Question

2. Sales numbers are determined by both a volume component and price component. Projecting prices depends on factors specific to the firm and its industry that might affect demand and price elasticity. Discuss whether it would be likely that the firm would be able to raise future prices for different types of business.

. As an analyst it is important when projecting sales to make estimates about future changes in sales volume. Compare how you might make estimates about future sales value for a company in different stage of life cycle.

4, Calculate the firm's cost of equity capital using the CAPM model.

6. Why a firm’s dividend policy is irrelevant? Discuss the key assumption in the theory.

Answer 1

Projecting the prices can be done by business in various ways

It's important to find out what your competitors offer and what they charge. If you phone your rivals and ask them for a quote, you can use this information as a framework.

It's probably unwise to set your prices too much higher or lower without a good reason. If you price too low, you will just be throwing away profit. If you price too high, you will lose customers, unless you can offer them something they can't get elsewhere.

The perception of your product or service is also important. In many markets, a high price contributes to the perception of your product as being of premium value. This might encourage customers to buy from you - or it might deter price-conscious customers.

It can be useful to charge different prices to different customers, e.g. to customers who purchase repeatedly, or buy add-on or related products, as a thank you for their loyalty. Bear in mind that customers who are expensive to satisfy will be less profitable, unless you charge them higher prices. One-off sales may cost you more than repeat business.

You can also use pricing tactics to attract customers. See the section below on different pricing tactics.

Whatever prices you set, check that they cover your costs and can deliver a profit. See the page in this guide on covering fixed and variable costs.

Stages Of Product Life cycle

Stage 1. Market Development

This is when a new product is first brought to market, before there is a proved demand for it, and often before it has been fully proved out technically in all respects. Sales are low and creep along slowly.

Stage 2. Market Growth

Demand begins to accelerate and the size of the total market expands rapidly. It might also be called the “Takeoff Stage.”

Stage 3. Market Maturity

Demand levels off and grows, for the most part, only at the replacement and new family-formation rate.

Stage 4. Market Decline

The product begins to lose consumer appeal and sales drift downward, such as when buggy whips lost out with the advent of automobiles and when silk lost out to nylon.

Cost of Equity = Risk-Free Rate + Beta * (Market Rate of Return - Risk-Free Rate)

The rate of return refers to the returns generated by the market in which the company's stock is traded. If company CBW trades on the Nasdaq and the Nasdaq has a return rate of 12 percent, this is the rate used in the CAPM formula to determine the cost of CBW's equity financing.

The beta of the stock refers to the risk level of the individual security relative to the wider marker. A beta value of 1 indicates the stock moves in tandem with the market.

The risk-free rate is generally defined as the (more or less guaranteed) rate of return on short-term U.S. Treasury bills, or T-bills, because the value of this type of security is extremely stable and return is backed by the U.S. government. So, the risk of losing invested capital is virtually zero, and a certain amount of profit is guaranteed.

Irrelevancy of Dividend policy

Modigliani and Miller suggested that in a perfect world with no taxes or bankruptcy cost, the dividend policy is irrelevant. They proposed that the dividend policy of a company has no effect on the stock price of a company or the company’s capital structure.

MM say that if an investor gets a dividend that’s more than he expected then he can re-invest in the company’s stock with the surplus cash flow. If the expected dividend is too small, then he can sell a part of his shares and replicate the same cash flow he would get if the dividend was what he expected. In both cases, investors are irrelevant to what the company’s dividend policy is because they can create their own cash flows.

Higher returns are what investors care about. They can have that return through re-investing or selling a part of their shares. If the market conditions are perfect, then they don’t care if the return is from dividends or from stock price appreciation.

They proposed that the dividend policy of a company has no effect on the stock price of a company or the company's capital structure. ... In both cases, investors are irrelevant to what the company's dividend policy is because they can create their own cash flows. Higher returns are what investors care about.

Assumptions of the Theory

For this theory to work, investors need a certain frame of mind and this can be achieved only if we live in a perfect world.

Some of the assumptions for this theory are:

• Taxes do not exist: Personal income taxes or corporate income taxes
• When a company issues a stock, there are no flotation costs or transaction costs
• When a firm decides its capital budgeting, dividend policy has no impact on it
• Information is readily and freely available to all investors. Information about the firm’s future prospects is available to the company’s manager as well as investors
• Leverage has zero impact on the cost of capital of the company