26 Jun THE CURSE OF COMPETITIVE MARKETS
There are 10 Principles that form the basis for financial management:
1. The risk-return trade off – we wont take on additional risk unless we expect to be compensated with
additional return
2. The time value of money – a dollar received today is worth more than a dollar received in the future
3. Cash – not profits – is king
4. Incremental cash flows – its only what changes that counts
5. The curse of competitive markets – why its hard to find exceptionally valuable projects
6. Efficient capital markets – the markets are quick and the prices are right
7. The agency problem – managers wont work for owners unless its in their best interest
8. Taxes bias business decisions
9. All risk is not equal – some risk can be diversified away, and some cannot
10. Ethical behavior is doing the right thing, and ethical dilemmas are everywhere in finance
What is the importance of these principles (300 words)
Please explain with the help of detailed examples, how any three of these principles
can benefit an individual or a corporation financially. (1200 words)
Section 2:
What is a firm’s cost of capital? What are the factors that determine a company’s cost of capital? Why do firms need to calculate the cost of capital? (500 words)
‘OK Shots’ is involved in the production of camera parts and has the following
inventory, carrying and storage costs:
• Orders must be placed in round lots of 200 units.
• Annual unit usage is 500,000 (assume a 50 week year in your calculations).
• The carrying cost is 20% of unit purchase price.
• The purchase price is $2 per unit.
• The ordering cost is $90 per order.
• The desired safety stock is 15,000 units (this does not include delivery time
stock).
• The delivery time is one week.
Given the above information:
i) Determine the optimal EOQ level. (Provide the narrative and calculation)
ii) How many orders will be placed annually?
iii) What is the inventory order point?
iv) What is the average inventory level?
Section 3
Part 1 –
ACME Industry will produce 200,000 units next year. All of this production will
be sold as finished goods. Fixed costs will total $300,000 and variable costs are
predicted to be 75% of sales.
i) If ACME Industry wants to achieve an Earnings Before Interest and Taxes of $240,000 next year, at what price per unit must it sell its product? (also provide calculation)
ii) Based on your answer to part (i), set up an analytical income statement that will verify your solution.
Part 2 –
How do decision makers identify costs that are relevant to a decision and what analysis techniques can incorporate relevant costing to present accounting information of use to the decision?
Section 4
Part 1 –
Why is the valuation of securities an important decision making factor for investors, businesses and governments? (500 words)
You have a substantial amount of money invested in three different unlisted financial
securities. As these investments are not traded on the financial markets, they do not
have an observable market price but you have ascertained the following information:
• Company Bonds: $1000 face value with 6 years to maturity, paying 11% per annum semi-annual
coupons. The required rate of return is 10% per annum.
• Preference Shares: Irredeemable, paying 8% annually on $10 par value and your estimate of the risk
premium for these shares is 7% per annum.
• Ordinary Shares: The last annual dividend paid by the company was 12 cents per share. The
company’s expected dividend growth is 5% per annum. The required rate of return is 10%.
On the basis of this information, estimate the value of each security (1000 words).
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