Managing Financial Principles and Management

Managing Financial Principles and Management



Managing Financial Principles and Management

Assignment 1

To: Shareholders of Raven Construction Ltd

From: Director Finance

Subject: Gearing Implications

Fixed capital is the fund which is required for the purchase of those assets that are to be used over a long period. Such assets are land, building, machinery, payment rights, copy rights and other overhead expenses. These expenses are born regardless of the number of units produced. Fixed capitals are thus, the funds which are required not only for the purchase of fixed asset but also non current assets at the start of business like copy right, registration etc.

The main factors which determine the requirement of fixed capital in a business are as follow.Nature of business: it determines the amount of fixed capital in a business. Huge fixed investment is required in public enterprises such as railways, electricity; sewerage system etc. manufacturing concerns also need sizeable amount of fixed capital trading and financial firms need less fixed capital. They require more working capital to invest in current assets.

Size of business: capital required by a business depends upon its size. Generally the large size of business, the greater is the need of fixed capital and vice versa.Type of business: if an industry requires automatic machines and uses modern techniques of production, it calls for the larger investment in fixed assets.Non current assets: investment in non current assets, like goodwill, patent, copy right, long term investment etc are a part of fixed capital and influence the fixed capital of a business.

Gearing, or leverage, describes the mix of long-term corporate funding provided internally (by shareholders) to that contributed externally (by lenders). Interpreting financial statements using ratio analysis. Ratios are a set of tools to enable the user to gain a deeper insight into a company (to facilitate planning, decision-making and control) — they are a means to an end, not the end in themselves. An appreciation of the factors that influence a company's gearing and the effects of gearing on shareholders returns are vital to interpreting gearing ratios.

Recommendations:

Calculation of Ratios for Raven Construction Pvt Ltd:

Ordinary Share Capital400,000

Bank Loan (repayable in 5 years time)800,000

Trade Creditors (short term)80,000

Bank Overdraft (short term)50,000

Debt to Equity Ratio =>850,000/400,000= 212.50%

Now, let us look at the post equity financing scenario,

Cost of Expansion:1,200,000

Post IPO Share Capital:1,600,000

Bank Loan:800,000

Bank Overdraft:50,000

Pre Expansion Debt to Equity Ratio:212.50%

Post Expansion Debt to Equity ratio:53%

Hence, the equity source of financing would help in making the Balance Sheet of the firm better and would bring down the leverage of the firm.

Assignment 2

Investment Appraisal

1. Discounted Cashflow Method

A

D.F

PV

B

D.F

PV

Initial Cost

20,000

-

(20,000)

15,000

-

(15,000)

Year 1

12,000

0.952

11,424

10,000

0.952

9,520

Year 2

10,000

0.907

9,070

10,000

0.907

9,070

Year 3

9,000

0.864

7,776

8,000

0.864

6,912

Year 4

6,000

0.823

4,938

5,000

0.823

4,115

Year 5

6,000

0.784

4,704

2,000

0.784

1,568

NPV

17,912

16,185

According to the DCF method, Machine A clearly gives higher NPV than Machine B. Therefore, investment should be done in Machine A.

2. Payback Method

Total Cashflows from Machine A = $43,000

Total Investment in Machine A = $ 20,000

Payback Period for Machine A = 2.15 years

Total Cashflows from Machine B = $35,000

Total Investment in Machine B = $15,000

Payback Period for Machine B = 2.33 years

According to the above calculations, Machine A paybacks its total investment earlier ...