Fin622 Assignment No 2 solution 2021-Corporate Finance-VU-semester fall 2021
Fin622 Assignment No 2 solution 2021-Corporate Finance-VU-semester fall 2021
Question: Part A
Cash management is the most critical factor in business success and sustainability, and robust cash-managed policies provide a competitive advantage to the corporation to capitalize on these opportunities even with limited resources. If cash is managed correctly, the business will remain
healthy in today's dynamic business environment. When a business's cash management is inadequate, it may experience severe liquidity problems, resulting in bankruptcy. The most critical factor affecting a business's profitability and long-term health is its liquidity. If the corporation manages the liquidity crisis appropriately, it will be more creditworthy and reputed
for lending institutes.
Suppose you are a finance person in Start Corporation. Your management gives you a responsibility to calculate optimal cash and analyze the liquidity, profitability, and risk of Star Corporation compared to its competitor Moon Corporation. The competitor, Moon Corporation,
has the same size and almost similar market share in the industry. The Start Corporation has a high level of investment in current assets and currently holds Rs. 50 million in the current asset while its competitor has Rs. 10 million in current assets. Star Corporation has the philosophy of
maximum purchasing of its current assets with equity and considers it less risky. But the competitor has thought of short-term debt financing for fixed assets.
Today, businesses operate in an open environment where other stakeholders have considerable influence on the operations and prospects of the business. The government is a critical player in this domain, and its policies impact the business directly and indirectly when the policy is tied with interest rates. In recent months, the government announced the contractionary monetary policy that caused the borrowing costly because of a surge in interest rates. Before the contractionary policy, the interest rate in the economy was only 7% per annum, but now it reached up to 12% per annum. The news in media and a few officials' statements show the existence of the contractionary policy for up to one year.
From the above information; you are advised to:
a) Calculate the “Spread and Return Point” of both corporations according to the Miller-Orr Model.
b) Which corporation should invest the money for the short-run as per Miller-Orr Model, and what is the logic?
c) Analyze the scenario and briefly elaborate on which working capital policies both corporations are adopting?
d) Which corporations’ profitability will be more affected with high-interest rates? Provide reasons
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Question: Part A
Cash management is the most critical factor in business success and sustainability, and robust cash-managed policies provide a competitive advantage to the corporation to capitalize on these opportunities even with limited resources. If cash is managed correctly, the business will remain
healthy in today's dynamic business environment. When a business's cash management is inadequate, it may experience severe liquidity problems, resulting in bankruptcy. The most critical factor affecting a business's profitability and long-term health is its liquidity. If the corporation manages the liquidity crisis appropriately, it will be more creditworthy and reputed
for lending institutes.
Suppose you are a finance person in Start Corporation. Your management gives you a responsibility to calculate optimal cash and analyze the liquidity, profitability, and risk of Star Corporation compared to its competitor Moon Corporation. The competitor, Moon Corporation,
has the same size and almost similar market share in the industry. The Start Corporation has a high level of investment in current assets and currently holds Rs. 50 million in the current asset while its competitor has Rs. 10 million in current assets. Star Corporation has the philosophy of
maximum purchasing of its current assets with equity and considers it less risky. But the competitor has thought of short-term debt financing for fixed assets.
Today, businesses operate in an open environment where other stakeholders have considerable influence on the operations and prospects of the business. The government is a critical player in this domain, and its policies impact the business directly and indirectly when the policy is tied with interest rates. In recent months, the government announced the contractionary monetary policy that caused the borrowing costly because of a surge in interest rates. Before the contractionary policy, the interest rate in the economy was only 7% per annum, but now it reached up to 12% per annum. The news in media and a few officials' statements show the existence of the contractionary policy for up to one year.
From the above information; you are advised to:
a) Calculate the “Spread and Return Point” of both corporations according to the Miller-Orr Model.
b) Which corporation should invest the money for the short-run as per Miller-Orr Model, and what is the logic?
c) Analyze the scenario and briefly elaborate on which working capital policies both corporations are adopting?
d) Which corporations’ profitability will be more affected with high-interest rates? Provide reasons
Mail me at
caring24by7@gmail.com
Transcript
00:00In today's video we are going to cover the solution of assignment number 2 of subject
00:11corporate finance with subject code FIN 622.
00:16Its last paid for submission of assignment is 26,000 per week means today it has total
00:22marks 10.
00:23So before reading the question let's see is there any special instructions regarding
00:30the extra time.
00:31Yes, you have 24 hours extra grace period after due date is usually available to overcome
00:36uploading difficulty.
00:38So you have more 24 hours extra time for uploading the solution of this assignment.
00:46So let's start the reading of this question then we are going to read out the task assigned
00:52with this question and then we are going to understand the task then we will jump into
00:59the solution.
01:01So let's start reading.
01:04Cash management is the most critical factor in business success and sustainability and
01:08robust cash management policies provide a competitive advantage to the corporation to
01:13capitalize these opportunities even with limited resources.
01:18This means that he is highlighting the efficiency of a company that have ability to manage
01:26their cash related issues efficiently and effectively.
01:32So due to this he has a competitive advantage over their competitors unless he has a limited
01:41resources.
01:42If cash is managed correctly the business will remain healthy in today's dynamic business
01:50environment.
01:51You know in this era of digital and dynamic business environment it is very important
01:58for the companies to manage their cash working capitals problem effectively and correctly
02:11that help the management to keep their business active and healthy.
02:15When a business cash management is in advocate it may experience severe liquidity problems
02:22resulting in bankruptcy.
02:24Those businesses which have failed to manage their working capitals in efficiently effectively
02:36they will suffer the severe problem of liquidity issues as a result the company may face or
02:44may go into the bankruptcy situations.
02:46The most critical factor affecting a business profitability and long term health is its
02:51liquidity.
02:52Liquidity is a very important factor for all the business that have critical effects on
03:01the business profitability and long term health.
03:04If the corporation manages the liquidity crisis appropriately it will be more credit worthy
03:10and reputed for lending institutions.
03:12Lending institutions means banking, investment bank and other institutions they give more
03:20credit or rely on the businesses which have ability to manage their liquidity crisis more
03:27appropriately.
03:28So, now the scenario is started here suppose you are a finance person and start corporation
03:37your management gives you a responsibility to calculate optimal cash and analyze the
03:44liquidity profitability and risk of start corporation compared to its competitor moon
03:50corporation.
03:51I think there is no need to explain this one the competitor moon corporation has the same
03:58size and almost similar market share in industry.
04:03It depicts that the moon corporation is same as of start corporation in terms of its size
04:11and its market share in the industry.
04:13It means that both corporations start and moon are same from the point of view of size
04:20and market share.
04:22The start corporation has a high level of investment in current assets and currently
04:27holds rupees 50 million in current assets while its competitor has rupees 10 million
04:31in current assets.
04:33Now we are going to compare the two corporations given in the scenario on the basis of their
04:39investment in current assets as mentioned and the start corporation heavily invested
04:46in current assets which is equal to amount 50 million as compared to rupees 10 million
04:54which is invested by its competitor moon corporation which is very less in numerical comparison
05:03Start corporation has a philosophy of maximum purchasing of its current assets with equity
05:10and considers it less risky.
05:13Start corporation thinks that if it purchases its current assets from its equity means its
05:21own money rather than debt money so it is less risky for them but on the other hand
05:30the competitor moon thought that short term debt financing is good for their fixed assets.
05:36Now today business operates in an open environment where the other stakeholders have considerable
05:42influence on the operation and purpose of business.
05:45It means that all the businesses are not alone to control everything there are many other
05:51stakeholders such as customers, employees, financial institutions, government and customer
06:01as well supplier as well all are the stakeholders that have interest in that businesses and
06:07they are very much influenced the operations of the business and even the decision of the
06:12businesses.
06:14So the government is a critical player in this domain from stakeholders point of view
06:19we are going to give more weightage to the role of the government because its policy
06:24impacts the business directly and indirectly when the policy is tied with the interest
06:28rate because government has the power of not only to regulate the businesses but through
06:35its policies it can influence the businesses regarding the interest rate which is a part
06:43of the monetary policy of the government.
06:47In recent months government announced the contractionary monetary policies that cause
06:51the borrowing costly because of a surge in interest rate.
06:55It has been observed that from the few months ago that the government is interested to apply
07:02the contractionary monetary policy as a result of which the borrowing cost becomes higher
07:09because of the rise in interest rate before the contractionary policy the interest rate
07:15in the economy was only 7% per annum but now it reached up to 12% per annum the new
07:21in the media and a few official statements show the existence of the contractionary policy
07:26for up to one year.
07:28These are some information that are related to start corporation and moon corporation
07:34in terms of amount and regarding these particular variance of daily cash flows 125,000 minimum
07:43balance 700,000 transaction cost is 77 daily interest rate is 0.02% in terms of decimals
07:50it is 0.0002 cash balance cash in any other words available cash 700,000 for moon corporation
08:04the values of the same particulars are 80,000 minimum balance is 40,000 transaction cost
08:11is 50 daily interest rate is same as we saw in the case of start corporation and cash
08:18balance or cash in hand or available cash is 57,398.
08:26So our first task is calculate the spread and return point for both corporations according
08:31to the Miller-Ord model.
08:33The second task is which corporation should invest the money for short run as per Miller-Ord
08:37model and what is the logic.
08:41Analyze the scenario and briefly elaborate which working capital policies both corporations
08:47are adopting.
08:49The fourth one is which corporation profitability will be more affected with the high interest
08:56rate provide reason.
08:58So now we jump into our solutions that's start solutions part one spread rate before going
09:06to discuss the solution I am going to request you that if you found any kind of error in
09:15calculations please mention in the comment section.
09:21So thanks for your cooperation in this regard so let's start reading solutions part one
09:27spread and return we are going to determine for the both corporations.
09:33Spread formula is 3 into 0.75 into total transaction cost into variance of daily cash
09:39flows divided by daily interest rate raised to power 1 by 3 or cube root 10 into 3.
09:46Return point is minimum balance plus spread by 3 means the value of the portion inside
09:55the basis scale basis.
09:59So for start spread is 3 into 0.75, 77 is the transaction cost into 125 is the variance
10:05of daily cash flows divided by 0.0002 raised to power 1 by 3 then 3 into 3304.79 and 9914.37
10:17is the spread for start company.
10:20On the right hand side we have the same formula for calculating the spread for moon corporations
10:27so 3 into only the difference is the values regarding the transaction cost and variance
10:33of daily cash flows here is 50 and 80,000 but the denominator is same so we will get
10:393 into 24, 2466.21 and total is 7398.64 this is the spread for moon.
10:47Now come to the return point which is equal to minimum balance plus spread over 3, 700,000
10:55plus separated by 3 is equal to 3304.79 so by adding this amount in the minimum balance
11:04we will get 700,3304.7, I think 79.
11:14Now on the right hand side for moon it is 42466.21 because the minimum balance is here
11:2240,000 and the spread by 3 is equal to 2466.21.
11:31Now move to the part 2, criterion for investing in short term as per Miller or Mudder, cash
11:40balance should be equal to or greater than maximum cash so maximum cash is equal to minimum
11:49balance plus spread so we are going to use these two conditions in order to check which
11:58corporation is qualifying for more investment in short term as per Miller or Mudder.
12:06Corporation maximum cash is equal to minimum cash which is equal to 700,000 plus spread
12:149,914.37 is equal to 709,914.37 on the right hand side we are going to calculate the same
12:27thing for moon which is equal to 47,398.64.
12:33Applying this criterion on both the corporation to find out which corporation should invest
12:41in short term.
12:43So here we see that 701 cash in hand which is cash in hand is not equal to or greater
12:52than 7 maximum cash which is equal to 700,914.37 so we strike out this corporation label start.
13:07So see the both conditions for the moon corporation here we see that maximum cash is 47,398 which
13:17is less than 57,398 which is in the hand of the entity.
13:27So we conclude that the moon corporation should invest the money for short run and the amount
13:33should be cash in hand minus return point cash in hand 57,398 minus 42,466.21 14,931.7
13:48and this is the amount that moon corporation should invest in short run as per Miller or
13:53Mudder.
13:54Now we move to the part 3 and start talking about the working capital policies as adopted
13:59by the both corporation start and moon.
14:03Start corporation has adopted the conservative working capital policy because of high level
14:10of investment in current assets as 50 million as described in the scenario enjoying low
14:18risk position due to the large amount of net working capital as he is investing high level
14:25of amount in the current assets taken from his equity rather than from debt financing
14:32so he has the healthy position and bear or faces the low risk position.
14:42Now discuss the same for the moon corporation the policy he has adopted is termed as aggressive
14:52he low level of investment as it is clear from the scenario that he invested 10 million
14:58in current assets and highly risk due to the rise in interest rate and on the other hand
15:03he is going to finance his fixed capital through financing means debt so as a result of rise
15:11in interest rate which is before 7% now is 12% due to contextual monetary policy so it
15:19has the more risk and its bearing cost increases.
15:23So move to the part 4 which is the last task moon's profitability is more affected due
15:30to the increase in interest rate I hope you have enjoyed this solution if you have any
15:35kind of query please drop in the comment section or if you want to contribute your knowledge
15:41regarding this solution if you found any mistake or typo error please associate in the comment
15:48section with all of us.
15:49Thanks for watching.
15:50Assalamualaikum.