Question

Analysis of three financial management questions: (i) capital budgeting, (ii) capital structure and (ii) working capital management
Define the three financial management questions and justify your group’s analysis by illustrating examples: Choose one or more events described by media (CNN Business, Financial Times, Dow Jones financial news etc.) about a company who is doing one or more activities related to the three financial management questions. Analyse that event (s) applying the three financial management questions. Note: Each question is to be illustrated by at least one event

Answer 1

(i) Capital Budgeting :

Capital budgeting is the process that a business uses to determine which proposed fixed assets purchases it should accept, and which should be declined. This process is used to create a quantitative view of each proposed fixed asset investment, thereby giving a rational basis for making a judgement.

Several Capital Budgeting Methods are :

1. Net Present Value Analysis method

2. Constraint analysis method

3. Payback period method

4. Avoidance analysis method

(ii) Capital Structure

Capital Structure is the mix of debt and equity that a business uses to fund its operations. A firm's capital structure may contain many components, including the following :

• Common Stock
• Multiple classes of preferred stock
• Bonds
• Debt having different terms and maturity dates
• Retained earnings

(iii) Working Capital Management :

Working capital management is a tactical focus on maintaining a sufficient amount of working capital to support business while minimizing the investment in this area. Ther core goal in working capital management is to ensure that there is always sufficient cash in hand to pay for liabilities as they come due for payment. Since there can be a high cost associated with funding working capital, there s an offsetting pressure to keep funding levels low. The latter goal is achieved by closely monitoring the turnover levels foe accounts receivables, inventory, and accounts payables, and taking action when the turnover levels vary from expectations.

The Five Basic Principles of Finance are

1) Cash Flow: Cash flow is the money that the business earns that can be redeployed to earn more money. Some businesses are cash flow positive and some are cash flow negative during a period. The aim of every business is to be cash-flow positive. In financial analysis of a business, it is the cash flow and not the profits that determine the value of the business. Consider a film production company that makes a franchise movie, while evaluating and projecting its cash flow one has to consider the box office collection along with this one should also consider the merchandise sales for the same.

2) Hedging principle: In finance, the use of financial instruments to offset any investment risk is known as hedging. Example a home buyer in California buys homeowners insurance to mitigate the risk of natural disasters like forest fires.

3) Time Value of Money: A Dollar today is worth more than a dollar post a year. Besides inflation, the other factor that makes this true is that if you have a dollar today you can invest it and earn net positive returns and you will have more than a dollar after a year. For Example let’s say you have $ 1 million today and you pass the opportunity to invest it in Govt bonds or a business vis a vis if you would have, then you would have had $1.15 million say if the business gave a 15% return

4) Risk and Return matrix: The Capital budgeting decision risk along with returns is a major consideration. The business must evaluate the investment return with the risk associated with it and whether it is fully compensated with the investors understanding.

5) Diversification: Diversification is the process of reducing risk/volatility by investing across asset classes. it is to have financial prudence of not putting all your eggs in one basket. For eg. An investor has $1million. he puts $400000 in equity $200000 in govt bonds and rests in rent yielding real estate.

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