaken. Their accounting book goes negative. Until such time that the board has taken their time to arrange given solution to their situation. Nevertheless, none of their solution has been yet effective to consider the immediate financial crisis they have experienced. The company considered raising funds by selling their assets. The Geita mining in Tanzania will be considered for sale to meet their financial needs, But then again the sales of this asset have not been the primary solution to their financial crisis.       They have also asked for many consolidation offers but companies have not taken risk since the depreciation of gold price in the market and their limited distribution. No companies have been interested until the coming of Lonmin pic. Since then it took almost a year to finally break the long term gold price and the strategic merging of Lonmin pic. The term of Lonmin pic values includes an offer of shares at US including a US 0 million to conceal their working capital. They have also restructured the additional board of director to help with the concerns they have been facing.  Going back to their financial reports show last February year 2011that the result shows stronger sales rather than the previous year since the new strategy was launch. This has proven a great deal of overcoming woes in mis-management of working capital and rising up against hindrances that a company may encounter.        From the two examples we have given above, shows that “Working Capital Management” techniques that they have used can promote financial stability and eliminate contagious risk in business. Even if you are an establish business does not guarantee a steady streamline of success. Working Capital Management thereby reduces the potential financial devastation if properly undertaken. Credit:ivythesis.typepad.com

Working Capital Management of ACCRA Brewery limited

WORKING CAPITAL MANAGEMENT We may define working capital simply as cash that are available to the company or organization. Therefor...