Corporate Finance

Question 1

The reason why large businesses organize themselves as corporations is as a result of the ability that corporations have in selling ownership shares via stock offerings in the stock and securities market. This attracts capital for investment and high quality human capital (Quiry& Vernimmen, 2011).

The ability to generate capital through sale of stock, treatment of corporate tax and the fact that shareholders have limited liability over their personal assets are the main advantage of corporations.

The main disadvantages of corporation are that they require huge start-up capital and attract high operating and tax costs.

Question 2

  1. a) Trade credit induces customers to make more purchases without paying immediately. This increases the sales volume of the business, introduces interest and late payment fees for the creditors thereby increasing the revenue of the business.
  2. b) Cash conversion cycle is defined as the number of days taken by a company to convert its inputs resources into cash flows. The shorter the period the more liquid the company is to invest in other activities to generate more returns (Quiry&Vernimmen, 2011).

Working capital is the difference between a company’s current assets and current liabilities. It measures the company ability to honor its short term obligations as they fall due.

2 (1) An increase in cash conversion cycle puts the company in liquidity problems in the short run, since it is unable to finance its current assets though its sales volume remains unchanged.

2)If the sales volume of a company increases permanently due to increases in the operating cycle, the amount of finances required to take care of current assets increases since most of the funds are held by its creditors.

3)This is because, during economic boom, many people will invest in other areas that promise huge returns and finance their transaction demand on credit terms.

Question 3

An increase in daily sales turnover will have the effect of increasing the optimal levels of accounts receivables. This is because the company will have more of its cash being held by debtors. Although this is a current asset, the company can not treat it as so until it issues a credit sales invoice (Quiry&Vernimmen, 2011).

b)Increase in the rate of return of US treasury securities, will increase the optimal levels of accounts receivable. This is because; most investors will be willing to invest in buying those securities for speculation purposes. This will in turn leave little cash dedicated for transaction motives and, therefore, encourage them to purchase goods on credit increasing accounts receivables.

c)If the rate of interest for acquiring a loan increases, the optimal levels of account receivables reduce. This is because many people will be discouraged from purchasing goods on credit due to the high rate of interest that is translated in the purchase of credit sales.

d)The overall increase in sales volume may either increase or decrease the optimal levels of accounts receivables. This will however depend on whether those sales were made on credit or cash.

Question 4

According to Keynesian macroeconomics, cash is held for three main purposes that include; transaction, precautionary and speculation purposes. Specifically holding cash provides investors and companies with opportunities to control risks and gain returns on their investments. For instance, a firm can not utilize all cash on marketable securities as it will need additional cash to care of its daily transactions(Quiry&Vernimmen, 2011).

The term float as used in a business is defined as the number of regular shares that a firm has issued to the public and those shares are available for investors to trade. Float is caused by changes in money supply. Changes in money supply will significantly have either a decrease or increases in float levels.

C1)Themarket yields on returns on securities increases, the firm should review its speculation demand cash holding upwards to take advantage of the high returns in trading in treasury securities.

ii)If the volatility of daily cash flow increases, a firm should reduce its cash that was to be used foe transaction motives.

iii)Iftransaction costs for either buying or selling marketable securities decreases, a firm should increase its funds for buying more marketable securities.

  1. iv) If cash receipts increases, firms should utilize the additional cash in purchasing marketable securities.

Question 5

The major cause of bad debts is due to lack of proper management controls. If firms put strict credit control measures, the problem of uncollected debts would reduce greatly. However,it is impossible for firm to operate without selling on credit because not all customers are creditworthy.

Question 6

The main goal of the financial manager of UIA must be to maximize the profits of the company. He must earn the highest possible profit of the firm as well as maximize the shareholders wealth.

Question 7

The primary goal of short term financial planning is to create objectives and a plan for the business to follow. It also allows the financial manager to address risks associated with introducing and implementing financial plans.

Question 8

Year 0 $5000[(1+0.08)^0-1]/0.08=5000

Year 1 $6000[(1+0.08)^1-i]/0.08=6000

Year 2 $7000[(1+0.08)^2-1]/0.08=14560

Year 3 $800[1+0.08)^3-1}/0.08=25971

He is going to receive 5000+6000+14560+25971=$51531

 

Question 9

  1. a) False, this is because money loses value with time and, therefore, a 15% discount rate can’tjustifies a 10% discount rate in terms of time value of money.

b)True, money deposited at a 12% discount rate today will have more value than if the discount rate was 8%.

c)True, at any given discount rate, the value of money is greater now than in the future due time value of money factor.

 

Question 10

  1. a) PV= A[1-1/(1+r)^n]/r where PV=present value, A=amount, r= discount rate and n= number of years. Therefore, the PV=12500[1-1/(1+0.14)^4/0.14=$36455
  2. b) pv=2500{1-1/(1+0.08)^6/0.08=$11563

 

Reference

Quiry, P., &Vernimmen, P. (2011). Corporate finance: theory and practice (3rd ed.). Chicester, West Sussex, U.K.: Wiley.

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