Financial Management Report: Risk, WACC, and Non-Profit Analysis

This financial management report is divided into two parts. Part A focuses on risk and capital budgeting, including the calculation of the Weighted Average Cost of Capital (WACC) pre-tax and after-tax, with sensitivity analysis based on changes in the cost of debt, preferred shares and equity. It provid...Read More

Running head: FINANCIAL MANAGEMENT
Financial management
Name of the student
Name of the university
Author note

1FINANCIAL MANAGEMENT
Table of Contents
Part A.........................................................................................................................................2
Risk and capital budgeting.........................................................................................................2
Part B..........................................................................................................................................4
Role of the financial management with regard to the ‘Not-for-profit organization’.................4
Reference....................................................................................................................................8

2FINANCIAL MANAGEMENT
Part A
Risk and capital budgeting
(a) Pre-tax cost
capital structure
Debt 40%
Preferred equity 10%
Ordinary shares 50%
Tax rate of the company = 40%
Cost of debt = Yield to maturity = 8.3%
Note: The effective annual rate of the debt is taken based on the current market scenario that
is the YTM on debt. However, the historical rate is not considered.
Calculation of cost of preference shares
Cost of preferred equity 10%
Face value $70
Market value $76
Dividend 8%
Cost of preferred equity = Annual dividend / Market value = ($70*8%)/$76 = 7.37%
Calculation of cost of ordinary shares as per CAPM
Cost of equity = Rf + β (Rm – Rf)
Where, Rf = risk free rate
Β = Beta
Rm = market return
As per the given question, Rf = 4%, Rm = 11.4% and β = 1.05
Therefore, cost of equity = 4 + 1.05 (11.4 – 4) = 11.77%

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(b) Calculation of WACC
WACC pre-tax –
WACC = wd (cost of debt after tax) + ws (cost of stock/RE) + wp (cost of PS)
WACC = 0.4(8.3) + 0.1 (7.37) + 0.5(11.77)
= 3.32 + 0.74 + 5.89
= 9.94%
WACC after tax –
WACC = [(1-0.4)*(0.4*8.3)] + (0.1 * 7.37%) + (0.50 * 11.77%)
= 1.99% + 0.74% + 5.89%
= 8.62%
Therefore, the After-tax WACC is better for investment.
(c) With changed data
Cost of debt = 9%
Cost of preference share = (0.08*$70) / $70 = 8%
Cost of ordinary shares under CAPM = 4 +1.15(11.4 – 4)
= 4 +8.51
= 12.51%
WACC after tax = [(1-0.4)*(0.5*9)] + (0.10*8) + (0.4*12.51)

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= 2.70 + 0.80 + 5
= 8.50%
Due to the increase in risk with regard to investment, the after tax WACC of SVI
dropped from 8.62% to 8.50%. However, the result may be inconsistent with the expectation
but it can be explained through the fact that the increased leverage will lead to higher
proportion of debt in the capital structure of the firm. Owing to the increased pre-tax cost of
all the finance sources, the deductibility of tax on the increased proportion of the debt is more
like compensation that leads to lowering of the WACC of SVI.
Part B
Role of the financial management with regard to the ‘Not-for-profit organization’
For the successful operation and smooth running of any enterprise, commercial as
well as non-commercial ones, several factors are of key importance. These factors may be
completely endogenous to the enterprise itself as well as exogenous in nature, the latter being
involuntary and not dependant on the working methods of the enterprise itself. The
endogenous factors, lying in the hands of the management of the enterprise, are therefore, of
more importance and needs to be taken care of by the management of the organizations in
order to keep the potential of the concerned enterprise increasing and achieving the short term
as well as the long term objectives and targets of the enterprise. One of the key endogenous
factors of immense significance and implications on any enterprise is the financial
management of the concerned enterprise. The term financial management, in general, refers
to the efficient management of the monetary belongings and funds of an organization,
including their effective usage and efficient and proper allocation, such that the objectives of
the concerned organization can be achieved efficiently.

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Both commercial, profit maximizing enterprises as well as not for profit enterprises
need effective financial management in order to operate efficiently in the economy. The
financial management for the not for profit organization is same as the financial management
of the commercial sector in various aspects. Though it may seem like the not for profit
organizations do not need a financial management framework, as robust as that of the profit
oriented ones, as the former is not concerned about persona revenue generation, however, for
the not profit organization too, financial management plays an important part (Kaaya 2015).
It is crucial to understand variance between the non profit organization and the profit making
organization. The main objective of the for-profit organization is earning profit and
maximizing the shareholder’s value. Though it is crucial for the for-profit companies to earn
profit, their main aim is to deliver the socially desirable requirement on continuous basis.
Further, the for-profits organizations depends on the exchange transactions and on the
contrary, not for profit organization depends on the money those are contributed for particular
purpose and the money is to be utilized for that particular purpose only that will decrease the
elasticity of the not for profit organization.
As discussed above the non-profit enterprises are mainly set up to serve social causes
and increase the welfare of the society as a whole. Therefore, much of their monetary
resources come from the donors and well-wishers, who patronize their initiatives. In some
instance, these organizations themselves try to perform some production activities, with the
help of their members, in small scales, to earn revenue, which in turn would be used to serve
the purpose of the organization. Therefore, for these types of organizations, it is of immense
importance to manage their financial resources and spending correctly, as they need to show
their earnings and expenditures in a detailed manner to the donors. Financial management is
also necessary for the not for profit organizations as their inflow of cash can be irregular and
they need to smoothen their expenditures depending upon a rather irregular cash inflow.

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Resources of are of immense importance to these organizations and they come in the
form of donations mostly and kept as reserve or asset by the organizations as the inflow are
scanty and irregular. Therefore, protecting these financial reserves and using them efficiently
are of utmost importance to the not for profit enterprises as their life and sustainability in the
long run, depend on these resources, thereby indicating the importance of proper financial
management framework in the not for profit industries (Brigham 2014).
Another aspect of huge significance, especially for the non-profit enterprises, which is
the reputation of these enterprises as almost all of the success and long term sustainability of
these organizations depend on the goodwill that the enterprise has in the economy. The
amount of donations received by the not for profit organizations also depend significantly on
the good will and reputation of the concerned enterprise. In this context, if there are
inappropriate usages of the funds received by any not for profit enterprise, then it may hugely
affect the operations, targets as well as the goodwill of the enterprise. This may also reflect
adversely on the fund collection of the concerned enterprise as donors may lose confidence
from the organization, thereby diverting their donations from the organization (Brigham and
Ehrhardt 2013). To prevent this, proper financial management, with regulations and limited
access to the funds, needs to be implemented in these not for profit organizations.
Financial management helps in forming the budget of the organizations, which, given
the limited resources present with them, may prove to be beneficial for the organizations as a
well-planned budget provides an insight to the members of an organization regarding fund
allocation and proper utilization of these funds in different aspects of the organization
(Finkler et al. 2016). The unforeseen events and shocks in the economy can also be mitigated
with the help of a foresighted budget plan on part of the company, which implies that
financial management is crucial for these organizations.

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Often, the non-profit organizations also involve themselves in producing activities,
the production levels being small and not of fully industrialized in nature. For this purpose,
proper allocation of the funds present with these not for profit organizations are required,
keeping in mind the costs and benefits of the productive activities. Therefore, along with the
formulation of a robust and foresighted budget, it is also of immense importance for the non-
profit organizations to manage their funds, to facilitate revenue-generating productive
activities, which help the organization to operate successfully in the long run (Ward and
Forker 2017).
Therefore, it is evident from the above discussion, that financial management
activities are of immense significance for the not for profit organizations, the significance of
these activities being more in some cases than that of the profit-targeting fully
commercialized organizations. The management appropriately should be done on a day-to-
day basis, to keep the working of these organizations smooth and keeping them free from
controversies.

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Reference
Brigham, E.F. and Ehrhardt, M.C., 2013. Financial management: Theory & practice.
Cengage Learning.
Ward, A.M. and Forker, J., 2017. Financial management effectiveness and board gender
diversity in member-governed, community financial institutions. Journal of Business
Ethics, 141(2), pp.351-366.
Finkler, S.A., Smith, D.L., Calabrese, T.D. and Purtell, R.M., 2016. Financial management
for public, health, and not-for-profit organizations. CQ Press.
Brigham, E.F., 2014. Financial management theory and practice. Atlantic Publishers &
Distri.
KAAYA, I.D., 2015. The Impact of International Financial Reporting Standards (IFRS) on
Earnings Management: A Review of Empirical Evidence. Journal of Finance, 3(3), pp.57-65.