Financial Management Assignment Exploring Knowledge Of Corporate Finance & Capital Markets

Question

Task:
Assignment Objective:

This financial management assignment is designed to assess students to the conception of Financial Management for exploring the knowledge of corporate finance and capital markets, emphasizing the financial aspects of managerial decisions. It touches on all areas of finance, including the valuation of real and financial assets, risk management and finance derivatives, the trade-off between risk and expected return, and corporate financing and dividend policy.

You will need to:

You are asked by the CEO of a listed company to be a listed corporate finance consultant to evaluate the group of companies under the umbrella to the basic principles of modern corporate finance. In this detailed & complete Corporate Financial Advisory Report onto the Topics covered include the time value of money and basic methods for optimal investment and consumption decisions. Furthermore, the report covers aspects in capital market theory and asset pricing. The report also provided a first insight to the importance of options in financial decision making and concludes with models concerning the firm’s optimal capital structure. Furthermore, your report gets familiar with the basic principles of event studies, the Modigliani-Miller-Theorem and long-term financing.

Remember your report to be read by a group of stakeholders whom have not had any financial knowledge background and by the end of this report, you will be illustrating your profound professional knowledge.

1. To give an introduction finance
2. To provide an understanding of the most important concepts and principles of corporate finance at a level that is approachable for a wide audience
3. To study essentials of investments, assets valuation, capital structure, specifics of financial markets instruments
4. To develop basic skills of valuing assets given forecasts of future cash flows.

Answer

Introduction:
As per the research on financial management assignment, finance is the science of money management; it studies how people and organizations raise, store, invest and spend money. Finance can be defined as the 'process' that represents the behavior of individuals or groups when they manage financial resources to achieve specific goals. Finance has several branches including corporate finance, economic finance, monetary finance, agricultural finance, etc. It also studies the flow of money in an economy and the factors that affect it study of financial markets is called financial economics or 'investment science' per se.

Brief Background to Case Study Organization:
Financial management is the practice of planning, executing, and controlling financial operations in order to achieve economic goals. It includes everything from the preparation of an annual budget for a large firm or department to buying lunch at a small convenience store. The three fundamental aspects of managing finances are: Economic analysis - Allocating available funds to use in the way that provides the greatest benefit.

Financial control - implementing and monitoring policies to ensure that goals are achieved and objectives met. Financial transactions - entering all financial information into a ledger system, the most common of which is double-entry bookkeeping.

Economic analysis: we can increase our profits by decreasing costs or increasing prices of products or services we offer. If we had a very large market share, we could decrease prices and increase demand for our products. We can also decrease costs by using more efficient processes or cheaper materials in the production of our goods and services.

Financial control: once we have analyzed how to maximize profits, we must ensure that the organization is following through on those actions. For example, if we decide to decrease prices, we will need to monitor how much the sales of our products decrease and ensure that marketing efforts are in place to increase demand.

Financial transactions: double entry bookkeeping means that every transaction is recorded twice - once as a debit (DR) and once as a credit (CR). For example, if two people go into a convenience store and buy $2 worth of donuts, the cashier will record that transaction two times. First, they will be recorded as $0 dollars in the cash register (DR). Second, $2 will be credited to each person's total amount owed for all their transactions since last time they were in the store (CR). We always debit the account of the left side of the equation and credit on the right. These transactions are then recorded into a ledger, which is just a type of accounting book that includes every transaction that has ever occurred in an organization.

Corporate financing decisions are the ways in which companies choose to obtain financial capital. Financing is often broken down into three categories: equity financing, debt financing, and hybrid financing. The two main types of equity financing are internal equity and external equity. The three main types of debt financing are bank loans, bond financing, and asset-based lending. Not all companies use equity or debt finance; there is also a hybrid form called mezzanine finance, which may be a combination of debt and equity.

The capital markets can be defined as the secondary market where securities such as stocks and bonds are bought and sold. Securities represent an ownership position in something while a financial instrument is a tradable asset, however it can also refer to other items such as derivatives which are derived from these assets. The main players within capital markets include stock exchanges, investment banks, mutual funds and hedge funds. Capital markets today are divided into three main categories which consist of primary markets, secondary markets and derivative markets. The primary market is where companies offer shares to the public for the first time while the secondary market is where exchanges such as those mentioned above take place. Derivative markets represent another category within this segment, derivatives are derivative securities which can be traded.

Financial instruments are used to raise money for organizations or individuals, they are traded on the financial markets. They can be split into three main categories. Tradable securities, loans, and financial derivatives. These are very specific sectors that have differences between them that is why this information will cover what differentiates these instruments, rather than giving you a complete overview of each instrument.

The three main categories of financial instruments are:

Tradable securities, which include common stock, preferred stock, and derivatives. Loans, which can be split into any type of loans such as personal, mortgages etc. Financial derivatives, the biggest share in this category is made up by derivative on futures contracts that are traded on major exchanges all around the world such as futures, options and swaps.

Unlike tradable securities that are similar to products that we buy every day like apples, financial instruments can be traded on exchanges or in over-the-counter (OTC) markets. In this context the OTC market refers to any place where instruments are bought and sold between two parties who agree on a price without using an exchange as a third party

When talking about financial instruments, the most popular traded instrument is the stock. The big difference between stocks and other tradable securities, such as bonds or debentures, is that shares give their holder a right to participate in the profits of the company that issued them. Another difference between them is that stocks carry a voting right, while bonds and debentures don't.

Most of the time when people trade stocks they do it on exchanges such as NASDAQ or NYSE (New York Stock Exchange). One way to increase the liquidity of a stock is by having more buyers and sellers participating in the market for this particular stock. If there was only one buyer or seller for a particular share, it would be impossible to buy or sell this share because the prices would be constantly changing depending on how many people are willing to buy at any given moment. This is due to how markets work; they balance between supply and demand.

There are some other features that stocks have, but these are more related to specific companies. For example some stocks might give you the right for attendance at shareholder's meetings while others don't

The last category of financial instruments is loans which can be split into two different types: Personal loans where borrowers receive a fixed amount of money that they agree to repay on an agreed upon date. The other type is mortgages where the borrowers are receiving a loan to buy a house.

Discounted cash flow analysis is a method used to estimate the value of a company based upon its ability to generate free cash flows for investors. The concept involves discounting future free cash flows back to present values using an interest rate commensurate with the riskiness of the projects from which the free cash flows arise. Project risk is a function of a number of factors including investment type, stage in company's life cycle, and business model.

Offering a new product or service to market is inherently risky. The end customer will often be making an upfront payment with no guarantee of future purchases by him/herself or on behalf of others. For example, if the company is on the cusp of introducing a new product, there will be some uncertainty as to how well it will actually sell. How much reliance should one place upon the past sales history of similar offerings? Will this product exhibit different characteristics which could affect popularity with target consumers? How heavily should historical success weigh against the riskiness of this new offering? All things being equal, an investor would typically expect a higher return for bearing this additional risk.

Discounted Cash Flow (DCF) is one of the most common methods to value companies. If you are an analyst or investor, then this method will be useful to you. This method is used to calculate the price of any company by its future cash flows, cost of investment and time period. DCF is simply a process for valuing a company by discounting the projected cash flows to obtain an estimated value.

There are three main valuations that DCF is used for, which are: (1) Valuation of existing companies, (2) valuation of new businesses and (3) valuation of entire industries.

To put this in simple terms, let's take a look at Walmart Inc. It is one of the largest retailers in US and around the world with a total revenue of 485 billion USD. If you were to value this company using DCF, then firstly you have to project its future cash flows for next few years by making estimates on things such as revenues, costs, growth rate and discount rates. The next step is to sum up all these cash flows and get an estimated value of this company. Finally, divide the total amount by the number of shares outstanding to get a price per share for that company.

The Present Value (PV) simply means how much money has been born that can be used to buy goods and services regardless of future values (FV). The Present Value is important because it can save you time, effort and money. And the following are some examples:

To purchase an apartment with an interest rate of 5%: "I want to repay my loan as quickly as possible" When you use the concept of Present Value, you can reduce your monthly repayment by increasing your monthly payment.

If you want to build a house for $100,000 : "I need $100,000" If you do not raise money using this method, it will take 200 months (17 years), but if you apply this method to reducing the cost of goods and services, it will take about 100 months (8 years). If you borrow $I00,000 at 5% annual interest: "Payment period 20 years. Repayment 120,000". If the monthly payment is reduced as much as possible after applying Present Value (PV), then we can reduce the term of debt repayment by a third.

The term "valuation" refers to an analysis of the value of something. When analyzing stocks, it is important to look at both qualitative and quantitative factors that affect the valuation of a company's stock. This article will focus on the more quantitative factors that are involved in valuing common stocks using fundamental analysis or technical analysis (market projections).

The value of a company is determined by the market price at which its shares are traded. The hype surrounding the IPO (Initial Public Offering) of a company and the general market environment play a significant role in determining how high or low that price will be. Unlike IPOs, traditional stocks may not be issued on any better terms than those offered to the public at large. Although there are certain risks involved when dealing with stocks, they also provide opportunities for investment in companies that may not be available via other avenues.

The price of a stock can fluctuate rapidly due to market volatility. It is important that investors take into account the risk profile of an individual holding before making investments. Setting financial goals is the first step in the investment process.

Fundamental analysis of stocks can help determine whether a stock fits within an individual's investment strategy. A stock's price, its market capitalization (current price multiplied by total number of outstanding shares) and other factors are used to make this determination.

Determining how much risk an investor is willing to take on in relation to their financial goals will help narrow down the list of potential investments.

There are many reasons why investors choose to trade stocks in the market; each investor approaches stock trading with different levels of experience and knowledge. When using fundamental analysis, it can be helpful to keep in mind that some information you find may be more relevant to one style of trading than another.

Technical analysis is a method used by investors and traders alike in order to predict market movements based on past price action, volume and open interest. The assumption is that the past will be an indicator of how the future will play out in terms of market movement when supported by applicable financial data available from a company's financial statements.

Technical analysis also takes into consideration other factors such as the number of shares traded daily, the moving average price and volume, both up and down. All these factors help to paint a picture of what a stock has been doing in recent history, a picture that can then be projected into the future based on current and prior trend analysis.

To study the Valuing Debt Securities, we must first understand the basics of how debt securities work. From there, we can move to the valuation aspect and explain how these securities are valued and why they should be valued in a certain way.

Let's start with the basics: what is a bond? A bond is an agreement between two people: The issuer and the buyer. The issuer owes the bondholder a certain amount of money over a certain period of time. The issuer pays the bondholder interest payments in accordance with their agreement and repays the principal at a predetermined date in the future. These agreements are defined in a legal document called a indenture which is signed between both parties to formalize their relationship.

From here we can see that a bond is merely an IOU. It's the promise of repayment with interest over time and it's given in exchange for money today. Bonds come in several different varieties: Corporate Bonds and Government Debt Securities (Treasury Bills, Notes and Bonds).

Theoretically there are more types but these two make up most of the bond market. Corporate Bonds are issued by non-governmental entities whereas Government Debt Securities are issued by the federal government of a country. Corporate Bonds will pay some rate of interest but this is not guaranteed, if the issuer defaults on these payments, the bond holder may lose their principal even though they have been receiving interest payments regularly. On the other hand, Government Debt Securities are guaranteed by the US government so if the issuer defaults on payments they will lose their principal. From here it's easy to see that Corporate Bonds are riskier than Government debt Securities because of this risk factor.

The risk of an asset can be thought of as the likelihood that its return will differ from expected. Riskier assets are more likely to have different returns than less risky, or "safe" assets - whether that difference is positive or negative is beside the point.

Risk can be broken down into two categories: systematic and unsystematic. Systematic risk is the market risk that affects all assets within its class (i.e. if oil prices drop, it affects the price of gasoline as well as all oil companies). Unsystematic risk, on the other hand, refers to the specific risk of a single asset (i.e. the risk that the price of oil will drop because of some bad news about an individual corporation). Despite its name, unsystematic risk is still market risk - but it's only relevant to a specific company or sector.

The relationship between risk and return can be simplified into one formula:

Reward = Risk or, more specifically Risk = (Reward - Risk Free Rate).

A portfolio is a collection of investments held by an individual or company. What makes Portfolio Theory difficult to understand, is that managers of portfolios often have to make decisions on their own, without knowing what the market will do next. The reason for this is because they are affected by the law of large numbers, which states that as more securities are added to a portfolio, the price movements of individual securities will be less and less important.

The law of large numbers in Portfolio Theory is actually quite simple: if we add more and more elements to a collection, each following their own pattern of behavior, then the overall pattern will be easier and easier to determine.

Capital structure is the way a business finances itself by using different types of capital like equity or debt. This also used to calculate cost of capital, which can be defined as the minimum return that investors require on an investment, usually expressed as percentage yield of the current share price. For example, if an investor purchases a share for $10 and the minimum return required is 15%, his cost of capital would be $1.5 (10 x 15%).

It is important to note that the more debt a firm uses in its capital structure, the higher its weighted average cost of capital since there are two types of interest payments that must be made. Furthermore, the cost of capital is also higher because there are additional risks inherent in holding debt since if the firm does not have enough operating income to pay for interest or principal repayment on outstanding debt it can result in bankruptcy or worse yet, default.

The cost of capital is an accountant's estimate or approximation of the interest rate at which a company could borrow money from a bank, two people with no knowledge of economics would have different estimates for this figure. A person who has been following stock market trends and news reports will probably be more careful to avoid making too high or too low an estimate.

A company that faces a high risk of bankruptcy is not likely to be able to borrow at all, making borrowing expensive. This means that the cost of capital will also be high. If the company continues to succeed and turns out to have been highly profitable earlier than it appeared from forecasts, its stock price increases. In other words, investing in the company is profitable for those who make a correct decision. The opposite of this case is also true: if a company fails, despite being highly profitable earlier than it appeared from forecasts, its stock price decreases. In other words, investing in the company is not profitable for those who made a mistake and invested in it anyway.

Conclusion:
Starting a business is risky and requires capital. The entrepreneur must make many decisions, each of which could affect his or her success. Because of this risk, entrepreneurs usually seek funds from outside sources, such as investors and financiers, rather than trying to finance their businesses using solely internal resources such as profits or savings. In the past, entrepreneurs who needed funds would turn to investors. An investor is someone who provides money in exchange for a share of ownership in the company.

References:
DCF Model Training - The Ultimate Free Guide To DCF Models. (2021, March 23). Corporate Finance Institute.
https://corporatefinanceinstitute.com/resources/knowledge/modeling/dcf-model-training-free-guide/.

DCF Analysis Pros & Cons – Most Important Tradeoffs In DCF Models. Financial management assignment (2020, February 27). Corporate Finance Institute.
https://corporatefinanceinstitute.com/resources/knowledge/valuation/dcf-pros-and-cons/.