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NATIONAL ECONOMICS UNIVERSITY BTEC HND IN BUSINESS

Assignment Cover Sheet

NAME OF STUDENT REGISTRATION NO UNIT TITLE ASSIGNMENT TITLE ASSIGNMENT NO NAME OF ASSESSOR SUBMISSION DATE

NGUYN THNH NAM 3099 Unit 2: Managing Financial Resources and Decisions Individual Assignment 1: UK Water Heater PLC 1 of 3 MFM.Huu Chi Nguyen 31st October, 2011

I, ___Nguyn Thnh Nam___ hereby confirm that this assignment is my own work and not copied or plagiarized from any source. I have referenced the sources from which information is obtained by me for this assignment.

_____________________ Signature

________31/10/2011________ Date

-----------------------------------------------------------------------------------------------------------FOR OFFICIAL USE

ASSIGNMENT GRADE

Unit Outcomes
Outcome Evidence for the criteri a Feedback Assessors decision Internal Verification

Identify the sources of finance available to a business

Explore the sources of finance available to a business (Unit 2, 1)

Assess the implications of the different sources Select appropriate sources of finance for a business project

Analyze the implications of finance as a resource within a business (Unit 2, 2)

Assess and compare the costs of different sources of finance

Explain the importance of financial planning

Merit grades awarded Distinction grades awarded

M1 D1

M2 D2

M3 D3

Professors additional feedback and comments

COMMON SKILLS & COMPETENCIES ASSESSED (indicated by X)


A. MANAGING & DEVELOPING SELF
1. Managing own roles & responsibilities 2. Manage own time in achieving objectives 3. Undertakes personal and career development 4. Transfer skills gained to new/changing situation

D. MANAGING TASKS & SOLVING PROBLEMS


X
12. Use information sources 13. Deal with a combination of routine & non-routine tasks 14. Identify & solve routine & non-routine problems

E. APPLYING NUMERACY B. WORKING WITH & RELATING TO OTHERS


5. Treat others beliefs and opinions with respect 6. Relate & interact effectively with individuals & groups 7. Work effectively as a team member 15. Applying numerical skills and techniques

F. APPLYING TECHNOLOGY
16. Use a range of technological equipment and systems

C. COMMUNICATING
8. Receive and respond to a variety of information 9. Present information in a variety of visual forms 10. Communicate in writing 11. Participate in oral & non-verbal communication

G. APPLYING DESIGN AND CREATIVITY


X X
17. Applying a range of skills and techniques to develop a variety of ideas in the creation of new/modified products, services or situations. 18. Use a range of thought processes

FOR OFFICIAL USE Comments By Assessor


Common Skills Grade

Assignment ( ) Well-structured Reference is done properly / should be done (if any) Overall, youve

Areas for improvement:

ASSESSOR SIGNATURE

DATE /

NAME:.........................................................................................

(Oral feedback was also provided)


STUDENT SIGNATURE DATE / /

NAME :........................................................................................

FOR INTERNAL USE ONLY

VERIFIED

YES

NO

DATE : .................................................................. VERIFIED BY : ............................................................ NAME : ..................................................................

Task 1: Select a Type of Ownership for UK Water Heater PLC. Vietnam and Assess Different External Sources of Finance
1. Select the type of the ownership to start and develop the business for UK Water Heater PLC, Vietnam The type of ownership for a company is very important, as it affects the financial aspect greatly. The methods to raise finance available to a business depend much on its ownership type. Therefore, to choose a type of ownership for UK Water Heater PLC in Vietnam, we must consider some elements in raising finance. In this situation, our financial needs have the following characteristics:
Purpose: Start a new business in Vietnam. (or expand the market, in Englands view) Amount needed: 200,000,000 a very large sum. Company status: Currently considerably high. The company has a high share price on the market (4.5 for a share of 1 face value), which means the investors are confident

about the companys profitability. Considering those factors, we can see that the company is able to issue and sell shares with considerable ease. Because of a large sum of money needed, selling shares would be an effective way to gain capital, and the high status of the company makes our shares easier to sell, and shares can be sold at a higher value. Hence, it is suggested that UK Water Heater PLC should select the ownership type of Quoted Limited Company. It is because this type of ownership allows the company to sell shares easily to the general public at a higher price than the face values. 2. Identify the external sources of finance available to UK Water Heater PLC., Vietnam The external sources of finance available for UK Water Heater PLC in Vietnam are:

Finance from shares: Selling shares may be the most efficient and popular method of gaining finance. Mostly this is done by working with an investment/merchant bank.

Ordinary Shares: These are any shares that are not preferred shares and do not have

any predetermined dividend amounts. An ordinary share represents equity ownership in a company and entitles the owner to a vote in matters put before shareholders in proportion to their percentage ownership in the company. Ordinary shareholders are entitled to receive dividends if any are available after dividends on preferred shares are paid. They are also entitled to their share of the residual economic value of the company should the business unwind; however, they are last in line after bondholders and preferred shareholders for receiving business proceeds. As such, ordinary shareholders are considered unsecured creditors. Also known as "common stock".

Preference Shares (or Preferred Shares): Dividends for these shares must be paid before paying dividends to ordinary shares, but Preference Shares do not include any voting rights.

New share issues: This involves selling shares at a fixed price per share to an issuing house (usually a merchant bank/ investment bank). The issuing house can sell the shares to the general public at a fixed price (this method is called Offer for sale) or sell them to its direct clients (Placing). A new share issue is suitable to raise a large amount of cash, and it prevent overdependent on existing shareholders, therefore reduces the risk of being taken over. However, the cost (expense) for issuing new shares is considerably high; and it may be difficult to declare the fixed price for the shares. It may also reduce the control of existing shareholders, therefore losing their interest in the company.

Right issue: Offering new shares at a discount (below market value) to

existing shareholders, the amount offered depends on the amount shares they are currently holding. These rights can be sold on financial markets.

This method is relatively simple and cheap, and can also raise a large amount of money. It also improves the control and profit for existing shareholders. However, if too many shareholders sell their rights, existing shareholders may lose control over the company. Finance from Loans:

Debentures: These are loans with fixed interest, usually secured with assets

(assets can be seized if the company fails to pay back the loan). Bonds are similar to debentures; they can be considered the same in certain cases. (Bonds are also called Commercial Papers)

Bank loan (mortgage): This source of finance may be short-term. A bank

loan may extend to 5 10 years at most. The ability to raise finance by bank loan depends on the status of the company (CAMPARI principles: Characteristic (history of borrowing & paying, Ability to pay back, Margin profit for the bank, Purpose of the loan, Amount of the loan, Repayment terms and Insurance).

Venture capital: This is the money from people/organizations who seek long-

term profit rather than short-term dividends. Examples of venture capitalists include pension funds and insurance companies.

Overdraft facilities: It is a kind of short-term loan when the company needs

the money for short term financial problem. UK Water Heater PLC can withdraw money with the amount higher than their bank account. The company has to pay daily interest and principal until they finish their debt payments.

Hire purchases: This method can be used when the company would like to

have some assets which do not need to be bought immediately. For instance, UK Water Heater PLC can buy some equipments and machineries at the low cost and they will be considered as renting. The remained money of the assets will be paid over a fixed period of time to purchase them. Company will own the assets after finish the payments.

Leasing: The lessee can use the assets which are leased from the lesser in a

short period due to the agreement. The lessee will have the advantage of cheaper cost for assets when they do not have to pay all the money immediately. After a rental time, leaser can sell the asset at a lower price (secondhand value).

Factoring: Company can sell their debt to a third party, who is able to collect

that debt in return of cash immediately.

Franchising: UK Water Heater PLC can prove attractive to many people

made redundant with large redundancy payments, or to people taking early retirement from first career, with a lump sum from their pension fund to invest. Beside those options, there is also another source of finance, which is Government Grant. However, the criteria to give these grants are usually very difficult. Some of those criteria are innovativeness and social/governmental benefits. The amounts of such grants are usually not very large, and the administrative cost (cost to improve the companys appeals to the government) is high. Therefore, government grant is not a suitable source of finance for UK Water Heater PLC to consider. After analyzing different external sources of finance, and considering the need to raise 200,000,000 to support the business plan of at least 20 years, we suggest that the company use income from selling shares (ordinary shares, preference shares, new share issues and right issues) and selling debenture notes as the main source of finance for long-term business operations. These methods can help the company raise a large amount of capital, and suitable for long-term business operations. Venture capital may be a supportive source as well. Bank loans, overdrafts and other short-term source of finance would be effective to be used for short-term operations. To better understand the differences between corporate bond/debentures and common shares and evaluate their advantages/disadvantages, please refer to the table below:

Sources

Common shares

Corporate bonds/debentures Implications

Issuing bonds/debentures means that Not Tax they can have the deduction in tax and increase profit for dividends.

affected

by

tax

since

the company must pay interest so dividends are paid after tax.

Debenture holders have no rights to Holders of common shares are vote Control in the company's general able to influence the corporation meetings of shareholders, but they through votes on establishing may have separate meetings or votes corporate objectives and policy, e.g. on changes to the rights attached stock splits, and electing the to the debentures. company's board of directors

Issuing common shares and corporate bonds both mean that the company needs capital for business operations or a new project. This can be positive or negative signs to investors: the company may be growing well and trying to expand, but in the other hand it may be suffering from loss and needs capital for operation. If the purpose of these actions is to have capital to recover from loss, the companys shares would generally go down in price. Moreover, if the company has a new project at hand, the appeal of that project to investors may differ. If investors consider the new project viable and profitable, the price of the companys shares would increase, and vice versa.

Task 2: Select the best method to gain finance


In order to select a appropriate method to gain the required amount of finance (200,000,000) for UK Water Heater PLC, we should base on the cost factor, the risk factor and the control factor as well.

To calculate the cost for different options, we use the Weighed Average Cost of Capital (WACC). Hereby are the WACC values of the five options. (Formulae/calculations can be found in appendix)

Option

WACC

Op1 - 100% Preference Shares

11.1%

Op2 - 100% Ordinary Shares

9.4%

Op3 - 100% Debentures

9.0%

Op4 30% Ordinary Shares, 60% Debentures, 10% Preference Shares

9.3%

Op5 50% Ordinary Shares, 20% Preference Shares, 30% Debentures

9.6%

The first option put the company in a harsh financial position: much fixed dividend must be paid each year (though dividend may be delayed in some circumstances, it is not very advisable). Moreover, this option has the highest cost of all. The second option is lower in cost but high in risk of dilution. It makes the company very 10

much dependent on shareholders. In addition, it does not help reduce the companys tax. However, this option has the least financial risk. The third option put the company in a strong financial risk: the company would have a large debt, and must pay a large sum of interest. However, it helps reducing the tax for the company. Considering the first three option, it is suggested that the company should choose a mixed option (i.e. not using only one source of finance). This will help balance the risk and cost factors. Between the other two options, the fifth option (50% ordinary shares, 30% debentures, 20% preference shares) is more advisable. It is because though higher in cost (9.6% to 9.3% of the fourth option), this option put the company in less debt and in a more stable financial situation in a long-term view. Dilution of control is reasonable (not too high), tax is reduced by a considerable amount, and financial risk is neutralized. So, in conclusion, it is suggested that we: Issue 50% ordinary shares, 20% preference shares and their price will be set at their respective current market price as traded in the London Stock Exchange, and 30% debentures at their price set at 500 per unit and interest rate at 12% per annum payable in 10 years.

3.2. Cash budget for UK Water Heater PLC, Vietnam


Quarter 1 Cash Received Cash sales Credit sales Total cash inflow Cash Payment Key Equipment Assembly Machine Salaries Building rental Material cost Overhead cost 0.00 0.00 0.00 15,000,000.00 4,500,000.00 11,250.00 3,750.00 26,250.00 24,000.00 Quarter 2 11,250.00 0.00 11,250.00 Quarter 3 14,625.00 63,750.00 78,375.00 Quarter 4 19,012.50 82,875.00 101,887.50

500,000.00 12,375.00 3,750.00 28,875.00 28,800.00 11

13,612.50 3,750.00 31,762.50 34,560.00

14,973.75 3,750.00 34,938.75 41,472.00

Income tax Advertising Miscellaneous costs Total cash outflow Net Cash flow Opening Balance Closing Balance

750.00 19,566,000.00 -19,566,000.00 20,000,000.00 434,000.00

7,500.00 6,750.00 900.00 588,950.00 -577,700.00 434,000.00 -143,700.00

6,750.00 1,080.00 91,515.00 -13,140.00 -143,700.00 -156,840.00

7,500.00 6,750.00 1,296.00 110,680.50 -8793.00 -156,840.00 -165,633.00

Period of cash shortages and surpluses: Reason and Solution From the cash flow forecast above, we can see that UK Water Heater PLC would have cash shortage for all four quarters of 2012. The figures were -19,566,000.00, -577,700.00, 13,140.00 and -8793.00 respectively.

In the first quarter, because the sold goods will be paid in the two following quarters so the cash inflow equal to zero, while they still have to pay many costs, especially the large amount of money paid for the equipment & machineries. That explained the negative net cash flow.

The total inflow of quarter 2 is much higher in comparison with the first quarter thanks to 15% of credit sales from the first quarter, and no equipment cost. However, in this quarter, the company has to pay the income tax, 10% increase of salary and material cost; 20% increase in overheads cost and other miscellaneous cost. All of those costs lead to the deficit in this period also.

Another deficit occurs in the fourth quarter of the year. The cash inflow is raising due to the received cash from 85% of the sales in quarter 1 and 15% of the sales in quarter 2. The cash outflow decreased greatly, because no payment was needed for equipment or machineries.

Another cash shortage occurs in the fourth quarter of 2012. The total inflow in this period increases significantly because of the increased credit sales from the two previous quarters are now paid and that make the biggest cash inflow for the company. But the cash outflow also increased due to the increase in many costs and the tax payment.

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All companies have to encounter the problems in managing cash flow because of some unexpected receipts and expenses may occur which are not forecasted in the cash budget. Those can come from factors such as: interest rate, inflation, economic crisis, changes in market price of even some disasters or turbulences which cannot be foreseen. For instance, UK Water Heater PLC can have problems from collecting the debt while their debtors suffer from some loss in business and do not have money for debt payments. In that situation, they cannot have the money for production as well as paying dividend for their shareholders. In order to ease the cash shortages, those methods below can be considered:

Trade credit: According to the information given in the scenario, the material cost is expected to increase by 10% in each following quarter. By using Trade credit, UK Water Heater PLC can reduce the cost of buying material. Trade credit is a short term loan that enables the company to buy raw materials with reasonable interest.

Debt collection policy: Having the bad debt could be a disaster for the company in their business in term of cash shortages. Therefore to avoid the risk of the bad debt from the debtors, UK Water Heater PLC should build a strong and specific debt collection policy.

Discount policies: UK Water Heater PLC should consider this solution in order to become more attractive with the customers. The economic is now recovering from the economic crisis so this policy may be appropriate while the demand of customer is also regain.

Bank loans: Having a loan is also contains some risk with a company. Moreover, to have a bank loan, the company has to meet the requirement of on-time payment, clearing profile as well as some assets for mortgage. However, this solution should be considered when the company wants to have a big amount of money immediately.

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Task 4:
4.1. Working capital requirement for UK Water Heater PLC for 2012: a) The annual costs incurred will be as follows. Materials Labor Variable overheads Fixed overheads Selling and distribution cost 35% of 20,000,000 0.00 15% of 20,000,000 0.00 32% of 20,000,000 0.00 13% of 20,000,000 0.00 5% of 20,000,000 0.00 b) The average of current assets will be as follows. Raw material Work-in-progress Material (30% complete) Labor (30% complete) Variable complete) Finished goods Materials Labor Variable overheads overheads 3/12 7,000,000 1/12 7,000,000 3 1/12 3,000,000 0 (30% 1/12 6,400,000 3 1,366,667 2/12 7,000,000 7 2/12 3,000,000 0 2/12 6,400,000 1,333,33 3 2,733,333 Debtors 2.5/12 20,000,000 4,166,667 10,016,667 500,00 1,166,66 533,33 250,00 583,33 1,750,000 1,000,00 2,600,00 6,400,00 3,000,00 7,000,00

c) Average value of current liabilities will be as follows. Materials 2/12 7,000,000 Labor 1/12 3,000,000 Variable overheads 1/12 6,400,000 15

1,166,666 250,000 533,333

Fixed overheads Selling and distribution

3/12 2,600,000 1/12 1,000,000

650,000 83,333 (2,683,333) 7,333,333

d) Working capital required (10,016,667 2,683,333) = 4.2 Advise to reduce working capital for UK Water Heater PLC, Vietnam:

Managing working capital is crucial for UK Water Heater PLC to operate in the most sufficient way. If they keep too high working capital, they will loose chances to make higher return because its cash tied up in current assets. But too low working capital makes the firm unable to pay off their creditors. Thus, an optimum level of working capital should be maintained. There are many ways to manage that. If they can collect monies due from debtors more quickly or reduce inventory levels relative to sales, the business will generate more cash or it will need to borrow less money to fund working capital. As a consequence, they could reduce the cost of bank interest or they'll have additional free money available to support other investments. Similarly, if they can negotiate improved terms with suppliers e.g. get longer credit or an increased credit limit; they effectively create free finance to help fund future sales. 4.3 EOQ and its meaning to UK Water Heater PLC: Calculate EOQ (Economic Order Quantity): Demand per year= 155,000 Ordering cost per order= 14 Carrying cost per unit= 2 EOQ = 1473 units EOQ (Economic Order Quantity) is an inventory-related equation that determines the optimum order quantity that a company should hold in its inventory given a set cost of production, demand rate and other variables. This is done to minimize variable inventory costs. If the firms decide to purchase more than the result of EOQ, this will lead to ineffective use of inventory. In the case of UK Water Heater PLC, EOQ = 1473 means that they should order 1473 units in one time and that is the most sufficient number. 4.4. Inventory reorder point: Calculate inventory reorder point: Lead-time: 10 days; safety stock: 1,700 tones; Daily usage = 155,000/(50*7) Inventory order point = lead-time*Daily usage + Safety stock 6,128 units Inventory reorder point is the number that illustrates the moment when firms need to place 16

new order. Particularly in this case, Inventory reorder point = 6,128 units means when they have 6,128 units left in stock, that is the time for UK Water Heater PLC to make new order. This order point depends on the lead-time, time for new order to be transported, and the daily usage.

4.5 Advise UK Water Heater PLC whether to adopt discount policy or the factor companys offer: Option A: Total credit sales: 150,000,000 Average collection period: 45 days Average debtors: 18,493,150 80% take the discount: 14,794,520 Reduction in debtors: 3,698,630 Saving in interest: 18,493,150 X 18% = 3,328,767 Cost of discount: 5% X 80% X 150,000,000 = 6,000,000 Benefits: -2,671,233
Option B:

Total Credit Sales Average Debtor Interest (avg. debtor x 18%) Bad debt (0,5% of credit sale) Debt collection employees Total cost of managing firm debt Factor Advance ( 70% x Debtor) Advance cost (19% x Advance) Interest (Debtor x 18% x 30%) Less saving in employee Bad dept (0.4% of sale) Service fee: Factoring cost Benefit of Factoring 150,000,000.00 18,493,150.00 3,328,767.00 750,000.00 48,000.00 4,126,767.00

12,945,205.00 2,459,588.95 998,630.10 (48,000.00) 600,000.00 45,000.00 4,055,219.05 71,547.95

The benefit of factoring is higher therefore the company should choose Option B

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Appendix
Weight average cost of capital in each option of UK Water Heater PLC: Option 1:

Cost of preference share = x 100% = (5/45) x 100% = 11.1% WACC = * Re = 11.1% * 100* = 11.1% Option 2: Re = 9.4%; = 100%

WACC = * Re = 12.4% * 100% = 12.4% Option 3:

Cost of debt = x 100% = Interest rate x (1-tax) = 12% (1-0.25) = 9.0% WACC = * Rd * (1-Tc) = 9.0% Op4: Ordinary shares Re = 9.4%; Preference share Re = 11.1%; Rd = 9%

WACC = 9.4% * 30% + 9.0% * 60% + 11.1% * 10% = 9.33% Option 5:

WACC = 9.4% * 50% + 11.1% * 20% + 9.0% * 30% = 9.62% Re: Cost of equity Rd: Cost of debt : Percentage of finance as equity : Percentage of finance as debt E: Market value of equity D: Market value of debt

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