Q1. I would rather have a savings account that paid interest compounded on an annual basis (Cornett, Adair, & Nofsinger, 2013). The reason for this is because for the monthly basis the interest is more likely to be higher than that of an annual basis.
Q 2. An amortization schedule is a detailed table showing regular payments that an individual pays over time for a mortgage. It is used in determining the amount of an outstanding loan at different times and adjusting the amount of loans so as to be in line with the expected monthly payments.
Q3. The early years are more use full in reducing taxes than the late years since in settling the loan during early years, and then it means that the time of the compounding factor is minimized. Therefore the overall interest will be low as compared to when you could have paid it in the later years.
Q4. The difference between an ordinary annuity and annuity due is in the difference between their payment periods and time in relation to the period that is being covered by the payment. In ordinary annuity, payments are made at the end of the covered period unlike in annuity where payments are made at some regular intervals of time.
Summing them up, ($594.1 + $705.8 + $838.53 + $995.9 + $1183.34 ), we will have $4317
Finding the average for the five years, ($4317/5) we get 863.537, and this is the future value of a $500 annuity payment for the period of five years at an interest rate of nine percent.
At eight percent interest:
A=P( 1 + 1/r)^n
Where;
P = $500
r = 8%
n = 5
1st year= $500(1+0.08)^1= $540*1.08 = $583.2
2nd year=$500(1+0.08)^2= $583.2*1.664 = $970.45
3rd year=$500(1+0.08)^3= $629.9*1.25971 = $793.43
4th year=$500(1+0.08)^4= $680.2*1.36049 = $925.5
5th year=$500(1+0.08)^5= $734.66*1.46933= $1079.5
Summing them, ($583.2 + $970.45 +$793.43 + $925.5 + $1079.5) we will have $4352.04
Finding the average for the five years, ($4352.04/5), we get 870.41, and this is the future value of a $500 annuity payment for the period of five years at an interest rate of eight percent.
Summing them up, ( $605 + $ 732.05 + 885.115 + $1,071.79 + $1296.54 ) we get $4590.50.
Finding the average for the five years, ( $4590.50/5), we get $918.099, and this is the future value of a $500 annuity payment for the period of five years at an interest rate of ten percent.
Summing them up, ($931.61 +$769.58 + $636.097 + $525.91) we will have $2863.197
Finding the average for the four years, ($2863.197/4) we get 715.8, and this is the present value of a $700 annuity payment for the period of four years at an interest rate of ten percent.
At nine percent interest:
A=P( 1 + 1/r)^n
P = $700
r = 9%
n = 4 years
1st year= $700(1+0.09)^4=$988.12*0.917=906.12
2nd year=$700(1+0.09)^3=$906.52*0.842=763.3
3rd year=$700(1+0.09)^2=$831.67=0.772=642.05
4th year=$700(1+0.09)^1=763*0.7508=540.204
Summing them we will have, ( $906.12 + $763.3 + 642.05 + $540.204 ) = $2851.67
Finding the average for the four years ( $2851.67/4), we get 712.92, and this is the present value of a $700 annuity payment for the period of four years at an interest rate of nine percent.
At eleven percent interest;
A=P( 1 + 1/r)^n
P = $700
r = 11%
n = 4 years
1st year = $700(1+0.11)^4 = $1062.65, $1062.65*0.901= $957.45
2nd year = $700(1+0.11)^3 = $957.34, $957.34*0.812 = $777.36
3rd year = $700(1+0.11)^2 = $862.47, $862.47*0.731 = $630.47
4th year = $700(1+0.11)^1 = $777, $777*0.659 = $512.04
Summing them up we get, ( $957.45 + $777.36 + $630.47 + $512.04) = $2,877.323
Finding their average for the four years, ($2,877.323/4), we get $719.33075, and this is the present value of a $700 annuity payment for the period of four years at an interest rate of eleven percent
Reference
Cornett, M., Adair, T., & Nofsinger, J. (2013).M:Finance.McGraw-Hill/Irwin; 2 edition
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The price of oil has plummeted over the last two months. Your first task is to explain the effect that this is having on the airline industry currently. How are airlines reacting? What adjustments, if any, are they making to their strategies? Second, you should select an airline and discuss the issues that must be assessed in the event of a prolonged period of low fuel prices. You should consider issues such as competitive positioning, fleet renewal schedules and risk assessment, for example. You should refer to the airline’s stakeholders and consider their expectations as well.
You can use charts and graphs as needed.
SAMPLE ANSWER
Fuel price and its effect on airlines
Introduction
The recent attenuation in fuel prices is expected to trigger a shift in various facets across the airline industry; ranging from possible reduction in air fares and higher profit margins for companies, to a reduction in the demand for fuel efficient airplanes as the need to hedge against increasing fuel prices diminishes. Airlines are already reacting to the lower costs of fuel it will only be a matter of time before companies review their strategies to accommodate the new status quo. The low cost of fuel is not only expected to reduce the cost of operation but it could also mean higher levels of competition as customers seek low priced planes. This paper is a discussion on the impact of low fuel costs on the airline industry to establish the reaction from airlines and adjustments that are currently going on in response to these changes.
Discussion
Impact of low fuel prices on the airline industry
The major force behind the high operational costs felt by airlines can be attributed to the cost of fuel. Accordingly, the plummeting fuel prices have the impact of reducing operational costs and this is directly reflected in the company’s level of profitability. Schifter (2015) notes that when the price of an input falls, the likely result is an increased level of profitability as a reduction in expenditure is witnessed. In an industry where the costs of operation have mostly been embellished by the ever increasing fuel costs, this marks a period of relief and a chance to record higher profits from operations (Australia freight transport report, 2015). This means that in the event that airlines do not reduce their fares immediately, they are expected to gain immensely from the elevated profit levels (Choudhury, 2015). Paris (2015) however notes that this may be short-lived because airlines may soon succumb to market pressures to lower air fares.
A major impact that the low fuel prices is having on the airlines is the pressure to reduce air fares in response to the low prices. The pressure from customers as well as governments is very high as fuel prices continue to fall and it is expected that most airlines will soon reduce their fares in order to remain competitive (Paris, 2015). Töytäri et al (2011) notes that in a competitive environment, companies aim at attracting customers through providing the most attractive packages and offering low prices is one of the tactics that companies use to attract customers. Furthermore, customers are likely to be attracted to lower prices and airlines that do not reduce their prices once the trend begins may end up losing their customers. The pressure to revise air fares downwards is therefore high among airline companies and this is expected to reduce prices across the industry.
A projected impact of the low fuel prices is that customers may lose out on the high end tactics that airplanes employ in order to maintain a decent level of clientele. The law of demand and supply portrays that as prices fall, supply also falls. This maybe applicable in the airline industry because lower fares do not lead to significant profits and the enthusiasm to provide services may not be as high as when fares are high (Tucker, 2010). Australia freight transport report (2015) notes that as fuel prices go up, fare prices go up and this means higher profitability for airlines; which in turn invest more in quality services in order to attract more customers. Low fares on the other hand will reduce such proactive strategies because it will be easy to attract customers without the need to invest in extra efforts. Customer comfort is therefore at stake as less may be invested in delivery of quality and unique services. In the event that airline fares may fall as a result of the reduced fuel prices, airline enthusiasm to make sales may be affected. Furthermore, low prices mean that more people can now afford to fly and less effort is needed to attract customers (Choudhury, 2015).
The low fuel prices are considered a major throwback for manufacturers of fuel efficient aircraft like the A320ceos and B-737 Max among others. Such aircrafts were designed to counter the high fuel costs and thus improve profitability for airlines. With fuel being the major line of expenditure for airlines, most airlines had the purchase of fuel efficient aircraft in their future plans in a bid to reduce costs and thus promote profitability (Schifter, 2015). Falling fuel costs however mean that airlines have less urgency to purchase fuel-efficient airlines as the normal aircrafts will still serve cost effectively given the low fuel prices. As noted by Flottau (2015), the main argument for fuel efficient aircraft is to lower operational costs and when this becomes less important as fuel prices fall by almost half, the result is lower demand. This basically means that the demand for fuel efficient airplanes could be negatively affected by the low fuel prices as more aircrafts consider the use of old aircrafts. The low prices mean that airlines can effectively delay the expenditure on new fuel efficient aircrafts and thus invest in other activities aimed at promoting business.
The reduced demand for these aircrafts also pose a threat to manufacturers who have currently accumulated huge orders in that customers may start cancelling their orders. This as noted by Flottau (2015) has caused a panic among manufacturers who may now be forced to speed up their production processes to avoid losses in case airlines decide to cancel orders. However, some experts are confident that this scenario is unlikely and indicate that airlines will only withdraw their plans to purchase their fuel-efficient planes if they are assured that prices will remain low for many years. Boeing’s earnings for example are still expected to continue rising despite low fuel prices and cancellations have been minimal (Rich, 2015). While airlines may choose to use their older aircrafts for longer periods, the demand for fuel efficient aircraft may not be significantly affected because an increased number of people who can afford to fly will still call for the purchase of more aircrafts.
Experts in the airline industry suggest that the reduction in demand for fuel efficient aircraft may not be immediate or very evident at this particular point because airlines may not have adjusted their strategies to respond to the new prices (Rich, 2015). Furthermore, it would be difficult to judge whether the reduction in the number of aircrafts ordered is as a result of the low prices or as a result of saturated orders and backlogs held manufacturers which may force them to regulate orders. In the event that the fuel prices keep falling, a shift in the demand curve for the fuel efficient airplanes is likely to change as shown below.
Q1
Qo
Quantity
Fig 1: Shift in the demand curve for fuel efficient aircrafts, with lesser quantities demanded at Q1.
Flottau (2015) refers to the strategy where airlines secured as many fuel efficient planes as possible as a form of hedging that is quite expensive. This followed an assumption that fuel prices will always be high as demonstrated by the global trends in the recent years; such that airlines sought to purchase the airplanes as a means of life insurance against skyrocketing prices and thus compete effectively. Until recently, the demand for the airplanes including the Boeing and Airbus have been high and order backlogs have been evident as airlines compete to own fuel-efficient planes; with manufacturers of these planes experiencing a boom. With the falling fuel prices, these manufacturers could see a fall in revenues as demand for the fuel efficient airplanes declines (Tucker, 2010). In the face of continued fall in the prices of fuel, reduced demand could see the supply curve shift to the left as indicated below. This denotes a change in the economic conditions which force the supply curve to shift as less quantities are supplied. At a similar price, p, a lower quantity of fuel efficient aircrafts will be supplied if fuel prices keep going down as indicated by q1 (Tucker, 2010).
Price
P
Q1
Q0
Quantity
Fig 2: Shift in the supply curve of fuel efficient manufacturers
Reactions from industry players
The effects of reduced fuel prices on the airline industry are undeniable and it is expected that players from the industries will react to these changes by adopting various strategies. So how are the airlines reacting in the midst of the changes identified? Tucker (2010) notes that, whenever the price of an input goes down, organizations are often left with two choices; to reduce the price of their products, or to add onto their profitability by maintaining current prices. Either way, a company’s actions affect future profitability levels and airlines must therefore make strategic decisions to react to the price changes without affecting the demand for their services.
A majority of airlines are yet to adjust their fares to fully match the low costs of fuel; a factor that has been associated with risk aversion. Airlines are still assessing the economy to determine whether the fuel prices will remain low in the future in order to avoid situations in which they reduce fares only to hike them following changes in the fuel prices (Paris, 2015). However, various airlines including Virgin Atlantic, Emirates and Qantas have already started reducing their fares by a huge magnitude in response to the falling prices and their actions are likely to trigger similar actions throughout the industry as airlines seek to compete with their peers (Paris, 2015; Saleem, 2015).
As indicated in a discussion above, the urgency for fuel efficient airplanes is expected to reduce if fuel prices keep falling and this may be reflected by changes in company strategies. Airlines are now considering keeping their older aircraft models as opposed to purchasing fuel-efficient airplanes. It is apparent that companies are increasingly becoming comfortable with their older models and thus considering the diversion of funds intended for the purchase of fuel-efficient planes. The need for bank facilities to purchase such planes may also be suspended by such companies if fuel prices continue to fall.
Case study of British Airlines
British Airways (BA) remains one of the most influential airlines in the world and its reaction to the low fuel prices is an important industry pointer and could possibly represent the industry’s reaction. British Airways is responding slowly to the changes in fuel prices and little has been done in terms of bringing down air fares (Paris, 2015). This can be attributed to the volatile nature of fuel prices which is often unpredictable. British Airways may be reluctant on reducing air fares because there is a probability that price adjustments made may need to be revised once again when there is another change in the market. In addition, fuel prices cannot be directly translated into lower fares because the airline purchases fuel long in advance and hence the reduction in current prices cannot automatically translated into lower prices. The pressure is however high as other airlines start reducing their fares. The likelihood therefore is that British Airways may end up lowering its prices to match its peers in order to retain its market.
While lowering air fares would seem the obvious reaction by airlines following the low fuel prices, the airline should not be quick to lower their fares because the volatility of the economy may not sustain the prices for a long period. In essence, revising the company’s strategy and budget based on the current low prices may not be a valid action because there is no certainty that the prices will remain low. It is however apparent that the company must effectively study the trends in the economy and strategies that are being adopted by other airlines in order to compete effectively (Heerkens, 2004).
The low prices of fuel present a change in the business environment for British Airways and different airlines may respond in their own unique way. The most likely effect of low fuel prices would be lower fares as airlines respond to market pressures to reduce prices. BA must engage competitive positioning tactics that will ensure that despite the changes adopted by other companies in response to the low fuel prices, the company still retains its market share through the season. It is notable that due to the low fare prices, clients have a variety of airlines to choose from and it is only through creating attractive features and creating value for clients that BA will prevent the airline’s customer from going for lower prices elsewhere (Töytäri et al, 2011). In the event of a prolonged period of low fuel prices, British Airways needs to weigh the possibility of reducing air fares according to the industry standards and thus attain a competitive position in the market. Töytäri et al (2011) suggests that the quality of service must be top-notch for any company that seeks to maintain competitive positioning. He indicates that customers are not only attracted to low prices but the nature and quality of services received could make them prefer a highly priced product.
British Airways may need to re-evaluate its fleet renewal schedules as it adjusts to current economic conditions. British Airways which is known for a well maintained fleet and affinity for low-cost airplanes may use this opportunity as a chance to invest in other projects as opposed to replacing its current airplanes with the fuel efficient planes. It is notable that one of the main focus for the airline was to replace its older models with fuel efficient ones in order to promote profitability over time. The lower prices however may call for a revision of the company’s fleet renewal strategy to reduce the need for fuel efficient airplanes.
As British Airways makes strategy changes following the low fuel prices, it is imperative that the management takes into consideration the need for risk assessment (Yilmaz, 2015). Flottau (2015), notes that, as fuel prices fall, there is a likelihood of various business risks including the possibility of rising prices in the future. According to Rich (2015), fuel prices are highly volatile and an airline must be extremely careful to avoid making decisions that may place it on the wrong side of fuel prices in the future. In addition, extremely low prices may push air fares too low for the companies to make adequate profits; especially where the company has invested highly in other systems for quality assurance. Companies which have not invested highly on class and quality measures including excellent customer care, social amenities for customers and in-flight services may find it easier to drop their prices in response to low fuel prices because this is the major aspect of their expenditure. World class airlines like BA however may have a hard time matching such prices because their expenditure is beyond fuel prices only. This means that the company may end up losing its customers to other airlines and this risk must therefore be averted through risk assessment which will lead to the adoption of effective strategies. In response to such a risk, BA may invest in continued dedication to excellent customer service and advertise the airline as an airline of choice for customers who choose comfort.
Conclusion
The low fuel costs dictate a change in various aspects of the airline industry. This discussion establishes that as the prices of fuel reduce, airlines are expected to experience pressure from customers to reduce air fares; which calls for airlines to react through well designed adjustments to their strategies. In the event of continued fall in prices, the probability of a fall in demand for fuel-efficient aircraft is apparent as the urgency to save on fuel experienced during high prices diminishes. Companies like British Airways must adapt effective strategies that promise to meet the needs of customers for lower prices while maintaining decent profitability. Risk assessment is highly necessary to assure continued profitability in the face of reducing fuel prices.
Reference List
Australia freight transport report 2015, Business Monitor International, London. Retrieved from
Töytäri, P. et al 2011, Bridging the theory to application gap in value-based selling.The Journal of Business & Industrial Marketing,Vol 26, Issue 7, pp. 493-502. doi:http://dx.doi.org/10.1108/08858621111162299
Yilmaz 2014, The management strategies for resource dependency risk in aviation business,International Review of Management and Business Research, Vol 3, Issue 3, pp. 1551-1563. Retrieved from http://search.proquest.com/docview/1618165539?accountid=45049
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It is to be analytical rather than descriptive. It should reflect a good understanding of the aid-growth theories and empirical methodologies
It is a research intensive exercise and involves identifying and discussing the relevant papers in the literature.
Articles like Burnside and Dollar(2000), Levine and Roodman (2003) should be used along side other journals and papers
SAMPLE ANSWER
Introduction
In our context today, many argue that financial developments measured in the eyes of a monetary indicator and credits are imperative in economic growth. These allegations have led economist to find a balance in the pursuit of financial liberalization for countries to grow faster. In as much as it may be empirically proven that there is a strong connection between growth and finance, there is no proper base that ascertains that the two antecedents spur growth. It is against this background that this paper seeks to explicitly analyze the finance-growth relationship through an empirical approach that incorporates other methods (Burnside, & Dollar, 2000).
Burnside and Dollar in their attempt to find out the impact of aid on the economy discovered that aid would only be effective in an economy that has a sound fiscal, trade and monetary policies. This has caused many donors to only focus their aid on good economic policies (Burnside, & Dollar, 2000). This dissertation aims to analyze the hypothesis behind aid as the most efficient agent in the growth of an economy. The paper will also address the impact that foreign aid intrigues in the economic growth of a country.
The Neo- Classical Model of Exogenous Growth
This approach introduces the components involved in sustaining a positive growth rate of a country per capita over a period. According to Burnside and Dollar, continual improvements in technological knowledge that in turn affects the forms of new goods, markets and processes are critical to sustaining growth. On the other hand, they allege that in the event that a country lacks technological progress, the fruits are most likely to decrease the impact of economic growth. In his approach, he describes the production function through a theory below;
Y-F {K} (Burnside, & Dollar, 2000).
In this theory, he explains that K is the capital stock while Y determines the aggregate stock that is determined only by a given state. This also entails a range of available approaches under different capital. K is a cumulative indicator that identifies the various capital goods and includes human, as well as physical capital (Burnside, & Dollar, 2004). This model puts into assumption the aspects of capital and labour as fully employed. The central purpose of the cumulative production function is that it diminishes returns to the accumulation of capital.
In order to ascertain that the rate of capital stock increases in a country in a given period, the Solow and Swan theory is incorporated. This approach assumes that people save a stable fraction S of their total gross income Y. However, this approach puts into assumption that taxes are not included in order to identify the national income and output (Burnside, & Dollar, 2004). A depreciated level of capital stock is connoted as δ. The rate at which capital accumulates is Sy, while the rate of the old capital that wears out is QK. The rate of the net increase of capital inclusive of the net investment is;
K=SF (K)-δK (Burnside, & Dollar, 2004).
According to this theory, savings and investments can only be identical when taxes and government expenditures, and international trade are excluded since they both represent the flow of income spent on investments goods rather than on consumed goods.
However, in the absence of a growth in technology and technological changes within a nation, the returns are more likely to diminish, this affecting the state of an economic growth (İnce, 2011). According to this author, boosting savings with the objective of increasing growth is considered void since an increase in s will only raise the rate of capital accumulation temporarily and will not affect the growth rate of a country (Batraga, Brasliņa, & Viksne, 2014). When S is however increased, the levels of output and capital are likely to increase thus changing the savings schedule to an increase.
Endogenous Growth Models
The use of endogenous growth model is a main alternative to the neoclassical growth approach. This model slightly varies from the neoclassical method of growth since it includes a couple of inputs such as technology, physical capital, human capital, social capital, intermediate goods, organizational capital and institutional design (Batraga . et al 2014). The increase of output according to this model changes with the other mentioned inputs, thus making it difficult to find stability in the linear relationship between investment and growth.
The neoclassical approach depicts that aid fills the financial gap and allows for greater investment and growth opportunities in a country. However, this assumption only finds base if the investment is liquidated and constrained and the incentives that should be invested are favourable (Boreham, 2008). In a nutshell, then the incentives to invest are low, the investments level also fall low. Aid, on the other hand, may also cause a negative effect on investment incentives, a factor that could cause a country to seek for more aid in the future. It is, therefore, imperative to consider the fact that aid can finance consumption rather than investment (Abdessatar, & Rachida, 2013). Burnside and Dollars allegation that aid increases growth under a good policy is substantial and does not ascertain if aid can lead to investments.
Theory of Aid and Growth
The standard model that has been in use for years now to justify aid is that of two-gap model that is attributed to Chenery and Stout. In this approach, the first gap is inferred to as that between the investment amounts required to achieve a growth rate and the available savings (Rajan, & Subramanian, 2008). The second gap is that which describes the import requirements that are needed for a given level of production, inclusive of the foreign exchange earnings. In this approach, economic growth is tied to the investments as shared in the GDP. This growth is adjusted to factors that reveal the state of the investment, whether high or low (Hansen, & Tarp, 2001). The amount of investments, therefore, sums the domestic savings and foreign aid of a country.
In summary, Burnside and Dollar, in their pursuit to find the balance in the relationship between foreign aid, economy and growth found that aid has a positive impact on growth and development of a country. This can only be possible is such a country has a good fiscal, trade and monetary policy and has few pressures on poor policies (Burnside & Dollar, 2000). These factors can be achieved when empirical ideologies that are growth oriented are introduced.
Conclusion
This dissertation focused on Burnside and Dollar (2000) ideologies that viewed the relationship between aid and GPA per capita of a country. In as much the results have faced a wide debate from empirical researches; aid has a significant negative impact on a countries GDP per capita growth (Gupta, 2004). However, when a good policy environment is cultivated, aid has a significant impact on the economy of a country. It is important that donors understand and create frameworks that provide them with better tools to improve developmental agendas in different countries (Easterly, Ross, & Roodman, 2003).
Works Cited.
Abdessatar, A., & Rachida, B. J. (2013). Institutional Quality and Financial Stress: Experience From Emerging Country. Studies In Business & Economics, 8(3), 5-20.
Batraga, A., Brasliņa, L., & Viksne, K. (2014). Identification of Innovation Ideas in Its Development Process. Management of Organizations: Systematic Research, (70), 23-40. https://www.doi:10.7220/MOSR.1392-1142.2014.70.2
Boreham, G. F. (2008). The Financial Markets Approach to Economic Development in LDCs. Service Industries Journal, 6(1), 22-41.
Burnside, C., & Dollar, D. (2000). Aid, policies, and growth. The American Economic Review, 90 (4), 847-868.
Burnside, C., & Dollar, D. (2004). Aid, Policies, and Growth: Reply. American Economic Review, 94(3), 781-784.
Easterly, W., Ross, L., & Roodman, D. (2003). New data new doubts: A comment on burnside and dollar’s “aid, policies, and growth” (2000). National Bureau of Economic Research Working Paper Series,
Gupta, K. L. (2004). Foreign capital and domestic savings: A test of Haavelmo’s hypothesis with cross-country data: A comment. Review of Economics & Statistics, 52(2), 214-216.
Hansen, H., & Tarp, F. (2001). Aid and growth regressions. Journal of Development Economics, 64 (2), 547-570. doi:DOI: 10.1016/S0304-3878(00)00150-4
İnce, M. (2011). Financial Liberalization, Financial Development and Economic Growth: An Emprical Analysis for Turkey. Journal of Yasar University, 6(23), 3782-3793.
Rajan, R. G., & Subramanian, A. (2008; 2008). Aid and growth: What does the cross-country evidence really show? Review of Economics and Statistics, 90 (4), 643-665.
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This assignment is 6 page double spaced essay and 1 page single spaced extended outline. The instruction will be uploaded.
This assignment should include only sources which are on the class website. No other sources should not be in the assignment. The sources are in the
"READING" category on the class website. And the sources are under “IV. THE MODEL REASSESSED: Economic Crises of the Last Two Decades”
The writer can choose which source he/she will use.
The class website is https://eee.uci.edu/14w/67300/
ID: IPEofEA
PW: uciuciuci
As an example, mid-term papers will be uploaded.
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It makes no difference whether your topic is ‘important’, but try, as best you can, to choose something interesting! A really successful presentation is one that begins with a really interesting question
Some example of economic naturalist questions include:
Why do brides spend so much money on wedding dresses, while grooms often rent cheap tuxedos, even though grooms could potentially wear their tuxedos on many other occasions and brides will never wear their dresses again?
Required:
Assuming that all entities involved in these arrangements are Australian residents, discuss the income tax consequences to Xena, Lawless, Gabrielle and Gaby of each of the following alternatives.
Option A: Xena issues 500 convertible notes with a face value of $1000 that will convert to 10 ordinary shares in Xena in seven years. The coupon rate is 5% per annum.
Option B: Xena will issue the lender 5,000 preference shares with a face value of $100 each and a dividend rate of 5%. In 7 years they will revert to ordinary shares.
Option C: Lawless is not satisfied with Xena acquiring a minority interest and initiates a takeover bid for Gabrielle. It makes an offer to purchase all shares in Gabrielle, issuing a $10 share in Lawless plus $10 cash for each share in Gabrielle. It succeeds in acquiring 85% of the shares in Gabrielle. Gaby accepts the offer.
SAMPLE ANSWER
The Income Tax Implications of the Transactions
In Australia, income tax is the most important revenue to the government within the boundaries of the Australian taxation system. Usually, it is levied on three sources in the individual citizens, including personal earnings, capital gains, and business income. It is recorded that the three elements of tax levy amount to approximately 67% of the federal government revenue. The system of taxation in this country is designed in a way that those who earn more pay more, while those who earn less remit relatively lower levies.[1] However, company taxes are calculated at a flat rate of 30%, as opposed to individual incomes, which are subjected to various progressive rates.[2] In this regard, the tax system ensures that each and every individual or entity is justly taxed, depending on prevailing circumstances. The following analysis focuses on presented case studies to calculate the taxes that can be levied in each case, and the subsequent income tax implications.
Duncan
The decision by Duncan to take the share offer and exercise his right to a full allocation was a wise decision. At the time of the offer, Duncan was on an income of $75,000, thus, his tax bill was as follows:
0 – 18,200
0
18,201 – 37,000
3,571.81
37,001 – 80,000
15,921.675
19,493.485
By choosing to exercise the share purchase via the Employee Share Trust Duncan was able to spread his income tax liability and avoid it altogether. This was not done illegally, but legally. The Employee Share Trust allows Duncan to purchase the shares but have the purchase allowed in tax since contributions. By using the Employee Share Trust, Duncan is influenced by the tax system that allows him to save and for that is able to invest both for his own good and for the community. He has managed to find a balance between work, investment and savings. This has allowed him to develop since by the time he cashes his options, he will make a tidy sum. By increasing the overall level of resources available to the Employee Trust Fund, Duncan has ensured he does not have to pay for any gains the share makes. Technically, the shares do belong to the trust fund, thus for Duncan, his income tax bill remains the same. This allows for efficiency in the Australian economy. Proper reporting encourages and promotes investments that reduce inefficiencies in resource consumption.[3] It could be argued that taxation does affect savings negatively. This argument is based on the assumption that both savings and taxation compete for the same finite pool of individual resources. However, this is not the case. Contributions which are the repayments and regular contribution to the Employee Trust fund attract tax deductions, while any interest is not taxed. However, withdrawals are taxed fully.
When Duncan finally cashes in his options at $1.00 above the market price, he will have to pay the full tax on this transaction. This strategy allows Duncan to postpone the tax liability to when he exercises his option. Duncan is able to postpone income by choosing to have the option exercised via the Employee Trust Fund. It allows Duncan to defer some of his income. Were he to exercise his options personally, it would mean taking his taxable income to a higher tax bracket. Furthermore, it could lower his income making it easy to meet the 2 percent floor required for taking certain deductions. When considering miscellaneous itemized deductions, Duncan could easily meet the 2 percent floor required for taking certain deductions. This is because the miscellaneous itemized deductions will allow Duncan to adjust gross income (AGI) when amalgamated. Duncan has managed to postpone income in order to delay the payment of his tax liability for as long as possible. With the anticipated change of employer, Duncan choice of year to exercise his option makes him lower his tax burden. On the year he cashes his options, there is no salary to swell up the income. This works to reduce the tax bracket.[4] This allows Duncan to derive the greatest advantage from his deductions.
Debbie
Debbie has been enjoying benefits that allow her to pay her taxes in a progressive manner. She only gets to pay for taxes on what she has used. For example, when she does not drive, she does not to pay for it. Additionally, the company parking offered by the company is not a direct cost to Debbie. Thus given the tax – her taxes have morphed to consumption tax in their nature; she is able to operate on a level playing ground. With the current income tax system being referred to as a progressive tax system, it will allow Debbie to operate on a level playing field. Debbie is not a low income earner. As a high-income earner, Debbie will pay tax at a rate of 15 percent as opposed to 25 – 30 percent that is applicable to other Australians.[5] Though it may seem unprogressive, the strategy allows for necessities to be exempt of have their tax levied at a lower rate. On the face of it, it would seem Debbie is not saving. However, a closer focus at Debbie reveals one who understands that taxation will only apply to her when she spends. For Debbie, the tax code performs a very important function; that of modifying her behavior. It was governments’ foresight of the future of IRA – that there was going to be Social Security System death, that it took the initiative to encourage individual savings secondary to the system. It is the consumption tax that would carry on the build-in-form encouragement. It should be evident that Debbie will not like all the tax decisions taken. She may feel that the government was been against her position, but she must remember that the government only makes decisions that will benefit the masses. Thus, it has been presuppose that if consumers only paid tax on what they had consumed as opposed to what they had earned. This way, even earnings that are not declared get captured when the earnings are used to purchase goods and services. This way, loopholes stop being major influencers. For Debbie, she will gain great benefits by paying her taxes as they fall due. When this is not achieved, it becomes very crazy when they must prepare quarterly estimated tax payments. When tax liabilities cease to become a burden on Debbie, the she, together with a large percent of the population would avoid tax troubles and live within their means.[6] For Debbie, compliance will allow her to enjoy the privacy and freedom – the tenets of a free society. The Tax man need not come and confirm Debbie’s individual and itemized consumption as captured in her bank account statement. With the need for federal withholding eradicated, there would be a net growth in net pay. This extra income that Debbie would have at her disposal would then be used to pay for goods and services. For Debbie, instead of having to estimate the tax payments and having to withhold at the source, will now increase the amount of tax payable on account of additional products and services sold.
As with any system of taxation, there is always the potential for abuse.[7] Levying a consumption tax in lieu of the income tax would give the responsibility to business owners and Debbie to collect and turn over the taxes. That is a lot of money to be entrusted to our nation’s companies. For Debbie, there is a very good answer to this quandary: She could embrace the use of a merchant branded card. When used for making purchases, the tax is paid directly without having to recalculate it item by item. That way the Debbie never has access to the funds and cannot abuse her position.
EW
EW’s choice of a share option plan as an incentive for employees is a cost-efficient and helps improve its overall business performance. When EW introduced the Employee share scheme, it was seeking to give valued employees an opportunity to own a part of the organization. To EW, the employee share scheme was an excellent commercial tool, that when applied assists in maximizing the intrinsic value of the organization.
EW granted each employee 1,000 ordinary shares at a discount of $1 per share below market value. Given the market value of the share was $5.30 at the time of implementing the strategy, each employee who took up the share option purchased the share at $4.30. With each employee having a choice between outright purchase or financing by EW Employee Share Trust, it is anticipated that the trust will recover the shares full price for the financed employees from the dividends received. To ensure that the share price is not vulnerable to speculative attacks, employees will be expected not to dispose the shares before three years have lapsed.[8] In exercising their option, Capital Gains Tax may be payable in gains exceed the employee’s annual tax free allowances. EW will be eligible for Corporation Tax Relief for the costs of establishing and administering the CSOP and the cost of providing the shares under the scheme.[9]
Practical Issues
To ensure the successful introduction and management of the employee share scheme, some critical issues will have to be addressed and laws adhered to in order to ensure that the distribution of shares abides by specific rules as spelt out with in the EW’s constitution and relevant legislation. These include the company’s Act 2006, the Financial Services and Markets Act and the listing rules of the Stock market, employees will be have restricted ability to dispose off their shares for three years if still employed o until they leave EW.[10] EW will also have to seek approval from the regulators to operate a tax-advantaged scheme as the one designed for EW. To ensure employees reap the maxim benefits from this strategy, there will have to be precise and specific communication with regards to the risks and benefits of the employee share ownership system. Adherence and fidelity to financial services regulations since the share schemes are financial and there are clear guidelines with regards to appropriate exclusions for scheme trustees and exemptions for their promotional materials. Finally, depending on the circumstances prevailing presently, there might be a need for a prospectus to be issued.
Addressingthetaxissues
The Australian Taxation Office (ATO) does considers that there are a number of acceptable methodologies for ascertaining the capital/dividend split, although not all have equal applicability in every case. Each share buy-back is unique and must be well thought-out to establish the most ideal methodology to address each cases. The ATO appreciates that there exists many methods of determining the capita component of a particular buy-back for tax purposes.[11] The Average Capital per Share method has emerged as ideally suited to the task. The suitability of this method is premised on its ability to identify the average capital for each share the company has on issue. It is this average amount that is the basis of determining the capital component for each of the shares bought back.
To get the average capital amount, the amount held in the company’s share capital account is divided by the number of shares on issue. When applying the formula for determining the average capital amount, some adjustment will have to be undertaken in response to the environment under which it operates. These adjustments will address the number of different share classes on issue, the number of partly paid up shares of issue and whether there has been a recent injection of capital in the organization.[12] When an organization does not consider the buy-back for market value consideration, it could very possible result in additional amounts being assessable to the exiting shareholder.
When implemented properly, a share buy-back allows the organization to effectively exit particular shareholders or reinvest surplus funds to a particular shareholder group.[13] Despite the tax bill that could be accrued, it can be petered over through application of methodologies that are recommended by ATO when determining the capital/dividend split.
Option A:
Xena issues 500 convertible notes with a face value of $1000 that will convert to 10 ordinary shares in Xena in seven years. The coupon rate is 5% per annum. Xena will have to generate enough resources to meet the interest obligations when they fall due. By choosing the convertible note, Xena is positioning itself for a productive future and wants the partner coming in to buy into the future of Xena. Despite it being a subsidiary of Lawless, it operates autonomously. The new debt will have an effect on the dividends payable to Lawless, which in turn will have an effect of the tax declared by Lawless. Gabrielle will have get a strong partner coming into its operations. The convertible notes will not only guarantee Xena can lock in the future dividends should Gabrielle continue on the current growth trajectory. Gaby should expect the transaction to result in value of the Gabrielle shares. From the current cost of $5, there should be significant shift. This will have to be captured in Gaby’s computation of her income tax.
Initial Recognition
The following accounting entries must be recorded upon initial recognition:
Dr – Cash/Bank
$500,000 (Total Proceeds)
Dr – Share Option (Premium)
$144,622 (Balancing Figure)
Cr – Liability
$664,622 (Note 1)
Note 1:
Present value of future interest payments and principal using 5%:
Year1:
$50,000 (interest)
x
[1/1.05]
=
$47,619.0
Year2:
$50,000 (interest)
x
[1/1.05^2]
=
$45,351.5
Year3:
$50,000 (interest)
x
[1/1.05^3]
=
$43,191.1
Year4:
$50,000 (interest)
x
[1/1.05^4]
=
$41,135.1
Year5:
$50,000 (interest)
X
[1/1.05^5]
=
$39,176.3
Year6:
$50,000 (interest)
X
[1/1.05^6]
=
$37,310.8
Year7:
$50,000 (interest)
X
[1/1.05^7]
=
$35,534.1
Year7:
$500,000 (principal)
x
[1/1.05^7]
=
$ 355,340.5
Total
$ 644,622.0
Subsequent Measurement
Interest expense will be charged using 5%. The difference between interest paid and interest charged will be added to the liability component as follows:
Interest Expense
Liability
$
$
Year1:
[664,622 x 5%]
33,231
[664,662 + 33,231 – 50,000*]
647,853
Year2:
[647,853x 5%]
32,392
[647,853 + 32,392 – 50,000]
630,245
Year3:
[630,245 x 5%]
31,512
[630,245 + 31,512 – 50,000]
611,757
Year4:
[611,757 x 5%]
30,588
[611,757 + 30,588 – 50,000]
592,354
Year5:
[592,345 x 5%]
29,617
[592,345 + 29,617 – 50,000]
571,962
Year6:
[571,962 x 5%]
28,599
[571,962 + 28,599 – 50,000]
550,561
Year 7
[550,561 x 5%]
27,528
[550,561 + 27,528 – 50,000]
528,089
*$50,000 is the 10% nominal interest.
Maturity
Following accounting entry will be required to account for the conversion of bonds into shares after three years:
Dr – Liability
$500,000
Dr – Share Options (equity)
$144,622
Cr – Share Capital
$500,000
Cr – Share Premium
$144,622
Option B:
Xena will issue the lender 5,000 preference shares with a face value of $100 each and a dividend rate of 5%. In 7 years, they will revert to ordinary shares.
The preference shares the best debt vehicle for a lender since the debt is secured and payment is preferred over other debts. Xena will secure the necessary funding needed to purchase a minority stake in Gabrielle. Xena must consider the loan and interest repayment when capturing its operational expenses. This will mean a reduction in the profitability of Xena, and by extension, reduced profitability to Lawless. Lawless as stated before will experience reduced profitability in the short run. In the long run, the investment will result in additional profitability and thus additional tax liability. Gaby will have their debt secured and preferred over any other debt in the organization. For Gaby, the periodic interest to paid out represent a regular income. This will have to be captured in order to determine the appropriate income tax liability. The
Initial Recognition
The following accounting entries must be recorded upon initial recognition:
Dr – Cash/Bank
$500,000 (Total Proceeds)
Dr – Share Option (Premium)
$144,622 (Balancing Figure)
Cr – Liability
$664,622 (Note 1)
Note 1:
Present value of future interest payments and principal using 5%:
Year1:
$50,000 (interest)
x
[1/1.05]
=
$47,619.0
Year2:
$50,000 (interest)
x
[1/1.05^2]
=
$45,351.5
Year3:
$50,000 (interest)
x
[1/1.05^3]
=
$43,191.1
Year4:
$50,000 (interest)
x
[1/1.05^4]
=
$41,135.1
Year5:
$50,000 (interest)
X
[1/1.05^5]
=
$39,176.3
Year6:
$50,000 (interest)
X
[1/1.05^6]
=
$37,310.8
Year7:
$50,000 (interest)
X
[1/1.05^7]
=
$35,534.1
Year7:
$500,000 (principal)
x
[1/1.05^7]
=
$ 355,340.5
Total
$ 644,622.0
Subsequent Measurement
Interest expense will be charged using 5%. The difference between interest paid and interest charged will be added to the liability component as follows:
Interest Expense
Liability
$
$
Year1:
[664,622 x 5%]
33,231
[664,662 + 33,231 – 50,000*]
647,853
Year2:
[647,853x 5%]
32,392
[647,853 + 32,392 – 50,000]
630,245
Year3:
[630,245 x 5%]
31,512
[630,245 + 31,512 – 50,000]
611,757
Year4:
[611,757 x 5%]
30,588
[611,757 + 30,588 – 50,000]
592,354
Year5:
[592,345 x 5%]
29,617
[592,345 + 29,617 – 50,000]
571,962
Year6:
[571,962 x 5%]
28,599
[571,962 + 28,599 – 50,000]
550,561
Year 7
[550,561 x 5%]
27,528
[550,561 + 27,528 – 50,000]
528,089
*$50,000 is the 10% nominal interest.
Maturity
The following accounting entry will be required to account for the conversion of bonds into shares after three years:
Dr – Liability
$500,000
Dr – Share Options (equity)
$144,622
Cr – Share Capital
$500,000
Cr – Share Premium
$144,622
Option C:
Lawless is not satisfied with Xena acquiring a minority interest and initiates a takeover bid for Gabrielle. It makes an offer to purchase all shares in Gabrielle, issuing a $10 share in Lawless plus $10 cash for each share in Gabrielle. Lawless managed in acquiring 85% in Gabrielle. Gaby accepts the offer. Gaby will have to account for the new income that constitutes the offer price. This being a one off-payment will make the income tax bill to be big. Gaby can chose to declare the income in the next financial year thus reducing its tax burden. Gabrielle will have acquired a bigger partner. This strategy, however, has the risk of not determining whether the new owner will change things or leave operations as currently secured.[14] Lawless on its part will have to report on more income tax, since all the dividends declared by Gabrielle now belong to Lawless, its income tax will grow exponentially.
In order to reduce the influence of Tax consideration on how financial arrangements are structured, the organization will embrace Taxation of Financial Arrangements (TOFA). In its implementation, TOFA aims to align even closer the taxation recognition of gains and losses on financial arrangements with the resultant gains or losses being commercially recognized.[15]
Despite TOFA providing an overarching and comprehensive framework aimed at addressing directly the economic substance of arrangement, it does not exemplify a code so exclusive that covers taxation of gains and losses from financial arrangements. Consequently, TOFA will provide Xena with the basic framework that is principle-based and ideal for the taxation of gain and losses from financial arrangement based on their economic substance rather that legal form. These will more often than not be included in assessable income or allowed as a deduction on revenue account.
Bibliography
Balachandran, Balasingham, Dean Hanlon, and Hanghang Tu. 2013. “Tax-induced earnings management within a dividend imputation system.” Australian Tax Forum 28, no. 3: 555-582.
Dempsey, Mike, and Graham Partington. 2008. “Cost of capital equations under the Australian imputation tax system.”Accounting & Finance 48, no. 3: 439-460.
Eccleston, Richard. 2013. “The Tax Reform Agenda in Australia.” Australian Journal Of Public Administration 72, no. 2: 103-113.
Evans, Chris, and Jason Kerr. 2012. “Tax reform and ‘rough justice’: is it time for simplicity to shine?.” Australian Tax Forum 27, no. 2: 387-410.
Handley, John C., and Krishnan Maheswaran. 2008. “A Measure of the Efficacy of the Australian Imputation Tax System.” Economic Record 84, no. 264: 82-94.
Ikin, Catherine, and Alfred Tran. “Corporate tax strategy in the Australian dividend imputation system.” Australian Tax Forum 28, no. 3 (July 2013): 523-553.
Kalb, Guyonne, Hsein Kew, and Rosanna Scutella. 2005. “Effects of the Australian New Tax System on Income Tax and Benefits with and without Labour Supply Responses.” Australian Economic Review 38, no. 2: 137-158.
Lavermicocca, Catriona, and Margaret McKerchar. 2013. “The impact of managing tax risk on the tax compliance behaviour of large Australian companies.” Australian Tax Forum 28, no. 4: 707-723.
Thompson, William D. 2010. “Taxation Law: A Long-term Plan for Australian Tax Reform – the Henry Report and the Government’s Response.” Keeping Good Companies 62, no. 5: 305.d
Whiteford, Peter. 2010. “The Australian Tax-Transfer System: Architecture and Outcomes.” Economic Record 86, no. 275: 528-544.
[1] [1] Handley, John C., and Krishnan Maheswaran. 2008. “A Measure of the Efficacy of the Australian Imputation Tax System.” Economic Record 84, no. 264: 82-94.
[2] Balachandran, Balasingham, Dean Hanlon, and Hanghang Tu. 2013. “Tax-induced earnings management within a dividend imputation system.” Australian Tax Forum 28, no. 3: 555-582.
[3] Ikin, Catherine, and Alfred Tran. “Corporate tax strategy in the Australian dividend imputation system.” Australian Tax Forum 28, no. 3 (July 2013): 523-553.
[4] Lavermicocca, Catriona, and Margaret McKerchar. 2013. “The impact of managing tax risk on the tax compliance behaviour of large Australian companies.” Australian Tax Forum 28, no. 4: 707-723.
[5] Handley, John C., and Krishnan Maheswaran. 2008. “A Measure of the Efficacy of the Australian Imputation Tax System.” Economic Record 84, no. 264: 82-94.
[6] Balachandran, Balasingham, Dean Hanlon, and Hanghang Tu. 2013. “Tax-induced earnings management within a dividend imputation system.” Australian Tax Forum 28, no. 3: 555-582.
[7] Whiteford, Peter. 2010. “The Australian Tax-Transfer System: Architecture and Outcomes.” Economic Record 86, no. 275: 528-544.
[8] Kalb, Guyonne, Hsein Kew, and Rosanna Scutella. 2005. “Effects of the Australian New Tax System on Income Tax and Benefits with and without Labour Supply Responses.” Australian Economic Review 38, no. 2: 137-158.
[9] Evans, Chris, and Jason Kerr. 2012. “Tax reform and ‘rough justice’: is it time for simplicity to shine?.” Australian Tax Forum 27, no. 2: 387-410.
[10] Thompson, William D. 2010. “Taxation Law: A Long-term Plan for Australian Tax Reform – the Henry Report and the Government’s Response.” Keeping Good Companies 62, no. 5: 305.
[11] Dempsey, Mike, and Graham Partington. 2008. “Cost of capital equations under the Australian imputation tax system.”Accounting & Finance 48, no. 3: 439-460.
[12] Evans, Chris, and Jason Kerr. 2012. “Tax reform and ‘rough justice’: is it time for simplicity to shine?.” Australian Tax Forum 27, no. 2: 387-410.
[13] Eccleston, Richard. 2013. “The Tax Reform Agenda in Australia.” Australian Journal Of Public Administration 72, no. 2: 103-113.
[14] Balachandran, Balasingham, Dean Hanlon, and Hanghang Tu. 2013. “Tax-induced earnings management within a dividend imputation system.” Australian Tax Forum 28, no. 3: 555-582.
[15] Eccleston, Richard. 2013. “The Tax Reform Agenda in Australia.” Australian Journal Of Public Administration 72, no. 2: 103-113. https://doi.org/10.1111/1467-8500.12019
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It is critical that the writer properly respond to all the requirement of this paper.The writer must clearly use APA 6th edition for this paper including all headings where necessary.
Loan Evaluation
As a practitioner-researcher, you will apply knowledge to real-life situations. In the following scenario, assume you are a loan officer for a bank and the owner of a small business approaches you regarding a loan. Consider the following questions as you formulate your decision:
• What financial ratios would you examine and why?
• Is there other information, in addition to the ratios, you would want to obtain from the business owner before making your decision on the loan?
• How would your answer change if it were a larger company seeking the loan?
Resources;
• Articles
• Graham, J., Harvey, C., & Rajgopal, S. (2006). Value destruction and financial reporting decisions. Financial Analysts Journal, 62(6), 27–39. Retrieved from Business Source Premier database.
Senior corporate executives make decisions as to which performance measurements to use in their financial reporting. As these reports affect the company’s stock market performance, the authors of this article explore the widespread practice and impact of executives opting to use factors which may make the company appear successful, while in actuality, they may cause the destruction of value.
• O’Connor, J., Priem, R., Coombs, J., & Gilley, K. (2006). Do CEO stock options prevent or promote fraudulent financial reporting? Academy of Management Journal, 49(3), 483–500. Retrieved from Business Source Premier database.
Large stock options for CEOs are a hotly debated subject. In this journal article, the authors explore whether these stock options encourage or discourage accurate financial reporting of a company’s profits. They conclude that certain other factors, when combined with large stock options, are more likely to result in fraudulent misrepresentation.
• Haskins, M. (2002). Instant insight. Strategic Finance, 84(3), 42–47. Retrieved from Business Source Premier database.
This article describes how Delta Factor reference tables may be used to turn finance ratio analysis into an accurate planning tool.
• Skogsvik, S. (2008). Financial statement information, the prediction of book return on owners- equity and market efficiency: The Swedish case. Journal of Business Finance & Accounting, 35(7/8), 795–817. Retrieved from Business Source Premier database.
This author discusses a financial model that uses financial statement information and a prediction formula to determine changes in medium-term book return on equity.
• Readings
• Course Text
Corporate Finance
• Chapter 3, “Financial Statement Analysis and Financial Models”
This chapter discusses methods for analyzing financial statements such as balance sheets, ratio analysis, and liquidity measures. These calculations are then used to develop long-term financial planning models.
• Chapter 4, “Discounted Cash Flow Valuation”
The concepts of present value, future value, and interest rate returns are introduced in this chapter along with details on multi-period situations, compounding periods, and perpetuates. Explanations are then given on how to make the calculations and then most effectively use the results.
SAMPLE ANSWER
Loan Evaluation
When a small business approaches a bank for a loan, its business plan is a very important component of what will finally influence the loan officer to approve the loan. While it may seem like the loans officer makes decision based on arbitrary standards, loan application will begin by interrogating the business plan to determine the different ratios.
Ratios are important since they give a peek into the business operation without having to visit the business in person (O’Connor, Priem, Coombs, & Gilley, 2006). The loan officer will want to understand how the business controls its expenses. This will be derived from the cost of goods sold/net sales; selling, administrative and other expenses/net sales; wages and salaries/net sales; interest expenses on borrowed funds/net sales; overhead expenses/net sales; depreciation expenses/net sales and taxes/net sales.
Of importance to the loans officer is the efficiency with which a business operates. This will be derived from the net sales/total assets, annual cost of goods sold divided by average inventory levels, net sales/net fixed assets and net sales/accounts and notes receivable (Skogsvik, 2008). Given a business will trade in a product, service or skill, it will be important to determine its marketability. This will be verified by the gross profit margin, or net sales less cost of goods sold to net sales, and the net profit margin, or net income after taxes to net sales.
The loans officer will also be interested in understanding how loan and interest will be covered by specific business aspects. This will include interest coverage (such as income before interest and taxes divided by total interest payments), coverage of interest and principal payments (such as earnings before interest and taxes divided by annual interest payments plus principal payments adjusted for the tax effect), and the coverage of all fixed payments (such as income before interest, taxes and lease payments divided by interest payments plus lease payments) (Graham, Harvey, & Rajgopal, 2006). Every business operates to be profitable.
The loans officer will develop profitability ratios like before-tax net income divided by total assets, net worth, or sales, and after-tax net income divided by total assets (or ROA), net worth (or ROE), or total sales (or ROS) or profit margin (Moyer, McGuigan, & Kretlow, 2009). Of importance to a business is the ability to meet expenses as they are incurred. The loans officer will determine the liquidity of the business through the current ratio (current assets divided by current liabilities), and the acid-test ratio (current assets less inventories divided by current liabilities).
Finally, the loans officer will seek to determine how the business is leveraged. This will be known through the use of the leverage ratio (total liabilities/total assets or net worth), the capitalization ratio (of long-term debt divided by total long-term liabilities and net worth), and the debt-to-sales ratio (of total liabilities divided by net sales).
Ratios will not tell the whole story as they only reflect the symptoms of a possible predicament as opposed to exposing the root cause and nature of the problem. The loans officer will, thus, make a more informed decision if they should investigate the reasons behind the trend exhibited by the ratios (Charantimath, 2006). After all, when a ratio changes, it could be as a result of a shift in the numerator or the denominator or both. A loans officer will also seek additional information that will capture the experience of the owner, the potential value of prospective customers and other non-balance sheet items (Haskins, 2002).
For a large company seeking a loan, a loans officer will seek the credit history of the organization. This will be given by the credit reference bureau. The company will also have to provide collateral and any options available. The choice of collateral used to secure a loan will affect the bank’s acceptable loan-to-value ratio.
References
Charantimath, P. M (2006). Entrepreneurship Development and Small Business Enterprise, Dorling Kindersley, New Delhi
Graham, J., Harvey, C., & Rajgopal, S. (2006). Value destruction and financial reporting decisions. Financial Analysts Journal, Vol. 62, No. 6, pp, 27–39.
Haskins, M. (2002). Instant insight. Strategic Finance, Vol. 84, No. 3, pp. 42–47.
Moyer, R. C., McGuigan, J & Kretlow, W (2009). Contemporary Financial Management, 11th Ed, South-Western Cengage Learning, Mason OH.
O’Connor, J., Priem, R., Coombs, J., & Gilley, K. (2006). Do CEO stock options prevent or promote fraudulent financial reporting? Academy of Management Journal, Vol. 49, No. 3, pp. 483–500.
Skogsvik, S. (2008). Financial statement information, the prediction of book return on owners- equity and market efficiency: The Swedish case. Journal of Business Finance & Accounting, Vol. 35, No. 7 and 8, pp. 795–817.
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Evaluate how “Employer and employee rights” impacts your role as an advanced practice nurse. What are the legal implications related to your practice. Analyze how understanding of the chosen topic will impact your future practice.
SAMPLE ANSWER
Corporate Liability
In any health facility, employee and employers have their rights. Violation of these rights may attract some consequences in terms of dismissal, fines and penalty among other disciplinary measure. These rights impacts on an advanced practice nurse in many ways.
Employee and employer rights provide a guideline on how advanced nurse practitioners should carry out themselves in healthcare setting. The rights enable APN to agitate and negotiate for fair treatment from their employers (Morrell, 2010). For instance, the rights grants APN an opportunity to demand for better working conditions, better selection and recruitment practices based on equality and fairness, good salary, allowances and a right to be heard before any disciplinary measures are provided such as dismissal (Rounds, Zych & Mallary, 2013). Furthermore, these rights allow the APN to demand for respect from their employers when providing his service to patients. Therefore, it is apparent that, these employee and employer rights are very critical in creating conducive relationship between the APN and their employers. The rights define the limitations and the issues that the two need to engage in hence enhancing delivery of quality healthcare to patients.
My practice as APN requires that I respect the legal system. Some of the legal implications that relates to my practice include issues concerning privacy, negligence and failing to meet the expectation professional qualification to render care (Lubbe & Roets, 2014). For instance, I will be held liable if I fail to take good care of the patient by failing to follow standard of care, failure to document, failure to communicate, failure to use equipment in a responsible way, failure to act as patient advocate and failure to assess and monitor patients intentionally (Badzek, Henaghan, Turner & Monsen, 2013). This may amount to negligence an offence punishable by law. Another example is to provide care to patients without any professional qualification and accreditation that permits me to do so. Other legal implications include engaging in fraud and related malpractices such as corruption.
In conclusion, as APN it is important to remain professional and adhere to ethical standards and law to avoid legal implications. Both parties to ensure positive working relationships in rendering quality care should respect employee and employer rights.
Understanding Financial Decision Making: Tools for Evaluation
Order Instructions:
For this paper, it comes in 7 parts and the writer must label each parts and complete a minimum of one page summary as indicated for each part. The writer must follow critically the instructions and the requirements for each part. The writer must use in text citations for each part , as each part must have a minimum of two sources or two different in text citations. The paper must have a minimum of 10 pages in total excluding any diagrams of presentations that the writer may use. Also remember that you will also have to write an executive summary at the end to conclude the paper as mentioned in the instructions.
In this paper, you will examine theoretical and empirical points of view and apply the knowledge you have gained from your study and research in order to understand how financial decisions are made within a large publicly traded company that you choose as an exemplar. You will utilize financial tools to evaluate current financial data and use your calculations to justify those decisions. Approach this exercise as though you were a financial consultant who has been asked to analyze the value of the company as a potential investment. This assignment will require access to in-depth financial information, so selecting a company for which this information is easily obtainable will be most beneficial.
You will conduct a detailed analysis of the financial dealings of your selected organization. Each week you will focus on a different aspect of the company’s financial information. You will explore the monitoring capabilities of the Board of Directors and use financial tools to compare ratios with one of the firm’s competitors. You will establish an estimated growth rate and predict future dividends. In addition, you will use annual reports as a tool in capital budgeting to determine potential real options, establish a market risk premium, calculate the weighted average cost of capital, and compare the mix of debt and equity that the firm uses to an industry average. Finally, you will prepare an executive summary of the company, complete with current stock prices and a recommendation on investing in the business you select. Your paper will contain topics unique to the company chosen, but will incorporate the themes covered in each section.
The Investment Analysis and Recommendation Paper will comprise a minimum of 10 pages in APA style format. Three to five diagrams and presentation slides may be included, but they will be additional to the required length of the paper
Part one
• This week, select a publicly traded company that you wish to analyze for this paper. Submit the name to your Instructor for approval. Obtain the company’s financial statements (annual report) and the most recent proxy statement.
Using the information on the proxy statement:
• Evaluate the monitoring potential of the firm’s Board of Directors.
• Identify the strengths and weaknesses of how the board is structured, as well as any ethical concerns.
Write a 1-page summary of your findings.
Part two
• Investment Analysis and Recommendation Paper
For this part, you will assess the company you selected for your Investment Analysis and Recommendation Paper relative to its competitors in terms of financial ratios. Financial ratio reports are available on numerous Web sites (examples: Reuters, Google, Finance, Hoovers). Remember, different Web sites may use slightly different definitions.
Using income statements and balance sheets for your company AND at least one of its main competitor’s, respond to the following:
•Calculate the DuPont identity for both companies for the past three years.
•Discuss any differences and/or trends that emerge.
Write up a 1-page summary of your findings, including any calculations you made, and how you gathered your information.
Part three
Investment Analysis and Recommendation
• This part of the Investment Analysis and Recommendation Paper requires you to establish an estimated growth rate in earnings and dividends for your company. Note, in the dividend growth model, “g” is the growth rate for earnings AND dividends. You might want to check historical growth rates for the company (in terms of earnings and dividends). Also, many people rely on analyst forecasts. Be sure to justify your growth rate selection and explain how you arrived at the number. Assume your company is a constant growth stock. Use your estimated growth rate to solve for the required rate of return using the dividend discount model. After completing your calculations, respond to the following:
• Does the number you arrived at seem logical or feasible?
• Did you face any problems or issues using the dividend growth model? Does your company pay a dividend?
• Is it reasonable to assume constant growth for your company?
Write up a 1-page summary of your findings, including any calculations you made, and how you gathered your information.
Part four
• For this part, you will read the text portion of your company’s annual report. As you do so, focus on the following:
• Identify potential real options that might arrive in this firm’s business.
• Are these options industry specific or company specific?
• How would these options affect their capital budgeting process?
• Justify your answers.
Write up a 1-page summary of your findings, including any calculations you might have made, and relate how you reached your conclusion.
Part five
• For this part of your Investment Analysis and Recommendation Paper, find an estimate of beta for your company. You might consider examining/using an industry average beta, especially if the reported beta you find seems unrealistic or inappropriate. Note: You should probably check your beta across a few different sources, because sometimes they vary. Find the current interest rate (yield) for 3-month Treasury bills. Determine an appropriate market risk premium. Be sure to consider the size of your firm when estimating an appropriate premium.
After making your calculations:
• Using all this information, what is the expected return for your company using CAPM?
• In Week 3, you estimated a required rate of return using the dividend discount model. How does your CAPM number compare?
Write up a 1-page summary of your findings, including any calculations you might have made.
Part six
• For this part, your assignment is to calculate the weights (proportions) of debt and equity for your company. For equity you can use the market value of stock (number of shares times the current stock price). For debt, you can use the book value of long-term debt (from the balance sheet). While market values of debt are “better,” they are rather difficult to obtain. Estimate the required rate of return on debt for your company. The following are three possible approaches: a) You can use the credit rating provided by Standard & Poor’s or Moody’s. Use the ratings to find current yields above risk-free rates. b) Go to FINRA Market Data. This will give the yield to maturity for EACH bond. You need one measure of the cost of debt, so you will have to figure out an appropriate way to handle multiple debt issues. c) If your company does not have publicly traded debt (and/or both the previous two approaches did not work), you will need to read the footnotes to the annual report. You may be able to get their estimated borrowing rate. After gathering the information:
• Estimate your company’s weighted average cost of capital. You can use the income statement information to estimate the tax rate.
• If your company uses this in the capital budgeting process (i.e., as the discount rate in NPV and IRR), what assumptions are they making?
• Does your company face any particular difficulties in using this rate? For example, does your company have different divisions or units that might have differing levels of risk?
Write up a 1-page summary of your findings, including any calculations you might have made, and describe which method you used to find the required rate of return on debt for your company.
Part seven
• For this part you will prepare the final section of your Investment Analysis and Recommendation Paper, consisting of the capital structure choices, as well as an executive summary of your research.
You will examine the mix of debt and equity that your firm uses. After finding this information:
• Compare this to an industry average or a main competitor. What are the differences?
• Based on what you know about your selected company, do these differences seem appropriate?
• Relate your company’s capital structure choices to the appropriate capital structure theory (ies).
Also, as a component of your executive summary, obtain the current stock price for your company and use it as an additional calculation. Based upon all of your research, would you recommend investing in this company? Justify your answer.
SAMPLE ANSWER
Ford Motor Group is a multinational public company that’s based in Michigan in the USA. Its shares are traded in NYSE under the initial F. It majors in automotive production and its current Executive chairman is William C. Ford, Jr. while the CEO is Mark Fields. The current brands or models are Ford Focus, Ford Escort, Ford Cortina, Ford Sierra and Ford Capri. There are several other brands that Ford manufactures besides an array of trucks and other automobiles. The Ford Family owns 2% of the company while the employees number about 181,000. It has a market capitalization of $54.65 Billion and its shares are currently trading at $14.09 dollars with a yield of 3.5%. Ford has 9 million outstanding shares while the market prices of its shares are currently costing 14.1 which amounts to a total of $126.9 million in outstanding stock valuation.
Part One
Board of Directors
The directors of Ford Motor Group have impeccable academic backgrounds and experience that warrant their positions. The executive management of the Ford board as at the end of July 2014 was chaired by William Clay Ford Jr., the executive chairman while the CEO was Mark Fields (CEO & President). For the other members of the board see appendix D.
Monitoring Potential of the Firm’s Board of Directors
Mark Fields, the current CEO and President, was initially appointed as the America’s President of operations in the year 2012. (Adams, 2008, p. 46) The board is mostly concentrated in running the operations of the company from the head office. Almost 50% of its annual turnover is achieved in North America while the rest are from South America, Europe, Asia, pacific and Africa. The duties of each director are not included in the reports together with the salaries of other senior staff. The academic background for the senior positions office holders is not available on the 2014 proxy annual report. The performance of Ford Motor Group has not been very impressive and it was expected that it would have more financial problems in the current financial period. However, Ford has endured hard times before and it’s expected that it will come out of financial woes on its own.
Strengths and Weaknesses of Board Structure
The major strengths of the Ford Motor Group board are the wide experience and skills the director’s posses. The executive chairman has been a director since 1988 and has also been the vice president at the commercial truck center before his recent promotion. He has also been the chair of the finance committee and the chairman of eBay Inc. The other board members are also equally skilled and experienced in automobile industry.
The board has also professional structures that vet all the qualifications of the directors before they are appointed. The nominating and governance committee scrutinizes all the background information on all the nominees before their names are forwarded to the board.
The major weaknesses of the board are the lack of clearly defined organization structures that spell out the role of each director and the hierarchy of the functions of their offices and their occupants. The structures are not clear and maybe they have their own system of operations but the structures have to be clearly drawn and the functions of each department clearly defined and addressed. (Corporate Ford Website)
Ethical Concerns
The other ethical issues that may arise is that some directors like Gerald L. Shaheen who may have served as the president of the Caterpillar Inc before he retired may be having the connections with the group hence his interests may also be linked to the company. H e should be allowed to serve the interests of one company only.
The other issue is that the company has some former politicians in the board like the former governor Jon M. Huntsman Jr. It reflects a little unprofessionalism to include some politicians in the board and who may have had different policies that may have been unpopular with some people hence it can influence the performance of the company negatively.
Part Two
Competitive Financial Ratio Comparison
Ratio analysis provides a diagnostic tool that identifies the areas prone to create problems for the company and evaluates the opportunities within the company and its competitors. The ratios of Ford Motor Group provide a relatively positive view of the company. Appendix C provides all the comparisons and ratio summaries for Ford and GM.
The net assets turnover for Ford Motor Group decreased by 2.5% in the year 2013 as compared to a 50% increase in the year 2012. GM registered a decrease of 13% in its net assets turnover in the year 2013 while in the year 2012 it experienced an increase of 6.5%. (Vance, 2003, p. 19)
DuPont Identity
The following is the Dopont model breakdown for Ford and GM. The profit margin for Ford amounted to 13% of sales for both 2013 and 2012. The return on Equity was 27% in 2013 while in2012 it was 36%. The profit margin on sales for GM amounted to 12% in 2013 while in 2012 it was 7%. The ROE for GM amounted to 13% and 17% respectively for the years 2013 and 2012 respectively. The return on assets amounted to 3 and 4% respectively. The earnings per share for Ford in 2013 and 2012 were 1.54 and 1.48 respectively while the dividends per share amounted to 0.4 and 0.2 respectively. Both companies are heavily leveraged and Ford is the one that has the highest concentration of debt compared to GM.
The interest expenses for Ford increased by 16.3% in 2013 while in 2012 it had decreased by 12.7%. The interest expense for Ford in the year 2013 and 2012 were 829 million and 713 million respectively. GM interest expenses decreased by 31.7% in 2013 while in 2012 the expenses decreased by 9.4%. The interest expenses for 2013 and 2012 were 334 Million and 489 Million respectively.
The net assets turnover for Ford’s decreased by 2.5% in the year 2013 as compared to the 50% increase in the year 2012. GM registered a decrease of 13% in its net assets turnover in the year 2013 while in the year 2012 it experienced an increase of 6.5%. The dividend per share for Ford in 2013 and 2012 was 0.4 and 0.2 respectively. (See appendix E) This represented a return of 22% to the shareholders in 2013 while in 2012 it was 23%. (Luenberger, 1997)
Financial Data of Ford Motor Group
The financial performance of Ford Motor Group seems to be better than General Motors for the years 2013, 2012 and 2011. (See table 1
Table 1
Ford (Billions)
Year 2013
Year 2012
Year 2011
Net income
7.15
5.67B
20.21
Revenue
146.92
195.06
135.61
Assets
202.03
189.41
178.35
Equity
26.38
15.95
15.03
GM (Billions)
Year 2013
Year 2012
Year 2011
Net income
5.35
6.19
9.19
Revenue
155.43
152.26
150.28
Assets
166.34
149.42
144.60
Equity
42.61
36.24
38.12
Differences or Trends
The equity multipliers for Ford are higher than those of GM which means that Ford is more levered than GM. (See table 2) and Appendix C for GM.
Table 2
DuPont Analysis
ROE
Profit Margin
Asset Turnover
Equity Multiplier
Ford
Year 2013
0.07
0.72
0.75
7.66
The ratios of Ford Motor Group for ROE and Profit margins are better than those of GM. (See Table 1 & 2 above) The equity multiplier for Ford Motor group is 7.66%. However, the asset turnover for GM is higher than Ford. (See Appendix C) The net assets turnover for Ford’s decreased by 2.5% in the year 2013 as compared to a 50% increase in the year 2012. GM registered a decrease of 13% in its net assets turnover in the year 2013 while in the year 2012 it experienced an increase of 6.5%. The current ratios for Ford Motor group for 2013, 2012 and 2012 were 2.11, 2.32 and 2.26 respectively compared to Gm’s 1.31, 1.3 and 1.22 for the same period respectively. The quick ratios for Ford Motor group for the same period were 1.98, 2.18 and 2.15 compared to GM’s 1.08, 1.02 and 0.95 respectively. Ford Motor Group seems to have higher and better liquidity ratios than GM. The financial stability of Ford Motor Group is more promising that GM’s. The other competitive ratios are attached on the appendix.
Part Three
The information was gathered from the Yahoo’s business finance websites
Dividend Growth Model
The dividend growth model is also known as the Gordon Model. The dividend growth model is a concept that determines the value of stock or a business firm. It utilizes the dividend yield as an investment strategy. Companies with reasonable payouts ratios and profitable dividend yields are considered safe investment. The following are the calculations for obtaining the Dividend Growth model;
Table 3
Growth Rate for Ford Motor Group
Analysis
Formula %
Year 2013
ROE
Net income/ Equity
0.27 %
Retention ratio
1 – (cash dividends/ net income)
0.78 %
Growth rate in earnings (g)
Retention ratio x ROE
0.21 %
For the formula used to calculate the ratios above see appendix E.
The Financial Information and Important Growth Trends for Ford Motor Group for 2013
Ford Motor Group
2013
ROE
Net Income/Equity
0.27
Retention Ratio
1-(cash dividends/net income)
0.78
Growth rate in earnings
Retention rate X ROE
0.21
Dividend Discount Model
Return rate R = Dividend /price of stock + g
0.24
Price of Stock
Dividend/Return Rate R – Growth Rate g
14.07
Issues with Using the Growth Model
The growth model is only an indicator and it cannot guarantee the performance of the company in future. However, it can be used to construct the investment portfolio of a business firm. The dividend earnings growth model for Ford has been calculated on average per year. There are financial periods where the dividend pay rate and amounts are similar hence the growth trend is not reliable as the average is very low. The general average however is 0.212%.
Reasonableness of Constant Growth
The growth rate number is logical as it reflects the general performance on the ground. The major problems with the calculation are the constant figures payable as dividends reflects a constant growth trend and the calculations reflect a zero growth trend. The company pays dividend as shown in the table above. It would be fair assume a constant growth trend for Ford Company.
Part Four
Annual Report
Potential Real Options
The potential real option analysis (ROV) refers to the valuation techniques that are applied in capital budgeting. To undertake some business initiatives or activities such as expansion or investment in capital projects or even abandon some projects is the objective of real call or even put option. Real options are different from the finance options as they are not traded on the securities and the option holders can also influence the real value of the options projects.
Stock Options for Employee compensation for the year 2013
Fair value per stock option
2013
2012
2011
5.03
5.88
8.48
Assumptions made
Annualized Dividend yield
3%
2%
–
Expected volatility
52.20%
53.80%
53.20%
Risk free interest rate
1.50%
1.60%
3.20%
Expected stock option (yrs)
7.7
7.2
7.1
Company stock options as at December 31 2013 (millions)
Outstanding options
Exercisable options
Shares
weighted av life yrs
weighted av Exc price
Shares
weighted av life yrs
Range Prices available in $
1.96 -2.84
15.5
5.2
2.16
15.5
2.16
5.11 – 8.58
23.2
3.1
7.29
23.2
7.29
10.11 – 12.98
29.1
5.3
12.58
19.1
12.56
13.07 – 16.64
11.3
2.8
13.86
9.8
13.71
Total stock options
79.1
67.6
Real options are also known as stock valuations. Several options in investment valuation and analysis depend on the objective of the project. The following is an example of employee stock valuation.
These options are company specific and they are payable on the range of prices available and the average years the employee has spent in the company. The share prices are weighted as shown on the table above. (Garrison, Noreen & Brewer, 2009, p. 65) The stock options would have to be provided for as their prices are usually provided for employees only and not for the general investors.
Capital Budgeting Process
The options would have to be provided for when budgeting for capital projects. All projects with average returns that are less than the weighted average cost of capital should be rejected as the cost of capital would be more the profits of the project.
Part Five
Beta
Beta is used in business finance a means of measuring the investment portfolio risk. A beta of 2 means that for every 1% change in the benchmarks value, the value of a given portfolio changes by 2%. The beta for Ford is 0.88%.
Expected Return – CAPM
The beta for Ford Motor Group according to yahoo business finance is 0.88%. The current risk free market rate is 0.03%. The rate of risk premium is the amount that the expected asset’s rate of return is extra or exceeds the market risk free rate of interests. The risk premium for trading companies is the company stocks or their expected rate of return less the risk free rate of return.
Capm =
rf + β (rm -rf)
rf = risk free rate
3.00%
β = Beta
0.88
rm = return on the market
10.00%
Capm =
9.16%
The average historical equity premium is 6.9%, so 7% is an estimate for the risk premium (Ross, Westerfield & Jaffe, 2013).
The average Capm rate is equal to 6.52% as calculated in the excel formula which is attached. The expected return for Ford Motor Group is 7%. Using the model, the rate of return is 6.52%.
The cost of equity using the capital asset pricing model = Risk Free Rate + Beta * Market Risk Premium = 3+0.88*3= 11.64 (French, 2003, p. 65)
Ford has outstanding shares numbering 3.88 Billion while the market prices of its shares were costing 14.07 which amounts to a total of $54.59 Billion. (Black, Jensen and Scholes, 1972)
The Capital Asset Pricing theory suggests that the cost of capital depends largely on how the asset was initially. The cost of the debt capital, the cost of the equity capital and the weighted average of the two depending on the debt and equity financing represents the actual cost of capital.
Dividend Growth Model versus CAPM
The CAPM is 0.916% compared to the 0.21 %. The differences are not so high but the most logical one is CAPM which is about 1%. However the general trend for the Ford Motor Group has been retrogressive trend at around -0.3. (Appendix B)
Part Six
Debt and Equity
Equity
According to Modigliani and Miller (1958, p. 260) the cost of equity capital is mostly determined by the asset’s cost of capital and not the other way round.
Ford has outstanding shares numbering 3.88 Billion (see table 5) while the market prices of its shares were costing 14.07 which amounts to a total of $54.59 Billion. The Capital Asset Pricing theory suggests that the cost of capital depends largely on how the asset was initially financed (Bierman & Smiddt, 1966). The cost of the debt capital, the cost of the equity capital and the weighted average of the two depending on the debt and equity financing represents the actual cost of capital. (Black, Jensen and Scholes, 1972, p.80)
Table 5
Ford’s Market Value of Equity
Company name
Year 2013
Shares outstanding
3.88B
Price as of 14.07 per share
Market value of equity
54.59B
26.83B
CAPM
6.52%
The rate of Capital Asset Pricing model for Ford Motor Group is 6.52%.
Debt
Interest payments that are payable by lenders are all deductible from the ones or a company’s taxable income while the payments to shareholders as dividends are not. Most tax systems encourage the companies to use debt financing instead of equity. (Black, Jensen and Scholes, 1972, p.118) The higher the interest rates the higher the incentive. The interest expenses for Ford increased by 16.3% in 2013 while in 2012 it had decreased by 12.7%. The interest expense for Ford in the year 2013 and 2012 were 829 million and 713 million respectively. GM interest expenses decreased by 31.7% in 2013 while in 2012 the expenses decreased by 9.4%. The interest expenses for 2013 and 2012 were 334 Million and 489 Million respectively. (Bodie, Kane, Marcus, 2008, p. 303)
The capital structure for Ford is mostly made up of borrowed money. In 2013, the long-term debts amounted to $114, 688 million while in 2012 and 2011 the debts amounted to 105, 058 and 99488 respectively. The total stockholder equity amounts to $26,383 Million and $15,947 million for the same period. Ford Company is highly levered and it needs to cut down on borrowing. General Motor’s long term debts amounted to $6573 Million and $3424 Million for the year 2013 and 2012 while the total stockholders equity amounted to $42,607, $36,244 and $38120 for the years 2013, 2012 and 2011. Gm is relatively levered. (Markowitz, 1959, p. 78)
The credit ratings for Ford currently are CCC+ from S & P performance of CC in 2012. Ford managed to pay its 9.9 Billion debts in the year 2014 and it helped to boost its credit rankings. Ford credit rankings place it in front of GM and Chrysler and they are currently fitting hard to avoid bankruptcy petition. (Luenberger, 1997, p. 48)
Table 6
Cost of Debt for Ford Motor Group for the year 2013
Company name
2013
Long term debt
Current Portion of Debt
Total Debt
114.69B
–
114.69B
Cost of Debt %
7%
Tax Rate
40
The cost of debt for Ford Motor Group is 7%, a rate which is fairly affordable. Given the current ratio of 2.11 Ford can comfortably afford to pay its debts.
Table 7
Calculations for Weighted Average Cost of Capital for Ford Motor Group
Ford
Value $
%
Equity (Rs)
26.38B
18.7
Debt (Rb)
114.69
81.3
Total Value
141.07
100Rs
The formula for calculating the weighted average cost of capital is:
Ford
Value
%
Equity(Rs)
26.38
0.87
Debt(Rb)
114.69
0.13
Total Value
141.07
1
Rwacc
3.98%
The WACC for Ford Motor Group is 3.98% which reflects a favorable position compared to its cost of debt which is 7%. (See Table 6 & 7 above)
Capital Budgeting Assumptions
The major assumptions are that the tax rate is 40%. Following the losses incurred by ford in its foreign branches no taxes were chargeable in 2013.
Competitive Review of Debt and Equity Mix
The average weighted cost of capital is higher for Ford than GM. In 2013, the WACC for Ford has a WACC of 3.98% while for GM it was 3.16%. Ford Motor Group seems to have slightly more debts compared to GM.
Competitive Review
GM
Value
%
Equity(Rs)
42.61
0.87
Debt(Rb)
6.57
0.13
Total Value
49.18
1
Rwacc
3.16%
Part Seven
Capital Structure Theories
According to Modigliani and Miller (1958, p. 261) the cost of equity capital is mostly determined by the asset’s cost of capital and not the other way round.
Ford has outstanding shares numbering 3.88 Billion while the market prices of its shares were costing 14.07 which amounts to a total of $54.59 Billion. The Capital Asset Pricing theory suggests that the cost of capital depends largely on how the asset was initially financed (Bierman & Smidt, 1966, p. 300). The cost of the debt capital, the cost of the equity capital and the weighted average of the two depending on the debt and equity financing represents the actual cost of capital. (Black, Jensen and Scholes, 1972, p. 120)
Some theories of the Capital assets pricing model, have been applied in relation to heterogeneous beliefs and risk free lending rate elimination (Black, 1997, p. 444).
Summary
Ford Motor Group financial performance seems to be improving as in the year 2013 it had a Gross Profit 7.9% as opposed to 2012 when it decreased by 5% from the previous year. The GP for General Motors on the other hand increased by 70% in the year 2013 while in the year 2012 it decreased by 43%. The net profit for Ford for the same period increased 26% in 2013 while in 2012 it decreased by 72%. GM registered a 13.7 % reduction in 2013 while in 2012 it registered a further reduction of 32.7%. The total shareholder’s equity for Ford increased by 65.5% in 2013 while in 2012 it increased by 6%. General Motor’s shareholders equity increased by 17.6% in 2013 while in 2012 it decreased by 4.9%. In 2012 Ford Motor Group reduced its total liabilities by almost 70% while GM increased its total liabilities by 15.6% in 2013. The sales revenue for Ford increased by 10% in 2013 while GM sales for the same period increased by 2.1%. Ford total sales revenues increased from $133,559 million in 2012 to $146,917 million in 2013. GM sales for the same period were 152256 million and 155427 million from the same period respectively. The interest expenses for Ford increased by 16.3% in 2013 while in 2012 it had decreased by 12.7%, GM interest expense decreased by 31.7% in 2013 while in 2012 it decreased by 9.4%. (Bodie, Kane, Marcus, 2008, p. 303)
The ratios for Ford also indicate that the liquidity ratios are above average for all the years for Ford Motor Group. The current ratios were 2.11, 2.32, 2.26 for the years 2013, 2012 and 2011. The quick ratios also indicated a positive trend. The Times interest earned for the year 2013 for Ford were 9.45, 11.83 and 11.63 for the years 2013, 2012 and 2013. The interest cover for the same period indicated the same results like Times interest earned. (Drucker, 1999, p. 155)
The ford Family owns 2% of the company while the employees number about 181,000. It has a market capitalization of $54.65 Billion and its shares are currently trading at $14.09 dollars with a yield of 3.5%. (Ross, Westerfield & Jaffe, 2013, p. 175) The net asset turnover for Ford decreased by 2.5% in the year 2013 as compared to a 50% increase in the year 2012. GM registered a decrease of 13% in its net assets turnover in the year 2013 while in the year 2012 it experienced an increase of 6.5%. The dividend per share for Ford in 2013 and 2012 was 0.4 and 0.2 respectively. This represented a return of 22% to the shareholders in 2013 while in 2012 it was 23%.
Ford Motor Group has a great potential to return to great profitability and also be able to pay off all its outstanding debts. The Current ratios and the quick acid test ratios indicate that Ford Motor Group has a stable liquidity and with the right leadership it would be able to make more profits like the earlier years. Given all these factors I would definitely invest my money in Ford Motor Group but I would be cautious besides I would also be requiring a plan on how the management of the company would be proposing to settle the huge loans that it owes several financiers. Ford may be earning some profits but it has a lot of debts that are four or five times its total equity. The classification of shares as common shares and also class B shares that have unequal voting rights is also some disquietedness among the shareholders.
Reference
Adams, S. (2008) Fundamentals of business economics. Financial Management (UK), 46–48.
Bierman, H. and Smidt. S. (1966).The Capital Budgeting Decision—Economic Analysis and Financing of Investment Projects. New York, NY: Macmillan Company. 300-55
Black, F. (1997) Capital Market Equilibrium with Restricted Borrowing, Journal of Business, July, 45:3, 444–55.
Black, F., Jensen, M.C. and Scholes, M. (1972) “The Capital Asset Pricing Model: Some Empirical Tests,” in Studies in the Theory of Capital Markets. Michael C. Jensen, ed. New York, NY: Praeger, 79–121.
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Drucker, F. (1999) Management Challenges of the 21st Century. New York, NY: Harper Business. 150 – 55
Ford Motor Company Annual Report (2013) Delivering Profitable Growth for All, www. corporate ford.com
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French, C. W. (2003). “The Treynor Capital Asset Pricing Model” Journal of Investment Management 1 (2): 60–72.
Garrison, R., Noreen, W. & Brewer, P. (2009) Managerial Accounting, New York, NY: McGraw-Hill Irwin. 65 -70
Gordon, M. J. (1962). The Investment, Financing, and Valuation of the Corporation. Homewood, IL: R. D. Irwin.
General Motors Company Annual Report (2013) www. corporate gm.com
Khan, M. (1993) Theory & Problems in Financial Management, New York, NY: McGraw Hill
Luenberger, D. (1997). Investment Science, Oxford University Press, Oxford: 48 – 75.
Markowitz, H. (1959) Portfolio Selection: Efficient Diversifications of Investments. Cowles Foundation Monograph No. 16. New York, NY: John Wiley & Sons, Inc. pp. 77 – 91.
Modigliani, F. and Miller, M. (1958) “The Cost of Capital, Corporation Finance, and the Theory of Investment,” AmericanEconomic Review, June, 48:3, 261–97.
Ross, S. A., Westerfield, R. W., & Jaffe, J. (2013) Corporate finance (10th Ed.) New York, NY: McGraw-Hill Irwin. 175.
Vance, D. (2003) financial analysis and decision making: tools and techniques to solve financial problems and make effective business decisions. New York, NY: McGraw-Hill.
Appendix A
The Historical Share Prices for Ford Motor Group
Date
Shares
2013
Low
High
Average
% Trend
1-Sep
16.21
17.35
16.78
8-Sep
17.1
17.68
17.39
3.63528
15-Sep
17.3
17.7
17.5
0.632547
22-Sep
16.69
17.34
17.015
-2.77143
6-Oct
16.35
17.12
16.735
-1.64561
13-Oct
16.92
17.55
17.235
2.98775
20-Oct
17.39
18.02
17.705
2.727009
27-Oct
16.76
17.72
17.24
-2.62638
4-Nov
16.55
17.2
16.875
-2.11717
11-Nov
16.64
17.2
16.92
0.266667
18-Nov
16.82
17.18
17
0.472813
2-Dec
16.42
17.2
16.81
-1.11765
9-Dec
16.2
16.79
16.495
-1.87388
16-Dec
15.17
16.99
16.08
-2.51591
23-Dec
15.1
15.5
15.3
-4.85075
30-Dec
15.25
15.64
15.445
0.947712
2014
6-Jan
15.35
16.11
15.73
1.845257
13-Jan
16.08
16.78
16.43
4.450095
20-Jan
15.78
16.68
16.23
-1.21729
27-Jan
14.9
16.01
15.455
-4.77511
3-Feb
14.4
15.13
14.765
-4.46457
10-Feb
14.78
15.36
15.07
2.065696
24-Feb
15.07
15.46
15.265
1.293962
3-Mar
15.03
15.83
15.43
1.080904
16-Mar
15.16
15.74
15.45
0.129618
30-Mar
15.48
16.49
15.985
3.462783
6-Apr
15.59
16.17
15.88
-0.65687
20-Apr
15.71
16.44
16.075
1.22796
27-Apr
15.75
16.2
15.975
-0.62208
4-May
15.43
15.95
15.69
-1.78404
11-May
15.55
15.9
15.725
0.223072
25-May
16.05
16.56
16.305
3.688394
8-Jun
16.5
17.12
16.81
3.097209
15-Jun
16.38
16.87
16.625
-1.10054
22-Jun
16.68
17.29
16.985
2.165414
29-Jun
17.07
17.4
17.235
1.471887
6-Jul
17.05
17.49
17.27
0.203075
20-Jul
17.51
18.12
17.815
3.155761
27-Jul
16.72
17.85
17.285
-2.97502
3-Aug
16.74
17.14
16.94
-1.99595
10-Aug
17.11
17.49
17.3
2.125148
17-Aug
17.51
17.52
17.515
1.242775
24-Aug
17.19
17.49
17.34
-0.99914
31-Aug
16.94
17.87
17.405
0.374856
7-Sep
16.5
16.87
16.685
-4.13674
14-Sep
16.16
16.77
16.465
-1.31855
28-Aug
14.44
16.4
15.42
-6.3468
5-Oct
13.52
14.7
14.11
-8.49546
12-Oct
13.26
14.25
13.755
-2.51595
19-Oct
13.65
14.49
14.07
2.290076
-15.6592
Trend
-0.31957
Source: www. Yahoo business Finance
Appendix B
The Financial Ratios of Ford Motor Group
Ford Motor Group
2013
2012
2011
Current Ratio
Total Current Assets/Total current liabilities
2.11
2.32
2.26
Quick Ratio
TT C/ Assets – inventories /TT/ C Liabilities
1.98
2.18
2.15
Receivable turnover
Annual credit sales/average receivables
Inventory Turnover
Cost of goods sold/Average inventory
17.00
17.51
19.87
Asset turnover
Sales/Average total assets
0.75
0.73
0.76
Dividend yield
Div per Share / Current Share price
0.03
0.01
Dividend cover
EPS/ Dividend per Share
3.70
7.40
Net assets turnover
Net assets / total sales
1.24
1.27
0.85
Times interest earned
EBIT/Annual Interest Expense
9.45
11.83
11.63
Debt to total Asset
Debt/Assets
0.57
1.03
0.56
Book value per share
9.17
9.17
9.17
Interest cover
EBIT/Annual Interest Expense
9.45
11.83
11.63
Profit margin on sale
GP/sales
0.13
0.13
0.14
R.R return on assets
EAT/Total Assets
0.04
0.03
0.11
R.R com stock equity
Profit after taxes/Shareholders equity
0.27
0.36
1.35
Earnings per share
Profit after taxes-pref div)/No. of comm O/S
1.54
1.48
Payout Ratio
cash dividends/income
0.00
0.00
0.00
ROE
Return On Equity (ROE)
0.27
0.36
1.35
ROA
Return on average Assets
0.04
0.03
0.11
Source: (Ford Motor Group Annual Report, 2013)
Appendix C
The Financial Ratios for General Motors
GM
2013
2012
2011
Current Ratio
Total Current Assets/Total current liabilities
1.31
1.30
1.22
Quick Ratio
TT C/ Assets – inventories /TT/ C Liabilities
1.08
1.02
0.95
Receivable turnover
Annual credit sales/average receivables
Inventory Turnover
Cost of goods sold/Average inventory
9.56
9.74
9.16
Asset turnover
Sales/Average total assets
0.93
1.02
1.04
Dividend yield
Div per Share / Current Share price
Dividend cover
EPS/ Dividend per Share
Net assets turnover
Net assets / total sales
0.27
0.24
0.25
Times interest earned
EBIT/Annual Interest Expense
23.33
-57.68
17.99
Debt to total Asset
Debt/Assets
0.04
0.02
0.02
Book value per share
Interest cover
EBIT/Annual Interest Expense
23.33
-57.68
17.99
Profit margin on sale
GP/sales
0.12
0.07
0.13
R.R return on assets
EAT/Total Assets
0.03
0.04
0.06
R.R com stock equity
Profit after taxes/Shareholders equity
0.13
0.17
0.24
Earnings per share
Profit after taxes-pref div)/No. of comm O/S
2.92
Payout Ratio
cash dividends/income
ROE
Return On Equity (ROE)
0.13
0.17
0.24
ROA
Return on average Assets
0.03
0.04
0.06
Source: General Motors Annual Report.
The data was obtained from the annual reports but the calculations were done using excel while applying the formulas shown on the tables.
Appendix D
Members of the Ford Motor Group Executive Board
Richard A. Gephardt, Ellen Marram, Stephen Butler, Kimberly Casiano, Edsel Ford, Homer Neal, Antony F. Earley, James P. Hackett, John L. Thornton, Gerald L. Shaheeen, James H. Hance, Jr., William W. Helman John C. Lechieter, James H. Hance and Jon M. Huntsman.
(Ford Annual Report, 2013, p.7)
Appendix E
The formula for calculating the Return on Equity (ROE) for Ford Motor Group
The formula for calculating the Dividend Discount Model for Ford Motor Group
Dividend Discount Model (DDM) =
Financial Data for Ford Motor Group
Ford Motor Group (Billions)
Year 2013
Net income
$ 7.16
Equity
$26.38
Total dividends paid
$1.57
Outstanding shares
3.88
Earnings per share (EPS)
$1.82 (dollars)
Dividends paid per share
$0.4 (dollars)
Stock price as of 2/11/2014
$14.07
Source: Ford Group Annual Report for 2013
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Application: Interpreting Cost-Benefit Analyses
Cost-benefit analyses are designed to do just what their name implies—weigh the costs and benefits of a program or policy. This is important because, in a world of finite resources, people want to make sure that funds are allocated to programs that are as financially efficient as possible, thereby maximizing the impact of each dollar. As mentioned in this week’s Discussion, cost-benefit analysis is a type of program evaluation. To use this type of analysis, researchers weigh costs and benefits in economic terms, in other words, analysts must determine what the costs and benefits of a program or policy are (i.e., the variables) and assign monetary values to these variables. It sounds easy enough but can sometimes be complicated when non-economic costs and benefits (e.g., enhanced neighborhood beauty, psychological damage caused by a crime, or job satisfaction) must be assigned a monetary value. It is important to note that cost-benefit analysis differs from cost-effectiveness analysis in that the latter compares program costs to program outcomes.
For this Application Assignment, you evaluate the cost-benefit analysis of the program presented in the article, “A Cost-Benefit Study of a Breaking the Cycle Program for Juveniles.” As you examine the study, locate the key variables and consider the findings. Then consider whether you would continue or discontinue the program, based on the evidence presented in the study. As you formulate your answer, think about the advantages and disadvantages of continuing or canceling the program and the potential consequences for the affected community.
The assignment (2–3 pages):
• Describe the key variables within the study and provide a summary of the analysis.
• Explain whether you would continue or discontinue the program, based on the evidence provided in the analysis, and why.
• Finally, explain potential consequences of your decision for the affected community.
Support your Application Assignment with specific references to all resources used in its preparation. You are to provide a reference list for all resources, including those in the Learning Resources for this course
Will attach other files.
SAMPLE ANSWER
Description of the key variables within the study and a summary of the analysis The case study is on the cost benefit analysis of a Juvenile Breaking the Cycle (JBTC) program in Oregon, in the United States of America. The JBTC program was initiated to provide the juvenile justice monitoring system; monitoring and coordinated treatment to youth who were adjudged to be at high risk of using banned substances such as marijuana and who stood the highest risk of recidivism. The key variables within the study were the case management costs which included employee benefits and administrative overheads, court costs, treatment costs and detention costs. The study involved comparing the JBTC group with a comparison group (Cowell, Lattimore & Krebs, 2010).
The study found that the average group in JBTC program, between intake and 6 months, incurred approximately $230 more costs per youth than the costs per youth in the average group in the comparison group. Costs per youth in the JBTC group in the period of 6 to 12 months rose to approximately $1,000 as compared to the similar period of 6 to 12 months in the comparison group. This implied that tax payers will have to pay more to fund the JBTC program at face value (Cowell, Lattimore & Krebs, 2010). However a further examination of juvenile justice costs showed that after intake, additional public costs on the majority of the unadjusted mean costs would diminish as youth progressed in the second year of the JBTC program. The additional juvenile justice costs in the 6-to-12 month period were found to be more by $434 per youth for the final 6 month period of the JBTC program. This difference fell to $52 which implies that the cost difference across would have greatly reduced in the second year after intake if juvenile justice costs were to continue to drive total costs of the program(Cowell, Lattimore & Krebs, 2010).
A decision on whether to continue or discontinue the program based on the evidence provided
Based on the analysis above, it would appear that the program should be discontinued due to the fact that the costs incurred by taxpayers in running the JBTC program in the first year was much higher than what was incurred by the average group in the comparison group. The analysis found that in the period between intake and 6 months the costs were more by $230 per youth and rose to $1,000 per youth in the period between 6 months to 12 months as compared to what was incurred by the average group in the comparison group (Cowell, Lattimore & Krebs, 2010). However after analyzing other factors it would be a prudent use of public funds if the program was allowed to continue. The study found that the juvenile justice costs, on the additional public costs on the majority of the unadjusted mean costs, would diminish as youth progressed in the second year of the JBTC program. The study did not include some crucial costs that would have affected the outcome of the cost- benefits study objectively such as probation costs, tax payer supported costs, etc. These costs might have altered the findings of the study (Cowell, Lattimore & Krebs, 2010).
The selection of the JBTC youth was drawn from youth who were at high risk of getting involved in substance abuse and at high risk of recidivism as opposed to the youth in the comparison group whose selection criteria is not disclosed. This explains why the costs of the JBTC program are higher since these youth would ordinarily have used substances and hence incurred higher costs even if they were in the comparison group (Cowell, Lattimore & Krebs, 2010). The two groups had dissimilar characteristics and should not have been compared at all. Data on costs incurred in the second year was also unavailable even though initial examination showed that these costs would be similar to what would be incurred by the comparison group. The study should be done for about four years to objectively determine its cost- benefit analysis and make a decision whether to continue or discontinue the program. With the rates of youth, drug and substance abuse, crime and arrests growing each year in the United States as shown in the study, it would be prudent to not only continue the program but expand it to include even more deserving youth (Yeh, 2010; Zedlewski,2009).
The potential consequences of the decision for the affected community
The decision to continue the program would initially incur the community substantial amounts of money for each youth joining the program in the first year which would be a burden to tax payers at face value. However, in the second year the costs would be much less and the benefits much more. The potential benefits of the program are however much greater in the long run. The JBTC program would address the problem of substance abuse and recidivism without which the youth would carry this behavior into adulthood (Cowell, Lattimore & Krebs, 2010). These adults would thereafter create dysfunctional families leading to high incidences of divorce, child abuse, suicides and crime. The costs at this stage in the lives of these youth would run into millions of dollars to manage. Youths who go through this program at this early stage in their lives would be remodeled to go back to school or put more attention to their studies and pursue a career which would eventually produce productive citizens for the benefit of the community. The program would contribute in a reduction in crime and substance abuse which is a menace to the community and keeps investors away from investing in the community (Braga, Kennedy, Waring & Piehl, 2001).
Cowell, A. J., Lattimore, P. K., & Krebs, C. P. (2010). A cost-benefit study of a breaking the cycle program for juveniles.Journal of Research in Crime and Delinquency, 47(2),241–262.
