Financial Strategies For ACME Iron

CAPM

Being a part of special analyst group of ACME iron, few issues have been faced and it has been raised in front of the chief financial officer of the company. The several prospective and financial strategies have been used to evaluate the financial performance of the company. The report briefs about the various issues of the company and their suggestions for the betterment of the company. In the report, various financial strategies such as CAPM, WACC, capital investment analysis, dividend policy, bankruptcy risk analysis, decision tree creation, real option analysis etc has been done so that a better report could be prepared about the performance of the company and the position of the company.

Evaluating the financial issues of an organization and resolving them on time is crucial part of a business. It aids the business to manage and run the operations in a better and efficient way. The report briefs that the financial position of the company is average and few changes are required to be done by the chief financial officer of the company to enhance the performance and the position of the company.

CAPM stands for capital assets pricing method. This model is used by the companies to segregate the market risk and individual stock risk. CAPM measures the required rate of return of the company. For evaluating and measuring the data from CAPM model, beta, market risk and risk free return is required to be evaluated. Beta is a measurement of changes in the stock price at a particular time (Cook & Tang, 2010). It briefs about the total risk of the company. On the other hand, risk free return of a country evaluates about the total interest rate of risk free securities and the inflationary rate. Lastly, the market return stands for the total return from the industry.

In case of ACME iron, it has been found that the risk free rate of the treasury bond of 10 years is 2.79% (Bloomberg, 2018). On the other hand, the expected market return is 6% and the beta of the industry is 1.82 (Betas by Sector, 2018). Through the data, the required rate of return of the company has been calculated. The required rate of return of the company is 8.63% which briefs that the investors expect 8.63% dividend from the company (Hise & Strawser, 2013).

It briefs that if the company raise funds through equity then the business is required to pay 8.63% as dividend amount to the stockholders. The cost of equity of the company is 8.63% which is quite higher and thus the organization should enhance the funds through equity after evaluating all the other resources and the business should accept the source which is less risky and less costly (Baker & English, 2011). 

WACC

Further, for evaluating the financial performance of the company and aids the managers of the company to prepare better financial strategies, capita structure of the company has been analyzed and the WACC of the company has been measured so that a better decision could be prepared (Khamees, Al-Fayoumi & Al-Thuneibat, 2010). Capital stricture depicts about the total capital of the company which has been raised by the company through internal and external sources to rise the long term founds of the company. WACC stands for weighted average cost of capital. This process is used by the financial analyst and the professionals to evaluate the total cost of capital which would be paid by the company to the sources from where the capital has been raised (Baker, Dutta & Saadi, 2010).

In the case, capital structure and WACC of ACME iron has been calculated. On the basis of annual report of the company, it has been found that the debt of the company is $ 13,00,00,000 and the total equity of the company is 17,04,23,000. Company has rise the long term funds only through debt and equity. On the basis of evaluation, it has been found that the weight of debt of the company is 43.27% and the equity weight of the company is 56.73%.

Further, the WACC of the company has been evaluated and it has been found that the total cost of debt of the company is 4.80% as the interest rate of the company is 8% and the tax rate of the company is 40%. Thus cost of equity of the company is 4.8% (8*(100%-40%)). In addition, the cost of equity of the company is 8.63% (Moyer et al, 2011)

Thus, the WACC of the company is 6.97%. The calculations of WACC brief that the cost of equity is quite higher. And at the same time, the weight of equity is also higher due to which the cost of capital of the company is also higher.

The WACC calculations have been done to evaluate the current cost of capital of the company and to brief the financial officer of the company about the ways through which the cost of capital of the company could be reduced.

Further, for evaluating the financial performance of the company and aids the managers of the company to evaluate the new investment opportunities, new weight average cost of capital has been calculated. WACC process is used by the financial analyst and the professionals to evaluate the total cost of capital which would be paid by the company to the sources from where the capital has been raised (Higgins, 2012).

In the case, company is planning to invest into the new project. The total initial investment of the project is $ 1 million and the cost of debt and cost of equity of the company is 8% and 12%.  The calculations of new project briefs that if the 50% funds would be raised by the company through debt and rest would be raised through equity than the total cost of capital of the company would be 10% (Brigham & Houston, 2012).

Dividend Policy

Further, it has been evaluate that the net cash flows from the new project would be $ 73,333.33.

On the basis of the cash outflows of the new project and cash inflow of the new project, the project breakeven on simple cash basis (Payback period) would be 13.64 years. And the project breakeven on the discounted cash basis would be Undefined as the total time period of cash recovery is over the useful life of the new ramp (Chandra, 2011).  

The net present value of the new project has also been evaluated to identify that whether the project would be profitable for the company or not. The net present value calculations brief that the net present value of the project is $ -3,08,693 which explains that if the organization would invest into the project then huge losses would be faced by the company (madhura, 2011).

The case briefs that AMCE Iron should not accept the proposal as the cost of capital of the company would be 10% and on the other hand, huge losses would be faced by the company.

Scenario analysis study has been done further to evaluate the different scenarios of the company and make a conclusion about the better scenario. The first scenario of the company briefs about the $ 15 million cash inflow per year for 10 years. The calculations of both the scenario are as follows:

Economic value added and market value added are the measurement of an organization to evaluate the financial performance o the company which is based on the residual wealth. In the case, EV, MVA, PE of industry, ACME iron and a competitor has been calculated to analyze that whether the performance of the company is good in context with the market and the industry.

The economic value added calculations of the industry, ACME iron and a competitor briefs that the EVA of all the three companies are not good. Though, the position of ACME iron is better than the industry average (Brigham & Ehrhardt, 2013). It expresses to the public about the lesser economic profits of the company. The internal positions are briefed about the EVA ratio and it explains that the performance of the company is required to be better.

Further, market value of the companies and the industry has been evaluated and it has been found that the market value of the ACME iron is far better than the industry and the competitors. It expresses to the public about the better market position of the company. The external positions are briefed about the MVA and it explains that the performance of the company is quite better. The company is just required to maintain the same level.

Further, the price earnings ratio has been calculated and it has been found that the P/E position of ACEM iron is better (Baker & Wurgler, 2015). It expresses to the public about the better investment position of the company. The external positions are briefed about the PE ratio and it explains that the performance of the company is quite better. The company is just required to maintain the same level.

Leasing is a contract in which one party agrees to pay the lessor for the use of property, building or any assets. In the given case, ACME iron is thinking to take a computer on lease. The after taxes cash flow of the leasing from year 1 to year 9 are as follows:

It briefs that the after tax cash flow of the computer would be $ 9,355 every year till 9 years. Further, the after tax cash flow of the 0 year has been calculated and it has been found that the total computer cost is $ 70650 out of which $ 7000 has been paid by the company as lease amount and thus the total flow would be $ 63,650. The after tax cash flow of o year is as follows:

Further, the NPV of the computer has been calculated to identify the loss or the profit of the company due to lease. It has been measured that the net present value of the computer is -$ 9,774.33. It expresses that the lease contract would offer loss to the company.

And, in case, the computer has residual value worth $ 500 than the present value would be -$ 20,395.

On the basis of both the cases (Residual value and non residual value), it has been found that huge losses would be faced by the company. Thus, it is recommended to the company to buy the computer rather than taking it on lease.

Ratios of the company have been calculated further to identify the performance and the position of the company.

On the basis of the above calculations and the analysis on the income statement and the balance sheet, it has been found that the relevant dividend policy should be followed by the company (Gibson, 2011). This dividend policy briefs that the net profit must be distributed by the company amount the stockholders of the company so that they could feel motivated towards the company and invest more amount in the company.

References

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