Question

C) Diamond Company is a manufacturing company which is involved in packaging business. At present the performance of the company is up the expectation. Keeping up with latest technology, the company decided to improve the quality of its products by upgrading its machinery.   The company assigned the task of estimating the amount of funds required for this upgrading to its financial manager Mr. Salim. Mr. Salim started the work by collecting the relevant data about the amount available from internal sources. Later, he will estimate the remaining amount to be raised from external sources and try to find out the alternative sources from which this amount will be mobilized.

Requirement:
(i)   By performing the above tasks, what are the functions performed by Mr. Salim?
(ii) As a financial manager, what are the principles he should concentrate while investing capital of the company? Explain.                                                                             (3Marks)

Answer 1

(i) Functions performed by Mr. Salim

(a) Mr. Salim will have to hold discussions with the treasury of the company to understand the amount of cash the company is holding & the extra cash that can be spared to provide a source of finance for the machine

(b) Hold talks with the risk team to understand any forex risks that might occur and the forward curve of the domestic currency & the foreign currency in which the payment has to be made

(c) Hold talks with banks to get a quote of the term loan spreads & to talk with primary market dealers over yields in case the company plans to issue debentures

(d) Hold talks with existing shareholders in case they can infuse further equity into the company through a rights issue. To hold talks with Investment Banker to seek a new equity investor

(ii) He should focus on capital budgeting issues like:

(a) The cost of capital (WACC) for the firm

(b) NPV (net present value) & IRR (internal rate of return) of the project

(c) Post-implementation FCFE/FCFF cashflows and valuation of the company

(d) Optimal debt/equity ratio that will reduce the WACC and improve the intrinsic value of equity