Risk and Return Assignment Help Examples Samples
- January 30, 2018
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Looking for Risk and Return assignment help homework help samples and examples. You are at correct place.
Usually, enterprises use either debt or equity capital to finance different projects. The management should thus be vigilant and cautious at the source of the financing they choose to finance various business operations. Which implies that only the long-term sources of the fund should be used to fund long-term projects and vice versa for current or short-term projects should be financed using the short-term sources of financing. The reason for above rationale is that there is always budget cliff for instance in case the firm utilizes what was planned to finance a particular cash generating project(CGP) even after a company has used funds from external sources as per our ratio analysis help researchers. The paper is addressing factors that a firm should consider when considering to borrow a debt capital to finance new projects‚ Furthermore it evaluates risk versus returns factor of such decision. Also it enumerates the advantages and disadvantages incurred by the firm on choosing such capitalization decision, and lastly it draws recommendations of the best practices which the financial management department should embrace to achieve proper strike off balance of risks and returns.
To get the clear logic of how borrowing a loan to fund a project with expectations that it will generate sufficient returns can paralyze firm operations as seen in below.
Using debt capital with the aim of financing cash generating project or buying shares can affect the enterprise operations adversary if not well management (Lioui & Maio, 2014‚p 485). This can be as result of the uncertain level of returns from the invested funds. Hence, consequently leading the returns to be much lower than the cost of loan. Thus leading to the phenomenon whereby the returns from such investments cannot service such loans. The impact of this can be financial distress which can prompt the financiers to put the Company into receivership.
Assuming an example whereby the firm takes a loan worth $1500000 at the initial interest rate of 10% per annum which at third repayment year was adjusted to 5% with a repayable period of 5 years. The money will be used to buy shares in the company with the hope that the returns from shares will be sufficient to service the loan.
Going by the above illustration the loan amortization table will be as follows over the repayment period.
|Year||Opening balance||Annual repayment||Interest||Principal||Closing balance|
The annual repayment amount for the first two years will be calculated as follows. Which is composed of principal plus interest
$1500000=periodic annual repayment (1-1/ (1+0.1)5) / 0.10=$395696
Annual repayment amount for the last three years
For the last three years, the annual periodic repayment after interest rate adjustment will be computed as follows
Since the opening balance at the third year is $984038 the annual repayment amount will be computed as follows;
$984038=periodic annual payment (1-1/ (1+0.05)3=$361347
Assuming that the money was invested in shares of company XYZ limited with the following returns on investment rate at discounting rate of 10%.
The present value of the returns from the company can be computed as follows;
|Year||Amount||PVIF(1/(1+r)n||Present value||Tax shield |
|Gross net present value||$406‚193||$121858|
|Less: Capital outlay||($1500000)|
|Net present value||($1093807)|
Analysis and interpretation of illustration
As observed from the above illustration even the periodic returns from the investment cannot cover up the annual loan repayment for the respective year. For instance during the first year, the returns on the investment (ROI) was $363636 which even cannot cover the cost loan at that particular period which amounts to $395696.Thus if funds generated out of such investment was to be used to service the loan, there would be the deficit of $395696-$363636=$32060 which is a substantial amount as calculated by our business analytics assignment help team. Furthermore, the net present value is negative ‚having a deficit of amounting to $1093807.
It is also advisable for management to be cautious when making decisions to use external sources of the funds to finance the project. The reason being that sometimes financial institution tends to adjust coupon rate on loan. Which will have a direct impact on the firm as observed on above loan amortization table. In such case, shifts lead the interest rate to shoot up. Which can be caused by factors such as financial crisis and high inflation rates in the economy.
The advantage of above arrangement
Tax shield benefit
Financial gearing offers the substantial tax shield benefit which lowers the tax obligation of the enterprise. For instance in above case tax shield benefit is calculated as follows, tax shield benefit is computed using the following formula. That is‚
Tax shield=Returns (1-t).
From the above illustration, the total tax shield benefits amounts to $121858.
Benefits from capping of interest rates
Sometimes government can issue directives which are meant to regulate interest rates levied by financial institutions. In such situation, such shift will benefit the enterprise as observed above where the interest rate shifted from 10% to 5% during the third repayment year as per our taxation homework help team. According to Dell’Erba and Sola, (2016‚p 396) fiscal policies have an effect on long-term interest rate hence should be considered when borrowing.
Benefits from derived from deflation
When there is deflation financial institution will tend to lower their lending rates in cases they had adjusted it upwards due to expected inflation (Ditchkus, Sierra & Reed 2011‚p 452). In such situations‚ the firm will benefit as in such scenario especially when it had borrowed before deflation occurs for its repayment burden will be lowered.
Unpredictable shifts in interest rate
When the inflation occurs, banks tend to adjust the lending rate upwards to cater for the operational costs. As for example Olaberría, (2015, p 16) noted Interest rates are greatly influenced by the level of direct investment in a particular country.
The uncertainty of returns on investments (ROI)
As seen from the above illustration the earnings from shares keep on fluctuating thus it can be risky for the firm to depend on such returns to service the debt capital.
Presence of hidden costs
Sometimes loan contract document contains some additional footnotes information which when not identified during contract initiation can cost the firm in future. Such clauses can be regarding possible cases of adjustment of the interest rate as observed from above illustration.
Factors to consider when obtaining a debt capital
Before the taking loan, the firm should consider the following factors which when not well evaluated paralyze the enterprise’s operations leading to the financial distress at their extreme levels. These factors include- interest rate and repayment period among other factors.
The interest rate on borrowing.
Interest on the loan is one of the key parameters that financial managers must consider when deciding on whether to finance the business operations by use of the loan. They can compare different lending rates being offered by the various financial institution and go for the cheapest source of the borrowing. Also in this stage of contract initiation, they must carry out cost-benefit of sourcing such funds even though future interest rates is unpredictable (Al-Abadi & Al- Sabbagh, 2006‚p 26).
Sometimes management acquires the loan for it to invest such funds in anticipation that they project such fund has been invested will be able to raise sufficient returns to cover up for the periodic loan installments repayments (ngelovska, 2016‚P 2). In such situation, the said project which can be either buying portfolio of shares from various companies or build the rental apartment may be probabilistic regarding the returns as per statistics case study assignment help experts.
In conclusion, it is always recommended for managers to strive to ensure that there is proper analysis when using debt capital to invest in projects having uncertain returns such as shares.
Al-Abadi, M, & Al- Sabbagh, O 2006, ‘Interest Rate Sensitivity, Market Risk, Inflation and Bank Stock Returns’, Journal of Accounting, Business & Management, 13, pp. 25-38.
Dell’Erba, S, & Sola, S 2016, ‘Does fiscal policy affect interest rates? Evidence from a factor-augmented panel’, B.E. Journal of Macroeconomics, 16, 2, pp. 395-437
Ditchkus, L, Sierra, G, & Reed, B 2011, ‘The Role of Managerial Prudence in Bank Loan Loss Provisioning’, Journal of Managerial Issues, 23, 4, pp. 447-464.
Lioui, A, & Maio, P 2014, ‘Interest Rate Risk and the Cross Section of Stock Returns’, Journal of Financial & Quantitative Analysis, 49, 2, pp. 483-511
ngelovska, J 2016, ‘Large share price movements, reasons and market reaction/ Velike promjene u cijeni dionica, razlozi i reakcije trzista’, Management: Journal Of Contemporary Management Issues, 1, p. 1,.
Olaberría, E 2015, ‘US Long-Term Interest Rates and Capital Flows to Emerging Economies’, Journal of International Commerce, Economics & Policy, 6, 2, p. -1