Introductory Financial Management - Math Problem Example

Student Name: Tutor: Title: Introductory Financial Management Course: Part One Alternative 1 The company has to have a contingency reserve to deal with the anticipated law suit and the subsequent settlement. The bond has to give the returns that will be used for settlement of the claim. Return on bond is 4% p.a. One customer complaint settlement is $5000 1000 customer complaint settlement is $(5000×1000) = $5000, 000 Duration of time is one year The coupon rate will be (100-4) % of $5000000 Coupon rate = 96% of 5000000 = $4,800,000 The face value will be $5000, 000 while coupon amount will be 4,800,000 The bond amount to be purchased today should be $4,800,000 Alternative 2 The present value of $5000, 000 before it is paid after a year. It is important to find the present value of the money by discounting it. The interest rate to be used will be 10% as stated in the cost of capital. Present value = Amount of settlement/(1.1)1 Present value = 5,000,000 ÷ 1.1 Present value = $4,545,454. If the complaints are paid $4,545,454 they will be indifferent to waiting for the court case since they would have received the same value of money that should have been paid after one year. Alternative 3 Using delaying tactics will give the company enough time to complete daily objectives and settle the claim when it deems ok. The city lawyer can only succeed in delaying the case for one more year. The outcome of the law suit is however not likely to change. The cost of capital for looking good is 10%. The lawyer has to be paid to use delaying tactics. The amount to be paid should not exceed the interest earned. The interest should be used to pay the lawyer. The future value of 5Milion dollar after two years = 5000000(1.1)2 = 6,050,000 Interest = 6,050,000 -5000000 = $1,050,000. The lawyer has to be paid the maximum amount of $1,050,000 a) Alternative two is suitable for the company since the lowest amount of money will be used for settlement. The company will only use $4,545,454. To settle the debt completely. In the first option $4,800,000 coupon rate of a bond has to be purchased in order to yield the required $5,000,000 after two years. The third option is expensive since the company does not only pay the settlement of 5million but also the salary of the lawyer. The second alternative remains to be the most cost efficient among the three. b) The third option of delaying tactics is viable since the company will invest the money into the company to yield more profits. However, investors and the public image of the company will suffer as the company continues with the legal battle which may end up costing the sales of the company. The company has to bear in the mind that any action done to the potential customers affects its market share. Ignoring ethical issues may affect the public perception of the company. Delaying tactics may portray the company as malicious in selling products that him the consumers (Shim & Siegel, 2008). Part Two A) The optimal order quantity/economic order quantity = Square root of (2CD ÷IP) D-Annual demand for the product -1500KG C-Delivery cost per batch-$75 P-Cost price per item-$30/KG I-Stock holding cost-$2.50 Optimal Order Quantity = (2×75×1500÷2.5×30)1/2 Optimal Order Quantity = (225000÷75)1/2 Optimal Order Quantity = (3000)1/2 Optimal Order Quantity = 54.77 B) The entire needs 1500Kgs of Lanolin One order consist of 50Kgs of Lanolin 1500Kgs will be equal to –orders 50Kgs- 1Order 1500Kgs = 1500÷50 = 30 Orders. Thirty orders will be placed in a year C) Ordering of new inventory It takes two weeks to deliver an order after placement. This is (7×2) = 14days Reorder point is the time where reorder inventory is made. Reorder point = (lead time in days) × (daily usage) Reorder pint = 14×1500/365 Reorder = 21000÷365 Reorder point = 57.53 D) Calculating average inventory level under the new policy On average, the inventory must be maintained at the safety level and the reorder level. The average inventory will therefore be: 100+57.53 = 157.53 E) Report of methodology used and discussion of results The optimal order quantity is the quantity that can be economically held in the company without straining the resources or running out of stock. There is a standard formula given for calculating optimal order quantity which is the same as economic order quantity. 54.77 is the economic order quantity or the optimal order quantity. This is the amount of raw materials that can be held by the company efficiently and make performing of daily objectives effective. The amount is obtained by substituting the annual demand, delivery cost per batch, cost price per item and stock holding cost in the formula. Subsequent calculation gave 54.77 as the optimal order quantity. Direct proportion was used to calculate the number of orders in a year. 1500Kgs of raw material (lanolin) was to be delivered in the entire year. 50Kgs make up one order; it subsequently shows that the number of orders in a year will be obtained by dividing the 1500kg by 50Kgs which is 30 orders in a year. The management has to spread out the thirty orders so that the lead time is not interrupted with and make the company to run out of raw materials. The reorder point is the time at which reorder quantity has to be made. In this case there is a formula for calculating reorder point. The value of 57.53 was established as the reorder point. Any time the inventory falls to this level, the company has to make arrangements to buy more inventory in order to avoid running out of stock. F) The supplier who delivers goods in time at an affordable price has to be used. This can be determined by looking at……………….. 1/45----------90 days X -------------60 days 90 * x = 60 * 1/45 X = (60* 1/45) / 90 X = 0.015 For the second supplier at net 60: 2/ 15 = 0.13 This implies that the second supplier has a better offer. The credit terms of the second suppliers are better as compared to the first supplier. Since the company objective is to minimize costs, it has to go for the raw materials that look affordable and therefore a huge discount has been given like in the second case (Brigham & Ehrhardt, 2010). Part Three a) i) Principal - $ 3000000 1st year 12% × 3000000 360000 Second year 3000000 - 1249050 2rd year principal 1750950 Interest 12% ×1750950 210114 3rd year principle 1750950 – 1249050 = 501900 ii) Interest 12 % × 501900 = 60228 b. Tax deductable Interest 0.4 1st year 360000 × 0.4 144000 2rd year 210114 × 0.4 = 84046 Third year 60228 ×0.4 24091 iii) Total after tax out flow = annual payments- deductable tax interest + maintenance costs 1st year net out 1249050 – 144000 + 45000= $1150050 2nd Year net outflow 1249050- 84046+45000 = $1210004 3rd Year net outflow 1249050- 24091 + 45000 = $1269959 Lease b) i) Year1 – interest 1200000 × 0.07= 84000 Tax benefit 0.4 × 84000 $ 33600\ This will be constant throughout the three years Net Outflow (to be discounted) 1200000 - $ 33600= 1166400 ii) This amount will be discounted for the three years as follows: Year Payment PV factor Amount 1 1166400 0.9091 1,060,374.24 2 1166400 0.8264 963,912.96 3 1166400 0.7513 876,316.32 Part Four a) EPS = (Earnings ÷ no of common shares outstanding)×100 (Lasher, 2010). EPS for Looking Good = (225000000÷900000000) ×100 EPS for Looking Good = 0.25×100 EPS for Looking Good = 25% EPS for Absolutely Fabulous = (50,000,000÷150,000,000) ×100 EPS for Absolutely Fabulous = (0.333×100) EPS for Absolutely fabulous = 33.3% P/E ratio = Current Price per Share ÷ EPS P/E ratio for Looking Good = 4.50÷0.25 P/E ratio for Looking Good = 18 P/E ratio for Absolutely Fabulous = 5÷0.333 P/E ratio for Absolutely Fabulous = 15 b) P/E ratio = Current Price per Share ÷ EPS P/E ratio = 5÷EPS 1.25 shares translate to one share 150million will be… 150÷1.25 = 120million EPS = ($50m ÷120m) ×100 = 41.67% P/E Ratio = (5÷0.4167) =11.999 P/E Ratio = 12 c) Good Looking is swapping 1.25 shares for each share of Absolute Fabulous. Absolute Fabulous share are 150million 1.25 shares will be equivalent to one share 150million? (150÷1.25) = 120million shares. Total share for Looking Good will be 120M +900M = 1020M EPS = (Earnings ÷ no of common shares outstanding) ×100 EPS = (225+50) M ÷1020M) 100 EPS = (275÷1020) 100 = 26.96% Post merger EPS for Looking Good = 26.96% d) P/E ratio = Current Price per Share ÷ EPS 12 = current price per Share ÷26.96 12= P/0.2696 Current market price = 12 ×0.2696 = 3.24 Expected market price per share = $3.24 References Brigham, E.F., & Ehrhardt, MC 2010, Financial Management Theory and Practice, Cengage Learning, New York Lasher, W, 2010, Practical Financial Management, Cengage Learning, New York Shim, JS & Siegel, JG 2008, Financial Management, Barron's Educational Series, Sydney. Read More