# FINANCIAL DECISION MAKING

FINANCIAL DECISION MAKING 9

FINANCIALDECISION MAKING

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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     Year 2015 Months                 January   February   March   April     Sales figure 50,000.00   80,000.00   60,000.00       Opening cash   18,000.00   15,440.00   18,880.00   14,320.00   Add cash from sales Cash from current Sales -30% 15,000.00   24,000.00   18,000.00   –     Cash from previous month sale-70% –   35,000.00   56,000.00   42,000.00     Total cash from 33,000.00   74,440.00 – 92,880.00   56,320.00   Less Cash for Purchases                   Purchases   80,000.00   60,000.00   70,000.00         Cash to buy Purchases-10% 8,000.00   6,000.00   7,000.00   –     cash paid the following month-50% – – 40,000.00   30,000.00   35,000.00     cash paid in two months- 40% – –     32,000.00   24,000.00   Total Cash needed for purchases per month   8,000.00   46,000.00   69,000.00   59,000.00     Net cash for operations   25,000.00   28,440.00   23,880.00   (2,680.00) Sales labor pay   1,500.00   1,500.00   1,500.00   1,500.00   commision-4% – 60.00   60.00   60.00   60.00   Total sales labor pay   1,560.00   1,560.00   1,560.00   1,560.00     Labor expenses 4,000.00   4,000.00   4,000.00   4,000.00     Other operating expenses 4,000.00   4,000.00   4,000.00   4,000.00     Total expenses   9,560.00   9,560.00   9,560.00   9,560.00   Closing Cash balance   15,440.00   18,880.00   14,320.00   (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).

   Budgeted       Actual   Variance=(BUDGET-ACTUAL)/ACTUAL   August September October November December January August September October November December January August September October November December January   £,000 £,000 £,000       £,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   210 200 125 210 150   205 150 200 200 200   2% 33% -38% 5% -25% Capital Received 0 500           500                     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)   -50 -50 -50 -50 -50   -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                                     Rental & Rates 5 5 5 5 5 5 5 5 5 5 5 5 0% 0% 0% 0% 0% 0% Admin & 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   500           500                     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               100 100                   Balance Crd. Fwd. 135 230 315 325 420 455 131 115 39 228 422 621

 Budgeted       Actual     August September October November December January August September October November December January   £,000 £,000 £,000       £,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   210 200 125 210 150 205 150 200 200 200 Capital Received 0 500           500         Total Cash reciepts 200 845 430 440 535 570 200 836 265 239 428 622 Less Cash Purchases (Raw Materials)   -50 -50 -50 -50 -50   -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                         Rental & Rates 5 5 5 5 5 5 5 5 5 5 5 5 Admin & 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   500           500         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               100 100       Balance Crd. Fwd. 135 230 315 325 420 455 131 115 39 228 422 621     0 -30

(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.