Understanding How Firms Function: An Assignment

Name and describe the business

Consider a business that you would like to work for at some point.

Imagine that you are the new owner of this business. Answer the following questions to show your understanding of how firms function and the issues that owners and managers encounter.

1.Name the business and give a description/overview of your understanding of how the business functions. i.e what it does, how it does it and where it makes its revenue. 

2.Explain a specific major financial decision that you may need to make as the owner/manager of this business. 

3.Describe the structure of the business and contrast the positives and negatives of this structure with alternative typical business structures in Australia.

4.Discuss any potential Agency issues that you may encounter if you choose to hire a manager for your business and suggest a way that you could use to overcome these. 

5.You have the opportunity to expand by taking over a rival business. Describe three (3) factors that you must take into consideration when deciding whether to purchase this business. Explain why each is important. 

6.The owner of the rival business agrees to sell to you. He will take payment one of three different ways. Using the information below, calculate which payment option would make more financial sense to you and state which you should accept. Use formulas not tables, and show working. Make a definite statement as to which option should be chosen. (5 marks)

Option 1:  An upfront Payment of $100,000 and a single fixed payment in 1 year of $35,000.

Option 2: An upfront Payment of $20,000, followed by further payments of $10,000 at the end of each month for the following 12 months.

Option 3. No upfront Payment. 50% of profit for the next two years, payable semi-annually as the profits are earned.

The expectations that you have for the new business and the financial economy are as follows:

Expected profits for the purchased business will be $140,000 in year 1, and $160,000 in year 2. Assume profits are earned in a consistent manner throughout the year. 

Expected annualised interest rates are flat from cash out for 1 year at 5% and then rise to 6% at 1.5 years and to 7% for the 2 year.

7.Think about the scenario described in question 6 and your eventual answer. Explain the risks that are faced by the Seller of the business in accepting your offer. In particular, use your understanding of Agency Risk and mention how Ethical behaviours in business might apply here. 

Explain a major financial decision

8.You just sold your car for $18,000. You have deposited it into your bank account. You are keen to invest the funds for one year as you are concentrating on your studies for the moment. Which of the following options for depositing the funds will earn you more interest over the coming year. Show your calculations including formula. 

a.Fixed Interest rate of 3% paid at maturity.

b.2.9% Interest rate compounded and reinvested on a monthly basis.

c.2.8% Interest rate compounded and reinvested on a daily basis.

9.Explain the effect that using compounding interest rates versus simple interest rates has on the return from an investment

10.a. Name and describe an example of an annuity that that is commonly encountered by businesses in the Australian economy. 

b. Calculate the Present Value of the following Annuity Payment.

$12,000 paid in arrears for 25 years. Assume that the current yield curve shows a 25 year bond rate of 6% p.a. 

Tip: Look at Topic 3. Seminar 3 notes explain this and then use the spreadsheet called NPV to check your calculations.

11.It is common in Australian Finance for Annual Percentage Rates (APR’s) to be quoted when discussing the level of interest.

a.Why would it be better for interest rates to be quoted as Effective Annual Rates (EAR) instead? 

b.Calculate the EAR in the following situation: APR 7%, Interest Calculated/Paid Monthly.

12.What are the two components of Holding Period Return? 

Calculate the HPR of the following share investment in NAB. Assume that the Share was held for exactly 3 months and one dividend was received with any attributable franking credit included in the total of the Dividend received. Purchase Price $23. Dividends received $2.50. Sale Price $26.50.

Show the total profit amount, and the HPR as a percentage gain on the investment. 

13.Calculate the Expected returns on the following investment.

In one year the probabilities of the following outcomes are as follows. A return of $25,000 is 30 % likely. A return of $50,000 is 40 % likely. A return of $100,000 is 20% likely. A return of $10,000 is 10% likely. 

14.As an accountant you have a client who does not like to take a large amount of risk with their investments. They have some money to invest and they ask you to tell them your thoughts on which asset classes are the least risky through to those that are most risky. They are considering investments in Property, Shares or Bonds. 

a.What will you tell them about the relative historical risks of these investments and their returns. 

b.From you understanding of the investment markets, what general rule could they use to reduce the risk of their portfolio?

15.The CAPM model divides the risks that investors encounter into two categories. Identify and briefly discuss these.