Mco 07
Mco 07
Debt financing, on the other hand, involves borrowing funds from creditors with the
promise of repayment with interest over a specified period. Common forms of debt
financing include bank loans, bonds, and debentures. Debt financing allows
businesses to retain full ownership and control while leveraging existing assets to
secure loans. Moreover, interest payments on debt are tax-deductible, reducing the
overall cost of financing. However, excessive debt can strain cash flows and
increase financial risk, especially if interest rates rise or revenues decline.
Retained earnings represent profits that are reinvested in the business rather than
distributed to shareholders as dividends. This source of financing is internally
generated and does not require external capital. Retained earnings reflect the
company's profitability and financial stability, signaling confidence to investors and
creditors. Moreover, using retained earnings avoids the costs and obligations
associated with external financing. However, relying solely on retained earnings
may limit growth opportunities, particularly for startups or rapidly expanding firms
with substantial capital requirements.
Each source of long-term finance has its merits, and the choice depends on various
factors such as the nature of the business, its growth stage, risk appetite, and capital
structure preferences. However, if I were to choose the best source of long-term
finance, I would lean towards a balanced approach that combines equity and debt
financing.
Equity financing offers flexibility and long-term partnership potential, while debt
financing provides leverage and tax advantages. By combining both, businesses can
optimize their capital structure, balancing the benefits of equity ownership with the
cos-tefficiency of debt capital. Moreover, diversifying funding sources reduces
reliance on any single financing method, enhancing resilience and adaptability to
changing market conditions.
In conclusion, the best source of long-term finance depends on the specific needs
and circumstances of the business. While equity financing, debt financing, retained
earnings, venture capital, and government grants each have distinct advantages, a
balanced approach that combines equity and debt financing is often optimal for
maximizing financial flexibility, minimizing costs, and achieving sustainable
growth.
2. Risk :
3]
FV
(1+r)t
Conclusion
value
Financial decisions refer to decisions concerning financial matters of a business concern. Decisions
regarding magnitude of funds to be invested to enable a firm to accomplish its ultimate goal, kind of
assets to be acquired, pattern of capitalization, pattern of distribution of firm’s, income and similar other
matters are included in financial decisions. A few specific points in this regard are
(a) Financial decisions are taken by a finance manager alone or in conjunction with his other management
colleagues of the enterprise.
(b) A finance manager is responsible to handle all such problems as involve financial matters.
(c) The entire gamut of financial decisions can be classified in three broad categories: Investment
Decisions, Financial Decisions and Dividend Policy Decisions
Investment Decisions Investment decisions, the most important financial decision, is concerned with
determining the total amount of assets to be held in the firm, the make-up of these assets and the
business risk complexion of the firm as perceived by the investors. The salient features of investment
decisions are as follows:
(i) The investment decision are of two types, viz, long term investment decisions and short term
investment decisions.
(ii) Long term investment decision decides about the allocation of capital to investment projects
whose benefits accrue in the long run. It is concerned with deciding
* What capital expenditure should the firm make?
* What volume of funds should be committed?
*How should funds be allocated as among different investment opportunities?
(iii) Short terms investment decision decides about allocation of funds as among cash and
equivalents, receivables and inventories.
(iv) A firm may have a number of profitable investment proposals in hand. But owing to
paucity of funds, finance manager should be meticulous in choosing the most profitable one.
(v) Thrust of financial decisions is on building suitable asset
2 Focus
*
*
*
*
Capital
* line or acquire
Another company
3
*
*
Potential return relative to their risk.
*focus on long term growth and value creation of the company
4
*
Finance
*
Financial stability
*
* financial structure
*
6 time horizon
* long
long term decision involve capital structure
planning
7 examples
Conclusion
Return l l
location and
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Qus 3] a) How does international financial management widen the scope of a
firm?
Ans] International financial management widens the scope of a firm by providing
avenues for expansion, risk mitigation, and access to diverse resources. Primarily, it
allows firms to tap into new markets, diversifying their revenue streams and reducing
dependence on a single market. By operating in multiple countries, firms can leverage
differences in economic cycles, currency values, and interest rates to optimize their
returns and hedge against risks.
IFM encompasses various activities, including:
Foreign Exchange Management: Dealing with different currencies and exchange rate
fluctuations.
International Investment: Making investments in foreign markets.
Capital Budgeting: Evaluating potential international projects and investments.
Working Capital Management: Managing short-term assets and liabilities in a global setting.
Risk Management: Identifying, assessing, and mitigating financial risks associated with
international operations.
Global Economic Integration: International finance facilitates the flow of capital, goods, and
services across borders. This integration fosters economic growth and development by promoting
trade, investment, and technological exchange.
Risk Management: By diversifying investments and operations across multiple countries,
businesses can mitigate risks associated with economic, political, and currency fluctuations.
Access to Capital Markets: International finance provides businesses with access to global
capital markets, enabling them to raise funds for expansion, research and development, and other
strategic initiatives.
Competitive Advantage: By operating in multiple markets, businesses can gain a competitive
edge by leveraging economies of scale, accessing lower-cost resources, and tapping into new
customer segments.
Innovation and Technology Transfer: International finance promotes the transfer of technology
and knowledge across borders, stimulating innovation and driving economic progress.
Conclusion
Financial management across borders is crucial in international financial management (IFM). It covers
foreign exchange, international investment, capital budgeting, working capital, and risk management.
Companies need IFM to develop abroad, access financial markets, and reduce foreign risks.
However, exchange rate swings, political and economic hazards, cultural differences, and
complicated regulatory regimes must be considered. Businesses may negotiate international finance
and expand sustainably by knowing these obstacles and using effective tactics.
Commercial banks
Commercial banks are one of the most important participants in the foreign exchange
market. They trade on their own behalf but also provide a channel for their clients to
participate in the market. They are essential for providing liquidity and are the backbone
of the forex market.
Commercial banks do not only help their customers facilitate their trades but also
participate in the market as speculators. Those desks are known as "proprietary trading
desks" and the mission of the prop traders is to make a profit for the bank. Following the
financial crisis of 2008, banks have become more risk-averse, and prop trading dwindled.
However, it can still be found within the banks, especially in countries with less regulatory
restrictions.
Commercial banks are amongst the best-informed market players, simply due to the
infrastructure, amount of capital available, and perhaps most importantly - their
knowledge about the market. Commercial banks can see a significant amount of flow
going through the market - from central banks to hedge funds and investment funds. This
information gives them a significant advantage.
Hedge funds
Hedge funds are the most prominent members of the group of speculators. While there
are several types of hedge funds, the ones that are most active in the FX market are the
global macro funds and the currency funds. Macro funds trade in many markets globally,
while currency funds are focused on opportunities in the FX market. Hedge funds can
handle huge positions in the market and are important participants.
Many traders are probably familiar with the story of how George Soros broke the Bank of
England in 1992. While the hedge fund industry has changed a lot since then, it still can
have a large impact on markets, especially when many of those funds go after the same
trade. This category also includes some smaller participants, like CTAs and system
funds.
Commercial companies
Retail traders
Individual traders usually access the market through a retail broker, but may also use a
prime broker if they have the necessary capital. Given the small amount of money
needed to open a trading account, retail traders have access to utilise leverage.
It is difficult to estimate the volume of global retail trading, but from the same survey
conducted by the Bank of International Settlementslatest in April 2019, $201 million was
traded by retail traders. Volumes have been steadily rising and this trend is unlikely to
change soon, as the currency market remains very attractive for individual traders
Governments:
Governments participate in the forex market to manage their
foreign exchange reserves and influence their domestic currency's value through
interventions
International Organizations:
Institutions like the International Monetary Fund (IMF) may participate in the forex
market to stabilize currencies or facilitate international trade and finance.
These participants interact in the forex market through various channels, including
electronic trading platforms, over-the-counter markets, and interbank networks,
contributing to its liquidity and volatility..
The payback period is the time required to recover the initial cost of an investment. It is
the number of years it would take to get back the initial investment made for a project.
Therefore, as a technique of capital budgeting, the payback period will be used to
compare projects and derive the number of years it takes to get back the initial
investment. The project with the least number of years usually is selected.
The payback period is a simple calculation of time for the initial investment to
return.
It ignores the time value of money. All other techniques of capital budgeting
consider the concept of the time value of money. Time value of money means that
a rupee today is more valuable than a rupee tomorrow. So other techniques
discount the future inflows and arrive at discounted flows.
You’ll want to forecast your expenditures and determine your funding requirements
before deciding what kind of leverage to use. Instruments like derivatives, where the
investment is a small fraction of the underlying position, can be used as leverage.
However, in this article, we focus on debt.
Let’s explore some practical examples of how businesses use leverage to fuel
growth and maximize returns in various industries:
Financial leverage
Using financial leverage allows your business to continue making investments even
if it’s short on cash. This is often preferred to equity financing, as it allows you to
raise funds without diluting your ownership.
Amplifying returns. When investments financed by debt yield higher returns than
the cost of borrowing, the company’s overall profitability increases.
Tax advantages. Interest payments on debt are often tax deductible, reducing the
effective cost of borrowing.
Maintaining control. Unlike equity financing, debt doesn’t require giving up
ownership or decision-making power.
Flexibility. Various debt instruments offer different terms and conditions to suit
specific business needs.
However, financial leverage also comes with risks, primarily the obligation to repay
debt regardless of business performance.
Apple Inc. Despite having large cash reserves, Apple has strategically used debt
to fund share buybacks and dividends. In 2013, they issued $17 billion in bonds,
taking advantage of low interest rates to enhance shareholder value.
McDonald’s Corporation. The company has used leverage to fund global
expansion and franchisee support. Their debt-to-equity ratio often exceeds 100%,
yet they maintain strong credit ratings due to consistent cash flows.
Tesla Inc. In its early years, Tesla heavily relied on debt financing to fund
research, development, and production scaling. This strategy allowed them to
become a leader in the electric vehicle market while preserving equity for early
investors.
When considering financial leverage, businesses must carefully assess their ability
to service debt and the potential return on investments funded by borrowed capital.
The optimal level of leverage varies by industry and company-specific factors.
Operating leverage
Operating leverage accounts for the fixed operating costs and variable costs of
providing goods and services. As fixed assets don’t change with the level of output
produced, their costs are constant and must be paid regardless of whether your
business is making a profit or experiencing losses. On the other hand, variable costs
change depending on the output produced.
You can determine operating leverage by finding the ratio of fixed costs to variable
costs. If your business has more fixed expenses than variable expenses, it has high
operating leverage. You can use a high degree of operating leverage to magnify
your returns, but too much of it can increase your financial risk.
Profit sensitivity. High operating leverage amplifies the effect of sales changes on
profits.
Break-even point. Businesses with high fixed costs typically have higher break-
even points (when revenues equal costs).
Scalability. Once fixed costs are covered, additional sales can lead to higher profit
margins.
These hypothetical case studies illustrate high vs. low operating leverage:
A software company invests heavily in development (high fixed costs) but has low
per-user costs (low variable costs). A 20% increase in subscribers might lead to a
50% increase in profits.
A retail store has low fixed costs (rent, basic staffing) but high variable costs
(inventory). A 20% increase in sales could lead to a 15% increase in profits.
3. Strategic Leverage:
This type of leverage involves using non-financial resources,
such as partnerships, alliances, or intellectual property, to enhance business
performance. Strategic leverage focuses on maximizing the value of intangible
assets and relationships to gain a competitive advantage
4. Technological Leverage:
Technological leverage involves using technology to
improve efficiency, reduce costs, and increase productivity. Investments in
technology can result in significant leverage by allowing businesses to achieve
more with fewer resources
Each type of leverage carries its own set of risks and rewards. While leverage can
amplify returns in favorable circumstances, it also magnifies losses in adverse
conditions. Therefore, it's essential for individuals and businesses to carefully
assess the risks and potential benefits before utilizing leverage in their financial
strategies
Total Profit After Tax = Rs. (7,500 + 8,200 + 7,900 + 8,900 + 6,500) = Rs. 39,000
Average Annual Profit After Tax = Total Profit After Tax / Number of Years
= Rs. 39,000 / 5 = Rs. 7,800
ARR = (Average Annual Profit After Tax / Initial Investment) * 100%
= (Rs. 7,800 / Rs. 50,000) * 100% = 0.156 * 100% = 15.6%
So, the Accounting Rate of Return (ARR) for this investment is 15.6%.