Financial Managment - Income Statement for Agri Enterprises - Assignment Example

work, Finance and Accounting Financial Management Question Examine the following for Agri Enterprises Ltd. Income mentfor Agri Enterprises for the year ended 30 June. 20132014 $$$$ Sales15 000 00016 600 000 Less Cost of goods sold10 500 00012 000 000 Gross profit4 500 0004 600 000 Less Operating expenses Selling expenses1 500 0001 550 000 General and admin expenses900 000950 000 Lease expense100 000100 000 Depreciation500 000490 000 Less Total Operating Expenses3 000 0003 090 000 Operating profits1 500 0001 510 000 Less Interest expense500 000450 000 Net profits before taxes1 000 000 1 060 000 Less Taxes (30% rate)300 000318 000 Net profits after taxes700 000 742 000 Dividends paid to ordinary shareholders165 000150 000 Dividends paid to preference shareholders50 00050 000 Balance Sheet for Agri Enterprises Ltd as at June 30, 2014 Assets$Liabilities$ Cash and short term deposits 500,000 Accounts payable4,000,000 Marketable securities 1,500,000 Accrued expenses250,000 Accounts Receivable 6,000,000 Short term loans 4,000,000 Inventories (cost value) 3,750,000 Total current liabilities 8,250,000 Total current assets 11,750,000 Debentures 10,000,000 Total non-current liabilities 10,000,000 Total liabilities 18,250,000 Land and buildings (cost) 5,500,000 Machinery and equipment (cost) 10,250,000 Shareholders equity Furniture and fixtures (book value) 4,000,000 4% Preference shares ($1) 1,250,000 19,750,000 $1 Ordinary shares fully paid 2,500,000 Less accumulated depreciation -6,500,000 Retained earnings / reserves 3,000,000 Total non current assets 13,250,000 Total equity 6,750,000 Total assets 25,000,000 Total 25,000,000 Note 1 Ordinary shares are currently trading at $3.50. The price earnings ratio for the industry sector averages 15.0 times. Note 2 Liquidation values for assets are at book value except for: Accounts receivable (90% of book value), Inventories (80% of cost), Land and Buildings (150% of cost), Machinery and Equipment (70% of cost), Furniture and Fixtures (75% of book value). (a)You are advising a lender on lending money to Agricorp Enterprises. (i)Nominate the 3 ratios you consider to be most important to a decision to lend to this company justifying your selection. The three ratios nominated are: Current ratio Debt ratio Earnings per share ratio Current ratio = current assets / Current liability This is one of the liquidity ratios that give the measure of the amount of cash accessible for the payment of debts. It is also known as the working capital ratio. Debt Ratio or leveraging ratio = Total Liability / Total Assets This is the ratio that gives the capacity of the organization to repay its long term debts. In essence, debt ratio is the actual measure of the organization’s financial leverage. Earnings per share = Net earnings / the number of shares This is the measure of the response of the investor on the subject of owning the tock of the company as well as the cost of issuance of the stock. They are majorly concerned with the return on shareholders’ investments in form of shares. (ii)Calculate the ratios for 2014. Current ratio = current assets / Current liability Total current assets 11,750,000 Total current liabilities 8,250,000 Current ratio = 11,750,000 / 8,250,000 Current ratio = 1.42424 Debt Ratio or leveraging ratio = Total Liability / Total Assets Total liabilities = 18,250,000 Total assets = 25,000,000 Debt Ratio or leveraging ratio = 18,250,000 / 25,000,000 Debt Ratio or leveraging ratio = 0.73 Earnings per share = Net earnings / the number of shares Net Earnings = 1,060,000 Number of shares 3,750,000 Earnings per share = 1,060,000 / 3,750,000 Earnings per share = 0.28267 (b)At a recent meeting of shareholders, the Managing Director of Agri Enterprises foreshadowed introducing an aggressive financing strategy for working capital as opposed to the firms long-held conservative strategy. (i)Explain the main considerations in deciding upon a working capital strategy. In the selection of the most appropriate working capital strategies, the Managing Director of Agri Enterprises considers four major factors including the type or nature of business, the cycle of working capital, the efficiency of management (ability) and the External or economic factors. For example, in the nature of business, the retail stores require stronger working capital since they require large amount of cash for consistent restocking of inventory products. The cycle of working capital is essential since the business can decide to run long term or short term financing. For the Agri Enterprises, the working capital is calculated annually, hence aggressive financing is appropriate. The cash flow of the organization is the focus, and the working capital strategy ought to maximize the cash flow by increasing the accounts receivables as opposed to accounts payables. The management efficiency (ability) is essential because it is important to assess the working capital in the past years to know whether the indicators have been positive. Since the working capital has been stable, the long term financing may limit its annual return. Finally, external economic factors are essential because of the interaction with external stakeholders such as suppliers, clients, partners and the community. The Managing Director of Agri Enterprises realizes that the working capital should take care of the constant cash flow to minimize the current liabilities. This demands that the company must set aside cash for its current assets as opposed to trading credit or liabilities. Strict monetary policies and limited business credit and lower consumer return require a strategy that can retain the working capital. The managing directors will seek to reduce the accounts payable and the balances of credit line. They will also avoid excess acquisition of inventory to improve the working capital performance. (ii)Outline an appropriate working capital strategy for a specific sector of industry you are familiar with. Various businesses need typically require different types of strategic plans for the working capital to operate. For instance, many retail stores require stronger working capital since they have to maintain higher capacities of cash to be consistent in the restocking of business inventory products. A good example of the industry application of working capital strategy is the Automobile dealing companies. They typically have no copious volumes of working capital since they apply basic plans for the generation of long-term business financing for the automobile inventory. As it attempts to maintain its level of cash flow, it limits its current liabilities and pays considerable cash for its current assets instead of its trade credit and its short-term liabilities. (c)Provide an estimate / s of value for the ordinary shares of Agri Enterprises using the information above. Estimation of the value of the ordinary shares 4% Preference shares ($1) 1,250,000 The value of shares = $3.5 x 1,250,000 = $4375000 4% Preference shares ($1) 19,750,000 Total value of shares = 3.5 * 19,750,000 = $69,125,000 $1 Ordinary shares fully paid 2,500,000 The value of shares = 3.5 * 2,500,000 = 8,750,000 Question 2 Owners of organisations are likely to find that the agency problem applies to staff decisions and actions of the highest to lowest paid employees. Agency concerns are not restricted to upper management decisions. (i)Comment on the nature of the agency problem. Agency problem is the conflict of interest that inherently occurs in the relationship between two organizations, where one is expected to serve the best interests of the other. The agent is expected to decide on how best to serve the interest of the principal. However, there may be a difference between the interests of the two. The agency conflict is best referred to as the conflict between the principal and the agent. In corporate financing, the agency conflict happens between the management of an organization and the stockholders. The managers are expected to make the best decisions to maximize the wealth of the stakeholders. (ii)Explain how an owner in employing the manager for their small - medium enterprise might ensure that agency conflicts do not arise? Even though it is impossible to eradicate the agency conflict completely, the organizations management can be encouraged to work in the best interest of its shareholders using incentives, including recognition and compensation based on the performance. Secondly, the organization can exercise direct influence on the shareholders. Other methods include threats to fire or threats to takeover. The organization also ought to have positive and negative influence on the core economic resource and strategic alliance. It is essential to increase the organizations’ capital and to create the organizational value. There has to be a written agreement prior to the engagement between the two parties. Every time the indicators of conflict begin to manifest, the agent and the principal refer to the written agreement for quick and reliable resolution. (10 marks) Question 3 (a) Complete the table below. Assume a required rate of return of 12% per annum. Par valueBond interest rate (per annum)Years to maturityInterest paidNo of periodsInterest payment per periodPresent value of interest paymentsPresent value of bond at maturityTotal present value of bondIs the bond issued at a par, premium or discount $%$ A$1,0008%12annually B$1,0008%10annually C$50012%5semi annual D$50012%5quarterly E$50014%10annually (b) Which of the bonds would be more attractive to you? Why? A. $1,000 8% 12 annually The return = 0.08 * 1000 * 12 / 12 = $80 B. $1,000 8% 10 Annually Return = 1000 * 0.08 * 10 / 12 = $66.67 * 1 = $66.67 C. $500 12% 5 semi annual Return = 500 * 0.12 * 5 / 12 * 2 = $25 * 2 = $50 D $500 12% 5 quarterly Return = 500 * 0.12 * (5 / 12) *4 = $100 E $500 14% 10 annually Return = 500 * 0.14 * (5 / 12) * 1 = $29.16667 Choice D is the optimal and the most attractive bond. This is because it yields the best annually, a return of $100. (5 + 5 = 10 marks)? Question 4 Consider the project below. Project Crop Gro is an agribusiness processing development project which involves a $4.5m outlay at the start of the projects life and then several additional investments along the life of the project. It is expected that the development will be saleable at the end of Year 10. The firms discount rate is 16%. Project Beta Cash outflows Cash inflows Yr 0 4,500,000 1500,000 900,000 2500,000 900,000 3900,000 4900,000 5500,000 900,000 6900,000 7900,000 8500,000 900,000 9900,000 105,550,000 * assume cash inflow and outflows occur at year end. (a)Calculate the projects payback, net present value (NPV) and internal rate of return (IRR). Payback Period = Yrn + cumulative cashflow(n) / Discounted cash flow (n – 1) Payback Period = 10 + 105,550,000 / 900000 = 127.278 Net Present Value (NPV) = Investment + CF1/ (1+ K) ^1 + CF2/ (1+ K) ^2 +…+ ∑CFt (1 + k) ^t Net Present Value = 4,500,000 + 1500,000 / 1.16 + 2500,000 / 1.16^2 + 3900,000 / 1.16^3 + 4900, 000/ 1.16^4 + 5500, 000/1.16^5 + 6900,000 / 1.16^6 + 7900,000 / 1.16^7 + 8500,000 / 1.16^8 + 9,900,000 / 1.16^9 + 105550000 / 1.16^10 NPV = 50224134 r is 16%. NPV at 16% discount rate = $50,224,134 because the NPV is higher than zero, we increase the discount rate NPV at 17% discount rate = $47,277,700 NPV at 36% discount rate = 19352299 NPV at 60% discount rate =10645924 NPV at 70% discount rate = 9222540 Since NPV is fairly close to zero at 70% value of r The IRR ≈ 70% (b)What advice would you give regarding accepting / rejecting the project? The project is not viable and hence, not worth taking up. This is because it requires too much discounting, as seen that the discounting IRR is 70%. The IRR is greater than its target internal rate of return. (c)Briefly explain, how would you estimate a discount rate for this project? The discounting rate is estimated by reducing the net present value towards zero. The discounting rate is taken for the net present value that is closest to zero. (d)How might uncertainty be addressed with this type of project? The uncertainty is addressed by increasing the rates further to make the NPV as low as possible. The discount rate has to equate the present value for the future cash flows of the investment with its initial investment. (e)Through the life of this project, what type of review should be undertaken by the firm in terms of project continuation? The review should be done on the strategies of assessing the business performance. If the Net present Value and the IRR are raising uncertainties, the discounting rates ought to be reviewed for the possibility of increasing them. (10 + 5 + 5 + 5 + 5 = 30 marks) ? Question 5 (a)Calculate the weighted average cost of capital for Grow Fast Ltd based on the following: (show workings) Debt The firm has issued $1,000 at 6% per annum (coupon rate) bonds maturing in 12 years time. The current sale price for such bonds is $970. Preference Shares The firm has $5 preference shares (6% dividends) with selling costs of $0.60 per share. Ordinary Shares The firms $1 ordinary shares are selling at $5.80 and new issues would entail flotation costs etc of $0.60 per share. Dividends per ordinary share for the most recent year were 60 cents and it is expected that dividends will grow by 6% per year which is their historical growth rate. Tax rate the firm pays tax at a rate of 30%. Capital sources Long term debt50% Preference shares10% Ordinary shares40% WACC = ((E / V) * Re) + [((D / V) * Rd) * (1 - T)] E = Market value of the companys equity = 970 D = Market value of the companys debt = 1000 V = Total Market Value of the company (E + D) = 1970 Re = Cost of Equity = 5.8 Rd = Cost of Debt = 50% T= Tax Rate = 30 % WACC = ((E / V) * Re) + [((D / V) * Rd) * (1 - T)] WACC = ((970 / 1970) * 5.8) + [((1000 / 1970) * 50) * (1 – 0.30)] WACC = 20.62234 10 marks Read More