FINC301: Module 4 Assignment - Financial Decisions and Valuation

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Finance Accounting
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Table of Contents
Question 1...................................................................................................................................................3
A..............................................................................................................................................................3
B..............................................................................................................................................................5
Question 2...................................................................................................................................................8
A..............................................................................................................................................................8
B..............................................................................................................................................................8
C..............................................................................................................................................................9
Question 3.................................................................................................................................................11
A............................................................................................................................................................11
B............................................................................................................................................................12
Question 4.................................................................................................................................................13
A............................................................................................................................................................13
B............................................................................................................................................................13
C............................................................................................................................................................14
References.................................................................................................................................................15
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Question 1
A.
Profit maximization for an organization means maximizing the profit i.e. maximizing the
difference between the revenue of the organization and cost of the organization. Profit
maximization can be a long term or a short term process adopted by the organization as
per its requirement. The organization should determine the selling price to be set for a
particular product or service which will be able to cover the variable as well as the fixed
cost of that product. The organization should conduct marginal analysis including
breakeven analysis to determine the whether the selling price determined by the
organization is able to cover costs incurred by the organization and maximize the profits
of the organization (Gartenstein, 2019).
On the other hand, wealth maximization deals with maximization related to an increase in
the overall business of the organization to ultimately increase the value of the
shareholders of the company. Wealth maximization of the organization can be
determined by calculating the price of the shares of the company and calculating the
changes in the prices of shares. If the price of the share is increasing continuously then it
represents that organization’s wealth is increasing and vice versa (Bragg, 2019). If this
concept is adopted by the organization then in that case organization should search and
invest in such available alternatives which maximize the returns and also mitigate the
losses that might be associated with the organization if such alternative is selected. The
organization should conduct various financial management techniques like capital
budgeting decisions to justify the alternative before selecting such an alternative.
There is a difference in both the concepts i.e. Profit maximization and wealth
maximization and there is a need to differentiate between the notions of both the
concepts. Profit maximization focuses on earning a large number of profits whereas the
focus of wealth maximization is to improve the market value of the shares thus improving
overall shareholders wealth. Generally, profit maximization decisions are based on the
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achievement of short term decisions whereas the wealth maximization concept is
determined to achieve the long term objectives of the organization.
In the view of financial management, it can be said that the concept of wealth
maximization is given priority and finance managers focuses on maximizing the wealth
in the long run. If risky decisions taken by finance managers are without any analysis and
reckless then the same can harm the organization in the long run as the same would affect
the share price in the market and shareholders would lose the trust in the organization.
The risky decisions might increase the profit of the organization in the short run but the
same is not relevant in long run wealth maximization (efinancemanagement, 2019).
Practical implications of differentiating profit maximization and wealth maximization can
be as follows:
 Differentiating the same would clarify the financial objectives of the company in
relation to long term and short term plans of the company.
 Differentiating would help in making decisions in relation to capital budgeting
and other such financial decisions.
 Differentiating the same would allow the company to determine the condition of
the organization and make decisions about dividend distribution and retaining the
earnings.
 Profit maximization is determined by the total amount of net profit earned by the
organization for the relevant period. If the same is increasing from the previous
year then it is a case of profit maximization. On the other hand, wealth
maximization is determined by the share price of the company prevalent in the
market which is calculated by the Market value of the company divided by the
total number of outstanding shares. There is a need to differentiate between the
two concepts from the perspective of financial management to determine the
calculations in relation to profits and market price of the share.
Thus it can be said that both profit maximization and wealth maximization are two
different concepts and organization needs to differentiate the same to make financial
decisions and in context of financial management to increase both the wealth of
shareholders and profit of the organization in the long & short run.
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B.
An annuity can be defined as a fixed stream of payments or investments made by an
individual or organization. The period in which the annuity is paid or received is known
as the phase of accumulation and it is just after the accumulation phase that the payout or
pay in begins for the particular annuity. An annuity can be divided into two types on the
basis of occurrence of the payment for the given period. There are basically two options
in payment, either the payment is made at the beginning of the period or the same is made
at the end of the period. An ordinary annuity is where the payments are made at the end
of the period and thus the annuity factor is taken at the end of the year. On the other hand
Annuity due is where the payments are in advance or at the beginning of the period. Thus
it can be observed that there is a difference of one extra period between annuity due and
ordinary annuity. Also, there is a difference in the investment future & present value if
the same is made using annuity due and ordinary annuity (Bragg, 2019). This can be
explained using the below example:
Ordinary Annuity
Years
Investme
nt per
Year
Number
of Years
Total
Investm
ent
Annuity
Factor @
10%
Futur
e
Value
Present Value
Factor @
10%
Presen
t
Value
1 Year-
5 Years 100000 5 500000 6.1051
61051
0 0.6209
37906
6
Annuity Due
Years
Investme
nt per
Year
Number
of Years
Total
Investm
ent
Annuity
Factor @
10%
Futur
e
Value
Present Value
Factor @
10%
Presen
t
Value
1 Year- 100000 5 500000 6.7156 67156 0.6209 41697
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5 Years 0 2
In the above example, it has been assumed that the company is investing the amount of
$100000 for the first five years. The rate of return is assumed to be 10%. The investment
made in an ordinary annuity is at the end of the year and in case of an annuity due the
same is at the beginning of the year. It can be seen that if the company invests at the
beginning of the year i.e. by using the method of an annuity due then, in that case, there
would be an extra period available to the company in comparison to an ordinary annuity.
Thus it can be seen that the future value of the investment would be higher in the case of
an annuity due than an ordinary annuity. There is a difference of $37906 between the two
types on the basis of time period considering the investment amount, time period and rate
of return is taken to be the same.
After analyzing the above example it can be seen that there would be an increase in the
value of investment in annuity due in comparison to ordinary annuity as in case of
annuity due the amount is invested in beginning of the year and the same in case of
ordinary annuity is at the end of the year providing an extra period to the investments
made. The difference between the two lies in the timing of the two annuities. The
company chooses the annuity on the basis of fund availability of the company. If the
funds are available with the company at the beginning of the period whether the period is
a month, year, quarter or any other period then the company opts in for the annuity due
option. Whereas if there is a constraint in the fund's availability of the company at the
beginning of the period and company can arrange funds easily at the end of the month
then the company should opt for an ordinary annuity. Also, an ordinary annuity is more
suitable for making payments like installments due to loans, etc whereas annuity due is
relevant for obtaining receipts by the individual or organization like rental lease
payments, etc.
Formula for ordinary annuity
Present value of ordinary annuity = PMT * ((1-(1+r)^-n)/r)
Where,
PMT= Period Cash Payment
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r = Rate of return or interest rate per period
n = Total number of periods
Formula for Annuity Due
PV of Annuity due = PMT + PMT × ((1 – (1 + r) ^ - (n-1) / r)
Where,
PMT= Period Cash Payment
r= Rate of return or interest rate per period
n = Total number of periods
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Question 2
A.
Principal
Amount 3000
Rate of return 4%
Year 4
Cost of car 15000
Formula for
compound
Interest Principal(1+(rate/100)*year)
Year Amount
Compoun
d Interest
Addition at
the end of the
year Total
1 3000 120.00 2706 5826.00
2 5826.00 233.04 2706 8765.04
3 8765.04 350.60 2706
11821.6
4
4 11821.64 472.87 2706
15000.5
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$2706 is the amount Polly needs to save each year as to get $15000 at the end of 4 years to
purchase the car. The schedule shows the addition of the same amount over a period of 4 years.
B.
If Quarterly Payment is $3434
Quarterly Installments 3434
Years 7
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rate of interest 7.2%
Total amount 96152
If the payment increases to
$3876
Quarters Amount
Cumulative
Amount
1 3876 3876
2 3876 7752
3 3876 11628
4 3876 15504
5 3876 19380
6 3876 23256
7 3876 27132
8 3876 31008
9 3876 34884
10 3876 38760
11 3876 42636
12 3876 46512
13 3876 50388
14 3876 54264
15 3876 58140
16 3876 62016
17 3876 65892
18 3876 69768
19 3876 73644
20 3876 77520
21 3876 81396
22 3876 85272
23 3876 89148
24 3876 93024
25 3876 96900
It is assumed that the installment (both current and hypothetical) given the question is inclusive
of the interest part and is treated as EMI (Equated Monthly Installments).
C.
Receipt 80000
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Years 10
Rate of return 5%
Year Receipt Interest Total
1 80000.00 4000.00 84000.00
2 84000.00 4200.00 88200.00
3 88200.00 4410.00 92610.00
4 92610.00 4630.50 97240.50
5 97240.50 4862.03 102102.53
6 102102.53 5105.13 107207.65
7 107207.65 5360.38 112568.03
8 112568.03 5628.40 118196.44
9 118196.44 5909.82 124106.26
10 124106.26 6205.31 130311.57
Total
1056542.9
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Particulars Formula Calculation
Present Value
Total amount/(rate of
interest)*years 648625.73
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Question 3
A.
Rate 8%
Years 20
Cash Flow 80,000.00
Years of support 25
Principal amount 40,000.00
Compound Interest
467,87
8
Total Amount
required 2,467,878.02
PV of the amount 529,478.80
Year Receipt Interest Total
Addition
at the end
of the year
Final
Total
1 40000.00 3200.00 43200.00 7496.20 50696.20
2 50696.20 4055.70 54751.90 7496.20 62248.10
3 62248.10 4979.85 67227.94 7496.20 74724.14
4 74724.14 5977.93 80702.08 7496.20 88198.28
5 88198.28 7055.86 95254.14 7496.20 102750.34
6 102750.34 8220.03
110970.3
6 7496.20 118466.56
7 118466.56 9477.33
127943.8
9 7496.20 135440.09
8 135440.09 10835.21
146275.3
0 7496.20 153771.50
9 153771.50 12301.72
166073.2
2 7496.20 173569.42
10 173569.42 13885.55
187454.9
7 7496.20 194951.17
11 194951.17 15596.09
210547.2
6 7496.20 218043.46
12 218043.46 17443.48
235486.9
4 7496.20 242983.14
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13 242983.14 19438.65
262421.7
9 7496.20 269917.99
14 269917.99 21593.44
291511.4
3 7496.20 299007.63
15 299007.63 23920.61
322928.2
4 7496.20 330424.44
16 330424.44 26433.96
356858.4
0 7496.20 364354.60
17 364354.60 29148.37
393502.9
6 7496.20 400999.16
18 400999.16 32079.93
433079.1
0 7496.20 440575.30
19 440575.30 35246.02
475821.3
2 7496.20 483317.52
20 483317.52 38665.40
521982.9
2 7496.20 529479.12
Every year Derek needs to add $7496.20 to his account to accumulate enough balance by the end
of 20 years to have sufficient funds for the next 25 years.
B.
Interest 10%
Years
Existing contract team's offer Josh's offer
Amount PV Value Amount PV Value Amount PV Value
1 815,000.00 740,909.09 402,500.00 365,909.09 527,500.00 479,545.45
2 367,500.00 303,719.01 385,000.00 318,181.82 757,500.00 626,033.06
3 274,000.00 205,860.26 385,000.00 289,256.20 365,000.00 274,229.90
4 184,725.00 126,169.66 395,000.00 269,790.31 282,500.00 192,951.30
5 184,725.00 114,699.69 395,000.00 245,263.92 252,500.00 156,782.63
Total
1,825,950.
00
1,491,357.7
1
1,962,500.0
0
1,488,401.3
4
2,185,000.0
0
1,729,542.3
5
It can be seen in the schedule that Josh's own offer is most beneficial for him. The
existing contract is the 2nd best option.
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