Finance Assignment

Tabular representation of Data………………………………3

Impact of new
strategy……………………………………………….4
• What the firm is actually trying to do
• Comparison of two strategies
• Impact on customer loyalty

1
What would be the cost of capital………………………….6

Current cost of capital……………………………………9

Impact of equity financing……………………………10

Recommendations……………………………………………11

Tabular representation of Data:

2
Current strategy 5 million units 20 pounds price Sale 100 million
pounds
Suggested strategy 6 million units 20 pounds price Sale 120 million
pounds
Discount
Current strategy 1/10, n-30
Suggested strategy 2/10 n-40
Expected Collection in percentage
Current strategy 40% pay within 10 50% within 30 10% within 50 days
days days
Suggested strategy 60% pay within 10 30% within 40 10% within 60 days
days days
Collection
Within 10 days Within 30 days Within 50 days
Within 40 Within 60
days days
Current strategy 38.808 49 9.8
(million pounds)
Suggested strategy 67.7376 34.56 11.52
(million pounds)
Calculations
Current strategy 100 * 98% = 98 100 * 98% = 98a 100* 98% =98
98 * 10% = 9.8
98 * 40% = 39.2 98 * 50% = 49b
39.2 * (1-.01) =
38.808
Suggested strategy 120 * 96% = 115.2 120 * 96% = 120 * 96% = 115.2
115.2 * 60% = 115.2 115.2 * 10% =
69.12 115.2 * 30% = 11.52
69.12 (1-.02) 34.56
Current strategy a. Uncollectible accounts expense 2% of Sales so 100 (1-.02)
= 98
Suggested strategy b. Uncollectible accounts expense 4% of Sales so 120 (1-.04)
= 115.2
Other Costs
Uncollectible Collection charges Customer analysis
expense
Current strategy 2% of sales = 2 3% of sales = 3 4% of sales = 4
million million million
Suggested strategy 4% of sales =4.8 2% of sales =2.4 2% of sales =2.4
million million million

3
Impact of new strategy
What the firm is actually trying to do:
Ultimate goal of the firm is to increase its profits that’s why firm is
analyzing alternate strategy what would be impact of alternate
strategy if it is implemented currently firm is making sale of 100
million pounds. Now firm is trying to increase its sale because in the
market the sale of its competitors’ products is increasing. Now firm is
trying to develop a strategy that will help firm to increase its sale.
Comparison of two strategies:
In previous strategy firm offered 1% discount to its customers who pay
his dues within 10 days and it was the practice of the organization that
40% of customers pay within 10 days. If new strategy is implemented
then firm will allow 2% discount to those who pay their dues within 10
days and it is also estimated that 60% of total customers would pay
within 10 days. If new strategy is implemented, then firm is expecting
that its percentage of sales would rise by 20%.
In comparison of two strategies we would come to know that currently
firm is receiving 38.808 million pounds within 10 days with the help of
existing strategy. But if new strategy is implemented then firm will
receive 67.7376 million pounds within 10 days. Liquidity position of the
firm will increase by 28.9296 million pounds if suggested strategy is
implemented and it will help firm because firm’s both current and
quick ratio will increase and this will increase capability of firm to meet
its short term obligation. Net working capital will increase as well.
But if other aspects are compared then it comes to know that new
strategy would result an increase in sales by 20 million pounds only
but in return firm has to bear sufficient amount of discounts that is
drawback. Currently, firm is offering discount 0.392 million pounds on
current strategy. On the other hand, discount on suggested strategy
would be 1.3824 million pounds. It shows a huge increase in discounts

4
almost 1 million pounds. If suggested strategy is implemented then
firm’s sale would increase by 20 million pounds but it has to allow 1
million discount to attract additional customer. And this is too much.
Firm is offering extra 1 million pounds on just 20 million pounds sale. It
is competitive market and there are chances that firm have to follow
available price in the market. It means firm has no control over its
price and there are lesser chances to earn 1 million profits on 20
million sale.. So there is possibility that firm will just increase its
liquidity in suggested strategy but not make profits and profits are our
ultimate targets. Another drawback is that firm’s uncollectible accounts
expense will increase by 2.8 million pounds in suggested strategy and
that is too much amount now there are certain chance that firm will
incur losses as compare to current strategy rather than making profits.
So it is strongly recommended that firm should carry on its current
strategy.
Impact on customer loyalty:
There would be positive effect on customer loyalty. Loyalty would
increase because customer would pay fewer prices than previous one
so there are lesser chances of customer switching, organization can
retain customer for longer time periods.

What would be the cost of capital?

1) Perpetuity: These are the fixed amount cash flows

paid on fixed intervals. In perpetuity if any investor
makes investment he / she would receive fixed
amount at end of certain period possibly one year.
From the investors point of view it is the rate of
return on the investment and from the firm’s point of

5
 view it is cost of financing or cost of acquiring
capital. Here, we are considering from firm’s point of
view so we call it cost of capital. In perpetuity firm
pays fixed amount of payment on fixed intervals to
which it acquires funds. Two things are considered
while calculating cost of capital in perpetuity. 1.
Amount of perpetuity paid at fixed intervals. 2.
Market value of total investment. Suppose firm pays
3 pounds each year on an investment and total value
of the investment is 15 pounds. How much cost is
firm bearing for this financing?

Cost = perpetuity payment / market value of

investment
= 3 / 15
= 0.2 or 20%

2) Preference Share: This is called hybrid security

because it possesses both equity and debt qualities.
In view from investors as well as firm it is equity but
from the payment point of view it is similar to debt
because firm has to pay a fixed amount of preferred
dividend to preference shareholders. If we analyze it,
it is similar to perpetuity because preferred stock are
issued for infinite time period and a certain fixed
amount is also paid every year to the holder of
preference share that’s why its calculation is some
what similar to perpetuity only change of name. We
mention dividend in place of perpetuity.
Suppose firm pays preferred dividend on preferred
stock 1 pound each year, market value of this share

6
 is 8 pounds. How much cost is firm bearing on this
financing?
Cost = Dividend / Market price of preferred stock
=1/8
= 0.125
= 12.5%

3) Common Stock (Non growth): Original owners of

the firm or company are common stock holders. They
have voting rights to elect board of directors and
BODs are wholly responsible to look after the
activities of manager on behalf of their owners. From
the company point of view it is also one of the
sources to raise financing and this is the most secure
way to raise funds. Like all firms also bears some
cost to raising funds by using this method. Here we
are concerned to calculate non growing common
stocks. First of all let me explain what it that? Those
firms who pay all its earning as dividend means if
payout ratio of firms is 100%, is known as non
growing firm. Why is it called no growing? Because,
firm pays whatever it earns and nothing left to
reinvest anywhere. So income level of firm remains
same that’s why it is called is no growing firm. It is
true in theoretical point of view but from the
practical situation is some what different. It is an
assumption that if firm pays all its earning as
dividend then nature of common stock is somewhat
similar than preferred or perpetuity. Because firm
does not hold any thing and pays what ever it earns

7
 it means that firm pays a certain fixed amount at
fixed intervals. Suppose a non growing stock pays a
dividend 2 pounds each year and market price of
stock is 16 pounds what is the cost?
Cost = 2 / 16
= 0.125
= 12.5%

4) Common stock (Growing): those firms which hold

certain percentage of earnings as retained earnings
are known as growing firms because they reinvest
that retained amount some where and earn a return
that will increase firm’s earning. At the same number
of shares if earning increases it will increase EPS and
same way there is a fixed payout ratio then same
proportion will also increase in DPS. These firms are
called growing dividends firms.
There is formula known as constant growth model:
Cost = {(Div0 (1+g))/ Market price of share} + g
Suppose a firm that pays dividend 4 pounds
yesterday and growth in dividends is 6% and Market
price of share is 24 pounds while g= retention ratio *
reinvestment rate

Cost = {(4 (1.06))/24)+.06

= {4.24/24} + .06
= .1767 + .06
= .2367 or 23.67%

Current cost of capital:

1) Equity Cost

8
 Cost = Dividend/ Market price per share
= 0.2/ 2.5
= .08
= 8%
2) Debt Cost
Cost = before tax cost of debt (1- tax rate)
Cost = 7% * (1-30%)
= .049
= 4.9%

Calculation of cost of debtor:

sales per day * DSO * variable cost * interest rate

65753425*24*70%*7%

For current strategy cost of debtor is :

Sales per 50,000 2,7

day ,000 20 365 39,726

40% 10 4
Daily Sales
outstanding 50% 30 15

10% 50 5

24

65,75
3,425

Variable 46,027,
Cost 70% 397.26

9
Interest
Rate 7%

3,221,9
17.81

sales per day * DSO * variable cost * interest rate

3287671*26*59835616*7
%

For future strategy cost of debtor is :

Sales per 60,000 3,2

day ,000 20 365 87,671

60% 10 6
Daily Sales
outstanding 50% 30 15

10% 50 5

26

85,47
9,452

Variable 59,835,
Cost 70% 616.44

Interest
Rate 7%

4,188,4
Total 93.15

Impact of equity financing

There are different things are perceived as signal from investors point
of view. Suppose if company raises its funds by using debt financing it

10
is perceived that firm is expecting good profits in near future and
that’s why it wants to share it only with existing share holder. On the
other hand if a firm is using equity financing then this signal is
perceived by the market analyst that firm is expecting to incur losses
in future that’s why it is increasing number of share holders to share
the loss among maximum shareholders or allowing maximum people
to share is loss as per share loss gets minimized. Though it is unethical
but it is done.

If we discuss from this company point of view same thing can also be
expected here because firm is trying to implement new strategy
though it will increase its sale as well as improve collection but there
are possible chances that firm may incur losses or decrease in its
existing profits.

From my point of view I would not expect positive signal for the
company to raise funds by using equity financing.

Recommendations
Whether new strategy should be implemented or not it should be
decided while analyzing few calculations. If suggested strategy is
implemented then firm will increase its sale by 20 million pounds and
will allow an additional 1 million pounds discount and this is too much.
Second thing firm’s uncollectible account expense would increase by
2.8 million pounds. In nut shell if we discuss that increase sell by just
20 million pounds will increase an additional cost of 3.8 million pounds
though other cost such collection cost or customer analysis costs are
lower in suggested strategy case but discount and uncollectible
accounts expense are given more weight age that’s why it is

11
suggested that if new strategy is implemented then there are chance
for the firm to increase liquidity but may cause firm in shape of lower
profits. So from my point of view new strategy is not suitable for the
firm and may bring lower the firm’s profits rather than giving benefit to
the firm.

For current strategy cost of debtor is :

Sales per 50,00 2,73

day 0,000 20 365 9,726

40% 10 4
Daily Sales
outstandin
50% 30 15
g
10% 50 5

24

65,75
3,425

Variable 1,917,8
Cost 70% 08.22

Interest
Rate 7%

8.82717E
+12

For future strategy cost of debtor is :

12
Sales per 60,00 3,28
day 0,000 20 365 7,671

60% 10 6
Daily Sales
outstandin
50% 30 15
g
10% 50 5

26

85,47
9,452

Variable 2,301,3
Cost 70% 69.86

Interest
Rate 7%

1.37704E
Total +13

13