MGB305 Accounting And Finance

Question 

Part A

Why is it important for companies to consider ethics in their capital budgeting? Give an example of an ethical consideration in the capital-budgeting process.  

Part B

Medigard is an innovative international company that specialises in retractable safety medical devices for the global market. Established as Medisafe Instruments Pty Ltd in 1999, Medigard focused on leading the way in safety equipment. As a result of extensive research and development, Medigard brought innovative, world-leading medical devices to the market.

In 2004, the Company listed on the ASX in 2004 as Medigard Limited (MGZ), raising $3.4 million capital. As an R&D company, Medigard sought to design and develop a suite of safety medical devices and associated products, instrumental in the medical industry for transforming the safety of disposable medical devices and associated equipment. Medigard products are simple in designs with minimal parts that enable inexpensive production.

1. Being a part of the treasury team of Medigard, your first exercise is to categorise Medigard’s capital structure into debt and equity capital. Begin by visiting the company’s website for 2016 financial report.http://www.medigard.com.au/investor-centre
2. Calculate after-tax Weighted Average Cost of Capital.
3. What alternative capital structure would you recommend to lower the cost of capital for the company? 

Guidelines:

• You are to calculate cost of debt and cost of equity capital to work out weighted average cost of capital based on 2016 company financials.
• To lower the cost of capital of the company, you are to suggest an alternative capital mix.

Part C

In 2018 Bluegum Enterprise is considering the acquisition of a new cooling system for one of its plants. The system requires an initial outlay of $54,200 in Year 0 and have an expected life of five years. The cooling system is expected to reduce the firm’s overall costs by $20,608 at the end of each year over its five-year life. In addition to the $20,608 cash flow from operations during the fifth and final year, there will be an additional cash flow of $13,200 at the end of the fifth year associated with the salvage value of the system, making the cash flow in year 5 equal to $33,808.

Given a required return of 15%, calculate the following:

(a) Payback period 
(b) Discounted payback period 
(c) Net present value 
(d) Profitability index 
(e) Internal rate of return 
(f) Should this project be accepted?
(g) If the required rate of return is 20%, should this project be accepted? 

Answer 

Part A:

Capital budgeting is the procedure of evaluating and selecting new fixed assets. It is the initial stage of analysis before the commencement of the project. In this context, Andor, Mohanty & Toth (2015) stated that capital budgeting would enable in developing the future of the firm. In other words, it identifies the opportunities available at present time, instead of making spontaneous process of decision-making.

On the other hand, ethics are socially acceptable principle sets within a firm that enables the same to establish the behaviour of its staffs in decision-making. The laws mainly help in guiding business ethics; however, unethical action could not be adjudged as illegal always (Rossi, 2014). Hence, ethical considerations are of utmost significance for an organisation to avoid personal bias. This is mainly intended to comprehend all the pertinent activities of the organisation. The most pertinent factors related to ethics in capital budgeting include conflict of interest and books of accounts that would help the organisation in maintaining integrity in its capital budgeting process.

Capital budgeting primarily helps the organisations to gain an insight of the cash flows in future, analyse probable investment projects along with monitoring and controlling expenditure. Thus, ethical considerations need to be present within the capital budgeting techniques for ensuring the future growth and prospects of the organisations (Rossi, 2015). For instance, if an organisation adopts unscrupulous measures for undertaking a specific project, it might result in incorrect valuation of the future cash inflows. As a result, the cash generating capacity is minimised, while the cash outflows are increased. Hence, the organisations are needed to maintain ethics in its system of capital budgeting (Schönbohm e al., 2016).

Part B:

Part C:

References:

Andor, G., Mohanty, S. K., & Toth, T. (2015). Capital budgeting practices: a survey of Central and Eastern European firms. Emerging Markets Review, 23, 148-172.

Rossi, M. (2014). Capital budgeting in Europe: confronting theory with practice. International Journal of Managerial and Financial Accounting, 6(4), 341-356.

Rossi, M. (2015). The use of capital budgeting techniques: an outlook from Italy. International Journal of Management Practice, 8(1), 43-56.

Schönbohm, A., Schönbohm, A., Zahn, A., & Zahn, A. (2016). Reflective and cognitive perspectives on international capital budgeting. critical perspectives on international business, 12(2), 167-188.