FIN205 Weighted Average Cost of Capital Assignment Sample

• Subject Code : FIN205
• University : Charles Darwin University My Assignment Services is not sponsored or endorsed by this college or university.
• Subject Name : Accounting and Finance

Business Finance - Question 1

Why do real returns matter more than nominal returns?

Real returns are annual percentage returns that have been realized on investments that are adjusted for price changes after taking inflation, taxes, fees, or other external factors into account. These adjustments are made to the nominal returns to determine what level of nominal return are basically real returns. In othr words nominal returns does not consider external factors (as discussed above) and therefore, real returns matter more than nominal returns

Business Finance - Question 2

Explain the concept of the efficient market hypothesis in share valuation.

As per the efficient market hypothesis for share valuation, the market prices of share reflect all the available material information. In other words it is not possible to beat or outperform the market that means an investor cannot earn above average returns on a sustainable basis. However, the theory was later criticized especially by behavioural economists, who propagate inherent market inefficiencies.

Business Finance - Question 3

What are the differences between bonus shares and share splits?

Both bonus share and share split are ways to distribute entity’s profits to the shareholders. In bonus shares, additional shares are issued to the existing shareholders. For example, announcement of a 3:1 bonus issue, shareholders will get three shares for every single share they hold. On the other hand in stock split, same share held by the shareholder gets split as per the split ratio that means no new share gets issued. For example a stock split in 1:3 ratio means that for every single share held by investor, it becomes 3 shares.

The face value does not change in bonus issue, but gets reduced after a stock spilt.

Business Finance - Question 4

In calculating weighted average of capital (WACC) why it is important to use the market values of debt and equity?

In calculating the weighted average cost of capital (WACC) for the entity as expected by the management from various providers of capital, it is very important to use the market values for various sources of financing including debt and equity. The reason is that market values tend to reflect the true or actual economic position of all these various type of financing, while book values are not capable of reflecting the same.

Business Finance - Question 5

What are the benefits that a public company can enjoy in comparison to a private company? Why are some of the largest companies still in private ownership?

Various forms of business structures have related advantages and disadvantages and a proper structure must be selected considering multiple factors related to business. Going public through an IPO also comprises of various benefits, but also attracts larger risks. The most popular advantage with public company is as mentioned above, that it can announce an initial public offering (IPO) to raise money. It shares the claim over the assets and the earnings with the public, but attracts not fixed costs as with debt financing. The other advantages are as follows:

• Widens the shareholder base and spreads the risk: The risk to the owners of the company gets spread among a large number of shareholders
• Other finance opportunities: Company can still source funds from debt or loans
• Growth and expansion opportunities

One of the main reasons that a company chose to remain private is that there are few requirements for reporting.

Business Finance - Question 6

What is meant by an ‘agency cost’ or ‘agency problem’? Do these interfere with maximising shareholder wealth?

An agency cost is a type of internal company expense, which comes from the actions of an agent acting on behalf of a principal. Agency costs or ‘agency problem’ typically arise in the wake of core inefficiencies, disruptions, and dissatisfactions like conflicts of interest between management and shareholders.

Maximising shareholder wealth or value is an important agenda of the management of the company, but management wants to grow the company in a sustainable way which may conceivably run counter to the shareholders’ best interests. Therefore, agency cost might interfere with maximising shareholder wealth

Business Finance - Question 7

What are the effects of financial leverage? Why does the risk of shareholders increase as the firm’s financial leverage rises?

[At an ideal level of financial leverage, a company's return on equity increases because the use of leverage increases stock volatility, increasing its level of risk which in turn increases returns.

Business Finance - Question 8

Why is the Net Present Value (NPV) considered to be theoretically superior to all other capital budgeting techniques?

NPV is considered a superior method of evaluating the cash flows from a project because it is able to rank projects of different sizes over varying periods of time to determine the most profitable course of action. It is the discount rate that is used to calculate a zero NPV for a series of cash flows

Business Finance - Question 9

What should managers consider when making the decision whether to finance internally or externally?

Internal sources of finance: Sale of Stock, Fixed Assets, includes Retained Earnings and Debt Collection.

External sources of finance: Loan from banks, Debenture, Preference Shares, IPO Public Deposits, Commercial paper, etc.

The managers should consider

• the cost,
• the time period for repayments,
• the amount that is required by the business
• The associated risk
• Legal compliances
• Requirements and availability of security or collateral

Business Finance - Question 10

Is it important to focus on cash flow in capital budgeting analysis? Explain your answer with the concept of time value of money.

Capital budgeting involves identifying the cash flows rather than accounting revenues and expenses because non-expense items like debt principal payments are also included in capital budgeting as they are cash flow transactions. The noncash expenses are adjusted as they are notional amount and can affect or disrupt the valuation results. Also the time value of money discounts the forecasted cash flows to the present level which is not possible with revenues or profits measures.

Business Finance - Question 11

What factors should a manager consider when negotiating the loan covenants in a long-term debt agreement?

A manager should consider the following factors when negotiating the loan covenants in a long-term debt agreement:-

• Net worth.
• Interest coverage ratio.
• Liquidity and performance ratios.
• Fixed charge coverage ratio.
• Current ratio/working capital.
• Debt ratio (leverage ratio)
• Debt service coverage ratio.

Business Finance - Question 12

Why has COVID - 19 impacted on global capital markets? Explain your answer based on your understanding of the concept of risk in capital markets.

COVID - 19 indeed impacted the global capital markets substantially, as the business stops, they do not require funds and in result the capital markets do not have clients to entertain.

Business Finance - Question 13

How is lease financing different than bank financing for corporations in raising funds?

Business Finance - Question 14

Would the future value future value be affected by: a) a decrease in the interest rate; or b) an increase in the holding period? Why?

[The time value of money is based on two main factors including interest rate and holding period. Any increase or decrease in these factors affects the future value future value of a deposit

1. decrease in the interest rate: future value will fall
2. increase in the holding period: : future value will rise

Business Finance - Question 15

Why is the dividend policy of a firm important for the company and its investors?

Dividend policy decides the distribution of firms profit to the investors, hence returns for the investors and also is cost to the company. Therefore dividend policy of a firm important for the company and its investors

Business Finance - Question 16

Which costs should be included in incremental cash flows, and which should be excluded? Explain from your understanding of sunk costs and opportunity costs.

Incremental Cash Flow = Cash Inflow – Initial Cash Outflow – Expense

Initial investment will include costs from buying land and setting up a plant to manufacturing the first unit of product. All will come under initial investment. However, initial investment does not include sunken cost and opportunity costs.

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