Apc308 Financial Management (MU CR)

SOLUTION 1

a) Calculation of Book Value and Market value cost of Capital (WACC) for Kadlex plc.

Weighted Average Cost of Capital as per book value and Market Value.

Cost of Capital

Cost of Equity (Ke)

Cost of Preference Share Capital (Kp)

Cost of Debt (Kd)

Capital Structure of Kadlex as on 31 December 2017

Total Value of Debt and Equity

Calculation of Weights

b) Cost of Capital of company as per the new structure of Kadlex plc

Weighted average cost of capital

Cost of Capital

Cost of Equity (Ke)

Cost of Preference Share Capital (kp)

Cost of Debt (kd)

Capital Structure of Company of company under the proposed new plans

Total Capital

Calculation of Weights

Recommendations over the projections of finance director.

The finance directors has propose to reduce the cost of capital by issuing new debts. The cos of debt will be increased to 11% from 10%. Also company will be repurchasing some of its equity shares from the proceeds which will be raising the share price to £2.85. The overall cost of capital of company using the new projections will be 25.41% that is lower than the current book value cost of capital but higher than the market value cost of capital. Therefore the projections made by finance manager should be adopted as it will increase the share value by reducing the cost of capital of company(Barkai, 2017).

c) Minimising the cost of capital using gearing in the capital structure.

Cost of capital is defined as rate of return which business must earn before generating the values. Before profits are turned by company sufficient income must be generated for covering the cost of capital used for funding its operations. It consists of both cost of equity and cost of debt that are used for financing a company. Cost of capital largely depends on type of finance company has chosen. The sources of finance will determine capital structure of company. Every company tries to have the best mix which will be providing adequate funding that minimizes cost of capital of company.

Cost of capital of the company can be minimized by making an optimal capital mix. Two of the main sources of raising funds are equity and debt financing. Companies reduce their cost of capital by cutting down its debt financing, lowering its equity or by capital restructuring (Berger, Chen and Li, 2018). Cost of debt refers to interest rates applied over borrowed loans from bank or non bank banking institutions. The coupon rate of debentures or bonds are the cost of capital. Cutting cost of capital will be lowering cost of non payments. If alternative capital is available at lower interest rates than it could be sourced for repaying the debts.

Cost of debt can be increased for lowering the cost of capital of company. The cost of equity investment is much higher in comparison to the cost of debts. Equity has high risks in comparison to other sources of capital. Company can avail the benefit of tax reduction in the debt capital that reduced the cost of debt which ultimately reduced the cost of capital of company. Debt capital is cheaper source of finance in comparison to equity. Debt instrument are also used by the companies for getting the tax benefits for payment of interests. If a company is having high equity it will be having higher cost of capital (Gatsios, and et.al., 2016). For reducing the cost of capita organisation can raise debt capital for purchasing back the equity capital. Buy back of equity shares will be increasing the price per share and wealth in aggregate of company. This way gearing can be used in the capital structure for minimising cost of capital. At the same time company should ensure that it does not raises debt beyond a benchmark as after that the interest cost will be raising higher. Debt involves greater risk of default and higher interest payment can affect the operations of company.

d) Evaluating the effect of short termism on bankruptcy and agency problem in company.

Short termism is suffered by people excessively over the short term results on cost of long term interests and objective of company. It is also defined as concentration over short tern benefits for profits sacrificing the long term security. Short termism is an significant concern faced by companies. This is demanding companies to maximise heir short term profits ignoring the long term effects and consequences (Harjoto, and Jo, 2015). Short termism in company could destroy wealth generation, impede innovation and even to bankruptcy. It may cause potential harm to business if not covered by company within time.

The short termism if not dealt effectively can lead to even bankruptcy of company. For instance companies for earning the short term earnings or for increasing the sales from existing products may not focus over other operations of business. Company may stop it spending over the research and developments of new products which is essential for future, as existing products is earning high revenues. Introduction of new substitute can enormously affect the sales and revenues. Also company is not available with new innovation that can help it to regain its market share. Company might not have enough funds to spend over research and development that can lead the company towards bankruptcy (Johnstone, 2016). Companies for earning the short term benefits of the adopt heavy finance from banks and financial institutions above their capacity. At times companies are not able to derive the expected returns from the investments over long run and ultimately goes bankrupt. Therefore organisations should earn short term profits thereby focusing over the long run benefits that a project could generate. In the long run company can benefit from the projects that may be no generating adequate results over short term. Therefore companies are required to make proper analysis before investing over the short term benefits.

Agency is termed as the relation between an agent and principal. Asymmetric information may arise conflict of interest in company. Conflicts arises where parties of business have separate interests like management and the shareholders. Conflicts arise when shareholders demand for short term returns from the company. Management of company always put efforts for driving the company towards success and growth keeping a long term perspective. If the management on shareholder's demand start focusing over the sort term benefits than it may lead to bankruptcy (Vartiainen, and et.al., 2019). Companies should focus over the lone term benefits thereby achieving the short term returns of company.

SOLUTION 2

Long term: Equity finance

1 & 2 Number of Shares to be issued and theoretical ex right price

3. Calculating expected value of earnings per share

4&5. form of an issue for price of each right issue & Presenting all the three options of the right issue in the tabular form

Right Issue

Right issue refers to an invitation the existing shareholders of company for purchasing the new additional shares of company. This kind of issues give the existing shareholders the right to securities known as right. In a right issue existing shareholders can purchase the shares of company at a discounted price than that is available in the market to general pubic. Through rights issue company gives shareholders a chance of increasing their shares. Right issue could be defined as way for cash strapped for raising the capita for paying their own debt. Right issues are generally offered by company for raising the additional capital for meeting the current financial obligations (De Lange, 2016). Companies may also issue right shares for carrying out the new investments plans for a new project.

In the present case company has planned to issue right shares at price that would be most beneficial for the company. It has proposed three prices at which the shares could be issued. Right issue will make the shares price to go down therefore the price at which shares would be least affected should be issued. Company shall issue right shares at £1.80 as this will not reduce the share values and also per share value is highest in the available option. Company could go for other options as aggregate value of the shareholders will be unaffected by the split of values between number of shares.

Theoretical ex right price refers to estimated share price of company after he right issue. It is estimated as weighted average price of each share of new as well as existing shares. Companies uses right issue for offering new shares to existing shareholders at discounted price. This is calculated for knowing the stock prices after the issue of right shares as issue increases number of outstanding shares.

Companies are required to offer choice between the cash dividends and scrip dividends to the shareholders. Advantages of scrip dividend.

Dividend refers to distribution of the rewards from earnings to the shareholders of company. Payment of dividend is decided and declared by the board of directors of company. Company is required to pay some proportion of their profits to the shareholders as every shareholder makes investment in company for earning a required rate of return. Though value of shares is increasing the wealth of shareholders but still return in form of dividend is essential for retaining and attracting new investors. Along with time span forms of dividend are changing. Today companies are giving choices for dividends in the form of scrip and cash dividends.

Cash Dividend

Cash dividend refers to payment by company to its shareholders from the profits in form of cash. This is also termed as transfer of economic value to shareholders from company rather than using the money for operations of company. This decreases share prices of company around the rate of dividend. Shareholders receiving cash dividend are required to pay tax on value of distribution that lowers its final value. For some people cash dividends are much beneficial as they provide them with regular income (Halla, Wagner and Zweimüller, 2017). Companies that pay cash dividend are regarded as financially strong and healthy. The cash dividends may disturb the cash flows of company that could be better utilised elsewhere. 

Scrip Dividend

Scrip Dividends refers to issue of new shares in place of dividend. Scrip dividends may be issued by company when they do not have enough cash available for issuing the cash dividends but payment of return is essential to shareholder. This dividend is also offered as an alternative t cash dividends so that payments of dividend are rolled automatically in more shares. In a scrip dividend companies give option to shareholders for receiving dividends in form of cash or stocks. It is different from stock dividend as in that company directly issues shares without giving choice for receiving cash. Companies are increasingly moving towards scrip as it helps in relating the cash funds that could be used effectively in the operations of company.

Advantages of Scrip Dividends

To Shareholders

The shareholder have an option of making choice between the cash or shares dividends. Shareholders receiving the shares in form of dividends are not required to pay tax on dividends that is received by them. Choices enable the people to choose as per their needs for instance old people may choose the cash dividend for meeting their living expenses. Investors may choose for increasing their stock exposures for having future price appreciations (Mazumdar, 2019). Shareholders are not required to pay the transaction cost or commission charges on shares.

To Company

Scrip dividend helps company in saving its cash. Every shareholder that elects shares over cash saves cash of company. The cash saved by company could be utilised in other productive operations that will help in generating revenues. Cash saved can be used by company in paying the interest to the debt holders. When a cash dividend is paid economic value is transferred from company to the shareholders.

CONCLUSION

Financial management is very essential for the organisation to keep a proper management of the financial funds of company. Today the business organisation for their expansion plans have to under take finances. There are various sources of finances that are available to the company through which finances could be raised. It is concluded that companies must have an optimal capital mix so that the cost of capital is minimum. Companies are required to ensure that mix of debt and equity is adequate so that company can earn required rate of return from the available capital. Companies can use debt financing for reducing their cost of capital where companies are more of the equity capital that is having high cost. There are situations when company for expansion plan may require additional funds. Companies must first offer the securities to its existing shareholders before issuing it in market. Right issues are available to the shareholder of company at discounted prices. Raising funds through right issue will decrease the share prices as the outstanding number of shares will be increased.

For more - Managing Business in International Environment

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