Task
Compare the corporate form of organization with the sole proprietorship and the partnership.
Describe the principles dealing with ways of creating value and economic efficiency
The major principles include comparative advantage and absolute advantage. Comparative advantage is the ability of a country to produce a particular commodity in a more efficient way than other countries. Countries that have modern machinery are likely to produce machine intensive products than other countries.
Absolute advantage is the ability of a county to be able to produce a particular commodity that other countries do not produce. For instance, a country that is endowed with a unique mineral that is not produced by other countries can be said to have absolute advantage over the production of that particular commodity.
Explain the underlying logic of the Time Value of Money principle
The basic logic underlying this principle is that a dollar today is much more valuable than a dollar ten years from today. This is because; money loses value as time goes by. Money held today may be invested in valuable investment vehicles and yield returns unlike money in the future that remains uncertain due to unforeseen economic changes such as inflation.
Explain how the CAPM is used for estimating required returns
Required returns are estimated using CAPM formulae below
Where:
is return that is expected of a particular capital asset
is the risk-free interest rate, usually the rate of government securities.
-is the sensitivity of the expected return to the market returns.
Denotes the rates of return that is expected in the market.
is sometimes known as the market premium ( which denotes the difference that exists between the market rate of return and the risk free returns.) Is also generally referred to as the risk premium restated, in terms of risk premium, we find that:
Given the values of risk free interest rates, the Beta coefficient, and market rate of return it’s easy to substitute in this formula to obtain the expected rate of return using the CAPM
Compare and contrast several factors of the business environment that can be difficult to deal with in practice in the capital budgeting process.
These factors are explained below
i) Sunk costs- these are costs that are already incurred such as the costs for a feasibility study, costs of research etc, and these costs cannot be recovered even if the project is not undertaken.
ii) Allocated costs- these are costs that are already in the firm such as staff, using an idle factory that’s already owned by the organization
iii)Opportunity costs- once an investment is underway, there are always other investment opportunities that are even more beneficial and also appealing but since the organization is already undertaking another project, such a good project my not be undertaken.
iv) Inadequate funds to invest in all qualifying investments- most times the organization does not have enough funds to invest in all viable investments and thus many viable investments are left out.
Explain how a large firm evaluates long-term investment projects in terms of capital budgeting and risk
Large firms usually invest in highly valued investments. In order to evaluate long-term investments, the firms uses several capital budgeting tools such as net present value, internal rate of return etc so as to be able to ensure that their investments is viable.
Explain how to look for options and opportunity costs caused by interaction among existing operations and new projects
In evaluating new and existing investments, a finance manager uses an appropriate capital budgeting tool such as the net present value so as to come up with an objective analysis of the investment options. Using this tool, the investor is able to determine the net present value of both the new project and the existing project before he decides on which projects are more beneficial given the capital constrains.
Compare and contrast the advantages and disadvantages of certain dividend policies
i) Constant payout ratio- in this method, the company pays a constant amount of dividends to shareholders. The major advantage of a constant payout ratio is that the company is able to predict with certainty the amount of dividends to pay out to shareholders. The shareholders are also able to predict the amounts of dividends that they shall receive, given their shareholding.
Fluctuating dividend policy- this policy requires that the company pays a fluctuating amount of dividends depending on the profitability of the Company. The major advantage of this policy is that the company is able to pay high or low dividends depending on the economic environment. The likely disadvantage is majorly to the shareholders who are not able to plan for their returns since such returns are fluctuating from time to time.
Small constant DPS plus extra dividends, here the company pays a fixed rate of dividends but incase the company makes a huge profit; it pays extra dividends over and above the fixed rate. The shareholders are able to benefit incase of a better economic environment in which a company operates.
How does financial distress affect the consumer-firm conflict relating to promises of future service?
A company that is experiencing financial distress is not able to deliver on its promises to its customers as a result of financial constrains resulting from the liquidity problems experienced during financial distress. Financial distress thus deteriorates the consumer firm conflict in relation to service delivery by the firm to its customers.
Explain external sources of long-term capital
These are sources of long term financing that are outside the organization. This means that the organization uses other sources other than its internal retained earnings, savings etc. some of the most common external sources of financing is the issue of shares or floating of debentures, bank loans etc.
Explain in your own words why you might expect to observe a negative correlation between financial leverage and operating leverage
The risks that a firm faces are made up primarily of both financial and operating leverage. A firm that has a high operating leverage and is generally risky, managers will naturally not want to add more to that risk and therefore choose low financial leverage. A firm that has a low operating leverage has a low risk thus the organization would want to take more risk so as to increase their return and therefore choose a higher financial leverage. This gives the inverse relationship between these two leverages.
Explore how firms issue securities and the markets in which they issue them
Firms issue securities to both primary and secondary markets through the following means.
i) Placing-this is where the company, instead of selling its shares directly to the public, arranges with a broker to sell the shares on its behalf.
ii) Offer for sale-this is an arrangement where the company sells its shares to a financial institution(Issuing house) which then prepares to resell the shares to the public.
iii) Private placing- this is when shares are offered to selected customers or brokers (usually institutional investors) instead of selling them to the general public.
Prospectus issues (Direct offer to the public) - in this case, shares are sold directly to the public by the company rather than through brokers or intermediaries.
Why is the true interest cost of a discounted loan always greater than the stated discount rate?
This is because, the interest on the loan is paid in advance an as such, the actual loan that one receives is net of interest for say the first month and thus the actual interest rate that one pays is usually higher than the stated rate. For instance, if one takes a loan of $1m at a rate of 10%, he receives $0.9m since $100 is used to repay his interest I the first month. If you take $100 divide by the amount of money received which is $ 0.9m, you obtain 11.1% and not 10% as initially stated.
Compare various forms of bankruptcy, emphasizing reorganization
There are basically four types of bankruptcy that one can file depending on whether you are an individual or a corporation. They are named after their respective chapters in the US bankruptcy code. They include:
i)Chapter 7 bankruptcy-it’s a liquidation bankruptcy. It means that trustees sell off all assets held by the debtors so that all debts can be repaid to the fullest extend. Its majorly bankruptcy that is filed by individuals, partnerships and corporations .After liquidation all debts that cannot be repaid through liquidation are immediately discharged.
Chapter 11 bankruptcy-it’s presumably the most complicated form of bankruptcy and is filed by the most troubled businesses. The debtor continues to operate and maintains ownership of all the assets then tries to work out a reorganization plan to get have the debts paid. The bankruptcy abuse prevention and consumer protection act of 2005 has imposed a maximum of 120 days so that after those 120 days, then the creditors can lay a claim on the company’s assets.
Chapter 12 is done specifically by farm owners where the owner still owns and maintains his assets while in Chapter 13 bankruptcy, the chapter deals with bankruptcy for individuals. The debtor in this case retains control of his assets and works out a three to five year repayment plan.
Please explain how to tailor capital budgeting techniques to evaluate a corporate acquisition
In evaluating corporate acquisition, its important for the acquiring firm to be able to do a proper valuation of the assets of the acquired firm so as to ensure that it doesn’t lose money in the transaction and at the same time it does not undervalue the firm being acquired so as to give value to the owners of the firm in question. In terms of the new firms fixed assets, net present value would be useful in estimating the present values of future streams of income that are expected to flow into the organization from the use of those assets. The liabilities on the other hand can be discounted at the prevailing interest rates so as to determine their values at the present. Money in cash and at bank is taken at the value existing at the present date.
Explain what limited partnership is and define the limited partner
In general, a limited partnership is one whose liability is limited to the partner’s share of contributions to the firm. Limited partner is one whose liability rests with his share of contributions to the capital of the firm and is not entitled to make any extra contributions to meet the obligations of the firm if need be.
Describe the process of due diligence
Before a company acquires another one, or a venture capital invests in a company, the process of due diligence is very important in ensuring that the deal is good and clean. it involves several steps as explained below
i) Compatibility assessment- this is done to ensure that the business being acquired is compatible with the acquirers existing business or his business interests.
ii) Financial audit- this is done to ascertain the financial standing of the company or assets being acquired. This is done to ensure that the company is properly valued to avoid purchasing an overvalued company.
iii) Macroeconomic environmental assessment-this involves evaluating the environment that the business operates to ensure that the company doesn’t operate in such a volatile environment that would render the acquisition undesirable.
iv) Legal audit- this relates to the legal requirements for the running of a particular business. This ensures that the business being acquired is not prohibited in a particular territory.
iv) Marketing assessment- this is done to see whether the companies marketing strategies can comfortably be aggregated with the existing business strategies and run as a unit, this will have far reaching impact on the marketing costs of the group company.
Describe the process of cash flow analysis
In an organization, cash flow analysis is done to determine the sources and uses of funds in a given financial year. In accounting, the net profit of the firm is adjusted for non cash expenses such as depreciations, loss in disposal of assets among others. It’s also adjusted for non trading incomes such as income from disposal of assets, income from write back of creditors among other non cash incomes. Further, the results are adjusted for changes in operating activities such as increase or decrease in debtors, increase or decrease in creditors, inventories etc to obtain the cash flow generated from/used in operating activities. Further, cash flows from investing activities and financing activities is adjusted and the total sum of cash flows from operations, financing and operating activities added up to cash and cash equivalents at the beginning of the year forms the cash and cash equivalents at the end of the financial year.
Define what is meant by periodic, compound and annualized return
Periodic return-its generally defined as the rate of change of asset value from the time the investment is done to the end of the investment period.
Compound return is the rate of return which is the cumulative effect of a series of gains or losses on the original investments
Annualized return is the return on investments after a period of one year.
Explain the components of Return on Investment (ROI)
Return on investment is a measure of the profits earned from each investment it’s computed as Net profit divided by the initial investment.Net profit is computed as income less cost of sales and other operational costs. Initial investment is the amount of money that a business man invests in the company so as to generate income.
Explain how to calculate Beta and Alpha for a stock or portfolio
Alpha is basically defined as the return earned by security or a portfolio given a zero market rate of return, while beta measures the volatility or sensitivity of a return given the market rate of return.
Alpha and beta of a stock for a stock or portfolio is calculated using the formulae below
Alpha = Actual return – Risk-free return – Beta × (Index return – Risk-free return)
Given the values of actual return, the risk free return of government securities, and the beta, one can easily substitute in the equation below to obtain the value of alpha.
With the value of alpha, the formulae can be rearranged to come up with the value of the company’s beta as follows
Beta= Actual return – Risk-free return – Alpha
(Index return – Risk-free return)
Explain how to calculate the simple and compound interest
Simple interest is calculated using the formulae X=Principle multiplied by the rate of interest multiplied by the time period. Clearly denoted as I=P*R*T while compound interest is calculated as I=P (1+R)ⁿ where I is the compound interest, P denotes the principle amount, R is the rate of interest, n is the time period for compound interest while T is the time period in years for simple interest.
What are Qualified Institutional Buyers (QIBs)? Please explain in detail
These are institutions such a financial institutions including banks, insurance companies, saving and loans companies, mortgage companies, and investment companies or institutions owned by qualified institutional investors. These investors must manage investments of at least $100m in forms of securities to attain the status of a qualified Institutional buyer.
Explain and compare cumulative and non cumulative dividends
Cumulative dividends are those dividends that will be payable in future even when the organization does not make a profit. In this case, the organization will pay dividends even when it doesn’t make a profit. Incase the company cannot pay dividends due to lack of funds; it will pay the cumulative amount of these dividends in the year when it makes profits.
Non cumulative dividends on the other hand does not accumulate and the company is not obliged to pay any dividends incase it does not make profits.
List and define the different participating convertible rights
What are some recent developments in the industry of a venture capital firm of your choice? Please explain in detail. Recent studies on venture capital industry in the United States have revealed that there has been a major growth in the industry with many businesses preferring the services of a venture capital than financial institutions since venture capitals also provide management services to their clients. The last decade, has also seen the great convergence of venture capital markets in the United States and Europe with the industry getting more segmented with likely continuing importance of the industry in the foreseeable future.
Describe the difference between European and American derivative
There are several differences between derivatives in the United States and Europe. One of the major differences is that the European derivatives cannot be exercised unless the expiry period of the derivative lapses while the American derivatives can be exercised any time before the expiry of the option.
American derivatives expire on the 3rd Saturday of every month while the European options expire on the Friday prior to the third Saturday.
European derivatives are valued using the Black and Scholes model while the American derivatives are not valued using any specific models.
How would you evaluate a possible portfolio company and its business plan?
In order to fully evaluate the company in terms of portfolio and business plan, an investor must consider the following issues
a) How the company gets its cash, this will clearly show how the company will be affected by several changes in the economic environment.
b) How much cash the company is able to generate and how fast the company is able to generate this cash, this is because of the basic principle of time value of money. A company that generates cash very fast is a very attractive investment option.
c) If the company is able to sustain its cash flows- in the United States, the steel industry was in the past as a blue chip industry but that’s not the case nowadays. Any viable investments option must be able to sustain its cash flows for a long period of time.
d) How costly it is to operate a business- a business that requires a less capital is likely to be a better investment vehicle than a capital investment. For instance an internet company is likely to take a lesser amount of money than a utility firm that requires billions of $ to set up the infrastructure alone.
e)whether the price being offered is attractive- the investor must satisfy himself that these securities s are not overvalued so as to make sure that he gets value for money on investing in these securities.
Please define the steps of the Crystal Ball Solution in detail
Steps involved in Crystal ball Solution.
a) Identify the Competition-find out about their products, their customers, their strengths and weakness to find out an entry point.
b) Target market wants and needs- Identify the target market wants and needs by utilizing information gained in marketing research to find out what the market really wants, the quantities, and quality and placing of these goods and services.
c)Matching the products and services to the needs and wants of the target market to ensure a perfect fit of these products to the requirements in the market so as to ensure that these products find the market expected in the initial projections in the business plan.
d) Preparation of a positioning strategy that will enable the business to launch its products in the market to gain a competitive advantage, for instance the owners of the business may employ price undercutting, also known as the penetration price strategy so as to gain a leading edge against already established players in the market.
What is the relationship between accounting rate of return and economic rate of return?
These two evaluation tools are used to evaluate the performance of an investment. The accounting rate of return is not a commonly used to evaluate investments due to its many shortcomings. One of the major shortcoming of the accounting rate of return is that its not fully adjusted for non cash items such as depreciation, amortizations etc. the economic rate of return, also called the internal rate of return is more preferred by investors since its more realistic as it takes into consideration the risks, taxes, price controls etc in computing the actual rate of return on investment.
Explain how R&D is financed
Research and development in organizations is financed through sources of financing like any other investment in the organization. Since the returns from R&D may not be realizable in the short run, its preferably using the less costly sources of funds such as internal sources like retained earnings. On rare occasions, external sources of financing such as venture capital and external borrowings especially in organizations that benefit a lot from research and Development.
Please explain the "Zero-sum" game?
A zero sum game is used in business circles to denote a situation or transaction where one party loses what the other gains. This means that there is no .external gains made from the deal and only the resources held by both parties are available. What one party loses is exactly the same that the other party gains
Describe global and regional market agreements designed to eliminate trade barriers
These are regional integrations that are aimed at reducing trade barriers among the member countries. The most important regional market agreement is probably the World Trade Organization that seeks not only to reduce trade barriers but also to promote trade between member countries. In Africa, the Common Market for East and Southern Africa (COMESA) allows member countries to trade without barriers to trade while allowing member countries to import and export duty free goods and services in the region
Examine motives for foreign trade
The primary motive of foreign trade is to enable countries to obtain those goods and services that they do not produce. It also enables countries to export excess produce to countries that need these produce. Africa for instance exports her excess agricultural produce to the European countries and the United States while she imports industrial products and heavy machinery from developed countries.
Foreign trade also enables countries to exchange manpower and technology among states.
What is the role of global finance in decision making?
Global finance enables traders in international arena to make viable decisions on investments and trade among the players in the international trade. It enables players to get information that is beneficial to ensure that business transactions are profitable. It also enables traders to avoid risks that would otherwise be very costly to traders in international trade.
Define balance of payments accounts and actual balance of payments
The balance of payments, simply known as the BOP is a summary for all transactions between a country and all other countries that it interacts with. Its shows all receipts to the country and all payments made by the state in a given fiscal year. Its made up of two accounts namely the Capital account-which shows the net increase in a countries asset both at home and abroad, and the current account which shows the effects of both imports and exports. It shows how much the country has received and paid and it should always be at a balance.
How does forecasting the needs of a multinational company take place?
Multinational companies will forecast their needs both financially and in terms of production by developing a financial or production projection for a period. For instance, a company from experience will be able to forecast how much money it will require on each of its operations through cash flow projections. The company can also predict the operating environment and project how much production will be able to satisfy demand for its produce in a given time period.
Explain in detail the International Monetary Fund and special drawing rights
The international monetary fund is an organization that is formed by 187 countries, that works to foster global monetary cooperation, to secure financial stability, and to facilitate international trade to reduce poverty around the world.
Special drawing is an international reserve asset that was created by the international monetary fund in 1969 so as to supplement its member’s official reserves. It’s based on four key international currencies and it’s freely exchangeable to any other usable currencies.
Explain the major classes of risk in trading of futures and options
There are different risks that result from the use of derivatives in international finance they are broadly classified as Default risk-the risk that the other party in the contract may not fulfill their part for the contract. Price risks, these are risks that prices of the derivative will be affected as at result of foreign exchange fluctuations, changes in interest rates etc.
Liquidity risk- this is the risk that one will not have enough liquid assets to settle their part for the contract when it falls due. Systematic risks- this is the risk that there may be problems in the financial system that may be affect the values of the derivatives.
Explain how speculators and U.S. companies use currency futures
A futures contract is a contract entered in today by two competent people fro the purchase or sell of a particular fixed number of a given currency at a fixed future date. Speculators usually get into these futures in the hope that by the time the future matures, the exchange rate will be favorable and that they shall be able to make a profit from the transaction.
Describe two major types of financial swaps: interest rate and currency rate swaps
The two major swaps that are the interest rate swaps and the currency swaps are explained below.
Interest rate swap is used by a company that wants to manage the changes in interest rates effect on its money. It’s an agreement between two parties that provides for the exchange of interest and principle of a loan with another loan that is pegged on a fluctuating interest rate. It safeguards the loan holder from effects of changes in interest rates. Currency swaps on the other hand is an agreement to the aspects eg the principle and interests of a loan in one currency for an equal net present value of the loan in a different currency, it’s usually motivated by comparative advantage between traders.
If foreign-exchange markets are perfectly efficient, why should no one pay for the services of currency forecasting firms?
If markets of foreign exchange were perfect, all dealers would have perfect information about every material item in foreign exchange market, including the exchange rates of all major currencies and this would render the services of currency forecasting firms useless in the country
Summarize the use of exchange management instruments
These are instruments that are used in international trade to reduce foreign exchange losses for companies that have assets and liabilities denominated in foreign currencies. Also used as foreign exchange hedging strategies, they include futures, options and currency forwards.
Explain in detail the techniques designed to reduce translation risk
Translation risk is the risk of foreign exchange loss when one converts foreign currency to the domestic currency. Companies usually hedge against the foreign exchange loss through the use of hedging strategies as explained above. These strategies are explained below.
Currency futures-these are contracts entered in today between dealers in international trade to buy or sell certain foreign currencies in future at an exchange rate already agreed today. It enables a trader to be able to predict with certainty the amount of money in the local currency that they shall receive in future from their business.
Currency forwards- in a currency forward contract, the holder has an obligation to sell or buy a specified amount of currency at a specific time on a specified future date. These contracts are usually not transferrable.
Currency options- these are rights to buy (call option) or to sell (put option) a specific amount of a currency at a specified price in a given period of time. Options, just as their names suggest are not an obligation and the seller or buyer may decide to back out of the transaction if the rate of exchange is not favorable.
Discuss three basic documents involved in foreign trade
The three basic documents used in international trade are bill of lading, international commercial invoice and the insurance certificate. The bill of lading is a document that is issued by the carrier of the goods to the ship owner as a contract of carriage of goods. In fact should there arise a claim on the loss of any goods the bill of lading will come in handy in ensuring that the claim is authenticated and used to follow up on the loss.
International invoice will show the amount of these goods and services to the customs office so as to decide the amount of duty chargeable on these goods and services.
The insurance certificate is important as a statutory requirement that all goods in transit must be insured against the likely losses.
Please describe in detail the Asian financial crisis of 1997-1998 and describe the policy responses to solve the crisis
The Asian financial crisis began in Thailand with the drastic drop in the value of the Baht against the US dollar. The government had made frantic efforts to save the local currency but on July 2nd, it decided to let the powers of demand and supply take their course. This led t the sharp decline of the home currency on the same day. This drop immediately triggered investor panic and all other regional currencies such as the Peso, the rupiah and the ringgit also started to experience buying pressure.foreigh investors also lost confidence in these economies since they were believed to be weak fundamentals. In all these countries, financial institutions collapsed and had to be rescued while others had to downsize resulting to retrenchment of many workforces. The crisis eventually led to the resignation of President Suharto.
Several measures were put in place in 1998 with two major objectives. To lower business costs and also to provide individuals and households with relief from the crisis. The budget in 1998 contained structures to lower costs of doing business such as the fifteen percent property rebate for commercial and industrial properties,5pc personal tax rebate among others. The government later announced an off budget measure worth S$2billion,a 10$corpotrate tax rebate, additional 40% property tax rebate among other policies.
Discuss several practical issues of foreign direct investment (FDI)
Foreign direct investment is the investment done by company, mostly multinationals, or governments in a country other than that of domicile. Its majorly characterized by huge investments in a country that is different from the home country, which means that all structures, taxation laws, the legal environment and other operating environments may significantly affect the conduct of business in those areas.
Some of the issues that confront an investor in FDI are
a) Taxation- naturally, taxation rules differ from state to state and from business to the other. A company contemplating FDI must check the taxation rules of the target country.
b)The legal environment- some countries will not allow FDI on some sectors of the economy so as to safeguard domestic investors, this poses a major challenge to FDI.
c)Economic climate- a country that ha a stable economy, stable currency and a moderate rate of inflations is likely to attract FDI tan a country that has a harsh economic climate.
d) Political climate- FDI will not flourish in a country with a volatile political atmosphere, such as countries that have frequent wars, political wrangles etc.
What is the role of a factor in foreign trade? How can a factor aid an exporter?
A factor is an individual or a company that advances funds to business men, in exchange for their trade receivables. In foreign trade, factors will advance moneys to exporters so that they are able to finance their export businesses and then recover these moneys from their trade receivables. Of course these debts are sold at a discount and the factor will not extend the full amount of the value of the debt to the exporter.
What are the four translation rules commonly used by multinational companies to consolidate their worldwide operations into home currency?
Current/non current rule-under this rule, all current assets and liabilities are translated at the ruling rate while non current assets are translated at the historical exchange rate, i.e the exchange rate at the period in which they were acquired.
Monetary/non monetary rule-here, monetary assets and liabilities are exchanged at ruling rate while non monetary assets and liabilities are translated at their historical exchange rates.
Temporal method-this one is just as similar to the monetary and non-monetary rule, wit exceptions in the translation of inventories.
Current rate method-here, all assets and liabilities are translated at the ruling rates and the current period while the equity is translated at the historical exchange rates. This is probably the simplest rule.
Analyze a firm's capital structure to describe how multinational companies consider corporate and country characteristics when they establish a capital structure.
A company’s capital structure is majorly composed of both equity and debt. Equity is the capital that is internally raised by the owners or shareholders of the company in order to run the company. Debt is that capital that is sourced from outsiders through loans, issue of debentures or any other forms of financing.
Before a multinational decides on its capital structure, it has to consider several factors but key among them is the corporate and countries characteristics. In the corporate, it has to consider its own capital structure in other areas where it operates and how it has managed top maintain that capital structure over a period. For instance, if a company has had a 60:40 equity debt formation in all other areas where it operates, it may consider the same capital structure in any other country that it may be involved.
In terms of country characteristic, the multinational will consider the cost of borrowing in a country, and the tax impact of debt in each country. It will also consider the availability of debt in a country before it decides on its capital structure since some companies may require more capital than may be available in the country thus resulting in borrowing from their mother countries, which may have tax implications in the country of investment. Such considerations, among others are critical in deciding a multinationals capital structure.
Discuss both unsystematic risk and systematic risk within an international context
Systematic risk- this is that risk that cannot be reduced or eliminated through diversification or portfolio theory. It’s also called market risk. It results from fundamental issues that affect a wide region such as the recent financial crisis, which affected most of the countries in the US, Europe and Asia, resulting to the collapse of many businesses. Such a risk cannot be diversified. Unsystematic risk is the risk that is industry specific, or it’s specific to a particular type of business. Fop instance an ice cream company will have a specific risk in cold weather since people will not consume ice-cream. Harsh weather conditions are likely to affect agricultural produce in agricultural economies such as most African countries but may not affect industry driven economies. This means that this risk can easily be eliminated through diversification.
