Question Sir i m doing mba through correspondence and exams are soon to come. Facing a lot of difficulty in financial mngmnt questions. It would be kind of you if you could ans them. pleaseeee...
Q.1) What is the "indifferent point" and why is it called so? What
is its usefullness?
Q.2) What is the economic value added?
Q.3) What is a warrant?How does it differ fron convertible
securities?
Q.4) What are the fifferent types of equity/ordinary share
capital?
Q.5) What is equipment lease? What are its essential elements?
Answer DAISY,
HERE IS SOME USEFUL MATERIAL.
REGARDS
LEO LINGHAM
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1.What is the indifferent point’ and why is it so called? What is its usefulness?
INDIFFERENT POINT IS
1: marked by impartiality : unbiased;
2. of no importance or value one way or the other;
3 marked by no special liking for or dislike of something
Indifference point
The decision of whether or not to acquire the production equipment can be analyzed with a concept called the indifference point, which has characteristics similar to those of the break-even point . The break-even point can indicate the situation where a person feels indifferently between two options because they both lead to zero profit. They choose between doing nothing (thus having a profit of zero) and following the alternative considered (where the profit at the break-even point is also zero).
The indifference point is based on being indifferent between two alternatives, but without the constraint of having zero profit. Let us assume two alternatives: one is better if sales are low, while the other is preferred when sales are high. The vertical axis is profit and the horizontal axis is sales volume. Alternative A is better if sales volume is low; Alternative B is better if the sales volume is high. Notice that there is a point where both alternatives give the same profit (point X). This is the indifference point because at this sales volume, the economic prospects of both alternatives are the same.
IT IS USEFUL BECAUSE
-IT HAS NO CONSTRAINTS.
-IT HAS NO RISKS.
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2.What is equipment lease? What are its essential elements
What It Is: Equipment leasing is basically a loan in which the lender buys and owns equipment and then "rents" it to a business at a flat monthly rate for a specified number of months. At the end of the lease, the business may purchase the equipment for its fair market value (or a fixed or predetermined amount), continue leasing, lease new equipment or return it.
Appropriate for: Any business at any stage of development. For start-up businesses with no revenues, "small ticket" leases, those of $100,000 or less, are feasible on the personal credit of the founders or owners-if they are willing to make the monthly payments.
Supply: Abundant. Of the billions of dollars individual and institutional investors pour into the capital markets each month, a good hunk finds its way to leasing companies that use these funds to purchase equipment on behalf of small businesses. With more and more money flowing into the markets, leasing companies are flush with capital. As a result, they are eager to do business and respond to competition with lower monthly rates.
Best Use: Financing equipment purchases. Leasing can also finance the soft costs often associated with equipment purchases, such as installation and training services.
Cost: Lease financing is generally more expensive than bank financing, but in most instances it's more easily obtained.
Ease of Acquisition: Easy for leases of less than $100,000. An application for a small-ticket lease is generally no more complex than a credit card application. Leases for more than $100,000 require detailed financial information from the business, and the leasing company conducts a more thorough credit analysis than it would for a smaller transaction.
Range of Funds Trypically Available: Unlimited
STEPS
Finding an equipment-leasing company is easy. Almost any equipment a business could conceivably need offers a lease option. Thought it's not apparent at first glance, the company offering the lease financing is not the same one that is selling the equipment. The company selling the equipment simply makes a direct referral to a leasing company with which it does business.
It's a good idea to get a quote from the leasing firm referred by the company that wants to sell you the equipment. The quote should be competitive. After all, the company selling products wants to sell as many as possible, and it surely doesn't win any points by referring a leasing company that gouges its customers. But it also pays to get another quote. Usually, the company selling the equipment works with more than one leasing company. Or ask a friend or a business associate for a referral.
As a final point, when looking for a leasing company you should understand whether you are talking to a broker-the person who simply structures deals, then gets them financed through any of the leasing companies he or she works with-or a leasing company that is actually putting its own funds on the line.
There's nothing wrong with brokers. The situation is analogous to working with an independent insurance agent. He or she might have intimate knowledge of the marketplace and know where to go to get the kind of insurance, or lease, in this case, you need. In theory at least, this may generate savings in excess of the broker's fees. But as when dealing with insurance agents, you should always keep one thing in mind when working with a broker: Buyer beware.
Using Equipment Leasing to Finance Your Business
Leasing equipment allows you to buy assets without the necessity for bank loans, and many equipment leases can be structured so they provide you with tax write-offs and depreciation deductions in the same way as purchasing assets.
Benefits of Leasing
Staying Updated
Leasing technology allows you to stay current with the latest equipment, in computers, office equipment, and specialized equipment for your business.
Easier to Obtain
Vendors are eager to lease to you, and in most cases you can get a lease quickly with minimal credit checks.
Lower Upfront Cost
You can also get an equipment lease without a large down payment, so you don't have to tie up a lot of cash in the lease.
Drawbacks of Leases
Cost of Financing
Lease interest rates are usually higher than bank interest. Although the lease may not specifically include interest, it may be hidden in fees and other costs.
Deduction of Lease Costs
Some leases may not be eligible to be deducted. Read your lease carefully and be sure you check with your tax preparer before signing a lease agreement.
In general, leasing is a good alternative to bank financing for high-tech equipment, if you are struggling to find financing for start-up or capital assets.
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3.What is a warrant? How does it differ from convertible securities?
a warrant is a SECURITY that entitles the holder to buy stock of the company that issued it at a specified price, which is usually higher than the stock price at time of issue.
Warrants are frequently attached to bonds or preferred stock as a sweetener, allowing the issuer to pay lower interest rates or dividends. They can be used to enhance the YIELD of the bond, and make them more attractive to potential buyers. Warrants can also be used in PRIVATE EQUITYdeals. Frequently, these warrants are detachable, and can be sold independently of the bond or stock.
Warrants are actively traded in some financial markets such as Deutsche Börse and Hong Kong. In Hong Kong Stock Exchange, warrants accounted for 11.7% of the turnover in the first quarter of 2009, just second to the callable bull/bear contracts.
Structure and features
Warrants have similar characteristics to that of other equity derivatives, such as options, for instance:
Exercising: A warrant is exercised when the holder informs the issuer their intention to purchase the shares underlying the warrant.
The warrant parameters, such as exercise price, are fixed shortly after the issue of the bond. With warrants, it is important to consider the following main characteristics:
Premium: A warrant's 'premium' represents how much extra you have to pay for your shares when buying them through the warrant as compared to buying them in the regular way.
Gearing (leverage): A warrant's 'gearing' is the way to ascertain how much more exposure you have to the underlying shares using the warrant as compared to the exposure you would have if you buy shares through the market.
Expiration Date: This is the date the warrant expires. If you plan on exercising the warrant you must do so before the expiration date. The more time remaining until expiry, the more time for the underlying security to appreciate, which, in turn, will increase the price of the warrant (unless it depreciates). Therefore, the expiry date is the date on which the right to exercise no longer exists.
Restrictions on exercise: Like options, there are different exercise types associated with warrants such as American style (holder can exercise anytime before expiration) or European style (holder can only exercise on expiration date).
Warrants are longer-dated options and are generally traded OVER THE COUNTER.
securities are convertible into another class of securities if the holder may have the other class of securities issued to them by the exercise of rights attached to those securities. An option may be a convertible security even if it is non-renounceable.
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Convertible Securities
A "convertible security" is a security - usually a bond or a preferred stock - that can be converted into a different security - typically shares of the company's common stock. In most cases, the holder of the convertible determines whether and when a conversion occurs. In other cases, the company may retain the right to determine when the conversion occurs.
Companies generally issue convertible securities to raise money. Companies that have access to conventional means of raising capital (such as public offerings and bank financings) might offer convertible securities for particular business reasons. Companies that may be unable to tap conventional sources of funding sometimes offer convertible securities as a way to raise money more quickly. In a conventional convertible security financing, the conversion formula is generally fixed - meaning that the convertible security converts into common stock based on a fixed price. The convertible security financing arrangements might also include caps or other provisions to limit dilution (the reduction in earnings per share and proportional ownership that occurs when, for example, holders of convertible securities convert those securities into common stock).
By contrast, in less conventional convertible security financings, the conversion ratio may be based on fluctuating market prices to determine the number of shares of common stock to be issued on conversion. A market price based conversion formula protects the holders of the convertibles against price declines, while subjecting both the company and the holders of its common stock to certain risks. Because a market price based conversion formula can lead to dramatic stock price reductions and corresponding negative effects on both the company and its shareholders, convertible security financings with market price based conversion ratios have colloquially been called "floorless", "toxic," "death spiral," and "ratchet" convertibles.
Both investors and companies should understand that market price based convertible security deals can affect the company and possibly lower the value of its securities. Here's how these deals tend to work and the risks they pose:
The company issues convertible securities that allow the holders to convert their securities to common stock at a discount to the market price at the time of conversion. That means that the lower the stock price, the more shares the company must issue on conversion
The more shares the company issues on conversion, the greater the dilution to the company's shareholders will be. The company will have more shares outstanding after the conversion, revenues per share will be lower, and individual investors will own proportionally less of the company. While dilution can occur with either fixed or market price based conversion formulas, the risk of potential adverse effects increases with a market price based conversion formula
The greater the dilution, the greater the potential that the stock price per share will fall. The more the stock price falls, the greater the number of shares the company may have to issue in future conversions and the harder it might be for the company to obtain other financing
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4.What are the different types of equity/ordinary share capital?
There are three basic types of equity:
-COMMON SHARES
-PREFERRED SHARES
-WARRANTS
Equity is viewed by the market as an ownership "share" in the revenue stream of a corporation's income once all prior obligations and debts have been satisfied. The "share" price is the relative value given to the corporations earning potential based on a number of factors. These include general economic conditions, both in the industry and in the overall economy, earnings projection, projected corporate growth, corporate stage of development, and financial ratio analysis. The overall analysis of a firm's future earning potential must be done through both fundamental and technical analysis, including charting and other indicators.
Generally, the structure of equity is that a "share" of the corporation represents the current market value of the firm, secondary to this is the potential for dividend income. There are various classes of equity for the individual investor to consider. The primary three groups into which equity may be subdivided are common stock, preferred shares, and warrants.
1.Common stock represents an ownership in a corporation
Common stockholders participate in the earnings stream of the corporation through dividends paid and capital gains made on a per share basis. Owners of common stock are responsible for the election of the Board of Directors, appointment of Senior Officers, the selection of an auditor for the corporate financial statements, dividend policy and other matters of corporate governance. This may also be done on a proxy basis, whereby a third party may be ceded the shareholders right to vote by the shareholder.
The responsibilities associated with common stock mean the investor participates to a greater extent in the fortunes of the firm. Capital gains, through the increase in market price of the firm's stock, accrue to a greater extent to the holder of common stock than to the holder of preferred stock.
Common stockholders also have a couple of significant rights should the business invested in be wound down: limited liability to the creditors of the firm and a residual claim on any assets or income derived once all prior claims (mortgages, bondholders, creditors, etc.) have been satisfied.
2.Preferred shares are stock in a company which have a defined dividend, and a prior claim on income to the common stock holder.
Should the company wind up operations, preferred shareholders are paid any obligations owed to them. Should a dividend be suspended by the Board of Directors, for what ever reason, the preferred share usually has a cumulative clause in it allowing that any unpaid dividends must be paid fully before any dividends may be declared and paid to holders of common stock. This means that the preferred share is a relatively more secure investment. The corporate issuing preferred shares may add differing features to the share in order to make it more attractive. These features are similar to those used in the fixed income market and include convertibility into common shares, call provisions, etc. Many have equated preferred shares with a form of fixed income security due to its defined dividend stream.
However, with the added security offered by the guaranteed dividend stream, the holder of preferred shares gives up the right to vote on issues related to corporate governance. Therefore, the preferred holder has little input into corporate policy.
Economic Value Added (EVA) is a financial performance method to calculate tne true economic profit of a corporation, EVA can be calculated as net" operating after taxes profit mmus a charge far tne opportunity cost of the capital ffivested.
EVA is an estimate of the amount by which earnings exceed or fall short of the required minimum rate of
return for shareholders or lenders at comparable risk.
Unlike Market-based measures, such as HVA. EVA can be calculated at divisional (Strategic Business Unit)
level.
Unlike Stock measures, EVA is a flow and can be used for performance evaluation over time.
Unlike accounting profit, such as EBIT, Net Income and EPS. EVA is Economic and is based on tne idea that a
business must cover both the operating oasts AND the capital costs.
Usage of the EVA method
EVA can be used for tne following purposes:
- setting organizational goals
- performance measurement determining bonuses
- communication with shareholders and investors motivation of managers
- capital budgeting corporate valuation analyzing equity securities
CALCULATION
NET SALES
-operating expenses
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OPERATING PROFIT [EBIT]
-tax
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NET OPERATING PROFIT [after tax]
-capital charges.[invested capital x cost of capital]
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ECONOMIC VALUE ADDED.
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