Six questions on business's finance

Résumé du document

In this document, we find answers to six questions about corporate finance based on the following subjects: The break-even point and the calculation of Net Income, The role of investment bankers, Why are the investment bankers fees lower for bonds than for stocks, Meaning of the risk-free rate and meaning of the beta, Role of the credit department, Options if the business needs more cash. Let us consider that two friends are opening up a business together. First, they must decide how much they need to sell in order to be profitable. They will be selling their products for an average of $45 per item. It costs them $20 to produce each item, and they have fixed operating costs of running the business at $82,000 per year. For their preliminary estimates, they will be borrowing $100,000 at an interest rate of 8% annually. We have to calculate how many items they would need to sell each year in order to breakeven at Net Income. Let us assume that depreciation is already included in the fixed operating costs and that the tax rate is 30%. Years later, the business is planning to sell their shares to the public. In order to help them, they will use the services of a small investment banking firm. In this context, we discuss the role of the investment bankers and the need to use them as well.

Extraits

[...] After many years, the business of the two friends is well. However, despite the fact that this situation is great, it generates a major problem: the working capital requirement increase. Thus, the company does not have enough cash to finance the growth. Working Capital: The Working Capital is the sum that the company has to finance its activities. Thus, it is the capital to finance activities requirements. We calculate the Working Capital with the formula: Working Capital Requirement: The Working Capital Requirement is the sum necessary to finance the activities. [...]

[...] The investment bankers' fees are based on the risk. Thus, more the risk is high, more the fees will be high. When we compare bonds and stocks, we can see two different methods. Stocks When the company issues stocks, it spread its capital between many stockholders. In consequence, the power is spread because for each stock, there is a percentage of voting right. In this case, the stockholder has no guarantee return on investment. He can speculate with the share price and hoping dividend if the company generates profit and if dividends are voted. [...]

[...] In our case, the minima than an investor can earn is 2%. In this calculation, the investor must take into account how much he can earn without taking risk. Then, he add the risk premium time β. The risk premium is the difference between the interest rate of the market and the risk-free rate. In consequence, the risk premium is the average risk of the market. Meaning of the beta Finally, the investor does the risk premium time β to obtain the risk of the specific share. [...]

[...] Question 4 An investor is considering buying shares in this company. He believes that this company is less risky than the average stock in the market and estimates that it has a Beta of He also believes that the market on average will earn 12% next year. If the risk-free rate is use the CAPM formula to determine the rate this investor would want to earn from this stock. Discuss the meaning of this number that you have calculated. Discuss what the risk-free rate represents. [...]

[...] They need to use an investment banker because this last one issues bond and stocks. In our case, these both solutions could be solutions to finance the growth and the increase of the Capital Corking Requirement. To resume, the company needs to use investment banker to issue bonds or stocks because the company must finance the increase of its Capital Working Requirement due to the growth of its activities. Question 3 The business needs to raise $3,000,000 from this stock issue to use after the investment banking firm is paid. [...]