MANAGEMENT ACCOUNTING III

5,156 views

Published on

Published in: Business, Economy & Finance
0 Comments
0 Likes
Statistics
Notes
  • Be the first to comment

  • Be the first to like this

No Downloads
Views
Total views
5,156
On SlideShare
0
From Embeds
0
Number of Embeds
3
Actions
Shares
0
Downloads
86
Comments
0
Likes
0
Embeds 0
No embeds

No notes for slide

MANAGEMENT ACCOUNTING III

  1. 1. O LYMPIA B USINESS S CHOOL SCHOOL OF ACCOUNTING & FINANCE ADVANCED DIPLOMA IN ACCOUNTING F ILO -T EXT MANAGEMENT ACCOUNTING III May, 1999 R AFFLES E DUCATION G ROUP Kuala Lumpur w Petaling Jaya w Penang w Singapore w Jakarta w Bangkok w Beijing w London w New-York
  2. 2. School Of Accounting & Finance Management Accounting III T ABLE OF C ONTENTS TABLE OF CONTENTS............................................................................................................................... 2 ASSESSMENT............................................................................................................................................... 4 INDIVIDUAL ASSIGNMENT ............................................................................................................................ 4 MID-TERM E XAMINATION ............................................................................................................................ 4 TEAM PROJECT ............................................................................................................................................ 4 FINAL E XAMINATION ................................................................................................................................... 5 ATTENDANCE ............................................................................................................................................. 5 FEES .............................................................................................................................................................. 5 CONTACT-TIME ......................................................................................................................................... 6 FULL-TIME ................................................................................................................................................... 6 PART-TIME................................................................................................................................................... 6 THE ACADEMIC TEAM ............................................................................................................................. 7 THE ACADEMIC PLANNER ...................................................................................................................... 8 INTRODUCTION ......................................................................................................................................... 9 THE SUBJECT CORPORATE FINANCE ............................................................................................................ 9 WEEK 1 ....................................................................................................................................................... 10 WEEK 2 ....................................................................................................................................................... 13 WEEK 3 ....................................................................................................................................................... 18 WEEK 4 ....................................................................................................................................................... 21 WEEK 5 ....................................................................................................................................................... 24 WEEK 6 ....................................................................................................................................................... 29 WEEK 7 ....................................................................................................................................................... 32 WEEK 8 ...................................................................................................................................................... 35 WEEK 9 ....................................................................................................................................................... 36 WEEK 10 ..................................................................................................................................................... 39 WEEK 11 ..................................................................................................................................................... 42 WEEK 12 ..................................................................................................................................................... 45 Olympia Business School Page 2 SoAF PJ/CI//1999
  3. 3. School Of Accounting & Finance Management Accounting III HOW TO USE THE FILO TEXT ? The Filo-text is a tool to assist you in your study at Olympia Business School. It provides general information on the course structure and also details on the syllabus that you will be covering throughout your course. The general information, provided at the beginning of this document, includes information on the following: • Assessment • Attendance • Fees • Contact time • The academic team • The academic planner To assist you in your classes and revision, this filo-text also provides information on the topics you will be covering in each of the classes you will be attending. This information includes the following: • The topic • The objective(s) of the lecture • The textbook, the chapter(s) and page(s) related to the given topic • Other reference books available on the topic • Additional reference material for your own research • The objective(s) of the tutorial • Questions to prepare for discussion during the tutorial • Questions for your personal research and self-assessment Use the Filo-text to prepare yourself prior to the lecture, between the lecture and the tutorial and after the tutorial. Olympia Business School Page 3 SoAF PJ/CI//1999
  4. 4. School Of Accounting & Finance Management Accounting III A SSESSMENT Student assessment will be evaluated based on the following: 1) Individual Assignment 15 % 2) Mid-Term Examination 15 % 3) Team Project 20 % 4) Final Examination 50 % Total 100 % INDIVIDUAL ASSIGNMENT An individual assignment will be given to the student on the first week and will have to be returned no later than on the 8th week. The marked assignment will be returned to the student no later than on week 10. The assignment will be related to the topics covered between week 1 and week 6 inclusive. It will comprise a written report of approximately 500 words. Should the student fail to submit his/her assignment on week 8, the result will automatically be zero. MID-TERM EXAMINATION A mid-term examination will be conducted during the lecture session of week 10. It will assess the students’ knowledge and understanding of the topics covered up to week 8. The results, together with the answer scripts, will be returned to the students no later than on week 12. Should a student be absent without a valid apology, the result will automatically be zero. TEAM PROJECT A team project will be assigned to students during the first week. The team will comprise of 4 to 6 students. The report of the team project will have to be submitted to the subject lecturer by no later than week 12 and will be presented on week 13. Late submission won’t be entertained and will automatically result in no marks being awarded. Olympia Business School Page 4 SoAF PJ/CI//1999
  5. 5. School Of Accounting & Finance Management Accounting III FINAL EXAMINATION The final examination will be conducted two weeks after you have completed your syllabus. The examination will take 3 hours. Registration for the examination is open from week 5 and closes on week 8. Make sure you register on time. No late registration will be entertained. The format of the examination is as follows: • Section A - Short Questions 5 * 4 Points • Section C - Essay-type Questions Any 4 out of 6 * 20 Points • Total 100 Points A TTENDANCE Attendance for both the lectures and the tutorials is compulsory. Any student not attending a class should provide a medical certificate or a written justification (signed by a parent or guardian in the case of a full-time student). Should a student fail to do so, he / she will be considered truant. If a student’s attendance for a given subject is lower then 70%, he / she will not be allowed to sit for the final examination. Punctuality is equally important. The lecturer is entitled to refuse entry into the classroom to any student coming late for classes. F EES The registration fee is to be paid upon registration. The course fee is paid either in full, per semester or by instalments. For payments made in full, the payment is due before the first lecture. For payments made by semester, the payment per semester is due on the first day of the semester. For monthly instalments, the first payment is due on the first day of class while subsequent payments are due on the first day of each subsequent month. Should any student have difficulty to pay his / her fees on time, he / she must meet with the (Deputy) Principal to arrange an alternative. Any student who has not settled his / her fees and has not met with the (Deputy) Principal will not be allowed to attend classes or sit for an examination. Olympia Business School Page 5 SoAF PJ/CI//1999
  6. 6. School Of Accounting & Finance Management Accounting III C ONTACT -T IME FULL-TIME Classes are conducted over a period of 12 weeks. Contact time consists of 1 1/2 hours of lecture and 1 1/2 hours of tutorial per week. PART-TIME Classes are conducted over a period of 12 weeks. Contact time consists of 1 ½ hours of lecture per week. For each hour of contact, the student is expected to spend at least 2 hours of unsupervised work, either individually or in groups. Olympia Business School Page 6 SoAF PJ/CI//1999
  7. 7. School Of Accounting & Finance Management Accounting III T HE A CADEMIC T EAM At the beginning of the first lecture, please fill-in the following: Day Time Room Starting Finishing Lecture Lecturer Consultation Tutorial Tutor Consultation Class Lecturer Consultation Lecturer-in-Charge Consultation Principal Consultation Head of Department Consultation Subject Representative Olympia Business School Page 7 SoAF PJ/CI//1999
  8. 8. School Of Accounting & Finance Management Accounting III T HE A CADEMIC P LANNER This is an outline of the topics you will cover for this subject. Please ensure you fill-in the dates of the respective lectures during the first lecture. Week Date Lecture Topic 1 The Finance Function 2 Capital Markets, Market Efficiency and Ratio Analysis 3 Investment Appraisal: Application & risk (1 ) 4 Investment Appraisal: Application & risk (2 ) 5 Sources Of Long-term Finance: Equity Finance 6 Sources Of Long-term Finance: Debt Finance, Hybrid Finance, And Leasing 7 Sources Of Long-term Finance: Debt Finance, Hybrid Finance, And Leasing 8 Mid-term Exam 9 The Cost Of Capital And Capital Structure ( 1 ) 10 The Cost Of Capital And Capital Structure (2 ) 11 Working Capital Management ( 1 ) 12 Working Capital Management ( 2 ) 13/14 Final Examination Olympia Business School Page 8 SoAF PJ/CI//1999
  9. 9. School Of Accounting & Finance Management Accounting III I NTRODUCTION THE SUBJECT CORPORATE FINANCE Welcome to Corporate Finance Corporate finance is concerned with the financing and investment decisions made by the management of companies in pursuit of corporate goals. As a subject, corporate finance has a theoretical base which has evolved over many years and which continues to evolve. It has a practical side too, concerned with the study of how companies actually make financing and investment decisions, and it is often the case that theory and practice disagree. The value of an option depends upon the extent to which it contributes towards the achievement of corporate goals. In corporate finance, the fundamental goal is usually taken to be to increase the wealth of shareholders. Olympia Business School Page 9 SoAF PJ/CI//1999
  10. 10. School Of Accounting & Finance Management Accounting III WEEK 1 Lecture Subject: THE FINANCE FUNCTION Lecture Objectives: On completion of this lecture, the student will be able to understand: • The role of the financial manager • Corporate objectives • How is shareholders’ wealth maximized? • Agency theory • Corporate governance Textbook: Chapter(s) Pages “Corporate Finance”, Denzil Watson & Tony Head, Pitman 1 1 to 17 Publishing, 1998 Reference Books: Chapter(s) Pages Investment Appraisal & Financial decisions 3rd Edition By Stephen Lumby Capital Budgeting and Long –term financial Decisions 2nd Edition By Neil Seitz Additional Reference Material: 1) Weston, J. Fred, ‘New Theme in Finance,” Journal of Finance , March, 1974. 2) Myers, S. C. “ Finance Theory and Financial Strategy,” Midland corporation Finance Journal, Spring, 1987. Olympia Business School Page 10 SoAF PJ/CI//1999
  11. 11. School Of Accounting & Finance Management Accounting III Tutorial Subject: THE FINANCE FUNCTION Tutorial Objectives: On completion of this tutorial, the student will have: • The role of the financial manager • Corporate objectives • How is shareholders’ wealth maximized? • Agency theory • Corporate governance Questions to prepare for discussion during the tutorial: 1) What are the functions and areas of responsibility that fall under the control of the financial manager? 2) Give examples to illustrate the high level of interdependence existing between the different decision areas of corporate finance. 3) Given the following possible corporate objectives, provide a rational argument explaining which of them should be the main goal of the financial manager: (a) profit maximisation (b) sales maximisation (c) maximisation of benefit to employees and the local community (d) maximisation of shareholder wealth 4) Explain how a financial manager can, in practice, maximise the wealth of shareholders. 5) Give some examples of good financial management. 6) Which of the following will not lead to a reduction of agency problems experienced by shareholders? (a) increased monitoring by shareholders (b) salary bonuses for management based on financial performance (c) the granting of share options to management (d) the use of restrictive covenants in bond deeds (e) the use of shorter contracts for management 7) What is meant by the ‘agency problem’ in the context of a public limited company? 8) How is it possible for the agency problem to be reduced in a company? 9) What goals might be pursued by managers instead of maximisation of shareholder wealth? 10) Do you consider the agency problem to be of particular relevance to UK public limited companies? Olympia Business School Page 11 SoAF PJ/CI//1999
  12. 12. School Of Accounting & Finance Management Accounting III Questions available for self-assessment: 1) The primary financial objective of a company is stated by corporate finance theory to be the maximisation of the wealth of its shareholders, but this objective is usually replaced by the surrogate objective of maximisation of the company’s share price. Discuss the ways in which this substitution can be justified. 2) Explain why maximisation of a company’s share price is preferred as a financial objective to the maximisation of its sales. 3) Discuss the ways in which the concepts of agency theory can be used to explain the relationships that exist between the managers of a listed company and the providers of its equity finance. Your answer should include an explanation of the following terms: (a) asymmetry of information (b) agency costs (c) the free-rider problem 4) Discuss ways in which the shareholders of a company can encourage its managers to act in a way which is consistent with the objective of maximisation of shareholder wealth. 5) The primary financial objective of financial management is usually taken to be the maximisation of shareholder wealth. Discuss what other objectives may be important to a public limited company and whether such objectives are consistent with the primary objective of shareholder wealth maximisation. 6) Discuss the significance of the Cadbury Report in the context of corporate governance in the UK. Have its recommendations led to improvements? Olympia Business School Page 12 SoAF PJ/CI//1999
  13. 13. School Of Accounting & Finance Management Accounting III WEEK 2 Lecture Subject: CAPITAL MARKETS, MARKET EFFICIENCY AND RATIO ANALYSIS Lecture Objectives: On completion of this lecture, the student will be able to: • Sources of business finance • The capital markets • Ratio analysis Textbook: Chapter(s) Pages Corporate Finance”, Denzil Watson & Tony Head, Pitman 2 23 to 44 Publishing, 1998 Reference Books: Chapter(s) Pages Investment Appraisal & Financial decisions 3rd Edition By Stephen Lumby Capital Budgeting and Long –term financial Decisions 2nd Edition By Neil Seitz Additional Reference Material: 1) Weston, J. Fred, ‘New Theme in Finance,” Journal of Finance , March, 1974. 2) Myers, S. C. “ Finance Theory and Financial Strategy,” Midland corporation Finance Journal, Spring, 1987. Olympia Business School Page 13 SoAF PJ/CI//1999
  14. 14. School Of Accounting & Finance Management Accounting III Tutorial Subject: CAPITAL MARKETS, MARKET EFFICIENCY AND RATIO ANALYSIS Tutorial Objectives: On completion of this tutorial, the student will have: • Sources of business finance • The capital markets • Ratio analysis Questions to prepare for discussion during the tutorial: 1) Explain the difference between retained earnings and retained profit. 2) Describe the factors that influence the relative proportions of internal and external finance used in capital investment. 3) What is the relevance of the efficient market hypothesis for corporate financial managers? 4) Which of the following statements about the efficient market hypothesis is not correct? (a) if the stock market shows weak form efficiency, then chartists cannot make consistently superior returns; (b) if the market is strong form efficient, only people with insider information can beat the market; (c) if the market is semi-strong form efficient, then fundamental analysis will not bring abnormal returns to analysts; (d) if the market is semi-strong form efficient, all past and current publicly available information is reflected in the share price; (e) if the market is weak form efficient, then all historic information about a share is embodied in its current market price. 5) Describe the features of a perfect capital market. 6) Explain the difference between allocational efficiency, pricing efficiency and operational efficiency. 7) Why is it difficult to test for strong form efficiency? 8) Describe the different benchmarks that can be used for ratio analysis. 9) Describe the five categories of ratios and list and define the ratios in each category. In each case, without referring to the calculations in the text, calculate the relevant ratio for Boater plc. Olympia Business School Page 14 SoAF PJ/CI//1999
  15. 15. School Of Accounting & Finance Management Accounting III 10) What are the potential problems associated with using ratio analysis to analyse the financial health and performance of companies? 11) Questions available for self-assessment: 1) Distinguish between the primary and secondary capital markets in the UK and discuss the role played by these markets in financial management. What are the desirable characteristics of primary and secondary capital markets? 2) While there is a large body of evidence in support of the efficient market hypothesis, it has been suggested that this evidence only shows that it is not possible to prove that markets are inefficient. Recent research has explored ‘anomalies’ in the behaviour of prices of securities. Briefly describe these anomalies and suggest possible explanations. 3) The following financial statements are extracts from the accounts of Hoult plc. Profit and loss accounts for years ending 31 December 1995 1996 1997 $000 $000 $000 Sales 960 1080 1220 Cost of sales 670 780 885 Gross profit 290 300 335 Administration expenses 260 270 302 Operating profit 30 30 33 Interest 13 14 18 Profit before taxation 17 16 15 Taxation 2 1 1 Profit after taxation 15 15 14 Dividends 0 0 4 Retained profit 15 15 10 Olympia Business School Page 15 SoAF PJ/CI//1999
  16. 16. School Of Accounting & Finance Management Accounting III Balance sheets for years to 31 December 1995 1996 1997 $000 $000 $000 $000 $000 $000 Net fixed assets 160 120 100 Current assets: Stock 200 210 225 Debtors 160 180 250 Cash 0 0 0 360 390 475 Current liabilities: Trade creditors 75 80 145 Overdraft 70 80 110 145 160 255 Net current assets 215 230 220 Total assets less current liabilities 375 350 320 8% debentures 120 80 40 255 270 280 Capital and reserves: Ordinary shares 160 160 160 Profit and loss 95 110 120 255 270 280 The 8% debentures are redeemable in installments and the final installment is due to be paid in 1998. Olympia Business School Page 16 SoAF PJ/CI//1999
  17. 17. School Of Accounting & Finance Management Accounting III The finance director is concerned about the poor liquidity of Hoult plc. and has asked you to report on the company’s recent performance. After calculating appropriate ratios, comment on the performance and financial health of Hoult plc. 4) You have been approached by Mr. Dayton, who is seeking advice about his investment portfolio. He is considering purchasing shares in companies listed on either the Unlisted Securities Market or the Alternative Investment Market. Mr. Green, a friend of Mr. Dayton, has told him that he should invest only in shares that are listed on markets that are efficient, since otherwise he cannot be sure that he is paying a fair price for them. Mr. Dayton has explained to you that he is not sure what an ‘efficient’ market is. 5) Critically discuss the following statements about stock market efficiency. (a) The weak form of the efficient market hypothesis implies that it is possible for an investor to generate abnormal returns by analysing changes in past share prices. (b) The semi-strong form of the efficient market hypothesis implies that it is possible for an investor to earn superior returns by studying company accounts, newspapers and investment journals, or by purchasing reports from market analysts. (c) The strong form of the efficient market hypothesis implies that since security prices reflect all available information, there is no way that investors can achieve abnormal returns. 6) Discuss the importance of the efficient market hypothesis to the following parties: (a) shareholders concerned about the maximisation of their wealth; (b) corporate financial managers making capital investment decisions; and (c) investors analysing the annual reports of listed companies. Olympia Business School Page 17 SoAF PJ/CI//1999
  18. 18. School Of Accounting & Finance Management Accounting III WEEK 3 Lecture Subject: INVESTMENT APPRAISAL: APPLICATION & RISK (1) Lecture Objectives: On completion of this lecture, the student will be able to: • Relevant project cash flows • Taxation and capital investment decisions • Inflation and capital investment decisions • Investment appraisal and risk Textbook: Chapter(s) Pages Corporate Finance”, Denzil Watson & Tony Head, Pitman 4 83 to100 Publishing, 1998 Reference Books: Chapter(s) Pages Investment Appraisal & Financial decisions 3rd Edition By Stephen Lumby Capital Budgeting and Long –term financial Decisions 2nd Edition By Neil Seitz Additional Reference Material: 1) Weston, J. Fred, ‘New Theme in Finance,” Journal of Finance , March, 1974. 2) Myers, S. C. “ Finance Theory and Financial Strategy,” Midland corporation Finance Journal, Spring, 1987. Olympia Business School Page 18 SoAF PJ/CI//1999
  19. 19. School Of Accounting & Finance Management Accounting III Tutorial Subject: INVESTMENT APPRAISAL : APPLICATION & RISK Tutorial Objectives: On completion of this tutorial, the student will have: • Relevant project cash flows • Taxation and capital investment decisions • Inflation and capital investment decisions • Investment appraisal and risk Questions to prepare for discussion during the tutorial: 1) A machine is to be purchased by Blake Ltd for $100 000. The expected life of the machine is four years, at the end of which it will have zero value and will be scrapped. Blake Ltd. pays corporation tax at a rate of 33% and its discount rate for investment purposes is 8%. What are the present values of the tax benefits arising to Blake Ltd from the purchase of the machine in the following circumstances: (a) first year capital allowances of 100% are available; (b) capital allowances are available on a straight-line basis over the asset’s life; (c) capital allowances are available on a 25% reducing balance basis? 1) Discuss which cash flows are relevant to investment appraisal calculations. 2) Explain, with the aid of a short example, how 25% reducing balance capital allowances are calculated. 3) Explain the difference between the nominal (or money) terms approach and the real terms approach to dealing with inflation in the context of investment appraisal. Olympia Business School Page 19 SoAF PJ/CI//1999
  20. 20. School Of Accounting & Finance Management Accounting III Questions available for self-assessment: 1) Explain whether general or specific inflation should be taken into account in investment appraisal. 2) Explain the difference between risk and uncertainty. 3) Critically discuss the use of the following techniques as methods of dealing with risk in the appraisal of capital investment projects: a) Sensitivity analysis b) Risk-adjusted discount rate c) Adjusted payback d) Monte Carlo methods. Olympia Business School Page 20 SoAF PJ/CI//1999
  21. 21. School Of Accounting & Finance Management Accounting III WEEK 4 Lecture Subject: AN OVERVIEW OF INVESTMENT APPRAISAL METHODS (2) Lecture Objectives: On completion of this lecture, the student will be able to: • The problem of unequal project lives • Empirical investigation of investment appraisal • Calculation of an optimum replacement cycle Textbook: Chapter(s) Pages “Corporate Finance” Co, Denzil Watson & Tony Head, 4 100 to 112 Pitman Publishing, 1998 Reference Books: Chapter(s) Pages Investment Appraisal & Financial decisions 3rd Edition By Stephen Lumby Capital Budgeting and Long –term financial Decisions 2nd Edition By Neil Seitz Additional Reference Material: 1) Weston, J. Fred, ‘New Theme in Finance,” Journal of Finance , March, 1974. 2) Myers, S. C. “ Finance Theory and Financial Strategy,” Midland corporation Finance Journal, Spring, 1987. Olympia Business School Page 21 SoAF PJ/CI//1999
  22. 22. School Of Accounting & Finance Management Accounting III Tutorial Subject: INVESTMENT APPRAISAL: APPLICATION & RISK (2) Tutorial Objectives: On completion of this tutorial, the student will have: • The problem of unequal project lives • Empirical investigation of investment appraisal • Calculation of an optimum replacement cycle Questions to prepare for discussion during the tutorial: 1) The financial manger of Logar plc is considering the purchase of a finishing machine which will improve the appearance of the company’s range of decorated fudges. She expects that the improved output will lead to increased sales of $110 000 per year for a period of five years. At the end of the five-year period, the machine will be scrapped. Two machines are being considered and the relevant financial information on the capital investment proposal form is as follows: Machine A Machine B Initial cost ($) 200 000 250 000 Labour cost ($ per year) 10 000 7 000 Power cost ($ per year) 9 000 4 000 Scrap value ($) Nil 25 000 The following forecasts of average annual rates of inflation have been prepared by the planning department of Logar plc: Sales prices: 6% per year Labour costs: 5% per year Power costs: 3% per year Logar plc pays corporation tax of 31% one year in arrears and has a nominal after-tax cost of capital of 15%. Capital allowances are available on a 25% reducing balance basis. Advise the financial manager of Logar plc on her choice of machine. Olympia Business School Page 22 SoAF PJ/CI//1999
  23. 23. School Of Accounting & Finance Management Accounting III 2) Discuss how sensitivity analysis can help management to assess the risk of an investment project. 3) Why is payback commonly used as a way of dealing with risk in investment projects? 4) Discuss the use of risk-adjusted discount rates in the evaluation of investment projects. Questions available for self-assessment: 1) Explain the meaning of the term ‘Monte Carlo simulation’. 2) Explain the difference between the lowest common multiple (LCM) and the equivalent annual cost (EAC) methods of deciding when to replace identical assets. 3) Nodil Ltd wishes to determine the optimal replacement cycle for its capping machine. The finance department has estimated the following costs and resale values for the next four years. Year 0 1 2 3 4 Initial (50 000) investment ($) Operating (14 000) (17 000) (20 000) (24 000) costs ($) Maintenance (3 000) (4 500) (7 000) costs ($) Scrap value (30 000) (18 000) (11 000) (6 000) ($) If the cost of capital of Notodil Ltd is 12%, determine the optimum replacement cycle using: (a) the equivalent annual cost method; (b) the lowest common multiple method. Olympia Business School Page 23 SoAF PJ/CI//1999
  24. 24. School Of Accounting & Finance Management Accounting III WEEK 5 Lecture Subject: SOURCES OF LONG-TERM FINANCE: EQUITY FINANCE Lecture Objectives: On completion of this lecture, the student will be able to: • Equity finance • The new issues market • Rights issues • Scrip issues, stock splits, scrip dividends and share repurchases • Preference shares Textbook: Chapter(s) Pages “Corporate Finance” Co, Denzil Watson & Tony Head, 5 122 to 136 Pitman Publishing, 1998 Reference Books: Chapter(s) Pages Investment Appraisal & Financial decisions 3rd Edition By Stephen Lumby Capital Budgeting and Long –term financial Decisions 2nd Edition By Neil Seitz Additional Reference Material: 1) Weston, J. Fred, ‘New Theme in Finance,” Journal of Finance , March, 1974. 2) Myers, S. C. “ Finance Theory and Financial Strategy,” Midland corporation Finance Journal, Spring, 1987 Olympia Business School Page 24 SoAF PJ/CI//1999
  25. 25. School Of Accounting & Finance Management Accounting III Tutorial Subject: SOURCES OF LONG-TERM FINANCE: EQUITY FINANCE Tutorial Objectives: On completion of this tutorial, the student will have: • Equity finance • The new issues market • Rights issues • Scrip issues, stock splits, scrip dividends and share repurchases • Preference shares Questions to prepare for discussion during the tutorial: 1) Explain the reason why the return required by ordinary shareholders is different from the return required by debenture holders. 2) Briefly outline some of the important rights of shareholders. 3) Briefly explain the various ways in which a company may obtain a quotation for its ordinary shares on the London Stock Exchange. 4) Outline the advantages and disadvantages which should be considered by a currently unquoted company which is considering obtaining a listing on a recognised stock exchange. 5) What are pre-emptive rights and why are they important to shareholders? 6) Discuss the advantages and disadvantages of a rights issue to a company. 7) XTC is planning a 1 for 4 rights issue at a 20% discount to the current market price of $2.50. If an investor is to sell their ‘rights per share’ how much should they sell it for? (a) 10 cents (b) 20 cents (c) 30 cents (d) 40 cents (e) 50 cents 8) ‘A conversion of existing capital reserves into ordinary shares, which are then distributed pro rata to existing shareholders’. This statement best defines: (a) scrip dividends (b) a rights issue (c) bonus bonds (d) scrip issues (e) stock splits Olympia Business School Page 25 SoAF PJ/CI//1999
  26. 26. School Of Accounting & Finance Management Accounting III 9) Explain why preference shares do not enjoy great popularity as a source of finance for companies. 2) Which one of the following statements best describes a cumulative preference share? (a) It has the right to be converted into ordinary shares at a future date. (b) It entitles the shareholder to a share of residual profits. (c) It carries forward the right to receive unpaid dividends to the next year. (d) It entitles the shareholder to a fixed rate of dividend. (e) It gives its holder voting rights at a company’s annual general meeting. Olympia Business School Page 26 SoAF PJ/CI//1999
  27. 27. School Of Accounting & Finance Management Accounting III Questions available for self-assessment: 1) Brand plc. generates profit after taxation of 15% on shareholders’ funds. Its current capital structure is as follows: $ Ordinary shares of 50 cents each 200 000 Share premium 87 500 Reserves 312 500 600 000 The board of Brand plc. wishes to raise $160 000 from a rights issue in order to expand existing operations. Its return on shareholders’ funds will be unchanged. The current ex-dif market price of Brand plc. is $1.90. Three different rights issue prices have been suggested by the finance director: $1.80, $1.60 and $1.40. Determine the number of shares to be issued, the theoretical ex-rights price, the expected earnings per share and the form of the issue for each rights issue price. Comment on your results. 2) Maltby plc., a company quoted on the London Stock Exchange, has been making regular annual after-tax profits of $7 000 000 for some years and has the following long-term capital structure. $000 Ordinary shares, 50 cents each 4 000 16% debentures 9 000 13 000 The debenture issue is not due to be redeemed for some time and the company has become increasingly concerned about the need to continue paying interest at 16% when the interest rate on newly issued government stock of a similar maturity is only 7%. A proposal has been made to issue 2 000 000 new shares in a rights issue, at a discount of 20% to the current share price of Maltby plc, and to use the funds raised to pay off part of the debenture issue. The current share price of Maltby plc is $3.50 and the current market price of the debentures is $112 per $100 block. Olympia Business School Page 27 SoAF PJ/CI//1999
  28. 28. School Of Accounting & Finance Management Accounting III Alternatively, the funds raised by the rights issue could be invested in a new project giving an annual after-tax return of 20%. Whichever option is undertaken, the stock market view of the company’s prospects will be unchanged and its P/E ratio will remain unchanged. Maltby plc. pays corporation tax at a rate of 31%. By considering the effect on the share price of the two alternative proposals, discuss whether the proposed rights issue can be recommended as being in the best interests of the ordinary shareholders of Maltby plc. Your answer should include all relevant calculations. 3) It has become increasingly common for companies to offer their shareholders a choice between a cash dividend or an equivalent scrip issue of shares. Briefly consider the advantages of scrip dividends from the point of view of: (a) the company (b) the shareholders Olympia Business School Page 28 SoAF PJ/CI//1999
  29. 29. School Of Accounting & Finance Management Accounting III WEEK 6 Lecture Subject: SOURCES OF LONG-TERM FINANCE: DEBT FINANCE, HYBRID FINANCE, AND LEASING ( 1) Lecture Objectives: On completion of this lecture, the student will be able to: • Loan Stock and debentures • Bank and institutional debt • International debt finance • Hybrid finance Textbook: Chapter(s) Pages Corporate Finance” Co, Denzil Watson & Tony Head, 6 145 to 150 Pitman Publishing, 1998 Reference Books: Chapter(s) Pages Investment Appraisal & Financial decisions 3rd Edition By Stephen Lumby Capital Budgeting and Long –term financial Decisions 2nd Edition By Neil Seitz Additional Reference Material: 1) Weston, J. Fred, ‘New Theme in Finance,” Journal of Finance , March, 1974. 2) Myers, S. C. “ Finance Theory and Financial Strategy,” Midland corporation FinanceJournal,Spring,1987 Olympia Business School Page 29 SoAF PJ/CI//1999
  30. 30. School Of Accounting & Finance Management Accounting III Tutorial Subject: SOURCES OF LONG-TERM FINANCE: DEBT FINANCE, HYBRID FINANCE, AND LEASING Tutorial Objectives: On completion of this tutorial, the student will have: • Loan Stock and debentures • Bank and institutional debt • International debt finance • Hybrid finance Questions to prepare for discussion during the tutorial: 1) Discuss briefly the key features of debentures and ordinary loan stock. 2) Briefly explain what is meant by the following terms that refer to fixed interest debt securities: (a) restrictive covenant (b) debenture sinking fund (c) redemption window 3) Explain the meaning of the following terms and state the circumstances under which their issue would be beneficial to lenders and borrowers: (a) deep discount bonds (b) zero coupon bonds (c) warrants (d) convertible loan stock 4) What are the advantages and disadvantages of raising finance by issuing Eurobonds? 5) Explain the difference between a conversion premium and a rights premium with respect to a convertible debenture. Olympia Business School Page 30 SoAF PJ/CI//1999
  31. 31. School Of Accounting & Finance Management Accounting III Questions available for self-assessment: 1) Bugle plc has some surplus funds that it wishes to invest in corporate bonds. The company requires a return of 15% on such bonds, and you have been asked to advise on whether it should invest in either of the following stocks which have been offered to it: (a) Stock 1: 12% debentures redeemable at par at the end of 2 more years, current market value per $100 block is $95. (b) Stock 2: 8% debentures redeemable at $110 at the end of 2 more years, current market value per $100 block is also $95. 2) Discuss, with the aid of a diagram, the relationship between the conversion premium, the rights premium and the market value of a convertible debenture. 3) Discuss the reasons for the growth in popularity of leasing during the last 15 years. What significant changes affecting leasing occurred in 1984? Olympia Business School Page 31 SoAF PJ/CI//1999
  32. 32. School Of Accounting & Finance Management Accounting III WEEK 7 Lecture Subject: SOURCES OF LONG-TERM FINANCE: DEBT FINANCE, HYBRID FINANCE, AND LEASING ( 2 ) Lecture Objectives: On completion of this lecture, the student will be able to: • The valuation of fixed interest debt securities • The valuation of convertible loan stock • Leasing Chapter(s) Pages Textbook: Corporate Finance” Co, Denzil Watson & Tony Head, 6 153 to157 Pitman Publishing, 1998 Chapter(s) Pages Reference Books: Investment Appraisal & Financial decisions 3rd Edition By Stephen Lumby Capital Budgeting and Long –term financial Decisions 2nd Edition By Neil Seitz Additional Reference Material: 1) Weston, J. Fred, ‘New Theme in Finance,” Journal of Finance , March, 1974. 2) Myers, S. C. “ Finance Theory and Financial Strategy,” Midland corporation FinanceJournal,Spring,1987 Olympia Business School Page 32 SoAF PJ/CI//1999
  33. 33. School Of Accounting & Finance Management Accounting III Tutorial Subject: SOURCES OF LONG-TERM FINANCE: DEBT FINANCE, HYBRID FINANCE, AND LEASING Tutorial Objectives: On completion of this tutorial, the student will have: • The valuation of fixed interest debt securities • The valuation of convertible loan stock • Leasing Questions to prepare for discussion during the tutorial: 1) A company has in issue a 10% debenture, redeemable at the option of the company between one and five years from now. What factors do you think will be considered by the company in reducing a decision on when to redeem the debenture? 2) Briefly outline the advantages and disadvantages to a company of issuing convertible loan stock? 3) What is the gearing effect of warrants? 4) A company has in issue some 9% debentures, which are redeemable at par in 3 years time. Investors now require an interest yield of 10%. What will be the current ex-interest market value of $100 worth of debentures? What would the current ex-interest market value be if the issue had been one of irredeemable loan stock? Olympia Business School Page 33 SoAF PJ/CI//1999
  34. 34. School Of Accounting & Finance Management Accounting III Questions available for self-assessment: 1 ) Discuss the reasons for the growth in popularity of leasing during the last 15 years. What significant changes affecting leasing occurred in 1984? 2 ) Explain the difference between a finance lease and an operating lease, and discuss the importance of the distinction for corporate finance? Olympia Business School Page 34 SoAF PJ/CI//1999
  35. 35. School Of Accounting & Finance Management Accounting III WEEK 8 MID-TERM EXAMINATION Olympia Business School Page 35 SoAF PJ/CI//1999
  36. 36. School Of Accounting & Finance Management Accounting III WEEK 9 Lecture Subject: THE COST OF CAPITAL AND CAPITAL STRUCTURE (1) Lecture Objectives: On completion of this lecture, the student will be able to: • Calculating the cost of individual sources of finance • Calculating the weighted average cost of capital • Average vs marginal cost of capital • The practical application of WACC • Gearing: its measurement and implications • The concept of an optimal capital structure • The traditional approach to capital structure Chapter(s) Pages Textbook: Corporate Finance” Co, Denzil Watson & Tony Head, 8 198 to 213 Pitman Publishing, 1998 Reference Books: Chapter(s) Pages Investment Appraisal & Financial decisions 3rd Edition By Stephen Lumby Capital Budgeting and Long –term financial Decisions 2nd Edition By Neil Seitz Additional Reference Material: 1) Weston, J. Fred, ‘New Theme in Finance,” Journal of Finance , March, 1974. 2) Myers, S. C. “ Finance Theory and Financial Strategy,” Midland corporation FinanceJournal,Spring,1987 Olympia Business School Page 36 SoAF PJ/CI//1999
  37. 37. School Of Accounting & Finance Management Accounting III Tutorial Subject: THE COST OF CAPITAL AND CAPITAL STRUCTURE Tutorial Objectives: On completion of this tutorial, the student will have: • Calculating the cost of individual sources of finance • Calculating the weighted average cost of capital • Average vs marginal cost of capital • The practical application of WACC • Gearing: its measurement and implications • The concept of an optimal capital structure • The traditional approach to capital structure Questions to prepare for discussion during the tutorial: 1) Gorky plc has in issue 500 000 $1 ordinary shares whose current ex-dividend market price is $1.50 per share. The company has just paid a dividend of 27 cents per share, and dividends are expected to continue at this level for some time. If the company has no debt capital, what is the weighted average cost of capital? 2) Five years ago, Eranio plc issued 12% irredeemable debentures at $103, a $3 premium to their par value of $100. The current market price of these debentures is $94. If the company pays corporation tax at a rate of 35 % what is its current cost of debenture capital? 3) Pollock plc has a capital structure consisting of 1 million ordinary shares, par value 25 cents and $100 000 of 10% irredeemable debentures. The current ex-dividend market price of the ordinary shares is 49 cents per share, and the current ex-interest market price of the debentures is $72 per $100 block. The company has just paid a dividend of 9 cents per share and dividends are expected to continue at this level indefinitely. If the company pays corporation tax at a rate of 33 %, what is its weighted average cost of capital? 4) Should companies use their weighted average cost of capital as the discount rate when assessing the acceptability of new projects? 5) A company incorporates increasing amounts of debt finance into its capital structure while leaving its operating risk unchanged. Assuming that a perfect capital market exists with no taxation, will the company’s weighted average cost of capital: (a) fall slowly (b) fall quickly (c) remain the same Olympia Business School Page 37 SoAF PJ/CI//1999
  38. 38. School Of Accounting & Finance Management Accounting III (d) fall to a minimum and then rise (e) rise steadily Questions available for self-assessment: 1) Smith plc, a quoted company, has the following long-term capital structure: $000 Ordinary shares, 50 cents each 4000 16% debentures 9000 13000 The current share price of Smith plc is $3.50 and the current market price of the debentures is $112 per $100 block. Smith plc pays corporation tax at a rate of 33%. Calculate the capital gearing of Smith plc based on (a) market values, and (b) book values, and discuss why a market-based estimate of capital gearing is generally considered to be superior. 2) The calculation of WACC is straightforward in theory, but in practice is not an easy task. Outline any possible difficulties that might be experienced when trying to calculate WACC. Olympia Business School Page 38 SoAF PJ/CI//1999
  39. 39. School Of Accounting & Finance Management Accounting III WEEK 10 Lecture Subject: THE COST OF CAPITAL AND CAPITAL STRUCTURE (2) Lecture Objectives: On completion of this lecture, the student will be able to: • Miller & Modigliani (I) – net income approach • Miller & Modigliani (II) and market imperfections • Miller and personal taxation • Peeking order theory • Does an optimal capital structure exist? Textbook: Chapter(s) Pages Corporate Finance” Co, Denzil Watson & Tony Head, 8 214 to 222 Pitman Publishing, 1998 Reference Books: Chapter(s) Pages Investment Appraisal & Financial decisions 3rd Edition By Stephen Lumby Capital Budgeting and Long –term financial Decisions 2nd Edition By Neil Seitz Additional Reference Material: 1) Weston, J. Fred, ‘New Theme in Finance,” Journal of Finance , March, 1974. 2) Myers, S. C. “ Finance Theory and Financial Strategy,” Midland corporation Finance Journal, Spring, 1987 Olympia Business School Page 39 SoAF PJ/CI//1999
  40. 40. School Of Accounting & Finance Management Accounting III Tutorial Subject: THE COST OF CAPITAL AND CAPITAL STRUCTURE Tutorial Objectives: On completion of this tutorial, the student will have: • Miller & Modigliani (I) – net income approach • Miller & Modigliani (II) and market imperfections • Miller and personal taxation • Peeking order theory • Does an optimal capital structure exist? Questions to prepare for discussion during the tutorial: 1) One-third of the total market value of Johnson plc consists of loan stock, which has a cost of 10%. Another company, York, is identical in every aspect to Johnson plc, except that its capital structure is all-equity, and its cost of equity is 16%. According to Modigliani and Miller, if we ignored taxation and tax relief on debt capital, what would be the cost of equity of Johnson plc? 2) Which of the following statements concerning capital structure is incorrect? (a) Bankruptcy risk is ignored in Miller and Modigliani”s first model. (b) Debt holders are not subject to the effects of financial risk. (c) The traditional approach assumes that capital markets are perfect. (d) Miller and Modigliani’s second paper takes into account the effects of corporate taxation. (e) Miller and Modigliani’s first model argues that no optimal capital structure exists and supports this proposition with arbitrage theory. 3) If a company finds that its cost of capital has changed does this affect the profitability of the company? 4) What is the significance of the arbitrage proof for Miller and Modigliani’s first paper on the cost of capital? Olympia Business School Page 40 SoAF PJ/CI//1999
  41. 41. School Of Accounting & Finance Management Accounting III Questions available for self-assessment: 1) Critically discuss whether you consider that companies, by integrating a sensible level of gearing into their capital structure, can minimise their weighted average cost of capital. 2) Briefly explain the traditional view that an optimal capital structure exists. Olympia Business School Page 41 SoAF PJ/CI//1999
  42. 42. School Of Accounting & Finance Management Accounting III WEEK 11 Lecture Subject: WORKING CAPITAL MANAGEMENT (1) Lecture Objectives: On completion of this lecture, the student will be able to: • The objectives of working capital management • Working capital policies • Working capital and the cash conversion cycle • Over trading Textbook: Chapter(s) Pages Corporate Finance” Co, Denzil Watson & Tony Head, 10 267 to 275 Pitman Publishing, 1998 Reference Books: Chapter(s) Pages Investment Appraisal & Financial decisions 3rd Edition By Stephen Lumby Capital Budgeting and Long –term financial Decisions 2nd Edition By Neil Seitz Additional Reference Material: 1) Weston, J. Fred, ‘New Theme in Finance,” Journal of Finance , March, 1974. 2) Myers, S. C. “ Finance Theory and Financial Strategy,” Midland corporation Finance Journal, Spring, 1987 Olympia Business School Page 42 SoAF PJ/CI//1999
  43. 43. School Of Accounting & Finance Management Accounting III Tutorial Subject: WORKING CAPITAL MANAGEMENT Tutorial Objectives: On completion of this tutorial, the student will have: • The objectives of working capital management • Working capital policies • Working capital and the cash conversion cycle • Over trading Questions to prepare for discussion during the tutorial: 1) Explain the different strategies a firm may follow in order to finance its cumulative capital requirements. 2) Describe the cash conversion cycle and explain its significance in determining the working capital needed by a company. 3) Describe the strategies that could be followed by a company seeking to deal with the problem of over trading. 4) Explain the difference between factoring and invoice discounting. 5) Discuss the possible reasons why a company might experience cash flow problems and suggest ways in which such problems might be alleviated. 6) Explain why a company may choose to have reserves of cash. 7) Discuss ways in which a company might invest its short-term cash surpluses, explaining 8) briefly the factors which it should consider in making its selection. 9) How might the creditworthiness of a new customer be checked? 10) Is it worth offering discounts to debtors to encourage prompt payment? 11) Suggest ways in which companies can exercise control over their levels of working capital. Olympia Business School Page 43 SoAF PJ/CI//1999
  44. 44. School Of Accounting & Finance Management Accounting III Questions available for self-assessment: 1) Sec plc. uses a large quantity of salt in its production process. Annual consumption is 60 000 tonnes over a 50-week working year. It costs $100 to initiate and process an order and delivery follows 2 weeks later. Storage costs for the salt are estimated at 10 cents per tonne per annum. The current practice is to order twice a year when the stock falls to 10 000 tonnes. Recommend an appropriate ordering policy for Sec plc, and contrast it with the cost of the current policy. 2) MW Ltd has budgeted its sales to be $700 000 per annum. Its costs as a percentage of sales are as follows: % Raw materials 20 Direct labour 35 Overheads 15 Raw materials are carried in stock for two weeks and finished goods are held in stock before sale for three weeks. Production takes 4 weeks. MW Ltd takes 4 weeks credit from suppliers and gives 8 weeks credit to its customers. If both overheads and production are incurred evenly throughout the year, what is MW Ltd’s total working capital requirement? 3) A company is considering offering a discount for payment within 10 days to its customers, who currently pay after 45 days. Only 40% of credit customers would take the discount, although administrative cost savings of $4450 per year would be gained. If sales, which are unaffected by the discount, are $1 600 000 per year and the cost of short-term finance is 11%, what is the maximum discount that could be offered? Olympia Business School Page 44 SoAF PJ/CI//1999
  45. 45. School Of Accounting & Finance Management Accounting III WEEK 12 Lecture Subject: WORKING CAPITAL MANAGEMENT (2) Lecture Objectives: On completion of this lecture, the student will be able to: • The management of stock • The management of cash • The management of debtors Textbook: Chapter(s) Pages Corporate Finance” Co, Denzil Watson & Tony Head, 10 276 to 284 Pitman Publishing, 1998 Reference Books: Chapter(s) Pages Investment Appraisal & Financial decisions 3rd Edition By Stephen Lumby Capital Budgeting and Long –term financial Decisions 2nd Edition By Neil Seitz Additional Reference Material: 1) Weston, J. Fred, ‘New Theme in Finance,” Journal of Finance , March, 1974. 2) Myers, S. C. “ Finance Theory and Financial Strategy,” Midland corporation Finance Journal, Spring, 1987 Olympia Business School Page 45 SoAF PJ/CI//1999
  46. 46. School Of Accounting & Finance Management Accounting III Tutorial Subject: WORKING CAPITAL MANAGEMENT Tutorial Objectives: On completion of this tutorial, the student will have: • The management of stock • The management of cash • The management of debtors • Questions to prepare for discussion during the tutorial: 1) Explain why a company may choose to have reserves of cash. 2) Discuss ways in which a company might invest its short-term cash surpluses, explaining briefly the factors which it should consider in making its selection. 3) How might the creditworthiness of a new customer be checked? 4) Is it worth offering discounts to debtors to encourage prompt payment? 5) Suggest ways in which companies can exercise control over their levels of working capital. Questions available for self-assessment: 1) A company is considering offering a discount for payment within 10 days to its customers, who currently pay after 45 days. Only 40% of credit customers would take the discount, although administrative cost savings of $4450 per year would be gained. If sales, which are unaffected by the discount, are $1 600 000 per year and the cost of short-term finance is 11%, what is the maximum discount that could be offered? Olympia Business School Page 46 SoAF PJ/CI//1999

×