BCO222 Business Finance II: Final Task Brief & Rubrics

BCO222 Business Finance II Task brief & rubrics Task: Final Assignment

Answer all questions across four case studies. The assignment assesses understanding of financial forecasting and planning, working capital management and firm liquidity, and sources of short-term credit and their costs. Submit a Word document with all answers, clearly indicating each case separately.

Paper For Above instruction

Introduction

Business finance is integral to the sustainable growth and operational efficiency of firms. This paper explores four detailed case studies that span financial forecasting, working capital management, capital structure decisions, and short-term credit considerations. Each case presents real-world scenarios requiring analytical rigor to guide strategic financial decisions. By scrutinizing the provided data and applying fundamental financial principles, this paper aims to demonstrate comprehensive understanding and critical evaluation skills relevant to contemporary financial management.

Case 1: Financial Forecasting and Planning for Majestic Corporation

Majestic Corporation's 2019 financial statements reveal key metrics needed to project the 2020 fiscal year. Sales for 2020 are expected to grow by 15%, and assets, costs, and current liabilities are proportionate to sales. The assumption that long-term debt and equity remain unchanged allows focus on operational variables.

Proforma Income Statement:

Sales for 2020 = €7,500,000 * 1.15 = €8,625,000.

Costs, being proportional: €2,000,000 * 1.15 = €2,300,000.

Taxable income = Sales – Costs = €8,625,000 – €2,300,000 = €6,325,000.

Taxes at 25% = €1,581,250; Net income = €4,743,750.

Dividends are paid at the same payout ratio as 2019: Dividends proportionally increase, or, if maintained at €720,000, the retained earnings increase accordingly. Thus, additions to retained earnings = Net income – Dividends = €4,023,750.

Proforma Balance Sheet:

Assets are scaled by 15% increase: Fixed assets = €12,500,000; Current assets = €3,600,000 + 15% = €4,140,000. Total assets sum to €16,640,000.

Liabilities and equity are updated respecting the unchanged long-term debt and borrowed equity: Current liabilities increased proportionally; equity increases by retained earnings. The balance sheet balances with these updates, maintaining the accounting equation.

External Financing Needs:

The increase in total assets (€3,840,000) minus internal funding (retained earnings) indicates external funds required. The firm can access options such as bank loans or issuing new debt/equity, but given no new equity or debt authority, internal financing and potential short-term borrowing are considered.

Adjusted Assets at 90% Capacity:

Operating at 90% reduces projected assets: Fixed assets remain unchanged, but current assets = 90% of the pro forma, lowering external funding needs.

Importance of Financial Planning:

Financial planning aligns forecasted operations with available resources, enabling prudent management of assets and liabilities, minimizing liquidity risks, and ensuring sustainable growth.

Case 2: Cash Budgeting for Marvin Corporation

The cash budget provides a forecast of inflows and outflows, vital for liquidity management. With data spanning credit collections, purchases, and disbursements, the cash budget allows for identifying potential shortfalls or surpluses.

Cash Collections:

- 35% of current sales collected in the same month.

- 60% collected from the previous month’s sales.

- 5% uncollected (bad debts).

Applying data for each month, for example, in January:

• Collections from January sales: 35% of €380,000 = €133,000.
• Collections from December sales: 60% of €210,000 = €126,000.

Total receipts in January = €280,000. Similar calculations are made for February and March.

Disbursements:

• Purchases are paid the following month: for January, payments equal December purchases (€156,000); for February, €147,500, etc.
• Wages, taxes, expenses, interest, and equipment costs are straightforward disbursements.

Final cash flow calculations inform the ending cash balance each month, critical for operational decision-making and identifying financing needs or surplus management.

Role of Cash Budget:

The cash budget serves as a financial thermometer, allowing managers to anticipate liquidity shortfalls or surpluses. It enhances decision-making regarding borrowing, investment, or expense adjustments, safeguarding the firm's operational stability.

Case 3: Capital Structure and Financing Decisions at Lake Corporation

Lake Corporation's current asset base of €950,000 includes €425,000 in permanent assets. It considers two financing plans, differentiated by the proportion of assets financed through short-term and long-term debt.

Plan 1:

• Long-term financing covers all fixed assets (€750,000) and half of permanent current assets (€212,500).
• The rest is financed short-term.
• Interest costs: 10% for long-term, 6% for short-term.

Plan 2:

• Similar to Plan 1, but additionally, half of temporary current assets (€162,500) are financed with long-term capital.

Earnings After Taxes Calculation:

EBIT = €350,000. Under each plan, interest expenses are calculated based on the financing structure:

• Plan 1: Interest = (€750,000 * 10%) + (Remaining short-term) interest (6%), leading to total interest expenses.
• Plan 2: Interest similar but with increased long-term debt, raising interest costs.

Taxable income = EBIT – Interest expenses. After accounting for 40% tax rate, net income is derived.

Analysis:

Net income under each plan determines profitability. The plan which yields higher after-tax earnings, considering the risk profile and cost, should be preferred.

Risks & Cost Considerations:

Long-term debt offers stability but entails fixed obligations, whereas short-term debt may be cheaper but riskier if interest rates rise. The company must balance these to optimize cost and minimize refinancing risks.

Case 4: Short-term Financing and Discount Decisions at Harper Corporation

Harper seeks €750,000 to avail a 5/15, net 40 credit terms. A banker offers a 25-day loan at a cost of €19,100. The analysis involves calculating the effective interest rate, alternative costs if delaying payment, and implications of using a bank loan with a compensating balance.

Effective Rate Calculation:

Interest cost = €19,100 over 25 days. Using 360-day year: Effective rate = (Interest / Loan amount) (360 / days) = (€19,100 / €750,000) (360 / 25) ≈ 36.48%.

Cost if Paying at 40 Days:

Interest for 40 days: Proportional; the cost increases, making the effective rate higher (~58%).

Decision to Borrow:

If the cost of the bank loan is less than the discount forfeited, it makes economic sense to borrow. Given the high effective rate (~36.48%), the firm must evaluate if the cash discount’s value outweighs borrowing costs.

Additional Borrowing with 20% Balances:

The necessary amount to maintain net €750,000 after the compensating balance is computed accordingly, increasing borrowing cost marginally.

Final Considerations:

The optimal decision hinges on weighing the cost of liberal credit terms versus the financing costs, emphasizing liquidity management and cost minimization strategies.

Conclusion

These cases collectively reinforce that strategic financial management involves detailed analysis of operational data, careful planning of financing options, and deliberate liquidity control. Sound financial decisions significantly influence a firm's growth trajectory and resilience against market fluctuations.

References

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