Capital Investment and Financial Management

A companys capital investment is the money it spends on fixed assets like land, machinery, and buildings. Cash, assets, or loans may be used to fund the project. Businesses may struggle to start the ground without capital investment. I plan to invest in my sisters small business which is an online store for hand-made bags. I think this project has a great potential as today hand-made things like bags are becoming popular among teenagers. I do think that we always select products with high return value as the main goal is to increase profit.

Before putting any money into a company, organization, or idea, it is critical to undertake market research and determine the companys market share. This can be used to find whether it is a good idea and what the potential return is (Brigham & Ehrhardt, 2020). Moreover, the initial capital expenditure must be sufficient to cover all costs of starting, opening, and operating the firm until the business generates enough revenue from sales and services to reimburse or cover all operating costs (What is capital investment, 2021). I think that my capital would be enough to invest in my sisters project. I made this investment decision in accordance with the amount of capital I have, the project needs and the potential revenues that I would obtain after starting the project.

Capital investment decisions are made frequently, and it is critical for a firm to assess its project requirements to chart a course for future growth. This choice is not as plain or straightforward as it may appear. With a huge outlay of capital, there is much on the line, and the long-term financial impact may be uncertain due to the capital outlay diminishing or increasing over time (What is capital investment, 2021). With regards to my project, there are many factors to consider, for example, how online operations will proceed, how much money my sister needs to sustain the store and the cost of making bags. A companys capital investment decision is a long-term growth strategy, and as such my investment is a part of my growth plan for future projects. Investments are made to improve operational capacity, increase market share, and increase revenue; thus, I am planning to expand the project further by allocating more investments in the future. Therefore, a deep financial analysis is required, considering the companys development into new goods or markets.

In general, there are risks that can be emerged during the project. Capital risk refers to the possibility of losing all or part of an investment. It relates to a wide range of assets that do not guarantee a complete return on investment. Investors take up capital risk, also known as market risk, when they invest in products or services that are not well-researched (What is capital investment, 2021). Therefore, it is extremely important to consider each aspect of a project. I observed how my sister was organizing her business and managing it for the past month, and I am now sure that I can invest in this business. This is because it provides a strong potential for growth. For my project, I would assess potential risks and try to understand how to overcome them by looking at the first three months after the project starts.

With regards to WACC is calculated by multiplying the cost of each capital source (debt and equity) by its weighted average market value, then adding the products to get the total cost of capital. The cost of equity can be estimated by applying the capital asset pricing model (CAPM). WACC is used by investors to judge whether an investment is worthwhile, and by management to determine whether a project is feasible.

Reference

Brigham, E. F., & Ehrhardt, M. C. (2020). Financial management: Theory and practice (16th ed.). Cengage Learning. Web.

What is capital investment? (2021). The Balance Small Business. Web.

Public Budgeting Leadership and Financial Management

Introduction

The responsibility assigned to the managers of the public budgeting sector is high, given the importance of the functions that these persons perform. Assessing financial flows, cost analysis, allocating funds, and other tasks require competence and literacy in this industry. At the same time, such nuances as the human factor, temporary crises, and other unforeseen phenomena can impede the activities of managers and create obstacles to the qualitative realization of immediate duties. To control the field of public budgeting correctly, one should have ideas about the practical methods of work and the theoretical aspects of this practice. The skillful use of approaches to assessing the upcoming activities and analyzing existing challenges may contribute to the efficient and error-free management of financial flows, a crucial component of sustainable economic development.

Necessary Skills and Knowledge

First of all, it is crucial to consider the nuances of management itself and a specific area under control. In particular, a person responsible for monitoring public monetary resources is aware of the importance of this position and realizes key responsibilities. In this case, it is necessary to study relevant literature on existing leadership approaches, the methods of eliminating conflicts, the ways out of a crisis, and other aspects of management practices. This will eliminate gross errors in assessing the state of the financial sector and help to understand the specifics of work better.

Also, it is essential to understand the generally accepted theories and concepts of control over the budget and its features. The process of funds distribution, as a rule, is based on standard schemes. According to Di Francesco and Alford, the budgetary theory in its classical presentation provides for the relationship between taxation and expenditure (48). Nevertheless, it is significant to pay attention to related factors that affect the circulation of money, for instance, the economic development of a specific region, the share of profits from individual industries, and other aspects. In addition, as Ho argues, experienced management implies assessing risks as the inevitable component of leadership activity (751). If a responsible person is aware of potential threats, this will make it possible to avoid a crisis due to preliminary analytical work and the aggregate evaluation of the situation. Therefore, when summing up the requirements mentioned above, the quality management of the public budgeting sector implies utilizing both practical and theoretical approaches to leadership.

Value of Experience

Concerning my practice as a manager of the public budgeting sector, I can note the importance of the studied approaches to the workflow organization. It is hard and immodest to talk about my personal contribution. However, when evaluating the quality of the activities performed, I can assume that I have managed to understand the systems structure, which is an important step in the organization of the monitoring process. Constant participation in solving current tasks is a valuable way of replenishing knowledge and skills, which, in turn, serves as a background for productive activities. As a result, my leadership role in this field has allowed me to understand the responsibilities and range of duties that the manager must take into account. Therefore, the experience gained is an essential platform for further studying the concepts and principles of working with public budgeting.

Conclusion

The detailed assessment of the approaches to the organization of the workflow and the theoretical foundations of managing the sphere of public budgeting may contribute to establishing error-free and productive activities. Both theoretical and practical skills are important for studying and subsequent implementation in personal practice. The thorough analysis of the whole sector structure is my personal achievement, and subsequent work may be aimed at honing individual attainments.

Works Cited

Di Francesco, Michael, and John Alford. Balancing Control and Flexibility in Public Budgeting: A New Role for Rule Variability. Springer, 2016.

Ho, Alfred Tat-Kei. From Performance Budgeting to Performance Budget Management: Theory and Practice. Public Administration Review, vol. 78, no. 5, 2018, pp. 748-758.

Government Budgeting and Financial Management

The public budgeting leaders have the responsibility of fulfilling various roles including planning, reforming, and budgeting. Public budgeting involves three areas that are mostly dominated by the fields of economics, planning, and data sciences. Planning is used to determine goals and setting up the necessary programs to achieve them. Programming also helps in the administering of efforts that efficiently assist in the achievement of the set goals.

Budgeting involves the handling of financial estimates and manipulation of resources that are needed by the agencies in executing of the laid out plans. For the communitys well-being, officials should have the capability of managing the budget, distributing resources and also predicting costs (Wildavsky, 2006)

The public budgeting leaders should have the skills of public budgeting, revenue planning, the ability to evaluate and solve problems when it comes to fiscal activities in the public sector, and the skills of budget presentation. After the budgeting exercise, leaders should complete the hypothesis testing and run a Confidence Interval Test to display confidence in their results. An interval test is a parameter between two values and statisticians will usually choose one of the following three degrees of confidence: ninety, ninety-five and the ninety-nine percent to help get the C1 test started (Wildavsky, 2006).

When serving as a public sector manager, an individual must understand the responsibilities of that come with this role, and that the duties of this position are comprehensive. The manager should be aware that the money that is spent belongs to the public, and that the federal law always constrains the scope of the projects whereby the public has the right of redressing them. In addition, a manager should constantly remember that he or she is responsible for tax money and the public trusts him/her to spend their revenue wisely.

In case of unexpected developments in the course of fund management, a public manager should be prepared to assume responsibility irrespective of the fact it is his/her fault. Statutory accountability and constraints of the manager and the other partners in the public sector should be laid out very clearly. Focusing on how legislation works and how it can be used flexibly is another way of streamlining public budget management (Bovaird, 2009). A strategy should be provided so as to ensure that the public is aware of what the organization is doing and make sure that they can contact him/her whenever anything is amiss.

A public manager should ensure that his/her role is clearly laid out and supported by internal and external structures. Therefore, a manager should introduce his/her strategy to each team member. Consequently, the manager should go through the documents and clearly illustrate the output that is required from all individuals and how the team will contribute towards the achievement of the set targets. The members should know they have a critical role to play in the success of the organization.

The members should be brought face to face with the people who benefit from the services that are to be offered. The roles of each member should be clearly laid out and the message should be heard to avoid any misunderstanding. Performance Appraisals should be used for the team members to know how they are fairing on. Rewards such as bonuses, awards either monetary or otherwise, and fully paid trips to different destinations should be motivating factors for all the members. The manager should be in the forefront practicing what he/she is preaching thus setting a good example to the members. Once the responsibilities are clear, the members are sent off to perform their duties whereby in case of any failure they should be answerable (OLeary & Bingham, 2009).

The manager should always have a contingent plan in case things do not work out as expected, because the public expects everything that holds their investment to be a success. The manager should always get things into perspective and in the case of any failure, the source of the problem should be pointed out. Overall, the leader should be able to take another persons blame in his/her capacity. Walking around with negative feelings is not a good way to fix a problem in public management affairs. In the case of challenges, the manager should also seek advice from other managers who have gone through similar issues.

The managers should also be very brave (OLeary & Bingham, 2009). Ego can get in the way once in a while since taking and giving responsibilities are straightforward. Tasks involved may be very different and some of them may be boring while others may be fascinating like flying out to various destinations or meeting very famous people. Boundaries should be kept since some things can never be entirely clear. Issues should be sort out with delicacy and tact, and every task should be pointed out for every individual. By giving out clear responsibilities to individuals, one creates a more confident and honest culture that has a positive attitude about winning. Consequently, this approach can prevent situations in which events seem to control people instead of people managing them.

Rational Decision Making

Budgetary decision-making can be rational whereas rational decision-making is the opposite of intuitive decision-making. In rational decision-making, people use analysis, facts, and systematic processes to come to a conclusion. Rational decision-making is the precise and analytical processes that business enterprises use to come up with a solid decision (Doyle, 2009, p. 701). Budgetary decision making in any business or organization occurs every day.

Some organizations utilize intuitive decision making in seeking solutions to modern-day business problems. The administrators use their perceptions and intuitions as a guide in the decision-making process. In this case, no facts are involved in this type of decision-making process. This approach requires an executive to sort out circumstances devoid of the necessity for critically thinking about the steps to be taken. When the decision-making process has no facts and there is a difficult decision to be made, the intuitive decision-making comes in handy.

A good example of a rational decision maker is James, the manager of a restaurant who is confronted by dwindling profits. When the manager was under enormous pressure to increase the amounts of profits from his business, he took a rational decision making approach and realigned the business model. In rational decision-making, the process includes defining the problem, identifying the decision criteria, allocating of priorities to the criteria, developing the alternatives, evaluating the options, and finally selecting the best option.

Defining the problem that is facing the business is the first step. The defining stage is relatively easy as the board of management should be aware of the difficulty. No matter how long the problem has persisted, a criterion on how the decision-making process will commence should be made. The evaluative stage determines the failures and the success of the alternatives (Doyle, 2009). Examples of such scenarios include situations where site-sensitivity analysis and the site-suitability are being conducted. On the other hand, going through the process thoroughly defines the problem, exploration of all the alternatives for the problem and gathering more information, evaluating the information, and identifying the best options in anticipation of the consequences (Doyle, 2009, p. 702).

Out of all the solutions that have been created, the best ones should be chosen and the site of operation should be developed at this choosing stage in reference to all the other available strategies. The rational decision comprises of a final solution and an implementation that is secondary to the site. The four stages that form the core of the Rational Decision Making Model are the identification of the problem, assessment, finding the best criteria to be used, and finally choosing the best and final solution.

Through a rational decision, the best and preferred alternatives are implemented to the problem and the preliminary task involves monitoring of the selected solution (Eisenhardt & Zbaracki, 2002). Furthermore, when a rational decision is used, building and the renovation are the key things throughout the implementation of a project. On most decision-making scenarios, monitoring and evaluation of outcomes and results is necessary. A rational decision supports the final supervision of the issue where the results are observed and put into records. In order to evaluate whether the rational decision made is effective, feedbacks are always welcomed and further actions may be taken to improve evaluation outcomes (Eisenhardt & Zbaracki, 2002, p. 18).

References

Bovaird, T. (2009). Public management and governance. New York: Taylor & Francis.

Doyle, J. (2009). Rational decision making. MIT encyclopedia of the cognitive sciences3(5), 701-703.

Eisenhardt, K. M., & Zbaracki, M. J. (2002). Strategic decision making. Strategic management journal, 13(2), 17-37.

OLeary, R., & Bingham, L. B. (2009). Surprising findings, paradoxes, and thoughts on the future of collaborative public management research. The Collaborative Public Manager, 2(4), 255-269.

Wildavsky, A. (2006). The political economy of efficiency: cost-benefit analysis, systems analysis, and program budgeting. Public Administration Review. 23(1), 292-310.

Euroland Foods S.A. Strategic Financial Management

Executive summary

In project evaluation, the following tools can be used to aid managers in project financing decision making: Net present value, Internal rate of return including modified internal rate of return and Payback period including modified payback. The project evaluation the following criteria can be used in deciding whether to finance a project or not:

  • Positive net present value. A zero NPV means just preserving the status quo which is not the objective of a for profit organization
  • An IRR higher or equal to the cost of capital
  • Environmental and societal consideration even if project has a positive NPV and an IRR higher than the required rate of return

The company can adopt the following procedures in analyzing alternative projects:

  1. Define the problem (Anthony, Hawkins & Merchant 2003, p. 877). Is it a make or buy decision? A replacement project or an expansion?
  2. Select possible alternative solutions (Anthony, Hawkins & Merchant 2003, p. 877).
  3. For each of the selected alternative, measure and evaluate those consequences that can be expressed in quantitative terms (Anthony, Hawkins & Merchant 2003, p. 872).
  4. Identify those consequences that cannot be expressed in quantitative terms and evaluate them against each other and against the measured consequences (Anthony, Hawkins & Merchant 2003, p. 877).
  5. Reach a decision (Anthony, Hawkins & Merchant 2003, p. 877).

Given that the IRR and PBP for the projects to be 12 per cent and 6 years for new market or product, 10 per cent and 5 years for market or product extension, 8 per cent and 4 years for efficiency improvement. The company is still better off allocating a portion of its financial resources to following projects, efficient-water treatment at four plants for 6 million, market expansion southwards and eastwards at 30 million each and project 4. The project 11 that acquisition of a leading schnapps brand and associated facilities is rejected because of capital rationing, it requires 60 million while the amount remaining is 54 million. Given the amount then the project 9 and 10 are taken. The IRR and Pay back period criteria as pointed out by the company, however, must be evaluated as to its accuracy. The cost of capital estimation is a very important decision since it can impact all the criteria in evaluating the project: a higher cost of capital means lower present value of the cash flows (excluding investment) generated by the project; and a higher benchmark to be compared with the IRR  the smaller the gap between IRR and the cost of capital, the higher is the chance of that project being rejected.

In evaluating the proposal of the company might also want to use IRR as a criterion. That is if the project has a required rate, then it is better of financing it. Although several finance practitioners have pointed out that sometimes IRR and PBP shows conflicting result, IRR prevails because of time value of money. Indeed any one of the two would serve the purpose (2004, p. 1643). These sometimes conflicting results, however, is due to the fact that IRR and PBP have intrinsic differences between one another. The IRR is a financial indicator and the PBP is an economic indicator of a capital investment.

After evaluating using quantitative then comes in qualitative Phase in Project budgeting. When project passes through the quantitative analysis test it has to be further evaluated in terms of qualitative factors. Qualitative factors are those which will have an effect on project but impossible to evaluate accurately in monetary terms. In the case the factors which will be considered will include the following; (Ghetti A. 2008):

  1. The societal effect of an increase or decrease in employees number.
  2. The positive and negative government political attitude towards project.
  3. Strategic consequences of conception scarce low materials.
  4. Positive or negative relationship with labor union about project.
  5. The possible legal difficulties possible to the use of patents, copy rights, brand names.
  6. Impacts on the firms image if the project is socially questionable.

The above factors should be factored in project. To enable project address them adequately to be certain of meeting at ultimate objectives.

These projects will be ranked as follows

Project No. Rank under IRR Rank under PBP Decision remarks
1 9 9 Reject
2 10 10 Reject
3 8 8 Reject
4 5 5 Accept
5 11 11 Reject
6 1 1 Accept
7 5 5 accept
8 7 7 accept
9 2 2 accept
10 3 3 accept
11 4 4 accept Not taken because of capital rationing

The projects taken should include

Project No. Rank Amount in million
6 1 6
9 2 27
10 3 22.5
7 5 30
4 5 27
Total 112.50

Discussion

In this company there are many constraints among them is capital rationing where the budget for all projects is Euro 120 million. The projects that have meet the acceptable criteria are worth euro 202.5 million, projects worth 112.5million were taken but two crucial were left out because of capital rationing. Capital rationing can be defined as constrains in resources regardless of cost. Capital rationing limits some qualitative factors to be considered when selecting a project. Some viable projects are rejected because of this constrains. In this case capital rationing is one period rationing therefore some projects can be postponed.

In evaluating whether to finance a project or not, the pay back period and the internal rate of return of that project were used. Hence, if the projects pay back period positive, then the company is better off financing that project and if the internal rate of return or IRR is equal or greater than the companys benchmark, then the company is really better off financing such project. This project evaluation is necessary and if done incorrectly might mean the financial failure of the organization since investment policy directly affects company value (Cohen & Yagil 2007, p. 60). Furthermore, capital budgeting or project evaluation is one of the most important decisions that face the financial manager. Prior studies spanning the past four decades show financial managers prefer methods such as internal rate of return or non-discounted payback models over net present value (Ryan & Ryan 2002, p. 355).

Internal rate of return or IRR of a cash-flow stream is the discount rate at which its pay back periods 0 (Johnstone 2008, p. 78). This means that when using the IRR as the discount rate the present value of the cash flows generated by the project and the initial capital investment for that project are equal. Hence, the 50 per cent IRR of the project 6, means given a return of 50 per cent is equivalent to a bank account with effective compound interest rate [50 per cent] accruing against both positive and negative balances (Johnstone 2008, p. 87). Each method is heighted below and its effects;

Payback Method

This method measures the length of time it will take for a business to recover the investment made. The measure uses the initial cash investment made and the average annual net cash flow. Dividing the former by the latter, the result is a number that represents the cash payback period in number of years. The formula is:

Cash Payback Period = Capital Investment

Average Annual Net Cash Flow

It is normal to average the annual cash flow since it is usual to see that cash flows are not constant through the period of the active performance of the capital assets obtained through the investment made.

The shorter the payback period the sooner the company recovers its cash investment. However, the adequacy of the payback period is dependant on the perceptions of the firm, the type of industry or service, and the macro and micro economic conditions. The payback period is usually considered viable if it is between 2 and 3 years. In some projects, in the initial period the cash flows fluctuate vastly and may even be negative at the start. In such cases, the cumulative net annual cash flow helps determine the time for recovery of the investment.

This method suffers from the limitation that it does not factor the differences in cash flows due to their timing or the time required for execution of the project. For example, two projects may require the same investment and have the same payback period, but the timing of the cash flows may be quite different. In such a case, the project that yields quicker net cash flows is preferable over the other.

Net present value

This method considers time value for money. It is calculated as shown below.

Net present value = present value of cash inflows  net investments

The criteria for accepting rejecting the project is if NPV e 0 accept the project otherwise reject the project. The project is accepted when the NPV e 0 because it will increase the shareholders wealth.

Internal Rate of Return (IRR)

This method also relies on the concept of calculation of present values. The IRR determines the interest yield of the capital project at which the net present value becomes zero. Returning to the NPV calculation, we note that a discount rate, based on the needed rate of return of the business, determines the present value of future cash flows. In the case of IRR calculations, the reverse is true, the rate is calculated using the net future cash flows and the IRR is the rate at which the discount will bring the net cash flow to zero, i.e. the present value of the net cash flows and the investment required are the same. Where the IRR is greater than the expected return or the cost of funds the project is financially viable and projects with higher IRR are more viable ( Ghetti A. 2008). Therefore, internal rate of return is the rate of discount that causes the present value of cash inflows to be equal to the net investment value of the project that is the rate which produces 0 net present values (McLaney E., (2003). The criteria for accepting and checking the project is that internal rate of return e cost of capital the project is accepted otherwise the project is subject to rejection. Calculation of the IRR requires two steps. The first step is to calculate the internal rate of return factor using the formula (Westerfield R., Jaffe, and Jordan ,2007):- This can be summarized as follows:

  • Annuity:  calculate the payback period of the project and Use the present value annuity factor table find the factor closest to the payback period. This could produce internal rate of return.
  • For mixed stream of cash flows:- Calculate the average annual cash flow to get fake annuity and divide by average annual cash flow into initial net investment in order to get a fake pay back period.
  • Simpler method is to use spreadsheet software such as Microsoft Excel that allows direct calculation of the IRR from a table of projected cash flows.

Sensitivity analysis and expected value

When evaluating projects with different risks probability assigning is best alternative. Probabilities are used and they provide a clear answer as compared to sensitivity analysis of risk. Therefore assigning probabilities to assess risk is more accurate. Probabilities provide an expected value of a figure which is a measure of accept / reject criteria for the project. It gives a weighted average internal rate of returns where the weights used are probabilities of various chances. It is more objective way of estimating risk. However when the project has different lives and of different sizes sensitivity analysis plays an important role. Sensitivity measures how sensitive a factor is to changes.

Recommendation

The procedures that are used by the company are good but they should be improved to reduce dependency on complicated formulas in estimating the internal rate of return. The probabilities that are used should be specific to specific internal rate of return. They have a wide range of internal rate of return to choose from which creates the urgency problem in the cost of capital.

Agency problem arises when the managers become subjective to the methods or to the decisions of which to accept or reject the project. There should be a proper criteria which will assist in coming to conclusion on the viability of the project or projects that are proposed. In this case there is laid down criteria while using internal rate of return and payback period, the managers may be subjective while choosing the projects. This is because the seven projects are acceptable. Therefore the criteria proposed may have also agency problems. Therefore the management for the company should come up with ways of evaluating the project to ensure there is dependency on the managers discretion on which project to choose.

Section D

Windfall tax has many advantages and disadvantages. Windfall tax is a tax on the excess profit of company of certain industry with the aim of meeting long term and short term financial needs of a country. It can be said to have some advantages; one of the advantage of windfall tax is that helps the government to raise short term finance to finance some activities. This advantage will become a disadvantage to the economy especially at this time of global financial crisis because businessmen at the energy sector will pass on the tax to the consumer and accelerating inflation of prices. It is usually in the energy industry where this tax targets. Industry players will pass on the gas and oil price taxes to the people and this will affect consumption and production. Another disadvantage is that industry players may create artificial shortage of that gas so that they may increase prices and thus increase inflation to the economy to recover the tax.

The government may think that windfall tax will raise funds for short term financial needs but it may slow down economic growth by discouraging importation and consumption as well as production since the prices will be high and this is the one of the worst effect of windfall tax. It will also discourage companies which are in the business of oil exploration or intend to be in that business from investment. Organization behavior is also affected by windfall tax through affecting the culture i.e. how things are done.

Firms will make losses especially if the price of raw materials goes below what was intended to be taxed. This will have one of the worst effect of discouraging investment among the energy industry players and this will reduce employment creation and Economic growth. This windfall tax which is only levied only once ensures that the companies in the oil industry to pay the taxes.

Apart the from the disadvantages of windfall tax, it be used to control carbon emissions by taxing oil companies at that are producing product with high levels of carbon. Another problem of windfall tax is that once they is windfall of profit it is imposed, however when there is windfall of losses the government does not come in to save the same industry players. It may cause industry players to come up with some unnecessary expenses that are aimed at avoiding to pay tax. Therefore this tax acts a control measure.

This tax system promotes fairness and ensures that the right amount of tax is paid by ensuring excess profits are taxed. No other taxes unrelated to income need to be paid for the windfall profits. The taxes are accurately calculated according to excess income only. This also ensures that every company is treated equally by not allowing some companies enjoy extra profits. It reduces economic inequality is among all companies of the country.

The tax is easier to manage because it is imposed on past profits and on already audited financial statements. It requires few personnel to correct the tax from the target corporations. It also taxed on the companies as lump sum to the company therefore the issue of the company been asked to re-audit their books becomes unnecessary. It will look like it is very expensive to the side of the company because it will be paid as lump sum but the good thing is that it redistribute the profit of a company.

When I talk of equity/fairness I mean equitable distribution of wealth. The tax payer who is a company making windfall profit is able to contribute his fair share to the cost of government management. In principle equity means that the company pays the tax has much as he benefits and it is through this benefit accrued that a company acquires the ability to pay tax. Windfall tax will not imposed on companies which not be able to pay but imposed on companies that will be able to pay. In essence a company that makes a abnormal profit will charged the tax without sacrificing the companies that are making losses at the time w hen there is windfall profit while others are making losses. For example the current financial crisis , a company can be making losses while others will making profits. If a company is making profits it is benefiting more than others Take the example below where equity has been described for two companies.

The graph may be interpreted to mean equal absolute, equal proportional, or equal marginal sacrifice.
Figure 1. The graph may be interpreted to mean equal absolute, equal proportional, or equal marginal sacrifice.

From the graphs above it will narrated as follows:

The how equitable is windfall tax depends on both the shape of the income utility schedule and equity of sacrifice of the government. The graph may be interpreted to mean equal absolute, equal proportional, or equal marginal sacrifice. Where the diagrams pertains to no windfall tax and the right to windfall tax company.MU and MU are the respective marginal utility of the income schedules which are identical and assumed to decline at a decreasing rate. No windfall tax income before tax is OB while that for windfall is OB. The total utilities derived by the two are OBDM and OBDM, respectively. If a given revenue T is to be drawn from the two, how will it be allocated.

Absolute Sacrifice beginning with the equal absolute sacrifice rule, no windfall tax, with income OB, pays CB, while H, with income OB, pays CB, where CB+CBDE while the loss to with windfall tax equals C B D, and T is distributed such that CBDE= CBDE.

If the MU schedule were constantly, equal absolute sacrifice would require tax liabilities to be the same for all incomes. Equal sacrifice would call for a head tax. But with a declining MU schedule tax liability must rise with income. This much is clear, but it does not follow that a windfall tax will be called for. As may be shown mathematically, the required tax distribution will depending on whether the elasticity of the marginal income utility with respect to income is greater than, equal to or less than unity. While it seems reasonable to assume that the MU schedule falls, there is non intuitive about its rate of decline. Thus there is no ready basis on which to conclude whether equal absolute sacrifice calls for progression, not to speak of the proper degree of progression.

Proportion sacrifice if the tax burden is distributed in line with equal proportional sacrificial will pay PB and with windfall tax will pay PB with PB+PB again equal to T. the tax is divided between the two so that the fraction of pretax utility lost for without windfall tax is the same as that for with windfall tax. It is evident that a constant MU schedule will call for proportional taxation. It can also be seen that a declining but straight- line MU schedule calls for progression, but generalization become difficult if the MU schedule falls at a decreasing rate, as is usually assumed. The result in any particular case depends on the level and slope of the MU schedule, as well as particular case on the initial distribution of income and the amount of revenue that is to be raised.

Marginal sacrifice under the equal marginal sacrifice rule, without windfall tax, pays FB and with windfall tax pays FB, where FB+FB is the required revenue T. the marginal sacrifice is the same, since FG=FG. At the same time, the total sacrifice for both is minimized. After tax incomes are equalized at OF=OF. if the marginal utility of income were constant, the distribution of the tax bill under equal marginal sacrifice would be indeterminate. Any distribution drawing at least some small amount from all taxpayers would meet the requirement. Given a declining Mu schedule, equal marginal sacrifice calls for maximum progression, i.e., the leveling down of income from the top until the required revenue is obtained. The rate of decline does not matter in this case. The principle of equal marginal sacrifice as applied leaves the taxpayers with the same income. It also results in least total sacrifice for both with windfall tax and without windfall tax combined. The same result is obtained whether we use an equal marginal, or a least toatal, sacrifice rule. But suppose the revenue requirement is les than the excess of there with over without windfall tax income. Here, equal marginal sacrifice cannot be achieved and the result must be stated in terms of least total sacrifice. To achieve least total sacrifice, the tax is applied so as to loop off incomes from the top down, leaving all those who pay tax with equal marginal sacrifice, but not necessarily including all individuals in the taxpaying group.

Social obligations are one of the main reasons that taxes are collected. The taxes collected are used only for public expenditure like infrastructure, defense, health and education therefore this tax helps the government achieve these. The economy needs to be stable and growth needs to be ensured. A windfall tax rate will help growth as the taxes are lower and more money is left for investment and expenditure. The economies are increasingly becoming international. The tax structure needs to be competitive with the other nations.

The maximum impact of the windfall tax system will be on the individual that is because the amount paid as taxes will charged on the consumers. The poor who live below the poverty line will have to get goods and services at a higher price.

The other main arguments for the system are simplicity, equity and meeting of socio-economic obligations. The system is also more efficient in the sense that it helps the economy perform better. Firms that pay taxes may pass on these taxes to the customers or suppliers. Hence, the taxes paid by the firm may be in accordance with profits. Those may be paid by the consumers in addition to the income taxes already payable. According to this argument there should be a windfall tax on extra income and no other taxes tax when the industry is no making windfall taxes as a whole. This will also lead to different consumption patterns which will also lead to different taxes from consumers of windfall taxed products. This will ensure a fair income tax. The simplicity of this system also enables easy calculation, collection and reporting.

After research it becomes apparent that there is a long way to go before windfall taxes accurately reflect the true economic picture. The windfall tax system is much fairer than the other tax structure as the poor have benefit of gaining through discouraged overcharging by industry players. The other system has too many tax induced distortions which fails to consider windfall taxes as a social mischief. The adjusted gross income calculation is way too complex and needs to be revised completely. The windfall tax system protects the poor and taxes the middle class and the wealthy fairly and equally. As the income from only activities that are making excess profits is taxed equally the system becomes really simple. The system eliminates the many adjustments resulting from encouraging and discouraging different activities that reduce consumption.

The money collected from the tax is used for basic social necessities and social security. The tax should be used to support activities that require charity. Taxing consumption to mange social behavior is not valid as the taxpayer has already paid a tax on the income.

In conclusion, I can say that the future is bright if countries unanimously agree to radically and introduce windfall to discourage multinationals from making unnecessary profits. The governments have to fulfill socio-economic obligations and enable equitable redistribution of income. It should also ensure overall development. The windfall tax is simple, fair and efficient. The perspectives will include the influences on the firms in association with the individuals. Finally, the money collected has to be spent where it is needed the most.

Works Cited

  1. Anthony, R., Hawkins, D. & Merchant, K. 2003, Accounting: Texts and Cases, 11th edn, McGraw Hill, Boston.
  2. Bosch, M., Montllor-Serrats, J., & Tarrazon, M. 2007, NPV as a Function of the IRR: The Value Drivers of Investment Projects. Journal of Applied Finance, vol. 17, no. 2, pp. 41-45.
  3. Cohen, G. & Yagil, J. 2007, A Multinational Survey of Corporate Financial Policies, Journal of Applied Finance, vol. 17, no. 1, pp. 57-69.
  4. Fischer D. E.and Jordan R.J. (2006) Security analysis and Portfolio management, Prentice-Hall, India.
  5. Ghetti A. (2008); Terrific introduction to financial management; Amazon
  6. Johnstone, D. 2008, What Does an IRR (or Two) Mean?, Journal of Economic Education, vo. 39, no. 1, pp. 78-87.
  7. Karathanassis, G. 2004, Re-Examination of the Reinvestment Rate Assumptions, Managerial Finance, vol. 30, no. 10, pp. 63.
  8. McLaney E., (2003; Business finance theory and practice; Prentice Hall
  9. Ryan, P. & Ryan, G. 2002, Capital budgeting practices of the Fortune 1000: How have things changed?, Journal of Business and Management, vol. 8, no. 4, pp. 355-364.
  10. Singh, S. & Gaur, P. 2004, How Close are NPVI and IRR as Criteria for Project Choice in Real Life?, Finance India, vol. 18, n0. 4, pp. 1643-1650.
  11. Tang, S. & Tang, H. 2003, The variable financial indicator IRR and the constant economic indicator NPV, The Engineering Economist, vol. 48, no. 1, pp. 69-78.
  12. Westerfield R., Jaffe, and Jordan (2007); Corporate finance core principles and applications by McGraw-Hill. ISBN-13: 978-0-07-353059-8/ISBN-10:0-07-353059-X

Appendix

Workings

Project 1.

The project takes 2 years and its IRR can be calculated. The project has a 5.8years payback period since it can no cover for its cost. It generates 11.6 million and uses 33 million.

Average net cash inflows = 11.6/2 = 5.8

Payback period (PBP) = 33million/5.8 = 5.6896years

IRR from tables using 5.6897at 2 years = it is less than 1%

Project 2

This project also results into cash flows that are lower than the initial investment. It means neither IRR nor PBP will be applicable. It uses 45 million and receives 35.6 million.

Average annual cash inflows 35.6/10 = 3.56 million

PBP = 45 million / 3.56 million =12.640 years

IRR from tables using 12.640 at 10 years = it is less than 1%

Project 3

The payback period of the project is 15million/2.25million = 6.667 years

Internal rate of return using tables of 3 decimal points at 10years is approximately 8% taking 6.667 as a present value interest factor of annuity.

Project 4

The project has enough cash flows to support further expansion.

Project 5

The pay back period is 21million / 0.15million = 140 years

IRR at infinity is less than 1%

Project 6

The present value of the project pay back periodis 15million x PVIF4years, 10.6%.

13.56 million

Net annual cash flows = 15m/4 = 3.75million

PBP = 6/3.75 million = 1.6 YEARS

IRR from tables = 50%

Project 7

Average annual cash flows =56.3 million/ 10 years = 5.63 million

PBP = 30million / 5.63 million = 5.3286 years

IRR at 10years using 5.3286 is 14%

Project 8

Average annual cash flows =48.8 million/ 10 years = 4.88 million

PBP = 30million /4.88 million= 6.1475

IRR at 10years using 6.1475 is 10%

Project 9

Assumption the gains will be equivalent to the current share of profits 20% of 56 million

11.2 million. Then the payback period is calculated as

Capital investment =27 million

PBP = 27million / 11.2 million= 2.4107 years

IRR at 4 years using tables at 9.6429 is less than 24%

Project 10

Assumption the gains will be equivalent to the 8 million annually. Then the payback period is calculated as

Capital investment =22.5 million

PBP = 22.5 million / 8 million = 2.8125

IRR at 3 years using 2.8125 is 16%

Project 11

Assumption the gains will be equivalent to the16.5 million annually. Then the payback period is calculated as

Capital investment =60 million

PBP = 60 million / 16.5 million= 3.6364

IRR at 6 years using 3.6364 is 16%

JD Sports and Sports Direct Companies Financial Management

Introduction

This paper is divided into two sections. The first part will focus on the financial analysis of two companies, JD Sports Fashion PLC and Sports Direct International PLC. Both are based in the UK but have a presence in other parts of the world and both trade in leisure and sports apparel. As part of the analysis, ten ratios will be calculated for each company. These ratios will then be interpreted, and a recommendation will be made on which company to invest in.

Various ways of improving the performance of the poorly performing company will be suggested. Finally, the limitations of ratio analysis will be discussed. The second part of the paper will focus on capital investment appraisal. Three techniques will be used to appraise two projects, and a recommendation will be made on the most viable project to invest in. Finally, the limitations of using capital appraisal techniques will be discussed.

Financial Analysis

Ratio Analysis

Table 1. Calculation of Ratios.

JD Sports Fashion PLC Sports Direct International PLC
2016 2015 2016 2015
Current assets 510,695 400,259 1,311,437 878,297
Inventories 238,324 106,336 702,158 517,054
Debt 6575 36,789 333,832 138,053
Current liabilities 348154 232960 540,608 382,621
Total equity 400,825 444,078 1,384,728 1,161,551
Cost of sales 937,431 782,703 1,619,681 1,591,748
Gross profit 884,221 739,550 1,284,644 1,240,812
Revenue 1,821,652 1,522,253 2,904,325 2,832,560
Operating profit 133,406 92,646 223,178 295,581
Profit for the period 100,630 69,755 278,981 241,353
Dividends 13,820 13,260 0 0
Ratios
Current ratios 1.47 1.72 2.43 2.30
Quick ratios 0.78 1.26 1.13 0.94
Gross profit margin 48.5% 48.6% 44.2% 43.8%
Operating profit margin 7.3% 6.1% 7.7% 10.4%
Net profit margin 5.5% 4.6% 9.6% 8.5%
Gearing ratios (debt/equity ratio) 2% 13% 24% 12%
Earnings per share 50.16 35.17 46.8 40.6
Return on capital employed 29.70% 25.50% 19.89% 22.53%
Average inventory turnover period 93 days 106 days 158 days 119 days
Dividend payout 13.7% 19.0% 0% 0%

Analysis of Performance

The liquidity of both companies will be evaluated using the current and quick ratio. These two ratios give information on the ability of a company to meet immediate obligations using short-term assets. They also measure a firms ability to manage working capital. The current ratio for JD Sports Fashion PLC dropped from 1.72 in 2015 to 1.47 in 2016, while the quick ratio decreased from 1.26 in 2015 to 0.78 in 2016 (Figure 1). This signals a decline in the liquidity level of the company.

The trend of liquidity ratios for JD Sports Fashion PLC.
Figure 1. The trend of liquidity ratios for JD Sports Fashion PLC.

On the other hand, the current ratio of Sports Direct International PLC rose from 2.30 in 2015 to 2.43 in 2016. Similarly, the quick ratio rose from 0.94 in 2015 to 1.13 in 2016 (Table1). The liquidity position of the company improved (Figure 2). A comparison of the two companies shows that Sports Direct International PLC has a better liquidity position than that of JD Sports Fashion PLC.

The trend of liquidity ratios for Sports Direct International PLC
Figure 2. The trend of liquidity ratios for Sports Direct International PLC.

The second category of ratios that will be analyzed is profitability. This set of ratios gives information on the earning power of a company. That is how a company can successfully generate revenues and convert them into profit. Therefore, the ratio analyzes the efficiency of pricing strategies that are used by a company and the effectiveness of cost management. The ratios that will be analyzed within this category are returned on capital employed, gross, operating, and net profit margin.

The gross profit margin for JD Sports Fashion PLC dropped slightly from 48.6% in 2015 to 48.5% in 2016. This decline can be explained by the fact that the cost of sales grew by a higher proportion than revenue. A disproportionate increase in the cost of sales can be caused by factors that are exogenous to the company. The decrease in the value of the ratio indicates that the profitability level dropped. The operating profit margin for the company improved from 6.1% in 2015 to 7.3% in 2016.

This can be attributed to growth in both operating profit and revenues. It shows an improvement in the ability of the company to manage operating expenses and to generate revenue for non-operating segments. The net profit margin also increased from 4.6% in 2015 to 5.5% in 2016. Finally, return on capital employed rose from 25.50% in 2015 to 29.70% in 2016 (Table 1). The values were high, which imply a high profitability level.

This ratio gives information on the efficiency of the company is using the available resources to generate revenues and profit (Horner 2013). Thus, profitability ratios for JD Sports Fashion PLC had an upward trend except for gross profit margin (Figure 3). These findings signify an improvement in profitability.

The trend of profitability ratios for JD Sports Fashion PLC.
Figure 3. The trend of profitability ratios for JD Sports Fashion PLC.

In the case of Sports Direct International PLC, the gross profit margin increased from 43.8% in 2015 to 44.2% in 2016. This can be explained by the fact that the revenues grew by a higher proportion than the cost of sales. The growth signifies an improvement in managing pricing and costs of sales. The operating profit margin dropped from 10.4% in 2015 to 7.7% in 2016. This was mainly caused by a significant increase in selling, administrative, and general expenses as a result of an expansion program.

Recently, the company has been expanding into the upmarket segment. This has contributed to a significant increase in operating costs. This ratio is vital because it shows how profitable the core operating segment of a business is. The net profit margin dropped from 8.5% in 2015 to 9.6% in 2016. This signifies an improvement in profitability. The growth can be explained by the significant income that was earned from investments.

The return on capital dropped from 22.53% in 2015 to 19.89% in 2016. This can be explained by the growth in capital employed. The decline can be an indication that the company did not effectively use the available resources to generate profit. Thus, only the gross and net profit margin improved (Figure 4).

A comparison of the profitability ratios for the two companies reveals that JD Sports Fashion PLC had higher values of gross profit margin and return on capital employed. On the other hand, Sports Direct International PLC had higher values of operating and net profit margin. The profitability for Sports Direct International PLC seems to be erratic, while for JD Sports Fashion PLC they are increasing.

The trend of profitability ratios for Sports Direct International PLC.
Figure 4. The trend of profitability ratios for Sports Direct International PLC.

The gearing ratios give information on the proportion of debt and equity that is used by a company. They focus on the capital structure of a company. The ratio is important to investors and debt providers because too much debt can reduce the amount of profit that is attributed to equity providers. In addition, it can affect the solvency of the company. Therefore, a company needs to maintain an optimal balance between the two sources of funding.

The debt to equity ratio for JD Sports Fashion PLC dropped from 13% in 2015 to 2% in 2016. This shows that the amount of debt used by the company decreased. On the other hand, the debt/equity ratio for Sports Direct International PLC had an upward trend (Figure 5). The values rose from 12% in 2015 to 24% 2016. The increase was caused by a £700 million refinancing loan and £915 million that was borrowed for opening up new stores (Sports Direct International PLC 2017).

Thus, it can be observed that Sports Direct International PLC has a higher gearing level than that of JD Sports Fashion PLC. The two companies have a low debt to equity ratios. They still have an opportunity to expand their operations through borrowing.

Gearing ratios.
Figure 5. Gearing ratios.

The earnings per share (EPS) for the two companies improved during the two year period (Figure 6). The EPS for JD Sports Fashion PLC rose from 35.17 pence in 2015 to 50.17 pence in 2016. Further, the EPS for Sports Direct International PLC increased from 40.6 pence to 46.8 pence. This ratio gives information on the amount of profit that is assigned to each share. A higher value of the ratio is preferred to lower values because they indicate a higher profitability level.

Earnings per share.
Figure 6. Earnings per share.

The average inventory turnover period measures the efficiency in handling inventory. That is the rate at which a company restocks. A higher rate is often preferred to a lower one because it signifies an elevated level of efficiency.

Further, some goods, such as perishable commodities, are likely to have a high turnover rate. The average inventory turnover period for JD Sports Fashion PLC dropped from 106 days in 2015 to 93 days in 2016 (Figure 7). Thus, the duration it takes before the company refill stock reduced, signifying an increase in efficiency (Nobes 2014). In the case of Sports Direct International PLC, the value of the ratio grew from 119 days in 2015 to 158 days in 2016 (Table 1).

This shows a reduction in efficiency because the company took a longer period before it replenished stock in 2016. Thus, JD Sports Fashion PLC had a higher efficiency level in stock management than Sports Direct International PLC.

The trend of average inventory turnover period.
Figure 7. The trend of average inventory turnover period.

The dividend payout ratios measure the proportion of net earnings that is paid out as a dividend. A low ratio indicates that a company retains a large proportion of net income. The dividend payout ratio for JD Sports Fashion PLC had a declining trend (Figure 8). The values dropped from 19% in 2015 to 13.7% in 2016. This decline can be attributed to the fact that the net earnings increased at a higher rate than the total amount of dividend that was paid. Thus, the proportion of net income that was retained in 2016 grew (JD Sports Fashion PLC 2017). Sports Direct International PLC did not pay out any dividends in 2015 and 2016.

The trend of the dividend payout ratio.
Figure 8. The trend of the dividend payout ratio.

Conclusion

A comparison of the performance of the two companies shows that JD Sports Fashion PLC had a better overall performance than Sports Direct International PLC. The company had growing values of profitability. Further, the gearing level was low. In addition, earnings per share were high and increasing. The efficiency in managing inventory was favourable. Finally, the company paid dividends in 2015 and 2016. The liquidity ratios were low.

However, the company is still able to meet immediate financial obligations. Thus, if this trend persists, the company is expected to perform even better in the future. Sports Direct International PLC had erratic and unpredictable performance. Therefore, based on this financial analysis, an investor should consider buying the shares of JD Sports Fashion PLC.

Recommendations on how to Improve Performance

There are a number of ways the performance of Sports Direct International PLC can be improved. First, the management could come up with effective ways of managing operating costs. This should be done to ensure that adequate profit is generated from operating activities. In addition, the costs of expanding their operations should be managed to ensure that it does not distort the trend of the bottom line. Further, the use of debt to finance operations should be done cautiously so that it does not significantly affect the capital structure and profitability. Finally, the management of the company needs to review its inventory management policies.

This should be done with an aim of ensuring that the inventory turnover is improved. This can be achieved by reducing the reorder quantity. A high inventory balance increases storage costs and wear and tear. Therefore, there is a need for the company to understand its market segment and know the rate at which the stock moves. Thus, reorder levels and quantity should be set to match the speed of stock movement.

The Limitations of Using Financial Ratios

Financial ratios are appropriate tools for analyzing the performance of a company. They allow for comparison of performance from one period to another. They also enable an analyst to compare performance of various companies. Even though ratio analysis is widely used, it has a number of limitations. First, financial ratios only make use of quantitative data. Thus, it ignores the qualitative aspect of performance.

Therefore, it is not comprehensive. The second drawback of this technique is that the operations of various companies often cut across different industries. Therefore, it is difficult to come up with industry average ratios that can be used for analyzing these companies. Another limitation of ratio analysis is that inflation distorts the values that are reported in the financial statements. This limits the ability to effectively compare performance over a period.

For instance, if the inflation rate is 10%, profit can appear to have increased by the same percentage yet this is not an actual increase. Another limitation of this technique is that it ignores the fact that companies use different accounting policies to prepare their financial statements. This makes it impossible to compare the performance. For instance, if a company records net sales while another company uses gross sales, then the sales values of these two companies are not comparable. Another limitation is that if ratio analysis is not done thoroughly, then it may not unearth the possible use of window dressing to manipulate the financial results.

A business owner can carry out some transactions at the end of a financial period with an aim of altering the anticipated results. Thus, an in-depth, considered ratio analysis should be carried out to provide any useful insights and information. Finally, interpreting the ratios can be a challenge. For instance, it is not easy to generalize a ratio as either good or bad because various factors need to be put into perspective in any analysis.

Capital Investment Appraisal

Investment Appraisal Techniques

Depreciation expense

Machine 1

  • = (£170,000  £20,000) / 6
  • = £25,000

Machine 2

  • = £170,000 / 6
  • =£28,333

Table 2: Workings for Project A.

Project A
Machine 1
Net profit Depreciation Cash flows Cumulative cash flows Discount rate at 20% Discounted cash flows
2017 65,000 25,000 90,000 90,000 0.8333 75,000.00
2018 65,000 25,000 90,000 180,000 0.6944 62,500.00
2019 65,000 25,000 90,000 270,000 0.5787 52,083.33
2020 55,000 25,000 80,000 350,000 0.4823 38,580.25
2021 55,000 25,000 80,000 430,000 0.4019 32,150.21
2022 45,000 25,000 70,000 500,000 0.3349 23,442.86
Residual value 20,000 20,000 520,000 0.3349 6,697.96
Total 290,454.60
Initial investment -170,000
Net present value 120,454.60

Payback period

  • = 1 + (80,000 / 90,000)
  • = 1 year and 11 months

Accounting rate of return

  • = ((25,000 + 35,000 + 45,000 + 75,000 + 85,000 + 65,000) / 6) / 170,000 * 100
  • = 55,000 / 170,000 * 100
  • = 32.35%

Table 3: Workings for Project B.

Project B
Machine 2
Net profit Depreciation Cash flows Cumulative cash flows Discount rate at 20% Discounted cash flows
2017 25,000 28,333 53,333 53,333 0.8333 44,444.42
2018 35,000 28,333 63,333 116,667 0.6944 43,981.46
2019 45,000 28,333 73,333 190,000 0.5787 42,438.25
2020 75,000 28,333 103,333 293,333 0.4823 49,832.80
2021 85,000 28,333 113,333 406,667 0.4019 45,546.11
2022 65,000 28,333 93,333 500,000 0.3349 31,257.03
Residual value 0 0 500,000 0.3349 0
Total 257,500.07
Initial investment -170,000
Net present value 87,500

Payback period

  • = 2 years + 53,333.3 / 73,333.3
  • = 2 years and 9 months

Accounting rate of return

  • = ((65,000 + 65,000 + 65,000 + 55,000 + 55,000 + 45,000) / 6) / 170,000 * 100
  • = 58,333.33 / 170,000 * 100
  • = 34.31%

Discussion and Conclusion

The net present value of project A is £120,454.60 (Table 2), while for project B it is £87,500 (Table 3). A project is selected if it has a positive net present value. In this case, the two projects have met the threshold. Therefore, they are both viable. However, project A and B are mutually exclusive. Therefore, the project with the highest value of net present value will be preferred because it promises elevated returns.

In this case, Project A will be selected for investment. Project A has a payback period of 1 year and 11 months, while project B has a payback period of 2 years and 9 months. Based on such criteria, a project with a shorter payback period will be selected because it will ensure that the initial investment is recouped within the quickest amount of time. Therefore, Project A will be considered for investment. Finally, the accounting rate of return for Project A is 32.35%, while for Project B it is 34.31%. Project B will be preferred here because it has a higher value of the accounting rate of return. However, overall, Project A will be selected because it promises higher returns and it has a shorter payback period (Warren, Reeve & Duchac 2013).

The Limitations of Using Investment Appraisal Techniques

The use of various investment appraisal techniques has gained popularity in evaluating the viability of a project. However, the three techniques that are used above have a number of limitations. A major drawback of the payback period criterion is that it does not take into account the effect of the time value of money. Secondly, this specific criterion does not use cash flow that occurs after the payback period. Therefore, the risks of future cash flows are ignored, and there is no concrete decision rule on whether a project can improve the value of a company.

The accounting rate of return also has several of limitations. The first limitation is that it does not take into account the timing of receipts from a project. Thus, it assumes that a project will generate stable profit throughout its entire life. Secondly, the accounting profits are subject to different accounting policies. In addition, accounting profit is often affected by non-cash items such as depreciation. Also, this criterion does not take into account the idea of discounting. Therefore, the concept of time value of money is not used.

Net present value is also considered to be one of the more superior techniques for appraising projects. However, it also has limitations. First, the use of this criterion requires a prior determination of cost of capital. The net present values are quite sensitive to changes in the discount rate. For instance, the use of high discount rates can lead to low or negative values of net present values. Therefore, it is difficult to come up with the most appropriate discount rate. Finally, this criterion does not consider the timing of cash flow (Brigham & Ehrhardt 2016).

References

Brigham, E & Ehrhardt, M 2016, Corporate finance: a focused approach, 6th edn, Cengage Learning, Boston, MA.

Horner, D 2013, Accounting for non-accountants, 9th edn, Kogan Page Limited, Philadelphia, PA.

JD Sports Fashion PLC 2017, 2016 annual reports and accounts. Web.

Nobes, C 2014, Accounting: a very short introduction, Oxford University Press, Oxford.

Sports Direct International PLC 2017, Annual reports and accounts 2016. Web.

Warren, C, Reeve, J & Duchac, J 2013, Financial & managerial accounting, 12th edn, Cengage Learning, Boston, MA.

BMW: Global Financial Management and Summary

Outline

Global operating companies are always facing financial risk related to currency volatility. It affects all aspects of the global companies. Global automobile industry is a major industry which is affected crucially by the currency fluctuations. In this case study, the foreign exchange risk management strategy of BMW, a major player in the automobile industry is discussed in order to identify the effectiveness of the strategies followed by it to get the optimum results.

What did BMW do in order to manage global financial risk and why?

Introduction

The currency risk management is a complex process. Relative strength of the dollar in respect of the relevant foreign currency, and the specific operating activities of the company are influencing the currency exposure management. In the management of currency exposure, factors such as financial, marketing, production etc have to be considered. International investment is an effective tool for avoiding the operating exposure risks. In order to reduce the operating costs and avoiding the complexity in dealing with currency exposure, BMW adopted various strategies. In the passenger car industry, there exists keen competition of well-functioning firms. Cost reduction is essential for getting competency in the industry. Thus BMW adopted translational production and operating strategy through joint ventures, mergers, and acquisitions.

The foreign exchange risk management strategy of BMW

In the initial stage of operation, BMW adopted home country production strategy. Due to higher transportation charges, exchange rate risks, higher operating costs through labour costs and related expenses with the raw materials as well as product distribution, BMW changed its production plant from home country to the marketing countries. Manufacturing plant of BMW was set up in USA in 1992 in order to avoid the exchange rate risks and exploit the opportunities of lower operating costs and reduced transportation charges. It helped the company to attain competing strength in the foreign market. In the home country the production costs are comparatively higher. The labor cost and social benefits legally obliged to offer to the customers are the highest in the world. The exchange rate of German currency over USD is also not favorable for the financial competence of BMW. In order to assist the marketing operations in Latin American region, BMW started new production unit in Mexico in 1994. This helped the company to exploit the benefits such as low cost labor with high quality in Mexico with potential demand for the passenger car in the Latin American region. Elimination of currency risks and exploitation of lower operating cost are the major factors behind the transnational production strategy of BMW. The diversification in production centers in different countries helps BMW to reduce the economic exposure at a greater level. It facilitates the transfer of production in case of decline in real exchange rate in one country to another that offers rising real exchange rate. BMW adopted acquisition strategy in UK by entering in $ 1.2 billion deal with British automaker Rover. It helped to attain the production capacity at low cost. It increased the production capacity of the BMW. The raw material resources for the production are procured from Latin America where the exchange rate and lower production costs make the purchasing at lower cost even though the transportation cost is higher. In order to compete in the industry, BMW reduced its product development cycles from seven to three years. The number of models and variation offered are diversified through applying up-to-date technology in the production process. It helped the company to keep up the changing customer preferences in time. BMW occupy the brand image of Luxury cars, and the acquisition of Rover provides BMW, to expand their product offerings in different ways. Introduction of Rover helped them to enter in the economy car industry sector without affecting the original image of BMW. Local governments are adopting incentive packages for attracting foreign investors towards the country. BMW is better facilitated through tax incentives and other benefits from the state of South Carolina for transplanting its production unit in that state. (Cheol, McElreath & Robert, n.d).

FX risk management principles

Corporate FX risk management principles are adopted by players in the international automobile industry to mange the FX risk at a reasonable level. As a part of the FX risk management, BMW adopted ways such as minimizing the transaction costs, accurate and timely information on performance versus objectives, rigorous error and compliance checking etc. To execute the companys FX policy in the most accurate manner, well qualified and experienced human resource are employed by the company. It provides the currency risk management and FX trading in the most appropriate manner. (Wallace, 1999). BMW has formulated measures for reducing the impact of global financial risk. Sales strategies of BMW are focused on improving the earnings. The alignment of sales volume in specific market is based on actual demand. Maintenance of strong customer relation and stable dealer organisation helped the company to ensure strong market positioning in the international automobile industry. The product and sales strategies of BMW are customer focused and thus maximum customer satisfaction is ensured by the company. The contrast in the companys business between emerging and mature markets remained sharply defined in the quarter. Tepid growth in the U.S., Japan and Western Europe was offset by strong demand from emerging markets. The U.S. in particular showed increasing signs of weakness, with deliveries down 9%. (Lagorace, 2008).

Conclusion

The transnational operating policy and marketing strategy of BMW are capable of exploiting the situational advantages and reacting quickly to the changes in market demand. Flexible working methods and working time accounts enable the company to change according to the demand in the market. BMW continues to aim to achieve a return on sales of at least 6% in 2010 through the application of market recovery strategies. The extreme flexibility of the BMW Groups production network provides a competitive edge in terms of the ability to realign production volumes where necessary. (Korzeniewski, 2008).

References

Cheol, Kim Yong., McElreath., & Robert. (n.d.). Managing operating exposure: A case study of the automobile industry; multinational business. (Provided by customer).

Korzeniewski, Jeremy. (2008). autobloggreen. Web.

Lagorace, Aude. (2008). BMWs profit hit by financial crisis, weak dollar: Falloff in U S deliveries. Market Watch.

Wallace, Jeffery B. (1999). Core principles for managing multinational FX risk. The Group of 31 Report. Web.

Personal Financial Management and Financial Literacy

Personal financial management is a useful method of controlling income and expenditures as well as planning future savings. By understanding the basic principles and minor aspects of money management such as the compound interest method, people can avoid bankruptcy and enhance their chances for the side income.

Since I did not have the opportunity to study personal financial matters in high school because there were no such classes and the schools administration only started to consider the introduction of personal finance courses, I learned everything from my parents, the Internet, and my experience. Having analyzed my knowledge, I can conclude that I know only the basics: the main principle that says to spend less than earn, the second rule of searching for side business and income, and the third rule of money management. These principles are self-explanatory, and people know them intuitively. As a matter of fact, my experience shows that in most cases simple intuitive knowing in not enough. I read the articles on the Internet about the effective money management and successfully followed the tips that were written in them because the theory is quite simple: calculate the income, divide it into parts, assign on various needs, and do not forget to put some amount of money for savings. However, the theme of side income is rather complicated because it concerns a wide range of components: hobbies, investments, education, and even relationships with people. Personally, I am interested in smart investments and the compound interest method of earning income.

In the previous unit, we learned how to calculate the total amount of money in the investment account using the exponential equation that operates with variables of ending and principal amounts of money, the interest rate, a number of annual compoundings, and a number of investment years. I found out that with $250,000 deposited for ten years at 8% interest I will earn nearly $577,400. As it turns out, the compound interest method is a real instrument for earning money. The process implies two components: time and money, and its principle say that the more time is given to the investment, the more money will an investor receive in the future (Ryan, 2011). This principle allowed me to derive a simple, self-explanatory rule: the investing activity should start as soon as it is possible.

Following the idea that was expressed in the previous paragraph, I regret that I did not know the principle more time  more money before. I would definitely start investing earlier. However, I cannot say that I learned this rule too late. For a young person that is only starting its personal finance management, I would advise to invest the money as soon as it is possible and to be an active investor. Active investors study the market and possibilities of deposits; they know the difference between bull and bear markets, understand the nature of market volatility, and avoid practicing market timing (Garman & Forgue, 2011). Personally, I contemplate the possibility of active investment. As opposed to passive investment activity that consists of depositing money in a bank and simply waiting several years to pass, active investment involves a constant analysis of the market, which helps to develop financial management thinking and to be in the course of current economic events. Consequentially, having become an expert that understands the nature of investments, a person has numerous chances to earn a significant income.

In conclusion, I may say that the course of finance helped me to learn certain interesting and beneficial aspects of personal money management such as investments. I realized that the compound interest method is a real instrument of earning income, and, moreover, our lessons made me involved in the theory of investment that studies various opportunities of earning money on the stock exchange market.

References

Garman, E. T., & Forgue, R. (2011). Personal finance. Boston, MA: Cengage Learning.

Ryan, J. (2011). Personal financial literacy. Boston, MA: Cengage Learning.