Financial Decision Making Assignment: Firm Value and Capital Structure

This assignment solution for a financial decision-making course (BAFI1100) analyzes Regal Automotive's financial data to calculate its operating and cash conversion cycles, demonstrating key financial metrics. The report explains the relationship between firm value and capital structure, discussing how companies finance their assets through equity or debt. It compares the cost of debt and equity financing, highlighting debt's tax advantages, and explores the concept of capital structure irrelevance, referencing the Modigliani-Miller approach. The analysis concludes that capital structure and firm value are not directly interdependent, and the optimal capital structure minimizes risk and cost. The assignment addresses the core concepts of financial decision-making, providing insights into capital structure, firm valuation, and the cost of financing.

Running Head: FINANCIAL DECESION MAKING 1
FINANCIAL DECESION MAKING

FINANCIAL DECESION MAKING 2
Table of Contents
Introduction...........................................................................................................................................3
Question 1.............................................................................................................................................3
Question 2.............................................................................................................................................4
Relationship between firm value and the capital structure.................................................................4
Lower cost of Finance, Debt or Equity..............................................................................................4
Question 3.............................................................................................................................................5
Capital Structure Irrelevance.............................................................................................................5
Conclusion.............................................................................................................................................5
References.............................................................................................................................................6

FINANCIAL DECESION MAKING 3
Introduction
Capital structure is one of the most important concept as it determines the how a firm has
financed its assets either through the help of the equity or through the help of the debt. This
report talks about the relationship between the firm value and the capital structure, finds out
whether the equity is cheaper or the debt and lastly enables to understand the irrelevance of
the capital structure.
Question 1
Regal Automotive
Operating Cycle
Inventory Turnover Ratio Inventory * 365 60203830 63.44
Sales 948968
Accounts receivable Ratio Accounts Receivable * 365 48576755 85.32
Cost of goods sold 569381
Operating cycle 148.76
Cash Conversion Cycle Amount Total
Inventory Turnover Ratio Inventory * 365 60203830 63.44
Sales 948968
Accounts receivable Ratio Accounts Receivable * 365 48576755 85.32
Cost of goods sold 569381
Accounts Payable Accounts Payble * 365 54156510 95.11
Cost of goods Sold 569381
Cash conversion cycle 53.64
The operating cycle of the Regal Automotive is 148 days approximately and the cash
conversion cycle of the company is 53.64 days.

FINANCIAL DECESION MAKING 4
Question 2
Relationship between firm value and the capital structure
The relationship between the capital structure and the firm value is simple. The capital
structure is a formation of the various sources of the funds acquired by the company and the
firm value mobilizes those funds, deeding upon the maturity time period. The funds further
can be classified as the long term as well as the short term. Firm value on the other hand can
be determined by the various means such as net shareholder’s equity. At times it can also be
based on the cash flow, components of the larger entity (Acaravci, 2015). For example in
case of the public company the value of the firm can be calculated by the multiplying the
number of the shares with the outstanding shares.
Lower cost of Finance, Debt or Equity
The equity financing is the way toward raising capital through the clearance of offers in an
organization. With value financing comes at a possession and enthusiasm for investors. Value
financing may run from a couple of thousand dollars raised by a business person from a
private speculator to a first sale of stock (IPO) on a stock trade running into the billions
(Ardalan, 2017).
The people or the lender get the guarantee as the obligation will be reversed respectively for
the particular financial year. the debt financing occurs when the company purchases the debt
component in return of the fixed interest component to be paid by the company for the
acquisition of the debt. The lower cost of the source of the finance is dependent upon the
nature and the size of the firm at times (Kodongo, Mokoaleli-Mokoteli, and Maina, 2015).
However in general the debt is cheap in comparison to the equity, this is because it gives the
tax advantage over the equity. The company has a vision always to enhance the wealth of the
company and due to this; the company anticipates that the debt investment at the low cost
would help increasing the earnings as well. The lenders have the limited liability and the first
hand on the assets of the company. The equity comes at cost of the risk and therefore it can
be concluded that the Equity is more costly than the debt (Nimtrakoon, 2015).

FINANCIAL DECESION MAKING 5
Question 3
Capital Structure Irrelevance
Capital structure is the structure that is a combination of the two variables majorly the debt
and the equity. The most crucial implication of the M&M assumptions is that the value of the
firm and the cost of the capital are mainly dependent upon the real assets of the company..
The theory of the irrelevance starts when the when Modi Gilani Miller Approach came into
existence that suggests that the market value is irrelevant from the capital structure
(Abeywardhana, 2017). The optimal capital structure is one where the weighted average cost
of capital being at its lowest and the entire value of the firm is maximum.
For example if the company has total current assets as in the case of the Regal Automotive
and if the company wish to switch from the debt to equity the value of the firm will remain
static and only the distribution of the net income between the shareholders will differ.
Conclusion
From the above analysis it can be understood that the company’s capital structure and the
value do not have the interdependency and moreover the capital structure shall be appropriate
to avoid the high risk and the high burden from the point of view of the company. The capital
irrelevance theory also stated that the value has its own position and in the end it is proven
that the debt is the cheapest amongst the debt and the equity but both of their individual pros
and Cons.

FINANCIAL DECESION MAKING 6
References
Abeywardhana, D.K., 2017. Capital structure theory: An overview. Accounting and finance
research, 6(1), p.133.
Acaravci, S.K., 2015. The determinants of capital structure: Evidence from the Turkish
manufacturing sector. International Journal of Economics and Financial Issues, 5(1), pp.158-
171.
Ardalan, K., 2017. Capital structure theory: Reconsidered. Research in International
Business and Finance, 39, pp.696-710.
Kodongo, O., Mokoaleli-Mokoteli, T. and Maina, L.N., 2015. Capital structure, profitability
and firm value: panel evidence of listed firms in Kenya. African Finance Journal, 17(1),
pp.1-20.
Nimtrakoon, S., 2015. The relationship between intellectual capital, firms’ market value and
financial performance: Empirical evidence from the ASEAN. Journal of Intellectual
Capital, 16(3), pp.587-618.