Financial Management: Theory and Practice - Mini Case Solutions

This assignment provides solutions to several mini-cases related to financial management. The solutions cover key concepts such as free cash flow valuation, business risk, and the impact of capital structure on firm value. The document explains operating leverage, including its calculation and implications, and discusses preferred stock, highlighting its characteristics and placement in the risk/return spectrum. Additionally, the assignment addresses dividend payout policy, exploring relevant theories like the irrelevancy theory, tax effect theory, and the bird-in-hand theory, and considering the perspectives of investors and the company. The solutions offer a detailed analysis of each case, providing a comprehensive understanding of the core financial concepts involved. This assignment is designed to help students understand the practical application of financial management principles.

Running head: FINANCIAL MANAGEMENT: THEORY AND PRACTICE
Financial Management: Theory and Practice
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1FINANCIAL MANAGEMENT: THEORY AND PRACTICE
Table of Contents
Mini Case...................................................................................................................................2
Answer to Part B (1)..................................................................................................................2
Answer to Part B (2)..................................................................................................................2
Mini Case...................................................................................................................................3
Answer to part A........................................................................................................................3
Answer to part B........................................................................................................................4
Mini Case...................................................................................................................................4
Answer to Part A (1)..................................................................................................................4
Answer to Part A (2)..................................................................................................................4
Answer to Part A (3)..................................................................................................................5
Answer to Part A (4)..................................................................................................................5
Answer to Part B........................................................................................................................5
Reference List............................................................................................................................7

2FINANCIAL MANAGEMENT: THEORY AND PRACTICE
Mini Case
Answer to part A
As per the definition of free cash flow valuation model the basic definitions are
depicted with:
 “V=Value of firm”
 “FCF=Free Cash Flow”
 “WACC=Weighted Average Cost of Capital”
 “rs and rd are related to stock and debt”
 “ws and wd = Percentage of the firm which is financed with debt and stock”
The implication of the capital structure on the value is taken into account with the
effect of debt on WACC and FCF.
Answer to Part B (1)
The business risk pertains to the uncertainty in the EBIT. The other risk factors
include demand uncertainty of the unit sales, output price, input price, degree of operating
leverage, type of liabilities and products.
Answer to Part B (2)
Operating leverage is considered as the change in EBIT as a result of the deviations
on the quantity sold. It needs to be further ascertained that with higher rate of the fixed costs,
the greater is amount of operating leverage. Similarly, the higher form of the operating

3FINANCIAL MANAGEMENT: THEORY AND PRACTICE
leverage is considered with business risk due to small sales decline caused and larger EBIT.
Q is seen as the quantity sold, where F is the fixed cost, V is the variable cost, TC equals to
total cost and P is considered as the price per unit.
Fixed Cost (FC) $200
Price per unit (P) $15
Variable Cost (V) $10
Operating Breakeven QBE
QBE F/(P-V)
QBE $40
Mini Case
Answer to part A
Preferred stock is regarded as a hybrid stock with the amalgamation of features from
“debt and common equity”. Similar to debt, the expenses to the investors are contractually
fixed however, like common equity, the “preferred dividends” may be omitted without the
placing the company in bankruptcy and default. The provisions for the preferred stock issues
is able to prevent firms from paying the “common dividends” when the “preferred dividend”
is not paid. In addition to this, the preferred dividends are considered to be cumulative in
nature and ensure that the dividends are omitted with accumulated and common dividend
payment. The preferred stock holders may be able to designate several directors in case
“preferred dividends” are omitted for certain duration which in general is regarded to be for
three consecutive quarters. Henceforth, preferred stock is placed between debt and common
equity in the “risk/return spectrum”. The floating rate preference has a bonus sum indexed to
the rate on the treasury securities so that it is always traded at par.

4FINANCIAL MANAGEMENT: THEORY AND PRACTICE
Answer to part B
The “call option” is a contract which provides the holders the right and not the
obligation to buy defined asset and stock at a specified price within a specified time period.
Moreover, warrant is a long-term and convertibles built with the implied call option. The
better understanding of the warrants and convertibles are valued appropriately to take better
decisions on warrant structuring and convertible issues.
Mini Case
Answer to Part A (1)
Distribution policy is considered as the distribution level which may reflect dividend
yield and distributions on the company’s stock, dividends, stability of the distribution and
repurchases of the stock. The floating deviations in the total pay-out and net income needs to
be stable with 26% and 28%. The new companies would initially start making the
distributions and mature firms will have the choice for dividend pay-outs (Li, Zhuang and
Shapiro 2014).
Answer to Part A (2)
Irrelevant theory refers to the concept that the variations in the dividend policy do not
have an influence on the share price. The two primary theories of irrelevancy include
Modigliani Miller Theorem and Clientele effect.
The dividend preference theory refers to the payment of the dividends which may
resolve the uncertainty in the mindset of the investors. Certain investors are seen to be having
the preference over capital gains.

5FINANCIAL MANAGEMENT: THEORY AND PRACTICE
The theory of bird in hand postulates the investors for the preference of dividends
from stock to potential capital gains due to inherent uncertainty in a latter situation.
Tax effect theory describes the implications of specific tax aspect with respect to
definite tax paying entity. Some of the other considerations are seen with time elements,
projections and estimates made for revenues, expenses, disposals and acquisitions (Kajola,
Desu and Agbanike 2015).
Answer to Part A (3)
As per the consideration of dividend pay-out amount of the dividend paid to the stock
holders are considered relative to the growth of the company. In this case the approach such
as Irrelevant theory, Tax effect theory, bird in hand and dividend preference theory is
considered vital in nature (Albrecher and Cani 2017).
Answer to Part A (4)
The investors perspective with the dividend pay-out is considered to be important
with investor’s perspective and in case the dividend of the company is too big. The investors
may be able to buy more stock when the dividend amount is over an individual’s
expectations.
Answer to Part B
(1) The different aspects of dividend pay-out policies may be chosen by the company. Some
individuals require cash income and other like to choose high pay-out stock. A number of
investors does not possess strong requirement for cash and they prefer low pay-out stock
(Chang, Kang and Li 2016).

6FINANCIAL MANAGEMENT: THEORY AND PRACTICE
(2) The influence of the dividend of the company needs to be increased or decreased as per
the company’s stock requirements. Company can’t ignore the client’s effect on the policy
and dividend policy which will result in CGT and transaction costs (Lee et al. 2015).
(3) The increment in the stock price is viewed with increased announcement of a dividend, so
most of the investors would choose from the dividends which the management of the
company conveys along with the information provided to them along with the investors
having the choice of larger than normal dividend and avoid smaller than expected
dividend (Kajola, Adewumi and Oworu 2015).

7FINANCIAL MANAGEMENT: THEORY AND PRACTICE
Reference List
Albrecher, H. and Cani, A., 2017. Risk theory with affine dividend payment strategies. In
Number Theory–Diophantine Problems, Uniform Distribution and Applications (pp. 25-60).
Springer International Publishing.
Chang, K., Kang, E. and Li, Y., 2016. Effect of institutional ownership on dividends: An
agency-theory-based analysis. Journal of Business Research, 69(7), pp.2551-2559.
Kajola, S.O., Adewumi, A.A. and Oworu, O.O., 2015. Dividend pay-out policy and firm
financial performance: evidence from Nigerian listed non-financial firms. International
Journal of Economics, Commerce and Management, pp.1-12.
Kajola, S.O., Desu, A.A. and Agbanike, T.F., 2015. Factors influencing dividend payout
policy decisions of Nigerian listed firms. International Journal of Economics, Commerce and
Management, 3(6), pp.539-557.
Lee, C.F., Gupta, M.C., Chen, H.Y. and Lee, A.C., 2015. Optimal payout ratio under
uncertainty and the flexibility hypothesis: theory and empirical evidence. In Handbook of
Financial Econometrics and Statistics (pp. 2135-2176). Springer New York.
Li, S., Zhuang, A. and Shapiro, D., 2014. Dividend Payout Policy and Institutional Investors
Ownership: Theory and Empirical Evidence. Working Paper, Belk College of Business.