Discussion (150 words each with reference) DQ 2 What is the real cost of a tax deductible expenditure?

What is the depreciation tax shield? Answer: For the tax deductible expenditure, cost is minimized by the tax shield amount of the expenditure. So what is left after deducting the tax shield from the initial amount is the true or real cost of tax deductible expenditure. Tax deductible expenditure has lower cost comparatively non tax deductible expenditure. For example, interest payment on debts is tax deductible. So the true cost of interest expense is as follows True cost of Interest Expense = (Interest Expense - Tax shield)

Depreciation Tax Shield: Depreciation Tax Shield is a tax reduction of the income tax of a firm that comes with the use of depreciation. The income tax is reduced by the amount of depreciation multiplied with corporate tax rate. Depreciation Tax Shield = (Deprecation amount x Tax rate) For the firms that use accelerated depreciation method, they will have higher depreciation shield in the early years of the life of assets.

DQ3 Describe and explain the DuPont Analysis. Give an example of how it is calculated. Describe the advantage of using this analysis. Answer: DuPont analysis examines the return on equity (ROE) by breaking it into profit margin, total asset turnover, and financial leverage. It was created by the DuPont Corporation in the 1920s. The DuPont analysis is also known as DuPont identity. DuPont analysis confirms that ROE is affected by Operating efficiency, Asset use efficiency, and financial leverage. In a DuPont analysis, the formula for ROE is: ROE = Profit Margin x Total Asset Turnover x Leverage Factor

The breakdown is: ROE = (Net Income/Revenues) x (Revenues/Total Assets) x (Total Assets/ Shareholders' Equity) Or, ROE = EBIT Margin Interest Burden Tax Burden Asset Turnover Financial Leverage Advantages: A better way to measure profitability. Identifies the strength of weakness of the break down components. Make future predictions with regard to the performance DuPont facilitates to make an evaluation of the capital needs of a company. It is useful for estimating the long-run business viability.

DQ4 Explain the percent of sales method of preparing pro forma financial statements or forecasting, what is the advantage of this method? Answer: The Percentage of Sales Method is a Financial Forecasting approach which is based on the premise that most Balance Sheet and Income Statement Accounts vary with sales. Percentage of sales method of expressing revenues, expenses, assets, liabilities and stockholders equity as percentages of sales and use these percentages to prepare a pro forma financial statements. Percentage of sales method is used to determine the cash requirement of the current year by analyzing the financial statements of the previous year and forecast the upcoming year. Advantage of Percentage of Sales Method: sales. Determining the cash requirement in the cash budget. Determine the company growth with sales. Accurate method of forecasting the revenues and expenses as these vary with the

Realistic assumptions are used as previous years financial statements are used. A base for preparing the marketing budget allocation. Good source of information for the master budget.

DQ6 Describe and discuss the term structure of interest rates Answer: Term Structure of Interest Rate is a graph that shows the relationship between maturity and yield of similar quality bonds, especially zero coupon bonds. It is also known as the yield curve. Term Structure of interest rates indicates different yield rates for the varying maturity period. So investors can quickly compare the different yields of short term and long term bond. The shape of the term structure normally takes three different forms. These are 1. Normal or upward sloping: If the long term yields are higher than short term yields then the term structure of interest rate is positive or normal. 2. Inverted or downward sloping: If the short term interest rates are higher than the longer term interest rates the term structure is negative or inverted. 3. Flat: If the yield is same for all the maturity level the term structure is flat. There are different theories regarding the shape of term yield curve. These are expectations theory, segmented market theory and liquidity preference theory.

DQ7 Explain and discuss the impact of the internet on working capital management based on the information on page 194 and your own experience Answer: With the internet management of working capital now has become much easier than ever before. Internet impacts how firms purchase their materials, sell their goods, collect their receivables and even manage their cash. Two major trends that affect corporations are the business-to-business supply exchanges and the online auction markets. B2B supply exchanges provide a common platform for the manufacturers and suppliers to come together and do business. The use of online auction companies for B2B markets helps companies to find the best ways to spend their money wisely and efficiently. The auction site removes the geographical barriers. Suppliers of all over the world now can bid on business that would never be possible with the internet. So the internet has an immense impact on the working capital managements of firms.

DQ9 Explain why it is necessary to understand the time value of money. Give some examples of how you would use the concept in your business or personal life. Answer: Each and every dollar has a time value. Receiving one dollar today is preferable to receivable one dollar in future. This is because if we invest one dollar today it will grow much greater. To allure us to postpone our current consumption and invest the money, we demand a return on this postpone money. This return may be in the form of interest or capital gain. Since money has its time value, we must understand this time value to use for the decision making. Understanding Time value is worthwhile because it enables one to take better decision. This decision may be business related or may be personal life related. For example, a financial manager must determine the present value of an investment opportunity to decide whether the project will create value or not. Even for personal decision making like buying auto with different financing options or choosing most profitable pension fund plans, time value concept is very helpful.

DQ10 Read the story on page 305 about the value of a small business. Explain what factors you would use to value a small business, including those mentioned in the article and other factors you may use. Answer: To value small business I would use several important factors. One of these is the liquidity factor. For small business, the liquidation of assets is not as easy as for the large firms. Lack of established market for the small business makes it difficult to liquidate the firm. So the small business should value should decrease due to the lack of liquidity. I will find out whether the small business is much dependent on a key person. If it does than the value of small business should be lowered much. I will make adjustments to previous earnings because small business tries to incorporate personal expenditure of owner to reduce the taxable income. I will also consider the product type of the business. If the product is basic goods and have high demand because of its quality then it small business can retain its value. Also the potential growth opportunity of the business needs to be considered.

DQ11 Read the Eli Lilly story on page 345. Discuss the concept of economic value added. Add your own thoughts. Answer: Economic Value Added is performance measurement toll. It is measured by the difference between the return and cost of capital. The return used in EVA is the Net Operating Profit after Tax (NOPAT). The cost of capital here is the weighted average cost of capital (WACC) of a firm. Economic Value Added is the concept of increasing firms value by taking projects that has higher returns than its cost of capital. EVA is easier to understand but difficult to implement. The developer of EVA, Stern Stewart Co. showed the business manager how to implement them. Eli Lilly is a successful example of EVA implementation. EVA is an important indicator because demonstrates how profitable the company is and the managements ability. Only growth of size of a firm is not a good indicator. That growth should be accompanied by profitability. And EVA measures that profitability. EVA has large advantages. It succinct how much wealth is generated and what is the source of the wealth creation.

DQ12 Explain why it is important for all companies, large and small, to use capital budgeting. Why do you think small companies often do not use it? Answer: Capital budgeting important for all companies regardless of its size, large or small. Capital budgeting is in fact a planning process to make investments that will extend beyond short term period. As this investments are substantial, for a long time period, irreversible in nature, and complex to decide the capital budgeting becomes the most important thing to perform. Further, it will affect the growth of the firms, the earnings and even the overall performance. So to assess the new and profitable opportunities and to assess the cash flows of a firm capital budgeting is an important tool. The reason small firms usually do not apply this sophisticated technique is due to the size of investment and the irregularity of the decision making. The lack of resource persons is also another reason for the non-use of capital budgeting. Large firms have the ability to collect the necessary data but small may not have the opportunity. But they do so in their naive way.

DQ14 Discuss the case of Bernie Ebbers and Worldcom on page 461. How would Sarbanes Oxley apply to this case if it would have been in effect at the time? Answer: Sarbanes Oxley Act was enacted in 2002 by the US congress in order to protect the interest of the investors from fraudulent accounting activities. The act established strict reforms in the accounting practices of the firms. Sarbanes Oxley Act was enacted in the response of the shocking accounting scandals in early 2000s. In the case of Bernie Ebbers and Worldcom the firms did accounting fraud and later on the CEO Mr. Bernie Ebbers claimed his innocence as being not much educated in accounting. According to Sarbanes Oxley act the top management of a firm much certifies that the accounting book are fair. And they know the policies used during the preparation of the accounting books. So if the Sarbanes Oxley act were present at the time of Mr. Ebbers case, he would no longer raise claim that was not knowledgeable in accounting.

DQ16 Explain the bond rating system as explained in the text Answer: A Bond rating is ratings done by the independent rating after the evaluation of the corporate bonds features and the issuing company. The major rating agencies are the Moodys Investor Service and the Standard & Poors Corporation. The ratings are AAA, AA, A, BBB, BB, B, CCC, CC, C. bonds with ratings like AAA and AA are considered to be good quality. Bond rating is assigned by making quantitative evaluation and qualitative judgment by the ratings firms. The factors considered in the rating process are the ability of the corporation to pay the interest and debt obligation, its size, its debt to equity ratio, its ratings of existing bonds, the working capital position etc. The ratings process is not fully disclosed by the ratings agencies in a detailed manner.

DQ17 Describe and contrast the rights of bond holders and preferred stockholders. Which has the best position in a default, which one would you buy all other things being equal. Answer: Both the bond holders and the preferred stockholders have seniority in financial claims relative to common stockholders. But between the bondholder and preferred stockholder, bond holders get the preference in the situation of firm default. The bond holders are the creditors of the firm. So when a firm defaults and liquidates the creditors is the first lien to receive their claim. Then comes the preferred stockholder. But in the exchange of bearing the risks the preferred stockholders receive dividends. Everything being equal I would purchase the bond. Because as the preferred stock does not provide me the option to convert it to common stock then I will not gain much if the company does good. So I would rather take a secured position regarding my collection of claims.

DQ18 Discuss the topic on page 601, Enticing Investors through Convertibles and Warrants. Would convertibles and warrants influence your decision to buy or not buy an investment? Answer: The convertible and warrants does influence the decision to buy and not to buy an investment. This will also influence me when making an investment decisions. Although some firms may have difficulties to support its working capital or other funding for the expansion, these firms may not be bad for investment candidate. Depending on the proposals and offer and the perspective market condition I may consider making some investment in the firm. If the convertibles and warrants are lucrative and will highly provide futures benefit I will consider their worth in my investment decision. Convertibles are favorable offer if the stock are going to do fine and warrants are also same because that allows to buy at a lower exercise price than the prevailing market price.

DQ21 Based on the story about Motorola on page 652, describe how the company manages currency risk Answer: Motorola hedges its currency risk with financial derivatives. As a multinational corporation Motorola has currency risk. As it operates business in different countries and in different regions the currency risk a major challenge for the management. The five major currency risk that Motorola has to hedge are euro, Chinese renminbi, Brazilian real, Indian rupee and British pound. The company hedges these currencies with derivative instruments like forward, futures options. The derivative usage here is solely for the hedging purpose. No speculative transaction is done to essentially benefit from the forecasted movements in the price of derivative or the underlying currencies.

DQ5 Read the story on page 136 and summarize why Japanese firms tend to be competitive Answer: The Japanese firms are highly competitive because of their highly leverage. Japanese firms are highly levered in both operational leverage and financial leverage. But only this higher value of leverage does not make them competitive. Both Japanese govt. and the firms have commitment to do research and make high technology intensive products. The employees are also loyal. Most banks and the industrial firms have good relationship. The banks and the firms often are seen to share the demerit of failure. But in case of USA firms, the loans are obtained from the money center giant banks like Citi Corp and Bank of America. These banks do everything it can do it the situation of the borrower weakens. But the Japanese firms have this opportunity. And they often do aggressive sales campaign to cover their sales target and avoid loss. All these factors give the Japanese firms the competitive advantages over other firms.