Financial Management





Financial Management

Question M

The three types of project risks are performance risk in which it is feared that the intended results will not be achieved according to the targets set (Kliem and Ludin 52). Secondly, in the cost risk, there is the possibility that due to inaccurate budgeting, charges for the project are bound to rise subject to market conditions such as inflation. Lastly, in schedule risk, unexpected delays during the implementation of the project occur. Usually, these delays have an impact on the overall cost of the project as they have a chain reaction on all activities involved.

 When making budgetary provisions, all the relevant items required should be outlined and a total cost arrived at. A reasonable amount of cash depending on the scale of expansion should be allocated to boost the total to cushion the project in case of fluctuations in the price of various commodities in order to minimize the cost risk. This can be aided by indicating the current prices against the projected price for each item. Thereafter, the maximum price allowed should be the one used when computing the total cost expected to be incurred until the project is completed.

            In addition, to decrease the schedule risk, all stakeholders and suppliers need to be consulted early enough to come up with a practical timeframe that is mutually agreed upon by all. Further, contracts indicating the extent of fines to be incurred in case of defaulting or delays need to be drawn. This will be a safety net to Harry Davies Industries should that happen. Similarly, to reduce the performance risk, the management needs to set realistic goals that are easily achievable but also challenging enough to make the project valuable to the company (Kliem and Ludin 55).

Once the project begins, follow up should be done to ensure that it is being done as per the agreed principles. Where there is a departure from the set timelines, a quick solution should be provided so that nothing else is slowed down. Alternatively, the project can be broken down to small components in which targets are well laid and properly managed from their onset to their conclusion.

Question N

 Equity raised internally through retained earnings has a lower percentage cost than common stock issued externally due to a variety of factors. By not going public, the company often saves itself legal and underwriting fees that would have been spent during the rights issue. This cash would have been reported as an expense in the cash flow records. The company foregoes also other fees like accounting fees. The money withheld from such an action improves the company’s reserves and raises the liquidity levels for other use.

The managers also are the ones who are aware of the actual valuation of a company’s shares. They are thus better placed to state the profitability of the business or the viability of a project. This information is only revealed to the public during floating of shares. However, most of the time, the public tends to undervalue the share price. This will result in shares being sold at a lower price thereby making the company incur huge losses that increase the cost of raising that equity (Kliem and Ludin 57). 

Question 0

1. The cost of newly issued common stock using the DCF approach relies on a number of variables: the current stock price, the amount of dividend per share expected to be given to the shareholders and the expected rate of growth in percentage form. Therefore, to calculate the estimated cost of the newly issued common stock:

(Expected dividend pay/ current price of stock) + Percentage expected growth rate.

(3.12/50) + 5.8

=5.85 %

2. The after tax cost of debt is calculated as a function of the interest rate the debt is supposed to accrue multiplied by (100 % minus the income tax rate that keeps increasing.)

(10/100) multiplied by $1,000= $100 per year is given to the lender per year

$100 multiplied by 30 years=$3,000

(Percentage cost of flotation/100) multiplied by the per value of the bond for the first year only

(2/100) multiplied by $1000=$20

Therefore, the cost of inflation added to the cost of interest paid=cost of after tax debt


Question P

One of the most common errors in estimating the WACC that should be avoided is the use of an incorrect formula for the WACC. This usually applies for a case in which the debt value is not equal to its book value. Furthermore, when the enterprise value (E+D) does not match the time consistency formulae, the resultant WACC is wrong. In addition, an error is made when the debt to equity ratio used to calculate the WACC differs from the debt to equity ratio that comes about from the same assessment (Kliem and Ludin 59). It usually occurs when a different capital structure is taken in to account. Only the outstanding debt and the projected debt should be used when estimating the WACC. Finally, once the wrong formula for the WACC is used especially when the debt value (D) is not equal to its book value (N), an error is committed.

Work Cited

Kliem, Ralph L, and Irwin S. Ludin. Reducing Project Risk. Pp. 52.Aldershot, England: Gower, 1997. Print.

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