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Sources of finance

There are numerous types of sources of finance. These sources are categorized in two; short-term and long-term sources of finance. In selecting the suitable source of finance, it is significant for any financial manager to conduct a comprehensive analysis of all sources. Sources of finance which are long-term have capital requirements for the duration of 5 to 10, 15, 20 years or more. One source of long-term funding is the capital market. Capital market refers to the mechanism and organization of institutions, companies, and the government source long-term financing. Therefore, capital markets are made up of all borrowings which are long-term and are sourced from financial institutions, money lending institutions and banks from foreign-based markets and the raising of capital via the issuing out of several securities such as bonds, debentures, and shares. For trading of securities, there are two primary divisions of a capital market. The first division is the main market and the second one is the secondary market. In the primary market new issue of securities are dealt with; acknowledged as fresh/new issue market. The secondary market is a place for selling and purchasing the present securities; known as the stock exchange or stock market.

Equity shares are another source of long-term financing. Equity share is ownership capital of business. For a public limited firm, it can raise finance via promoters or the public by issuing out ordinary equity shares. Shareholders who receive return and dividend of capital ownership after the compensation of preference shareholders are known as ordinary. These shareholders carry a company’s risk. One advantage of equity shares is that equity shares are very liquid and can easily be sold in the capital market. Also, a large base of equity capital promotes the creditworthiness of a company. One disadvantage of equity shares the price in the market of equity shares fluctuates extremely broadly whereby in many occurrences they lessen an investment’s value.

Another long-term source of funds for a business is debentures. A debenture is a debt acknowledgment document of a company with a common seal. It comprises of conditions and terms of interest payment, loan, and security offered (if any) and loan redemption by a company. Debenture incorporates bonds, debenture stock and any other securities of a firm. Therefore, a debenture is a tool for raising long-term debt.

For the short term sources of finance, indigenous bankers are an example of short term sources of finance for business. Some businesses depend on indigenous bankers for loans and other financing services to meet their working capital necessities.

Leasing is another source of short-term finance. This source implies that a business is compensating for the usage of merchandise; however, it doesn’t own the product. A lease arrangement on a commodity doesn’t imply that the firm pays a certain sum of cash monthly for some years. One advantage of lease agreements is that they are cheaper to coordinate rather than purchasing the merchandise. Also, leases are flexible. Lastly, the owner of the product is always responsible for the overall maintenance which decreases the cost of business operations.

Comparison and contrast of rights issue of shares and loan stocks

A rights issue of shares is defined as dividend of subscription rights to purchase extra securities in a firm and it’s made to the existing holders of securities of a company. In case the rights belong to equity securities, in a public corporation, then it is a non-dilutive pro rata method of raising finance. Also, rights issue can be defined as an invite to present shareholders of a company to buy extra new shares in the firm. On the other side, a loan stock is shares of a company which have been pledged/used as collateral for a loan issued to the company.

Rights issue offers the current shareholders of a company security "rights", which grants the shareholders the right to buy new shares at a discount rate in relation to the current price in the market. However, until the specific date in which the fresh shares can be bought, the shareholders can buy or sale their rights in the share market normally. For the loan stock, it is most valued for a loan lender if the shares are/were traded publicly and are unrestricted, so as to make the shares easily tradable for cash. In this organization it is of less usage if a business is held privately, since the loan lender can’t sell the shares easily.

In a rights issue, there are no significant risks involved. On the other hand, in the arrangement of a loan stock, it can be risky on the side of the lender because the shares value in the market being utilized as collateral can drop. In case a share of the principal amount of the loan is being paid back in terms of an on-going arrangement, this factor is less of a problematic, because the balance of the loan will be decreasing periodically.

In regards to rights issue, the shareholders have three choices considering what action to take concerning the issue of the rights. As a shareholder, you can; 1. Fully subscribe to the rights issue; 2. Disregard your rights or; 3. Sell your rights to another individual.

The source of finance which would be more beneficial for the buildings and noncurrent Assets

The source of finance that would be beneficial would be loan stock because by the look of things, Telco is performing well.

A source of finance for working capital

Working capital is defined as funds required by a business to conduct its day-to-day processes, such as paying wages, buying raw material and covering overhead costs. For the Board of Directors of Telco, a source of finance for working capital can be trade credit. In this service, suppliers would offer Telco goods and services and pay them at a later date. This source of working capital can be attained from all suppliers reliant on Telco’s business arrangements.

Task 2

Advise to the Board of Directors

Weighted Average Cost of Capital = we* Ke + wd* Kd 

Where w is weight and K is cost of capital

Cost of equity, Ke = expected dividend   + growth

Current market price of share

Pay-out ratio = expected divided

Current price of share

0.33 = 0.1

Retention ration, b = 1 – 0.1 =0.9

Growth, g = 0.9 * 0.14 = 0.126

Ke = 0.3 + 0.126 = 0.2263

New capital structure

 

£

£

Equity: ordinary shares

7000000

 

Reserves

4900000

11900000

WACC = 0.226

ii.-Ke ;

Pay-out ratio = expected divided

Current price of share

0.3

1

= 0.3

Retention ration, b = 1 – 0.3 =0.7

Growth, g = 0.7 * 0.14 = 0.098

Ke = 0.3 + 0.098 = 0.398

1

Kd = interest

market value

= 0.05*100

102.5

= 0.0489

New capital structure

 

£

£

weight

Equity: ordinary shares

5000000

 

 

Reserves

4900000

9900000

0.623

Loan stock

6000000

6000000

0.377

Total

 

15900000

 

 

 

 

 

WACC= 0.623*0.398 + 0.377*0.0489

= 0.266

iii.

Ke = 0.226

Kd = 0.0489

New capital structure

 

£

£

weight

Equity: ordinary shares

8000000

 

 

Reserves

4900000

12900000

0.811

Loan stock

3000000

3000000

0.189

Total

 

15900000

 

 

 

 

 

WACC = 0.811*0.226 + 0.189*0.0489

= 0.193

The management should therefore issue a £3,000,000 loan stock and 1000000 shares which lowers the weighted average cost of capital. This effect is brought about by the greater proportion of the cheaper debt in the capital structure. In making this decision, management should be aware of the financial risk which comes with a greater proportion of debt. On the event that the firm’s cash flows fail to meet the fixed payments of the debt the firm could go in to liquidation. This debt can also make the ordinary shareholders demand a higher required rate of return. This explains why it is more expensive to have a £6,000,000 loan stock in the capital structure. Issue of shares alone will also dilute ownership of the firm.

The company's current earnings per share

 

£

Profit before interest and tax

840000

Interest

0

Tax 30%*840000

(252000)

Profit after tax

588000

Earnings per share = earnings attributable to shareholders

Number of shares

Number of shares; 5000000 + 2000000 = 7000000

588000 = £ 0.084

7000000

  1.  

 

£

Profit before interest and tax

840000

Interest  5%*6000000

(300000)

Profit before tax

540000

Tax 30%*540000

(162000)

Profit after tax

378000

Number of shares; 5000000

Earnings per share;

378000 = £ 0.0756

5000000

iii.

 

£

Profit before interest and tax

840000

Interest  5%*3000000

(150000)

Profit before tax

690000

Tax 30%*690000

(207000)

Profit after tax

483000

 

Number of shares; 5000000 + 1000000 = 6000000

Earnings per share

483000 = £ 0.0805

6000000

Task 3

Advantages of the NPV method

There are various advantages associated with the NPV method. First of all the method takes into account the notion that a future value of a currency will be worth less than its present value. Therefore for each period the cash flow will be discounted by a different capital cost secondly, the NPV method gives us an insight on whether a particular investment will bring in value for the investors and the firm and by what value. Thirdly the method takes into account the capital cost as well as the likely risks inherent while making future projections. Generally a cash flow projection of about 5 years will be less certain compared to a projection done in a years’ time .

3.c. payback period = initial investment

Cash inflow per period

 

Year

profit

depreciation

Cash inflow

0

 

 

 

 

1

45000*0.1

4500

4500

9000

2

(1.2*45000)*0.1

5400

4500

9900

3

(1.25*54000)*0.1

6750

4500

11250

4

(1.15*67500)*0.1

7762.5

4500

12262.5

Note: on the 4th year the cash flow will be 12262500 + 2000000 = 14262500

year

Cash flow 000

Cumulative cash flow 000

0

(20000)

(20000)

1

9000

(11000)

2

9900

(1100)

3

11250

10150

4

14262.5

24412.5

2 + 1100      = 2.0978 years

11250

(3d)   Net Present value;

Year

Cash flow    £ 000

Discount factor

Present value   £ 000

0

(20000)

1

(20000)

1

9000

0.926

8334

2

9900

0.857

8484.3

3

11250

0.794

8932.5

4

14262.5

0.735

10482.9

Net present value

16233.7

(3e).

If the firm invests in Brunei, the payback period will be 2.0978 years as compared to 2.45 years in investing in Indonesia. This means that the firm will take a shorter period of time to recover the amount invested in investing in Brunei. This makes investment in Brunei the better choice.

The net present value achieved in investing in Brunei is £ 16233700 as compared to £4,275,000 achieved in investing in Indonesia. Both NPVs are positive making the investments viable but that of Brunei is way higher making the investment in Brunei more favourable.

The initial investment in Brunei is low at £20,000,000 compared that to be made in Indonesia of £27,500,000.

In conclusion, the management should invest in Vocal-phone in Brunei and it will have a more profitable venture.

(3f)

Define the concept of unit cost and explain briefly how they can be calculated

Unit cost explains the overall spending incurred by any firm in its production, storage and sale of a single item of a specific service or product. A unit cost includes all the fixed overhead costs, as well as all the variable costs, and the direct labour expenses, instituted in the production of a single unit. Determination of the unit costs is an efficient way of checking whether firms are effective in the production of their goods. Unit cost constitutes a crucial calculation formula that can be used to evaluate stocks that only produce goods having low fixed costs. Overall, the bigger a firm is the lesser its unit cost by calculation of economies of scale. Organisations producing products or services consider unit cost as a formula for measuring profitability.

In general unit cost is calculated by the combination of fixed and variable costs then by dividing the outcome by the total number of units produced.

Unit Cost=Variable cost +Fixed cost/ Number of units produced

(3g)

Factors that should be taken into account by an organisation such as Telco when setting prices for their output

Setting the prices of products is a crucial factor to maintain the customer while still considering remaining within the projected revenues. The set prices will have an effect on the type, number as well as the nature of customers coming to purchase the products. The following key factors should be taken into account when setting the prices of products. First of all is the competition factor. For every product in the market, there is a company offering similar product. Therefore a business should strive to offer prices that are considerable particularly prices below those of customers. However if the firm sets prices higher than those of competitors the customers will shift. This does not mean that low prices should be set. They may have detrimental effects on the profitability of a company.

Another factor is the cost. A business will have to sell at a price that is higher than the production cost in order to make profit.in addition the operation costs should be taken into consideration. Thirdly there is the consumer demand factor .market research will often show how a product is doing in terms of demand in the market. If the demand is high the business can choose to increase the price. Product positioning is another factor that will assist in setting the price of a product. Product positioning is based on a consumer’s perspective. Products that are selling at low prices are associated with low quality and vice versa. Therefore the prices should be set accordingly such that they do not reflect that a company is of low quality.

Task 4

The main trends and messages contained within the cash flow

Cash flow statements are among the most crucial financial within an enterprise or a project. Cash flow statements consist of a documentation of cash flows in and out of an enterprise or a project. A cash flow can be compared to a bank’s checking account. The deposits in a cash flow statement are considered as the inflows whereas the withdrawals represent cash outflows. The net cash flow represents the balance while checking the account within a particular period of time.

Cash flow statements define the entry of cash flows which transpired within the accounting period that has passed. Cash flow budget defines the projections of future cash flows. Cash flow statements are not only associated with the cash flow amounts but also cash flow timings. Most of these cash flows are formulated within various timing periods.

A Working capital is a crucial element in analysing a cash flow. Working capital is the sum total of the money required to assist in business operations as well as the transactions. When working capital seems to be an adequate, formulating cash flow budget might not be grave and vice versa.

Profitability vs. liquidity problems

Liquidity in an organisation refers to ability to pay off its current debts.  Liquidity can also explain the ability of a firm to have available cash or assets that can be used to cover debts or other liabilities. Profitability refers to the revenues a company is left with after it has paid off its debts. There is a close relationship between liquidity and profitability. A company might be able to bring in revenue from the business transactions it is involved in. However the profitability revenue might not be enough to pay off its current debts. This will bring along a situation whereby the company is in trouble with its liquidity. Therefore a company should take credit within its profit margin to stay safe.

Seven users of accounts and their needs

Financial information has many users. The following are the main users of financial information

Investors

Corporation’s stakeholders require this financial information as it will assist them in making decisions and help them make better investment choices

Management

The management might at some point comprise of the owners. These hired professionals, the manager require the information to make profitable decisions. They act on behalf of the stakeholders whose primary objective is profit.

Creditors

Creditors of moneys for example the banks will require information to establish whether the company will be able to pay off its loan and how much loan it will be accredited

The suppliers

Just like any other users of financial information suppliers will be interested in knowing if and when the company will be able to meet its obligations once they are due. Most importantly the suppliers are interested in the liquidity of a company and its ability to pay off the short-term responsibilities.

Government

Agencies within the state, such as those dealing with tax, will be interested in a company’s financial documents for taxation purposes. Generally the government would like to establish the revenue earned by a company to establish how much it will contribute to the economy in terms of taxes

Employees

Employees will require to be updated on financial information of the firm they are working in. They would like to know if the company s in apposition to pay their salaries and career developments in terms of its expansion.

Customers

Customers too would like to know about the future operations and aspects of a company. They would like to know if his financial information available is enough to continue its existence as well as its operations in the future.

Task 5

5a

Profitability ratios;

Profit margin = net income

Net sales

2016

2015

 

= 204

2200

 

 

=128

1800

= 0.0927

=0.0711

Return on capital employed = net operating profit

Total assets – current liabilities

2016

2015

Profit before tax

654

458

Interest

21

22

Profit before interest and tax

675

480

Total assets

3800

3510

Current liabilities

(178)

(140)

 

3622

3370

= 675

 3622

=480

  3370

0.186

0.142

Liquidity ratios;

Quick ratio = total current assets – inventory – prepaid expenses

Current liabilities

2016

2015

Total current assets

200

130

inventory

(100)

(75)

 

100

55

Current liabilities

178

140

=100

  178

= 55

   140

0.562

0.393

Current ratio = current assets

Current liabilities

2016

2015

Total current assets

200

130

Current liabilities

178

140

=200

  178

= 130

   140

1.124

0.929

Current ratio explains how well and easily Dot is able to pay off current liabilities. In 2016 the ratio is 1.124 showing an improvement from 0.929 in 2015. Even with the improvement the ratio is still significantly low. The current assets just cover the current liabilities; creates a liquidity problem.

Quick ratio shows whether the current assets have the greatest percentage being inventory. Inventory and prepayments take long to cash out. This makes quick ratio a test of ability of Dot to meet obligations of current liabilities. In 2016 it was 0.562 as compared 0.393 in 2015. This is an indication of an improvement but Dot is still poorly performing.

Return on capital employed is a measure of how efficiently Dot can generate profits from capital invested. It is long-term in nature. In 2016 Dot would make 14.2p for every £1 while in 2016 they would make 18.6p for every £1. This ratio is still low despite the improvement.

Profit margin shows the return on sales. Dot earned 7.11p for every £1 in 2015 and 9.27p for every £1 in 2016. It shows that Dot is still ineffective in converting sales to profits.

Management should not go ahead with the takeover because the Dot is not well performing.

(5b)

Sole proprietorship is unincorporated business with a single owner. Partnership on the other hand is a business arrangement where two or more persons pull their resources and share the business profits or losses in a predetermined ratio.

Financial statements are all the reports about the firm’s financial performance. Sole proprietorship’s reports differ from those of a partnership in the following ways;

Sole proprietorship accounts will only show one capital account as compared to the partnership which has capital accounts equal to the number of partners in the partnership. This capital account is part of financial statement showing the amount contributed by each of these individuals to the business. It is the basis of calculation of the interest on capital as part of returns to these owners of the business.

Sole proprietorships are owned by a single person which means profits in the income statement will belong to him/her alone. This means there are no additional sections in the income statement for the division of these profits as it is in the case of in partnerships and companies. In a partnership there will be a section for proration of profits as per the profit share ratio which is usually a component of a partnership deed.

Statement of financial position will have the section of owner’s equity of a sole proprietorship with only one capital account whereas partnerships will have the section showing balances of partner’s capital against the name of each partner.

It is a requirement that partners prepare statement of changes in equity to show how equity has changed throughout the year. On the other hand, sole proprietorship does not prepare changes in equity statement.

Salaries paid to partners offering services to the partnership are recorded as salaries in the statement of comprehensive income whereas sole proprietors record salaries paid to them as a withdrawal.

(5b)

Telco is a medium size company. What are the main differences in the financial statements of sole traders, partnerships and limited companies?

The financial statements of different business structure differ. For instance in the sole partnership there is only one capital account compared to a partnership whereby there’s more than one capital account. The account numbers is defined by the number of partners.in a sole partnership the entire profit goes to the owner whereas in the partnership and limited companies have established sharing ratios. Also in a sole proprietorship the balance sheet belongs to the single owner. On the other hand in the partnership the balance sheet indicates the balance of each partner.

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