She Can Facilitate It By Conducting Risk Analysis And Developing Strategies To Avoid, Mitigate Or Minimize Those Risks. Case Studies Examples

Question 1

She can develop a financial plan for short term and long term duration that will act as a roadmap and a benchmark for performance evaluation.

She can develop financial recommendations based on deviance reports from financial projections.

Question 2
Debt financing increases the return on equity (ROE). From exhibit 9 it can be observed that the net income available for equity holders decreases as the Debt/Capital ratio increases. This is because interest expense is an allowable expenses for the purposes of taxation. Therefore, it offers a tax shield benefit reducing the amount of taxes paid the CPK and consequently, its profitability.
Cost of Equity = Risk free rate + β (Market return – risk free rate)
Market return – risk free rate = Risk premium

The risk premium based on what is charged by the bank of America is 0.80%

Risk free rate = LIBOR = 5.36%
Market return = 5.36%

Question 3

Value of shares = DPS/ Re

Assuming that the company paid out the entire 1.08 earnings per share as dividend

The shares that will be purchased will be purchased using debt. Therefore, the shares purchased will be given by the debt amount divided by the share price.
Tax deductibility refers to expenses that allowable from the net income when determining the amount upon which tax will be applied. Interest expense is an allowable expense for tax purposes whereas dividend is not allowed for tax purposes. This means that if the company has debt that it pay interest on as part of its capital structure, it will end up with a higher return on equity relative to a no debt scenario. The higher the debt the higher the return on equity. It can be observed from exhibit 9 where the return on equity increased gradually and was highest when the debt ratio in the capital structure was 30 percent.

Question 4

I would recommend a capital structure that incorporates both debt and equity. Debt increases the tax shield benefit. Besides, debt has a lower cost compared to equity financing. However, there are disadvantages of high debt in the capital structure. The company will have liquidity risks as it has to pay interest and the principal within certain regular interval. The payments are a legal obligation unlike dividends. The second risk is bankruptcy risks. Since payment of interest and the principal is a legal requirement, failure to pay may result in bankruptcy.