Part A: Written report
Background
Financial managers are, arguably, vital to the survival of any corporation. They generally have a say on decisions that directly impact the performance and value of businesses. These decisions are, invariably, related to which projects to pursue (capital budgeting), how to raise funds (capital structure), and how to safeguard the business’ daily operations (working capital management).
In this context, knowing how to interpret financial statements has the same importance to a manager as the ability to understand medical results has to a physician. One of the most important tools in this regard is the financial ratio analysis, whereby information is combined in a way that portrays the status of the company in terms of important aspects (e.g., liquidity, profitability, efficiency, etc.).
Assignment question
To get a good grasp of financial ratio analysis, this assignment asks you to identify a company whose capital structure ratios (e.g. debt ratio and interest coverage ratio) and profitability ratios (e.g. return on assets and return on equity) are either readily available (i.e., through IBISWorld or Marketline) or, else, can be calculated through its financial statements. Then, upon collecting observations from the last 5 years and industry aggregates, answer the following:
Based on a trend analysis, elaborate on whether the company you have chosen is improving or deteriorating in terms of its capital structure and profitability ratios, highlighting any areas (and appropriate actions) for improvement.
How does the company compare to its peers, i.e., are its ratios similar to the industry- average financial ratios (or else, to those from its main competitor)? Would there be any issues of concern and, if so, how to address them?
Is it possible to identify any relationship between capital structure and profitability ratios? (Hint: frame your discussion in terms of risk vs return).
The cash conversion cycle (CCC) is the most relied upon measure to determine how effectively a company is converting resources to cash and managing its working capital. Calculate the CCC for your selected company (if possible or choose another suitable company) over the last 5 years. Evaluate whether CCC changed during this period. What drove this change? Whether this change is in favour or against the interest of the chosen company and why?
Assume your selected company is considering raising funds for expansion from the securities market. The company has the following two alternatives:
Issuing bonds having 14% annual coupon rate. Interest will be paid semi-annually. The bonds will have a face value of $1,000 and will mature in 10 years from now. Current yield to maturity is 12%. Rumours have started circulating that Moody’s will soon downgrade the credit rating of your selected company’s bonds, which will result in a 3% p.a. increase in the yield to maturity, from 12% to 15% per annum.
Issuing additional ordinary shares. Assume they just paid a cash dividend of $1.20 per ordinary share. Security analysts agree with top management in projecting steady growth of 8% in dividends over the foreseeable future. The required rate of return for shares of this type is 15%.
Determine the price of the bond before and after the rumour and explain the expected change in the price of the bonds. Also, calculate the value of the ordinary share. What relationship exists between the coupon interest rate and yield to maturity and the market value of a bond? In your opinion, which security should be issued by your example company on the basis of their current capital structure and why?
Part B: Reflective Practice
Reading
In preparation for Part B, read the following article:
Robb, CA 2014, ‘The personal financial knowledge conundrum Journal of Financial Service Professionals, vol. 68, no. 4, pp. 69–72.
Background
Robb (2014) emphasises the importance of financial literacy and the understanding of financial concepts for all individuals. Indeed, it is important for helping us to make day-to-day decisions that are more effective in managing, saving and investing our finances to reach the financial goals we have set. It is beneficial not only for individuals or households but also for anyone responsible for managing areas of a business.
Question
In this task, we ask you to reflect on any one of the financial decisions you have made in the past, either in your personal or professional life. In particular, address the following:
What was the task and which principle of finance did you use in making the decision? Describe your experience and the outcome.
Would you consider using a financial advisor for the same task in the future? Do you agree with Robb (2014) that individuals who use planners should be more involved and will ultimately make better decisions when they themselves have a fundamental knowledge of financial concepts?
Sample Solution
