FINANCIAL DECISION MAKING

FINANCIAL DECISION MAKING 9

FINANCIALDECISION MAKING

Classname

School

Question1

(a)

Calculation of Earnings available to share holders

Year

2,013

2,014

Sales revenues

15,000,000.00

20,000,000.00

Less: Fixed operating costs

Less: Variable operating costs

Earnings before interest and taxes (EBIT)

15,000,000.00

20,000,000.00

Less: Interest

Convertible bond (1,000,000 at 10%)

100,000.00

100,000.00

Preference shares(500,000 at 5%)

25,000.00

25,000.00

Net profits before taxes

14,875,000.00

19,875,000.00

Less: Taxes (T AX RATE= 30%(0.30)

(4,462,500.00)

(5,962,500.00)

Earnings available for common stockholders

10,412,500.00

13,912,500.00

Calculation of the EPS FOR 2014

Earnings attributable to ordinary shareholders for the year

EPS for 2014=

Weighted average shares + Bonus element + Fair Value Element x( time apportionment)

Calculation of the EPS FOR 2013

Earnings attributable to ordinary shareholders for the year

EPS for 2013=

Weighted average shares + Bonus element

The theoretical Ex-Rights Price

Brady Plc`s Value before rights issue

2,000,000.00

2,000,000 shares at X1

Cash raised from the rights Issue

Number of shares= 2,000,000/3 X1=666,667

666,666 X 3( Price)

2,000,000.00

Value of the company after rights issue

4,000,000.00

Theoretical Ex-Rights price per share

4,000,000/2000,000 +666,6666

1.50

The Fair value element

Cash raised from rights issue

2,000,000.00

Theoretical ex rights per share

1.50

Number of shares issued at fair value

1,333,333.00

2000000/1.5

Bonus Element

Number of shares issued

2,000,000.00

Less Number of shares at fair value

1,333,333.00

Number of deemed bonus shares

666,666.00

Weighted Average shares

Calculating the Weighted Average shares

2013 shares at start of the year

2,000,000.00

Add bonus

666,666.00

weighed shares

2,666,666.00

2014 shares at the beginning of the year

2,000,000.00

Add Bonus

666,666.00

time value =1,333,333X 4/12

444,444.00

Weighted average shares

3,111,110.00

EPS

2,013

2,014

Change

Earnings available to shareholders

10,412,500.00

13,912,500.00

34%

Weighted average shares

2,666,666.00

3,111,110.00

17%

EPS

3.90

4.47

15%

BradyPlc.’sEps indicates that the company’s profitability hasincreased due to the rights issue. As a result of the issue, theweighted average number of shares has increased from 2,666,666 to3,111,110 .The returns to the shareholders in terms of earnings pershare have also increased consequently. In addition, the increase ofearnings available to shareholders is approximately 34% while half ofthe results trickle down to the shareholders inform of EPS whichincreases with almost half the increase in earnings (Frenkel,2012,P.450).

(B)

Thepossible shortcoming from the above calculation is that it does notshow the trend on Brady PLC’s profitability. This is because thecalculation ignores the fact that a percentage of the shares equal to33% of the new shares were offered bonus free{666,666/2,000,000}.i.e. free of cost to the owners. It is henceimportant to add the effect of the bonus element that is involved inthe calculation of EPS (Lindzey, 2005, P.511).

Question2

James International Limited cash Budget

&nbsp

&nbsp

Year 2015

Months

&nbsp

&nbsp

&nbsp

&nbsp

&nbsp

&nbsp

&nbsp

&nbsp

January

&nbsp

February

&nbsp

March

&nbsp

April

&nbsp

&nbsp

Sales figure

50,000.00

&nbsp

80,000.00

&nbsp

60,000.00

&nbsp

&nbsp

&nbsp

Opening cash

&nbsp

18,000.00

&nbsp

15,440.00

&nbsp

18,880.00

&nbsp

14,320.00

&nbsp

Add cash from sales

Cash from current Sales -30%

15,000.00

&nbsp

24,000.00

&nbsp

18,000.00

&nbsp

&nbsp

&nbsp

Cash from previous month sale-70%

&nbsp

35,000.00

&nbsp

56,000.00

&nbsp

42,000.00

&nbsp

&nbsp

Total cash from

33,000.00

&nbsp

74,440.00

92,880.00

&nbsp

56,320.00

&nbsp

Less Cash for Purchases

&nbsp

&nbsp

&nbsp

&nbsp

&nbsp

&nbsp

&nbsp

&nbsp

&nbsp

Purchases

&nbsp

80,000.00

&nbsp

60,000.00

&nbsp

70,000.00

&nbsp

&nbsp

&nbsp

&nbsp

Cash to buy Purchases-10%

8,000.00

&nbsp

6,000.00

&nbsp

7,000.00

&nbsp

&nbsp

&nbsp

cash paid the following month-50%

40,000.00

&nbsp

30,000.00

&nbsp

35,000.00

&nbsp

&nbsp

cash paid in two months- 40%

&nbsp

&nbsp

32,000.00

&nbsp

24,000.00

&nbsp

Total Cash needed for purchases per month

&nbsp

8,000.00

&nbsp

46,000.00

&nbsp

69,000.00

&nbsp

59,000.00

&nbsp

&nbsp

Net cash for operations

&nbsp

25,000.00

&nbsp

28,440.00

&nbsp

23,880.00

&nbsp

(2,680.00)

Sales labor pay

&nbsp

1,500.00

&nbsp

1,500.00

&nbsp

1,500.00

&nbsp

1,500.00

&nbsp

commision-4%

60.00

&nbsp

60.00

&nbsp

60.00

&nbsp

60.00

&nbsp

Total sales labor pay

&nbsp

1,560.00

&nbsp

1,560.00

&nbsp

1,560.00

&nbsp

1,560.00

&nbsp

&nbsp

Labor expenses

4,000.00

&nbsp

4,000.00

&nbsp

4,000.00

&nbsp

4,000.00

&nbsp

&nbsp

Other operating expenses

4,000.00

&nbsp

4,000.00

&nbsp

4,000.00

&nbsp

4,000.00

&nbsp

&nbsp

Total expenses

&nbsp

9,560.00

&nbsp

9,560.00

&nbsp

9,560.00

&nbsp

9,560.00

&nbsp

Closing Cash balance

&nbsp

15,440.00

&nbsp

18,880.00

&nbsp

14,320.00

&nbsp

(12,240.00)

Asillustrated in the above table, the closing balance at the end of thethree months is estimated at 14,320 (McLaughlin,2002, P.312 ).

(B)

Fromthe table above James Construction Company is likely to Borrow cashin the months of January and months of April. However, the companymay be required to invest the extra cash generated in the month ofFebruary and March. At the end of March, the company is likely tohave cash deficiency given the declining trend depicted from itssales (Paramasivan, 2009, P. 811).

Question3

  1. Pay Back Period

Replace

Refurbish

Initial investment

250,000.00

80,000.00

Return

13%

14%

year (t)

Cash inflows

1

70,000.00

45,000.00

2

100,000.00

40,000.00

3

110,000.00

10,000.00

4

50,000.00

50,000.00

Payback period Replace option

Payback period

cost

year

Cumulative revenues

250,000.00

1

70,000.00

70,000.00

2

100,000.00

170,000.00

3

110,000.00

280,000.00

4

50,000.00

payback year =2 and fraction of Third year equivalent to (250,000-170,000)/110,000= 80,000/110,000

pay back=2 years

0.727272727

2.9

years

months=0.72*12 months=9 months

or 2 years and 9months

Pay back period Refurbish

cost

year

cumulative revenues

80,000.00

1

45,000.00

$45,000

2

40,000.00

$85,000

3

10,000.00

$95,000

4

50,000.00

payback year =1 and fraction of second year equivalent to (80,000-85000)/40000= 5,000/40,000

pay back=1 years

0.125

1.125

months =0.125 *12 months= 2 months

or 1 year and 2 months

(B) Net present values

Present value for Replace option

Yr (n)

Revenue

present value interest factor [(1+r)^-n] at r= 11%

present value

cost

1

70,000.00

0.900900901

63,063.06

250,000.00

2

100,000.00

0.811622433

81,162.24

3

110,000.00

0.731191381

80,431.05

4

50,000.00

0.658730974

32,936.55

Total present value

257,592.91

Less Cost

(250,000.00)

NPV=total present value – cost

7,592.91

Present value for Refurbish option

Yr (n)

Revenue

present value interest factor [(1+r)^-n] at r = 11%

present value

cost

1

45,000.00

0.900900901

40,540.54

80,000.00

2

40,000.00

0.811622433

32,464.90

3

10,000.00

0.731191381

7,311.91

4

50,000.00

0.658730974

32,936.55

Total present value

113,253.90

Less cost

(80,000.00)

NPV= Total present value – cost

33,253.90

(C)Investment Appraisal Using the Net present value

Project type

IRR

Cost of Capital

Net present value

Replace

13%

11%

7,592.91

Refurbish

14%

11%

33,253.90

Accordingto the Net Present value, replace option is the most viable for thefirm. This is due to the positive cash flows that emerge consequentlyamounting to 7,592.91. Compared to the refurbish option which resultsinto negative present value at (33,463) (Seabrook, 1982, P. 135).

D-Investment Appraisal to the Board of directors of East Ville PLC.

The results of capital expenditure analysis are as presented in thetable below.

Project type

IRR

Cost of Capital

Payback Period

Net present value

Replace

13%

11%

2 years, 9 months

7,592.91

Refurbish

14%

11%

1 year 2 months

33,253.90

Payback decision making criterion

Paybackperiod criterion: Payback period calls for the time the project takesto pay back the initial investment or the cost. The project thattakes the shortest period is selected (Siegel. 2002, P. 211). Thetable indicates that the Replace option has a payback period of Twoyears and nine months while the refurbishment option has a paybackperiod of one year and Two months (Thomson,2004 P.450).Accordingto this decision criterion, the refurbishment option is advantageousto the company because it takes a shorter period to return the moneyused to buy the Asset (Pigou, 2011, P.350).&nbsp

IRRdecision making criterion.

TheIRR is the internal rate of return. It indicates the rate at whichthe company should invest its funds to attain positive inflows foreach project (Lawrence, 2011, P.612).&nbsp For each project, the netpresent value when discounted at the IRR, it produces a Net presentvalue of Zero. The rate is used to evaluate the viability of projectssuch as the ones at hand of replacement and refurbishment (Director,2014 ,P.415). The IRR should be more than the Cost of capital for theNet present value to be positive. The relationship is due to thenegative relationship that exists between interest rates and the netpresent values. The higher the interest rate, the lower the netpresent value. It indicates that suppose the net present value at IRRis equal to Zero, then the lower the rate the higher the Net presentvalue. As a result, projects with lower costs of capital than the IRRare more desirable as they produce higher Net present values andcontribute positively to the firm. The projects with Net presentvalues higher than the IRR are expected to produce negative Netpresent values which in return contribute negatively to the firm.

Byuse of the IRR, criterion, both projects are acceptable since the IRRis higher than the cost of capital. The IRR indicates that bothprojects are capable of producing positive results to the investors’funds. However, the lower the IRR the better the returns frominvestment. Consequently, The IRR calls for the investment in theReplace option in contrast to the payback criterion (Bodden, 2013, p.33).

Thecost of capital is the cost at which the company is paying to attainthe funds it uses for its activities such as the investment inmachines. It is used to evaluate the net present values from theinvestment options. The criterion calls for acceptance of projectsthat have a positive net Present value and rejection of those withnegative present values. As a result, by using these criteria, therefurbish option is preferred due to the production of a higher netpresent value of 33,253.90 compared to the replacement option with anNPV of 7,592.91. This is similar to the decision from the paybackcriterion and in contrast to the IRR criterion. The Payback option isrejected because it has a lower net present value (Brigham, 2004, p.64).

(E)Importance of the time value of money

Thetime value of money is important as the saying goes that a shillingtoday is not a shilling tomorrow. The idea is that money loses itsvalue due to time passage. Some of the factors such as inflation arethe main causes of the phenomenon. Also, there is the lostopportunity cost of using the money today compared to tomorrow. It ishence important to compare the value of money taking the time factorsince most investments provide returns after some time. The returnshave to be valued in terms of the cost at the time of investment inorder to make well informed decisions (Bodden, 2013, p. 33).

Question4

(A)

Asindicated in the table below, the variance analysis on cash receiptsis moderate. The Variance indicates that upon synchronization of theperiod of receipt from the period of sale for cash receipts and theseparation of the period of acquiring raw materials from the time ofpayment creates coherence. However, the changes in variances indicatethat the company should establish the various levels of sales inorder to have better projections.

Thesmall changes in variance and the overall average of the forecasts indicates that in terms of expenses, the company has done well inestablishing the consistency of expenses and their forecasting hashence been made a lot easier. Consequently, the firm is able toestablish with precision the level of expenses that it requires at agiven level of sales. It is hence important to attain such precisionin the case of sales and raw materials acquisition in order to be ina position to efficiently manage cash and avoid outages that requiresthe firm to borrow (Horne,B,.2002, P.311).

&nbsp

Budgeted

&nbsp

&nbsp

&nbsp

Actual

&nbsp

Variance=(BUDGET-ACTUAL)/ACTUAL

&nbsp

August

September

October

November

December

January

August

September

October

November

December

January

August

September

October

November

December

January

&nbsp

£,000

£,000

£,000

&nbsp

&nbsp

&nbsp

£,000

£,000

£,000

£,000

£,000

£,000

&nbsp

&nbsp

&nbsp

&nbsp

&nbsp

&nbsp

Br Fwd. Cash on Hand/(OD)

200

135

230

315

325

420

200

131

115

39

228

422

Cash Receipts

&nbsp

210

200

125

210

150

&nbsp

205

150

200

200

200

&nbsp

2%

33%

-38%

5%

-25%

Capital Received

0

500

&nbsp

&nbsp

&nbsp

&nbsp

&nbsp

500

&nbsp

&nbsp

&nbsp

&nbsp

&nbsp

&nbsp

&nbsp

&nbsp

&nbsp

&nbsp

Total Cash reciepts

200

845

430

440

535

570

200

836

265

239

428

622

0%

1%

62%

84%

25%

-8%

Less Cash Purchases (Raw Materials)

&nbsp

-50

-50

-50

-50

-50

&nbsp

-50

-55

60

65

70

0%

0%

-9%

-183%

-177%

-171%

Cash available for operations

200

795

380

390

485

520

200

786

210

299

493

692

0%

1%

81%

30%

-2%

-25%

Less Cash operations expenses

&nbsp

&nbsp

&nbsp

&nbsp

&nbsp

&nbsp

&nbsp

&nbsp

&nbsp

&nbsp

&nbsp

&nbsp

&nbsp

&nbsp

&nbsp

&nbsp

&nbsp

&nbsp

Rental &amp Rates

5

5

5

5

5

5

5

5

5

5

5

5

0%

0%

0%

0%

0%

0%

Admin &amp Sales Expenses

3

3

3

3

3

3

3

4

4

4

4

4

0%

-25%

-25%

-25%

-25%

-25%

Distribution Expenses

2

2

2

2

2

2

1

2

2

2

2

2

100%

0%

0%

0%

0%

0%

Direct Labour

25

25

25

25

25

25

30

30

30

30

30

30

-17%

-17%

-17%

-17%

-17%

-17%

Taxation Paid

&nbsp

500

&nbsp

&nbsp

&nbsp

&nbsp

&nbsp

500

&nbsp

&nbsp

&nbsp

&nbsp

&nbsp

&nbsp

&nbsp

&nbsp

&nbsp

&nbsp

Managerial Wages

20

20

20

20

20

20

20

20

20

20

20

20

0%

0%

0%

0%

0%

0%

Add back depreciation

10

10

10

10

10

10

10

10

10

10

10

10

0%

0%

0%

0%

0%

0%

Total

-65

-565

-65

-65

-65

-65

-69

-571

-71

-71

-71

-71

-6%

-1%

-8%

-8%

-8%

-8%

Overdraft repayment

&nbsp

&nbsp

&nbsp

&nbsp

&nbsp

&nbsp

&nbsp

100

100

&nbsp

&nbsp

&nbsp

&nbsp

&nbsp

&nbsp

&nbsp

&nbsp

&nbsp

Balance Crd. Fwd.

135

230

315

325

420

455

131

115

39

228

422

621

&nbsp

&nbsp

&nbsp

&nbsp

&nbsp

&nbsp

Budgeted

&nbsp

&nbsp

&nbsp

Actual

&nbsp

&nbsp

August

September

October

November

December

January

August

September

October

November

December

January

&nbsp

£,000

£,000

£,000

&nbsp

&nbsp

&nbsp

£,000

£,000

£,000

£,000

£,000

£,000

Br Fwd. Cash on Hand/(OD)

200

135

230

315

325

420

200

131

115

39

228

422

Cash Receipts

&nbsp

210

200

125

210

150

205

150

200

200

200

Capital Received

0

500

&nbsp

&nbsp

&nbsp

&nbsp

&nbsp

500

&nbsp

&nbsp

&nbsp

&nbsp

Total Cash reciepts

200

845

430

440

535

570

200

836

265

239

428

622

Less Cash Purchases (Raw Materials)

&nbsp

-50

-50

-50

-50

-50

&nbsp

-50

-55

60

65

70

Cash available for operations

200

795

380

390

485

520

200

786

210

299

493

692

Less Cash operations expenses

&nbsp

&nbsp

&nbsp

&nbsp

&nbsp

&nbsp

&nbsp

&nbsp

&nbsp

&nbsp

&nbsp

&nbsp

Rental &amp Rates

5

5

5

5

5

5

5

5

5

5

5

5

Admin &amp Sales Expenses

3

3

3

3

3

3

3

4

4

4

4

4

Distribution Expenses

2

2

2

2

2

2

1

2

2

2

2

2

Direct Labour

25

25

25

25

25

25

30

30

30

30

30

30

Taxation Paid

&nbsp

500

&nbsp

&nbsp

&nbsp

&nbsp

&nbsp

500

&nbsp

&nbsp

&nbsp

&nbsp

Managerial Wages

20

20

20

20

20

20

20

20

20

20

20

20

Add back depreciation

10

10

10

10

10

10

10

10

10

10

10

10

Total

-65

-565

-65

-65

-65

-65

-69

-571

-71

-71

-71

-71

Overdraft repayment

&nbsp

&nbsp

&nbsp

&nbsp

&nbsp

&nbsp

&nbsp

100

100

&nbsp

&nbsp

&nbsp

Balance Crd. Fwd.

135

230

315

325

420

455

131

115

39

228

422

621

&nbsp

&nbsp

0

-30

&nbsp

&nbsp

&nbsp

&nbsp

&nbsp

&nbsp

&nbsp

&nbsp

&nbsp

(B)

Thecompany has sufficient funds to operate in the positive balancewithout necessarily having to borrow overdrafts. The originaloverdraft is enough to kick start the necessary process. Hence thereis need to separate the bank overdraft from the cash that flows intothe company’s bank and later create a strategy to repay the bankoverdraft as illustrated (Horne.2002, P.311).

(C)

Tannehillplc can improve their cash management by using the basic cashmanagement principles. First, they should fasten the rate at whichthe collect cash from their sales. The credit period given tocustomers should be reduced to three weeks as opposed to the currentone month. Second, the company should try to bargain for more time topay for its purchases. The current period should be extended to threemonths as opposed to the current two months. As such, the companyshall always have enough cash to conduct its operations (Horne, 2002,P.311).

4.0References

Bodden,V. (2013).&nbspFinancialmanagement.Mankato, MN: Creative Education.

Brigham,E., &amp Houston, J. (2004). Fundamentalsof financial management(10th ed.). Mason, Ohio: Thomson/South-Western.

Director,A. (2014).&nbspFundamentalsof financial management,.Chicago: American library Association.

Frenkel,J., &amp Razin, A. (2012).&nbspFundamentalsof financial management(2nd ed.). Cambridge, Mass.: MIT Press.

Healey,J. (2004)&nbspFinancialmanagement.Thirroul, N.S.W.: Spinney Press.

Horne,B,(2002).&nbspUnderstandingunemployment new perspectives on active labour market policies.London: RoutledgeLingens, J., &amp Lde, K. (2006).&nbspPareto-ImprovingUnemployment

Lawrence,F. (2011).&nbspFinancialmanagement.London: H. Milford, Oxford University Press

Lindzey,G., &amp Hall, C. (2005). Fundamentalsof financial management(10th ed.). Mason, Ohio: Thomson/South-Western.

Louis,C., (2011).&nbspTheoriesof personality: Primary sources and research,.New York: Wiley.

McLaughlin,E. 2002.&nbspFinancialmanagement.New Delhi: New Age International (P).

Paramasivan,C., &amp Subramanian, T. (2009). Financialmanagement.New Delhi: New Age International (P).

Pigou,A. (2011).&nbspFinancialmanagement.New York: H. Holt.

Seabrook,J. (1982).Fundamentalsof financial management.Chicago: University of Chicago Press.

Siegel.(2002).&nbspFinancialmanagement.New Delhi: New Age International (P).

Thomson,K. (2004).Fundamentalsof financial management(10th ed.). Mason, Ohio: Thomson/South-Western.