Acc00716 Finance And Business Case Assessment Answers

b) Assess the working capital management of your assigned company, focusing on its cash conversion cycle for each of the 30 June 2015 and 30 June 2016 financial years. Incorporate the company’s context within your evaluation and compare with a competitor or other relevant benchmark. As in Assignment 2, use DatAnalysis to access your assigned company’s financial data.

a) What does the use of commercial paper suggest about the credit risk of Telstra?

b) What asset financing policy does the quote above suggest Telstra may follow? Justify your answer and outline the benefits of that policy in comparison with alternative policies.

2^ndProject Proposal - Conveyor System

1^st Project Proposal - Device Part Project

The set of information regarding proposal one is summarised and shown below:

In this proposal Initech is exploring the possibility of expanding the production for a new generation of mobile devices in the overall production unit.

• Economic life of project as the equipment would be liquidated after 5 years
• Cost(new plant and equipment and their installation)
• New plant and equipment will depreciate at a rate of
• After completion of project, the plant and equipment supposed to sell which becomes the salvage value.
• Amount of depreciation charge on an annual basis
• Book value plant and equipment(at the end of 5 year)
• Loss amount (as the carrying cost of plant and equipment is greater than the amount received through sale)(Damodaran, 2007).
• Post tax salvage value = Proceeds from equipment sale + Tax benefits on account of loss on sale = 200,000 + 0.3*200,000 = $ 260,000
• Revenues through sale (t =1)
• Fee paid to the consultants (i.e. $75,000) would not be the part of capital budgeting analysis because of it being a sunk cost as it no longer is possible to avoid this cost irrespective of the output (Beck et. al., 2013).
• Variable costs of the project would be equivalent of
• Building rental, fixed salaries and other fixed costs directly related to the project are
• would be expected to grow at a yearly rate of till the end of the project.
• Investment incurred in net working capital for the project expected to be
• Project will result in extra profit(after tax)
• Tax rate = 30%
• Cost of capital = 14%

Necessary Assumptions

• Net working capital associated can be recovered during the project duration also depending upon the deficit or surplus based on next year revenue.
• All the cash flows are assumed to take place at year end only.
• The plant and equipment (general purpose equipment) would be liquidated after the project gets completed (5 years), irrespective of the fact that the life of the plant and equipment is 10 years and also the sales proceeds would be equal to the projected price at that time.

To compute net present value (NPV) for the project the above highlighted assumption and information would be used. The output from excel is given below:

The NPV for the project is positive $983,262. Therefore, it would be suggested that Initech should adopt the project proposal and implement it at the earliest. Because, the positive value of NPV is the indication of the financial profitability of the project, the hence the interests of the shareholders are furthered with the implementation of such projects (Ross, Trayler and Bird, 2007).

2^nd Project Proposal - Conveyor System

In this proposal it was stated that the existing conveyor system cannot be further repaired and thus needs to be replaced on urgent basis. The three options of conveyor system are available from which the most appropriate system need to be selected.

System A and System B has an economic (useful) life of 10 years. However, system C has an economic life of 20 years. It is apparent that the economic life of the proposed systems is different and hence, the NPV cannot provide the appropriate comparison metric and recommendation regarding the selection of project. Hence, the equivalent annual annuity would be computed for all the system. The system for which the equivalent annual annuity comes out to be least (since there is net outflow involved) that system would be taken into account by the company to replace the existing system (Troughton et. al., 2012).

Formulas:

Net Present value (NPV) =

Equivalent annual annuity

System A

Economic life = 10 years

Total cost (purchase and installation) = $ 40,000

Net cash flow (

After tax cash flow

Net Present value

Equivalent annual annuity

System B

Economic life = 10 years

Total cost (purchase and installation) = $ 55,000

Net cash flow ()= -$ 9,000

After tax cash flow

Net Present value

Equivalent annual annuity

System C

Economic life = 20 years

Total cost (purchase and installation) = $ 130,000

Net cash flow ()= -$ 1,400

After tax cash flow

Net Present value

Equivalent annual annuity

It can be seen from the above computation that System A for which the equivalent annual annuity comes out to be (would be taken into account by the company to replace the existing system (Damodaran, 2007).

Question 2

Considering that the company establishes self owned stores at various locations, hence a brand new store opening would be a typical capital project to be considered for JB Hi Fi.

Total initial outlay = $ 6- 7 million

Capital for operational expenses = $ 1 million

Duration – Initial lease of 5 years with an inbuilt option for the lessee to extend the term further

Product line – Besides, the normal product line, the company would also introduce books in order to enhance cross selling

Pattern of cash flows- High outflows at the starting which would tend to moderate once the store opens and gradually if all goes grows well positive operational cash flows would be realised by the project within some months.

The NPV is dependent on certain key factors such as cost of capital, location where the store is opened which would determine the catchment area and potential for sales, customer satisfaction determining the incidence the repeat customers, general economic environment coupled with the income level of the neighbourhood (Troughton et. al., 2013).

The relevant data for Jb Hi Fi (selected company) and Harvey Norman Holdings (one competitor) are summarised in the tabular form indicated below (Morningstar, 2017a; 2017b)

Cash Collection Period = Receivables Turnover Period + Inventory Turnover Period – Payables Turnover Period

In accordance with the data retrieved for JB Hi Fi, it is apparent that there have been a marginal increase in the overall cash conversion cycle caused due to marginal increase in the inventory turnover days and also receivables turnover days. However, on the positive front, the payables turnover days has also seen a marginal increase which is positive. In comparison with the competitor i.e. Harvey Norman, the movement for JB Hi Fi is not encouraging as it is essential to decrease the cash cycle since it tends to lower the total demand for working capital. This allows for lower leverage and hence going forward JB Hi Fi should aim in this regard (Beck et. al., 2013).

Question 3

1. It is apparent that Telstra raises the requisite finance through the use of commercial paper which is highly risky considering the unsecured nature of this type of debt. As a result, only companies that are very secured and have negligible default or credit risk avail this means. This clearly implies the Telstra would have a very low amount of credit risk (Ross, Trayler and Bird, 2007).

• The conservative policy is based on usage of long term financing only.
• The aggressive policy is based on usage of short term financing only
• The matching principle focuses on flexibility with the usage of financing means which matches the duration of the asset purchased.

Telstra used commercial paper for working capital and hence the only options are aggressive and matching principle. But considering the long term loan requirements in the telecom business, it seems highly difficult to imagine that short term debt would be used for financing those and thus the strategy used in maturity matching only. This strategy has high degree of flexibility unlike the other available alternatives which need to be committed to either long term or short term financing. The commitment to either of the strategies can be essentially inefficient in terms of financial management for the firm. In the alternative strategies, in the cases when there would be a mismatch between the maturity of the financing and the underlying asset, there are operational issues and incremental expenses which indicates that matching maturity is preferable (Troughton et. al., 2012).

References

Berk, J., DeMarzo, P., Harford, J., Ford, G., Mollica, V. and Finch, N. (2013) Fundamentals of corporate finance (2nd ed.), London: Pearson Higher Education

Damodaran, A. (2007) Corporate finance: Theory and practice (2nd ed.), New Delhi: Wiley

Morningstar (2017a), JB Hi Fi Limited, Retrieved on May 9, 2017 from https://financials.morningstar.com/ratios/r.html?t=JBH&region=AUS&culture=en_US 

Morningstar (2017b), Harvey Norman Holdings Limited, Retrieved on May 9, 2017 from https://financials.morningstar.com/ratios/r.html?t=HVN 

Ross, S. A., Trayler, R., and Bird, R. (2007). Essentials of corporate finance (3rd ed.), Sydney: McGraw-Hill Australia

Troughton, G.H., Fridson, M.S., Scanlan, M. and Clayman, M.R. (2012) Corporate finance: A practical approach (2nd ed.), New York: John Wiley & Sons.