Financial Management

Solutions to Exercises Session 2 (Capital Structure) 14-1QBE = [pic] QBE = [pic] QBE = 500,000 units.

14-4From the Hamada equation, b = bU[1 + (1 – T)(D/E)], we can calculate bU as bU = b/[1 + (1 – T)(D/E)]. bU = 1. 2/[1 + (1 – 0. 4)($2,000,000/$8,000,000)] bU = 1. 2/[1 + 0. 15] bU = 1. 0435.

14-8Facts as given: Current capital structure: 25% debt, 75% equity; rRF = 5%; rM – rRF = 6%; T = 40%; rs = 14%. Step 1:Determine the firm’s current beta. rs= rRF + (rM – rRF)b 14%= 5% + (6%)b 9%= 6%b 1. 5= b. Step 2:Determine the firm’s unlevered beta, bU. bU= bL/[1 + (1 – T)(D/E)] 1. 5/[1 + (1 – 0.

4)(0. 25/0. 75)] = 1. 5/1. 20 = 1. 25. Step 3:Determine the firm’s beta under the new capital structure.

bL= bU[1 + (1 – T)(D/E)] = 1. 25[1 + (1 – 0. 4)(0. 5/0. 5)] = 1. 25(1. 6) = 2.

Step 4:Determine the firm’s new cost of equity under the changed capital structure. rs= rRF + (rM – rRF)b = 5% + (6%)2 = 17%. 14-9a. a. If net income = $1,000,000 and dividend payout ratio = 40%, then the total amount of dividend paid in Year 0 was 40% x $1,000,000 = $400,000. Therefore, the current dividend per share, D0, = $400,000/200,000 shares = $2. 0.

D1 = $2. 00(1. 05) = $2. 10. Therefore, P0 = D1/(rs – g) = $2. 10/(0. 134 – 0.

05) = $25. 00. b. Step 1:Calculate EBIT before the recapitalization: The firm is 100% equity financed, so there is no interest expense. (EBIT = EBT NI = EBT – Taxes = EBT – EBT(T) = EBT (1-T) ? EBIT = EBT = NI/ (1-T) = $1,000,000/(1 – T) = $1,000,000/0. 6 = $1,666,667. Step 2:Calculate net income after the recapitalization: EBT = EBIT – Interest expense = $1,666,667 – 11%($1,000,000) $1,666,667 – $110,000 = $1,566,667 NI = EBT (1–T) = $1,566,667(.

) = $934,000 Step 3:Calculate the number of shares outstanding after the recapitalization: The company takes out a $1,000,000 to repurchase stock currently prices at $25. Number of shares after recapitalization: 200,000 – ($1,000,000/$25) = 160,000 shares. Step 4:Calculate D1 after the recapitalization: Given the 40% payout ratio: D0 = 40%($934,000/160,000) = $2. 335. D1 = $2. 335(1. 05) = $2.

45175. Step 5:Calculate P0 after the recapitalization: P0 = D1/(rs – g) = $2. 45175/(0. 145 – 0. 05) = $25. 8079 ( $25. 81.

Impact of International Financial Crisis on World International Markets

Introduction

Financial markets and credit institutions are fundamental in the modern economy as they coordinate the networks and production circuits by directing capital to where the maximum profit level can be obtained. However, in 2008 the global markets witnessed the worst financial crisis that can only be compared to the days of the Great Depression, which occurred in 1929-1930 (Gokay, 2009; Rose, 2010). A drop in the profits of financial institutions led to a sharp fall in the stock exchange markets (Altvater, 2007; Kim et al., 2009).

Consequently, there was a spectacular fall in the share prices in most of the world’s major markets, as a number of European and American banks declared massive losses in the 2007 end of year results. Financial crises can occur at national levels but the effect of the same at international levels causes major shifts in the world’s economy. Strategic financial management is cited as an important tool that corporate need in order to predict and overcome similar future scenarios of financial crisis (Scott, 2010).

The purpose of this review is to gather information concerning the impact of international financial crises on the global market. The literatures reviewed will be critically evaluated to determine the causative factors contributing to international financial crises. The role of strategic financial management in corporatism as a way to manage episodes of financial crisis will be analysed. Causes of the global financial crisis Woods (2006) asserts that some economists focus on international factors such as recession in major export markets, contagion, and capital account liberalization as causative factors of financial crisis.

At domestic level, some economists have cited uneven deregulation of the sector of finance (Gamble, 2009), artificially high interest rates, poor fiscal and monetary policy (Burrows & Harris, 2009; Chamon, Manasse, & Prati, 2007), corruption, and capital misallocation as contributors of financial crisis (Engelmann, 2009). The IMF has found itself being criticized on being the push factor to financial crisis because of the pressure that it puts on countries to liberalize their capital accounts.

This is in contrast to IMF’s objectives of giving strict policies to countries that face financial crisis and urging the countries to develop strategies by which they can avoid the situation. Although there is no clear agreement among the economists on how the global financial crises occurred, Dodson and Sipe, (2009) and Kendra, (2009) assert that a major immediate cause is believed to involve the world’s market mortgage-lending that was sub-prime and led to the real estate bubble. A large number of people, who were most considered as bad credit, were offered mortgages by banks (Lapavitsas, 2009).

House prices on the other hand were rising and the prices were anticipated to continue increasing (Archer, 2009). Therefore, it occurred that if people could not keep up with their mortgage payments, then repossession of their houses took place and sold at a tremendous profit. It was paradoxical that the increased lending was the same one that pushed up the house prices higher, and the greater and easier availability of mortgage funding led to the increased demand for housing (Fung, & Forrest, 2002). High housing prices made the owners feel rich and several people reached out to buy houses leading to a consumption boom.

The mortgage lenders would borrow elsewhere in order to lend and this resulted to different kinds of loans which were packaged as financial instruments. The finance market was therefore composed of endless strings of bilateral transactions and this involved incredible financial instruments attached with high risks. Enormous and endless profit seemed to be gained until the periods of bad credit set in. The economic growth slowed in the US and the UK as there was a high number of mortgage holders who could not afford the interest rate, leading to a high number of repossession.

Investors bought the repossessed houses through mortgage-backed securities schemes leading to a sharp decline of the house prices (Sheng & Kirinpanu, 2000). In turn mortgage lenders could not raise enough cash to pay back their loan sources and the chain continued. This led to losses across the world’s financial sector and it was difficult to deal with the problem at hand because the financial instruments were complicated. Furthermore, capital flows became restricted as lenders were afraid to give out credit because of uncertainties of whether they would be repaid.

This became the credit crunch by which there was a sudden reduction of the availability of liquid cash in the financial markets (Kyung-Hwan & Renaud, 2009). All this, not only affected the real estate market and the financial sectors but also led to an important reassessment of asset values in the entire world (Nesadurai, 2000). The credit crunch is a severe drawback to financial institutions as well as the entire economy that governments poured billions of money into private banks in order to revive the culture of borrowing and lending (Coffey, Hrung, Hoai-Luu, &Sarkar, 2009; Okimoto, 2009; Sharma, 2004).

However, nationalizing of banks by the government and the take on their debts has the danger of creating a debt larger than the country’s GDP, a case that occurred with Iceland (Crouch, 2008; Foreign Affairs, 2009; Gokay, 2009). Jessop (2010) draws comparisons of the financial crisis in the world markets from traditional economists’ perspectives-Marx and Engels in the mid-1840 and the present economists’ views. In the traditional modality, frictions that were entailed in the plurality of local markets and states, underdevelopment of finance, and production clumsiness inhibited the expansion of the world market (Lucarelli, 2010).

On the other hand, the achievement of neo-liberalism was for the purpose of reducing these frictions and constraints on the capital accumulation that were deriving from and inefficient financial markets and the national power bodies-the states (McNally, 2009). Impact of the financial crisis The recent financial crisis had a major impact on various firms across the globe (Ruhl, 2010). Various investment banks became bankrupt as potential; clients became hit by a low purchasing power. Several other stock-broking firms witnessed takeovers as mergers and acquisitions were considered the way out of the financial crises.

For some firms, the situation was so severe that a closedown was necessary to prevent further losses (Corwin & Harris, 2001). This financial crisis led to governments of most developed nations like the US and the European community to come up with some dramatic interventions with the aim to curb the situation in the financial markets (Konings, & Panitch, 2008). The collapse of the financial market did not only affect individual national firms but it was a considered as a match to the decline of the overall global economy.

The world witnessed a period of inevitable economic recession marked with financial shock, and sharp economic loss in most markets. Even as firms seek financial management strategies to curb the financial crisis and initiate a recovery process, the IMF still predicted a slow economic growth by developed nations (Gokay, 2009). In fact, the UK’s economy was predicted to shrink at -1. 3 percent in the end of 2008 while that of the US was set to contract by -0. 7 percent by 2009 (World Future Review, 2009).

This therefore indicated that if there was to be any global economic growth, then it would be contributed by emerging economies at an almost 100 percent basis (Gilpin, 2003). The economic performance of emerging economies would be a critical tool that would attain the hope for the global economic revival and growth after the 2010 year (Diao, Li, & Yeldan, 2000; Liao, K. 2001). The emerging world economies predicted for higher growths include the developing Asia and the Middle East (Hiwatari, 2003). On the other hand, the IMF is usually perceived to impose harsh policies on countries that face financial crisis (Kwon, 2004).

For instance, the financial crisis that occurred in the 1990s in East Asia prompted some countries to seek help from the IMF and loans were given but with stricter regulations and comments on financial crisis and how to manage the situation (Woods, 2006). Countries that face financial crisis may be deserted by commercial creditors and therefore the IMF becomes the last resort. However, IMF gives the financial assistance with strings attached and these include formal conditions, influences over the design, implementation, and project/program procurement as well as informal pressures.

This implies that countries facing financial crises and seeking IMF’s assistance to some extent lose their freedom in transacting costs at the world market. Nevertheless, the credit crunch period was a realization time in which many spectators believed that it was time for more and better financial regulations (Desai, 2010; Warby, 2010). Strategies to financial crisis management According to Poon (2003) and WDI (2001) the evolution of the global finance has heightened competition among the major world cities as the cities strive to become the prominent control centres of the world’s financial flows.

Internationalization has been associated with international bonds and shown to account for over 90 percent of the global securities market (Dervis, 2010; Teichman, 2007). The rapid expansion of trans-national corporate activities (Roggoff, 2006), industrial development of the emerging economies, and financial deregulation and the relaxation of capital controls among countries is evidence enough that there are increased financial activities at global level. Some world’s financial and capital cities strengthen hierarchical tendencies as they seek to financial concentration and productivity through differentiation (Olsen, 2009).

At the global scale, this can be observed with London, Tokyo, and New York which tend to dominate the financial hierarchy (Latter, 2001). Top tier cities tend to feature lower share trading value and risks, and market and share concentrations (Kyong, Tae, & Chiho, 2006). Sassen (2001) asserts that global cities are basic agents in financial services production. The services provide trans-national corporations with the necessary capabilities to conduct global operations (Miller & Rosenfeld, 2010). Strategic financial management and crisis management can help reduce the challenges of financial crises periods (Asmussen, 2009).

Deeg and Perez (2000) assert that convergence in national systems of corporate finance and governance can be achieved from the growth of international financial markets and, the lifting of capital controls. Conclusion A financial crisis is a challenging period to the economy of the world as major hit backs affect the financial systems. The impact is felt at individual, local, national and international levels. Problem that result from the world’s markets and affect the financial systems would certainly affect the economy because the latter is driven by finances.

Financial crises period feature periods of low capital flows as financial lenders withhold their services while investors become cautious in buying investment as and this reduces the rate of economic growth. Concerned organizations need to adopt financial management strategies that are realistic, efficient and effective when implemented so as to control major financial crises in the future.

List of Reference

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Provide support to ensure that team members can competently perform required roles associated with the management of instances

Determine and access resources and systems to manage financial Budgets as plans, monitoring and communication tools

• What is the point of budgets and why should they be monitored?

In order to plan effectively – both strategically and in terms of operations – management must have analyses that provide estimates of income and of factors that will cause variation in any or all of the factors related to income. Income will change and sales volumes will fluctuate. This is a certainty. Yet in order to maintain and initiate operations a forecast of how much things will change is necessary. Thus financial information – on costs, environmental factors, expenses, units, capital, revenue, variance etc is brought together to provide a picture which relates directly to operations – its planning and function. Properly conceived budgeting can mean the difference between a general drift that might (or more likely will not) lead toward a desired goal, and a plotted course toward a predetermined objective that holds drift to a minimum.

Managing financial information and budgeting is not simply a once yearly (or 6 monthly) process – where a budget is prepared and at the end of the budgeting ERM you check to see whether your business activities match the projections. If you use the budget in this way, you might get a very big surprise at the end of the year. Use the budget to monitor work activities, resource use and income. The other thing that should be remembered is that it is very difficult for employees to work toward achieving a budget if they do not know what the projections are. Reports and other relevant financial information must be communicated to the employees within the organization, as well as to other shareholders and stakeholders.

Responsibility accounting

Responsibility accounting is a method of attributing costs to specific departments/ sections/ teams or project areas within an organization. In this way a fair assessment of team and individual performance can be based on the resource costs for which the team/ section etc is responsible, and over which its members can exercise control and seek to improve their performance.

Responsibility accounting can provide a sound basis for team decision making. It can be positively motivational because members who are directly responsible for the management of their own team/ section/ visional costs, can relate operations to financial outcomes. They become, to a large degree, self-managing; waste reduction and cost improvement techniques are within their sphere of influence.

Involvement

The guidelines that should be followed if budgeting is to serve effectively as a source of motivation are that:

1. subsequent evaluations of performance should be made carefully with opportunities to explain apparent deficiencies objectives reflected in a budget should be obtainable
2. they must be realistic – and clearly communicated
3. employees who will be affected by a budget should be consulted when the gadget is prepared and should be kept up to date with regard to monitoring

Performance evaluation

One of the hallmarks of leading-edge organizations is the successful application of performance measurement to gain insight into, and make judgments about, organizational effectiveness – to drive improvements and successfully translate strategy into action. A cohesive and clear performance measurement framework that is understood by all levels of the organization, including employees, process owners, customers, and stakeholders, supports objectives and the collection of results.

High-performance organizations

Leary identify what it takes to determine success and make sure that all employees and managers understand what they are responsible for. Accountability for results is clearly well-understood and assigned. Budgets – as a planning/ forecasting and as a monitoring/ evaluation tool, contribute to the determination of performance expectations (Key Performance Indicators and Key Results Areas). They contribute to the design of information collection systems and those information results are, in turn, used to develop and design future budgets/ forecasts. Accountability requires understanding and information. It is amazing that in so many organizations employees have no awareness of the relationships between costs, profits and their own contribution to financial success. The communication aspect of a budget should enable employee awareness and involvement in waste reduction, cost cutting and revenue raising. Yet managers often withhold this information from employees.

Performance measurements offer information on what expenditures are needed and on how to priorities expenditures – how to develop the financial plan (budget) that will support all organizational operations. They help to identify what works and what does not so as to continue with and improve on what is working and repair or replace what is not working. Thus performance management and budgets are critically linked. Budget analysis produces information about the efficiency with which resources are transformed into services and goods, on how well results compare to a program’s intended purpose, and on the effectiveness of operations in terms of their specific contribution to program objectives. For this reason, it is vital that information be collected, collated and stored, so that it is both accessible and useable for hose purposes

Budgeting steps

Cash flow is the movement of money in and out of a business – the process through which the business uses cash to generate products/services for sale to customers, collects cash from sales, then completes this cycle all over again. Organization’s need cash flow in order to operate. The cash position changes constantly, depending on material/stock/supplies purchases, leases or wages payments or incoming payments. Inflows are the inward movement of money from the sale of products/ services.

If your organization extends credit to customers and allows them to hare the sale of the goods or services to an account, then inflow occurs as money is collected on the customers’ accounts. Proceeds from bank loans are also cash inflow. Outflows are the movement of money out of a business – generally the result of paying expenses. If the business involves reselling or on-selling goods, then the largest outflow is most likely to be for the purchase of retail inventory’. A manufacturing business’s largest outflows will mostly likely be for the purchases of raw materials and the supply of other production components. Purchasing fixed assets, paying back loans, and paying accounts payable are also cash outflows. Profit is not the same as cash flow. It is possible to show a healthy profit at the end of the year, and yet face a significant money squeeze at various points during the year.

Assignment tools

Budgets provide for money and specify where it should be spent. They determine who should be accountable for what activity and are used to allocate human resources to processes, functions and projects. They are also used to match resources to results. The intention of budgets is to ensure: 0 sufficient cash flow which will meet all financial obligations 0 maximum profitability

Types of budget

There are a number of different budgets that will be prepared in an organization.

Some of these are: sales training cash flow capital expenditure operations advertising etc. Managers, frontline managers and supervisors will deal with some of these budgets; either trying to stay within budget, in terms of expenditure, or to reach budgetary expectations with regard to revenue (income). The different cost centre in the organization will obviously have different budgetary applications. The master budget pulls each of these individual budgets together to form a budget for the overall organization and provides a marry of the financial sources and requirements for operations. It establishes planned and authorized expenditure and when compared with financial reports and running operational information, provides a monitoring tool so you can determine whether events over the budget period are following the predicted course.

It indicates revenue shortfalls, excess of over cost spending and sign efficient changes in the economic performance of the organization, a department, project or product. Thus budgets tell you where the organization’s money is going and where the resources for operations will mom from. They tell you, therefore what money is available for your team/ division/ section or what the organization’s expectations are with regard to income generation by your team/ section/ division. Budgets are one of the most commonly used management tools. Every business, large or small, public or private, profit oriented or not- for-profit should have a budget of some sort.

They enable the organization and the people working within it to pull together its commitments, projects and plans and all its costs and to contrast expenditure with expected revenues. A budget enables an organization’s financial manager (or team) to anticipate the business’s cash resources and make sure they are available ahead of time. Every budget process, therefore, develops a cash flow budget and in most organizations there will be a capital budget (usually extending for more than a year), which sets expected needs against the various sources of capital, providing the basis for capital resources allocations – money for capital expenditures (CAPE).

Rapports for expanding business, changing operations, purchasing new machinery and equipment are allocated from the capital budget. As a managerial and planning tool, when properly deployed, budgets ensure that key resources (including people) are assigned to priorities and results. In their capacity as a reporting and monitoring tool, they enable managers to know when to revise and review plans, either because results are different from those expected (better or worse) or because environmental, economic, market or technological conditions no longer correspond with the budget assumptions.

Forecasting and operations budgeting

Budgets are concerned with the uncertain future. They forecast or predict what will happen to the various parts of the operation, and used to ask questions such as:

1. What historical data or trends can we use to help us?
2. How much cash will we need to operate the business?
3. What profit will We make?
4. What will happen to costs?
5. What can we sell?

Developing cost consciousness

Controlling costs and continuously improving our cost performance requires that teams and individuals constantly review work procedures, practices and systems. This requires the cooperation of the whole team and their ongoing support to develop a cost conscious culture where searching for improvements is part of everyday activities. Many people in organizations know how to do things better and save costs and time, but they are often reluctant to suggest them.

There can be a number of reasons for this: fear of rejection, fear of loss of a job if the idea could reduce the number of employees, or simply because they think the company does not care or would not act on their suggestions. One of the other reasons for this reluctance might come from the fact that they have not been informed of the budgetary requirements applicable to the team or group with which they work, therefore the significance of their suggestions is lost. These are the barriers that team leaders, frontline managers and supervisors have to overcome so that their team/ work group members will talk freely with them and know that good suggestions will be recognized, acted on and rewarded.

Information regarding budgets should be disseminated to team members; they should be given opportunities to contribute to the development Of new budgets, the tools to use for monitoring the budget and the training that will enable them to understand how their work impacts on organizational cost/ profit ratios. If they do not have this information, they cannot be expected to erect their work activities at cost savings and effective income generation. Thus, not only do team members require the right information, they also require the skills to be able to use that information to add value in terms of their work and in terms of improvements to work.

Budgets as controls (setting direction)

Organizations apply financial controls in order to monitor progress. Cost or actively centered budgets and actual expenditure reports or financial statements are compared and analyses to budgets to identify variance, its causes and corrective actions. As a monitoring tool, budgets enable assessment of success in various areas – are we under, over or on budget? Figures show the organization’s performance relative to a specified time frame – last week, last month etc. They act as an early warning system for poor performance and danger, or for the need to revise a forecast. Performance against budget should also be viewed as a warning system for opportunities – for performance that is better than expected and should, therefore be analyses and where appropriate, reproduced. Budgets as reporting tools Budgets are financial reports. They report on what is expected to happen.

Comparing and monitoring what actually happens (or is happening) over a set period gives a picture of how well the organization is progressing in achieving its goals. In most organizations a business manager, accountant or accounting department will be responsible for the organization’s overall financial management. This is usually achieved through input from the various cost centre which are the units, divisions or sections in an organization which carry accountability for their own expenditure. Such responsibility might relate to day-to-day operations or to the management of specific projects. The employees in the various cost centre would be responsible for collating, collecting and recording the data that will support financial plans.

Examples of cost centre include the following departments

Production marketing administration manufacturing

Smaller organizations will probably not be broken into separate cost centre. You might be required to record and collect financial data, and, at times, prepare financial reports, oversee the budgeting functions in your section/ division or manage project budgets. At the least, you should be able to read and understand the information contained within financial budgets and reports. Financial information relating to operations, costs, credit analysis, inventory management, invoices and accounts, etc enables management to monitor and control cash flow, production and productivity, solve problems, plan for continuous improvement, implement quality control procedures and to plan future strategies.

Doing business in China

Following 20 years of negotiations, China officially joined the WTO on 11 December 2001. Chinas accession bears great significance for the countrys economy and the future of global trade. Many industries that were previously restricted only to domestic enterprises are now open to foreign investors. These industries range from banking, telecommunications, distribution, construction, engineering, and insurance to professional services including legal, accounting, and architectural services. Furthermore, restrictions on domestic sales by foreign manufacturing companies will also be lifted. Most of the prior requirements of foreign exchange balancing, local content and export performance will be eradicated in accordance with a WTO timetable. Perhaps the most significant change involves the form of corporate structure. Foreign non-life insurers will be allowed a 51% equity ownership without geographical restrictions two years after WTO accession, and any foreign-invested fund management company or telecommunications company may own up to 49% of the enterprise by 2004.

Three primary sectors operate within the Chinese economy: state-owned, collective and private. The state-owned and collective sectors are limited exclusively to domestic businesses. The private sector consists of individually owned Chinese businesses, as well as all foreign business entities. To promote economic development in certain areas, the Chinese government has granted special status to 5 Free Economic Zones, and to 14 open coastal cities, as well as to several coastal open economic zones, high-technology development zones and free trade zones (Country Commercial Guide).

As a socialist country, the government authorities closely monitor Chinas economy. The government determines the countrys investment plans according to a five-year plan, with investment and production targets set annually based on the previous years performance. The Ministry of Commerce (MOC) or its local delegates must approve foreign-investment projects, depending on their size. Once established, foreign entities must report regularly to the local government agency in charge. Although all matters, including salary and wage rates, and pricing of products, raw materials and utilities supplies are subject to government oversight, centralized control is gradually being relaxed (Ambler, Witzel).

Foreign trade

Foreign trade is subject to controls to protect the domestic market, limit the use of foreign exchange for imports and ensure that exports will not result in insufficiencies in the domestic market. Foreign trade is regulated primarily through import and export licensing and quotas. The MOC is the authority responsible for setting foreign trade policies and issuing import and export licenses. Foreign investment enterprises (FIEs) that import and export products subject to controls must first obtain a relevant license from the MOC. Commodities subject to license and quota controls are determined by the MOC annually, according to domestic and foreign market conditions, government policies and foreign trade laws.

The government issues notices of goods that are prohibited from being imported into China and goods that are subject to licensing and quota control. FIEs, when importing capital investments and raw materials for production, must obtain the necessary licenses unless such items are used for export-oriented production. FIEs must submit their import plans every six months to obtain an import license.?  Goods that are prohibited from being imported into China are also prohibited from being exported from China. In addition, information that carries state secrets and articles of cultural value are also prohibited from being exported. FIEs must apply for export licenses every six months on the basis of an annual export plan to obtain an export license valid for the current year.

In Chinas liberalized economic regime, there are many ways to finance imports. The most commonplace are the letter of credit and documents against payment. Under these methods, foreign exchange is allocated by the central government for an approved import. Other methods are:

• bank or enterprise loans “many Chinese companies have relationships with local banks or other enterprises that will loan funds for the purchase import
• foreign supplier loan“ the supplier helps to finance, on behalf of the Chinese buyer, the purchase of its equipment

Labor

Under the old so-called iron rice bowl system, an individual assigned to a work unit would normally remain with that unit for the rest of his or her working life. Today, some individuals are allowed to seek their own jobs to relieve an overburdened system of its responsibility and to help to find employment for all graduates. FIEs can integrate a joint venture partners work force, hire through a local labor bureau or job fair, advertise in newspapers, or rely on word of mouth. Representative offices, for the most part, must hire their local employees through a labor services agency. Skilled managers, especially those with marketing skills, are often in short supply although many companies have found an abundance of talented and highly-motivated recent university graduates. Experienced managers command salaries far greater than their counterparts in Chinese enterprises, making localization an expensive proposition for many companies. Finding and keeping engineers and technicians can also be difficult. Many Chinese workers move rapidly from job to job within the foreign-invested and growing private sectors. Workers are paid a salary, hourly wages, or piece-work wages. The provision of subsidized services, such as housing and medical care, is common, and compensation beyond the basic wage constitutes a large portion of a ventures labor expenses.

Currency

Chinas official currency is the renminbi (RMB), which is issued by the Peoples Bank of China (PBOC). The RMB is denominated in units of fen, jiao and yuan. Ten fen equal 1 jiao, and 10 jiao equal 1 yuan. In general, references to amounts of RMB indicate units of yuan, unless otherwise indicated. In 1994, the government unified the dual exchange rate and the RMB now trades in a managed float. The daily exchange rate is announced by the PBOC based on the interbank rate of the preceding day. Designated banks quote their exchange rates based on the exchange rate and floating range announced by the PBOC.?  (Ambler, Witzel). The PBOC and State Administration of Foreign Exchange Control (SAFE) regulate the flow of foreign exchange in and out of the country, and set exchange rates through a managed float system. To better control this flow, almost all Chinese enterprises and agencies are required to turn over their foreign currency earnings to the banks in exchange for renminbi. Foreign-invested enterprises (FIEs) are permitted to keep foreign exchange in foreign exchange accounts at commercial banks. The Chinese government has eliminated the foreign-exchange swap centers on which FIEs used to trade among themselves, and all FIEs have been integrated into the formal banking system.

Tax Rules

All FIEs and FEs are subject to the Income Tax Law of the PRC on Enterprises with Foreign Investment and Foreign Enterprises, which is levied by the central government. In addition, local authorities are entitled to levy a surcharge and collect certain registration and license fees. FIEs include Equity joint ventures (EJV), Cooperative joint ventures (CJV) and Wholly foreign-owned enterprises (WFOE). A FIE is subject to tax on its worldwide income. However, a foreign tax credit is allowed for income taxes paid to other countries by branches of the FIE, limited to the PRC income tax payable on the same income. If CJVs are not legal persons, the parties to the joint ventures may elect to be taxed separately on their share of the income received or, with the approval of the local tax bureau, taxed as a single entity. FEs include foreign companies, enterprises and other economic organizations such as representative offices, contracted projects and royalty arrangements. FEs are subject to tax only on their income from PRC sources. The taxation of FEs depends on whether the enterprise has an establishment in China.

In general, FIEs and FEs with establishments in China are taxed at an effective rate of 33% (national tax rate of 30% plus local tax rate of 3%). A reduced rate of 15% applies to FIEs and FEs with establishments in China located in Special Economic Zones (SEZs). FIEs engaged in production and manufacturing activities located within the Coastal Open Economic Regions and within the 14 Open Cities, Provincial Capitals and Changjiang Cities, are taxed at a reduced rate of 24%. FIEs engaged in production and manufacturing activities in Beijing and Chongqing are also taxed at a reduced rate of 24%. FIEs engaged in production and manufacturing activities are granted favorable tax treatment during their start-up period. These entities are granted a two-year tax exemption and a three-year 50% tax rate reduction beginning from the ventures first profit-making year. In addition to the initial five-year tax holiday, China also grants special tax concessions for certain priority industries, low-profit operations and projects in remote or economically depressed areas. Foreign investors reinvesting their share of profits in the same investment venture or in a newly created foreign investment venture for a period of five years or longer are entitled to a 40% refund of the tax paid on the amount reinvested. The tax refund increases to 100% if the reinvestment is in an export-oriented or technologically advanced enterprise.

Restrictions on Interest Deductions

Reasonable interest payments on loans are deductible after examination by the local tax bureau. However, no deduction is allowed for shareholders loans if the registered capital pledged by the parties is not fully paid-up. Chinese Government restricts the debt-to-equity ratio of foreign-funded firms and sets minimum equity requirements. For investments under $3 million, debt cannot exceed 30% of the total investment. The debt/capital ratio for investments in the $3-10 million, $10-30 million, and over $30 million ranges cannot exceed 50, 60, and 70 %, respectively. Debt for investments over $60 million is limited to two-thirds of the total value of the investment.

Long-term investments are stated at the actual cash amount paid or the cost of the tangible/intangible assets contributed, as agreed in the investment contracts. An enterprise must review the value of its long-term investments periodically and value the investments at the lower of cost and the recoverable amount. If the recoverable amount is less than cost, a provision for diminution must be made for the difference. Enterprises must set aside sufficient provisions for bad debts. Losses on bad debts are recognized when a debtor becomes bankrupt or dies and the bankrupt assets or legacy are insufficient for liquidation, or if a debtor has not settled its account for more than three years.

Depreciation and Amortization Allowances

Based on the nature and utilization method of fixed assets, an enterprise must determine a reasonable expected useful life and expected residual value for each asset, and select a reasonable depreciation method after considering technological development, environmental, and other factors. An enterprise’s applicable management body, such as a meeting of the shareholders, board of directors or managers must approve the depreciation policy and submit and file the policy with the relevant parties as stipulated by the law or administrative regulations. An approved policy may not be changed arbitrarily thereafter. Depreciation of tangible properties must be computed using the straight-line method. Unless approval is obtained from the tax authorities, the residual value of fixed assets may not be less than 10% of cost. The tax authorities must approve the use of accelerated depreciation. The following figures show minimum useful lives for certain assets in years: buildings “20 production equipment, trains and ships”.

In conclusion, doing business in China in reality is not that promising and easy. Nevertheless, many companies worldwide have tried to enter the market. They stated being aware of the difficulties and the time needed before achieving profits. China has opened their market more and more but they need to. China needs to open as to satisfy their local needs. Every year, about 12 – 15 million jobs are needed as to keep pace with the population growth (Debate). Besides, the financial market seems to get a little overheated and precaution is required. Companies nowadays face a certain failure in China. Their investments are not paying of and losses are not rare.?  Nevertheless, despite all complications, in long term perspective China seems to have a huge investment potential.

References

1. Doing Business in China. Tax and Law report. Ernst &amp Young Global Limited, 2003.
2. U.S. Department of State FY 2002 Country Commercial Guide: China U.S. Foreign Commercial Service and the U.S. Department of State, 2002 &lt
3. Ambler, Tim. Witzel, Morgen. Doing Business in China. 2nd edition. Routledge/Curzon, 2004.
4. Morrison, Wayne M. China’s Economic Conditions. Congressional Research Service Report IB98014.
5. Foreign Affairs, Defense, and Trade Division. National Council for Science and the Environment. September 21, 2000 ;lt http://www.ncseonline.org/NLE/CRSreports/international/inter-10.cfm?;amp
6. “”Debate: all this talking about China””. Jacqueline Oud – Marketing and Strategy Website. 24th February 2004 ;lt http://www.jacqueline-oud.com/2004/02/24/debate-all-this-talking-about-china-a36.html;gt

Case1: Credit Decision – Agarwal Case
On August 30, 2006, Agarwal Cast Company Inc., applied for a $200,000 loan from the main office of the National bank of New York. The application was forwarded to the bank’s commercial loan department. Gupta, the President and Principal Stockholder of Agarwal cast, applied for the loan in person. He told the loan officer that he had been in business since February 1976, but that he had considerable prior experience in flooring and carpets since he had worked as an individual contractor for the past 20 year. Most of this time, he had worked in Frankfert and Michigan. He finally decided to “work for himself” and he formed the company with Berry Hook, a former co-worker.

This information seemed to be consistent with the Dun and Bradstreet report obtained by the bank According to Gupta, the purpose of the loan was to assist him in carrying his receivables until they could be collected. He explained that the flooring business required him to spend considerable cash to purchase materials but his customers would not pay until the job was done. Since he was relatively new in the business, he did not feel that he could compete if he had to require a sizeable deposit or payment in advance. Instead, he could quote for higher profits, if he were willing to wait until completion of the job for payment. To show that his operation was sound, he included a list of customers and projects with his loan application. He also included a list of current receivables. Gupta told the loan officer that he had monitored his firm’s financial status closely and that he had financial reports prepared every six months. He said that the would send a copy to the bank. In addition, he was willing to file a personal financial statement with the bank. Question:

1. Prepare your recommendation on Agarwal Cast Company
Caselet 2
This case has been framed in order to test the skills in evaluating a credit request and reaching a correct decision. Perluence International is large manufacturer of petroleum and rubber-based products used in a variety of commercial applications in the fields of transportation, electronics, and heavy manufacturing. In the northwestern United States, many of the Perluence products are marketed by a wholly-owned subsidiary, Bajaj
Electronics Company. Operating from a headquarters and warehouse facility in San Antonio, Strand Electronics has 950 employees and handles a volume of $85 million in sales annually. About $6 million of the sales represents items manufactured by Perluence. Gupta is the credit manager at Bajaj electronics. He supervises five employees who handle credit application and collections on 4,600 accounts. The accounts range in size from $120 to $85,000. The firm sells on varied terms, with 2/10, net 30 mostly. Sales fluctuate seasonally and the Examination Paper of Financial Management

IIBM Institute of Business Management 4
average collection period tends to run 40 days. Bad-debt losses are less than 0.6 per cent of sales. Gupta is evaluating a credit application from Booth Plastics, Inc., a wholesale supply dealer serving the oil industry. The company was founded in 1977 by Neck A. Booth and has grown steadily since that time. Bajaj Electronics is not selling any products to Booth Plastics and had no previous contact with Neck Booth. Bajaj Electronics purchased goods from Perluence International under the same terms and conditions as Perluence used when it sold to independent customers. Although Bajaj Electronics generally followed Perluence in setting its prices, the subsidiary operated independently and could adjust price levels to meet its own marketing strategies. The Perluence’s cost-accounting department estimated a 24 per cent markup as the average for items sold to Pucca Electronics. Bajaj Electronics, in turn, resold the items to yield a 17 per cent markup. It appeared that these percentages would hold on any sales to Booth Plastics. Bajaj Electronics incurred out-of pocket expenses that were not considered in calculating the 17 per cent markup on its items. For example, the contact with Booth Plastics had been made by James, the salesman who handled the Glaveston area. James would receive a 3 per cent commission on all sales made Booth Plastics, a commission that would be paid whether or not the receivable was collected. James would, of course, be willing to assist in collecting any accounts that he had sold. In addition to the sales commission, the company would incur variable costs as a result of handling the merchandise for the new account. As a general guideline, warehousing and other administrative variable costs would run 3 per cent sales. Gupta Holmstead approached all credit decisions in basically the same
manner. First of all, he considered the potential profit from the account. James had estimated first-year sales to Booth Plastics of $65,000. Assuming that Neck Booth took the, 3 per cent discount. Bajaj Electronics would realize a 17 per cent markup on these sales since the average markup was calculated on the basis of the customer taking the discount. If Neck Booth did not take the discount, the markup would be slightly higher, as would the cost of financing the receivable for the additional period of time. In addition to the potential profit from the account, Gupta was concerned about his company’s exposure. He knew that weak customers could become bad debts at any time and therefore, required a vigorous collection effort whenever their accounts were overdue. His department probably spent three times as much money and effort managing a marginal account as compared to a strong account. He also figured that overdue and uncollected funds had to be financed by Bajaj Electronics at a rate of 18 per cent. All in all, slow – paying or marginal accounts were very costly to Bajaj Electronics. With these considerations in mind, Gupta began to review the credit application for Booth Plastics. Questions:

1. How would you judge the potential profit of Bajaj Electronics on the first year of sales to Booth Plastics and give your views to increase the profit?
2. Suggestion regarding Credit limit. Should it be approved or not, what should be the amount of credit limit that electronics give to Booth Plastics.
END OF SECTION B
Examination Paper of Financial Management
IIBM Institute of Business Management
Section C: Applied Theory (30 marks)
? This section consists of Applied Theory Questions.
? Answer all the questions.
? Each question carries 15 marks.
? Detailed information should form the part of your answer (Word limit 200-250 words). 1. Define Capital Structure. Discuss the important factors that should be considered while determining Capital Structure.

2. What is the concept of working capital? Discuss the dangers of inadequate as well as excessive working capital.

Bonds issues are one way that firms are able to raise money to finance their different projects, specifically long term projects. A bonds issue provides creditors with bonds certificate that allow them to earn fixed interest till the date of maturity along with the principle amount. Most companies prefer issuing bonds over taking loans from banks because they feel that loans are more restrictive and expensive. The difference between issuing bonds and issuing stock is that stock holders have ownership while bonds issue liability for the company.

The bonds that company issues sometimes have a call or a refund provision for the benefit of the issuer. These are some characteristics or features that are available when bonds are issued. ( Frederick Lownhaupt, 2008) The issuer of the bonds that is, the person who lends to the organization often looks for the option of call or refund provision. This means that an issuer has the right to call or redeem sum amount or the entire debt or loan at a date before maturity. As an issuer I would want to have that option for several reasons but the most important reason is that the issuer needs to secure his or her interest.

If the right is unavailable, the issuer may be getting lower rate of interest over the principle in the future when interest rates may have gone up, this results in lower returns than the issuer could actually get if he or she reinvested that amount with the current interest rate. Basically the companies impose a provision that denies the issuer the right to redeem the bonds ten or so years of the date of issue. There is however a difference between call protection and refund protection.

call protection is absolute which means that the issuer cannot redeem the bonds at all till the time of maturity, in refund protection only give you protection from one kind of redemption. This is why many organization suffer losses, it’s because thy do not understand the difference between a call protection and a refund protection. In refunding, the issuer is effused the right to redeem the bonds for the first ten years of the date they were issued with the money that is earned through issuing debt obligations that have a lower cost that are ranked either equal to or superior than the debt that the issuer wants to redeem.

(Frank Fabozzi, 2001) if I am an issuer, I would want call or refund protection because, as a company I have made an agreement to pay a fixed interest rate till the day the loan is going to mature, if the issuer is allowed to redeem the loan whenever the wish, it will be costly for me to issue new bonds as the interest rate will be higher than before and other costs that involve in issuing bonds such as fee to brokers and dealers and other relative costs. if I have issued the bonds I would like the protection or call and refund provision because that would save me a lot of cost for at least ten years or more till the time the bonds mature.

it would also give me a certainty that there will be no cash flow problems for the project or the plan that the bonds were issued for. Even if I give the issuer the right to redeem, the bonds will be called on a premium for the protection and benefit of the one who has issued the bonds. Conclusion Therefore it is important for the issuer of bonds to have this privilege or right so that it secures the investment and time spent in issuing the bonds and also reduces or protects them from the cost of reissuing new bonds. References

• Bond Portfolio Management, Frank Fabozzi, wiley, 2001, http://books. google. com. pk/books? id=5qj02oqoTFsC&pg=PA51&lpg=PA51&dq=call+or+refund+provision+on+bonds+issued&source=web&ots=IpDQh2_U0I&sig=R7aY43fGzKwxZW0ajH7OI8bNIq0&hl=en&sa=X&oi=book_result&resnum=1&ct=result#PPT1,M1 • How Bonds Work, Fidelity Investments, 1998-2008, http://personal. fidelity. com/products/fixedincome/howbondswork. shtml • Frederick Lownhaupt, Investment Bonds, Their Issue and Their Place in Finance; A Book for Students, Investors, and Practical Financiers, 2008,READ BOOKS, http://books.

google. com. pk/books? hl=en&id=xuH1uNIW-SUC&dq=bonds+issue&printsec=frontcover&source=web&ots=3AD64SSQe9&sig=UFCtB1VislF124JGVrvKepeIQfQ&sa=X&oi=book_result&resnum=3&ct=result • Call Provision, The Free Dictionary, 2004, http://financial-dictionary. thefreedictionary. com/call+provision • Esme E. Faerber, All About Investing, 2006, Mgraw Hill, http://books. google. com. pk/books? id=0FKvNuyl-RoC&pg=PA164&lpg=PA164&dq=call+or+refund+provision+on+bonds+issued&source=web&ots=8eHhATot06&sig=J1RhmnLEJB7CHqmEkxDjJvgG9Rs&hl=en&sa=X&oi=book_result&resnum=8&ct=result

The commonly stated goal of a firm is to maximize its value and thereby multiple shareholders’ wealth. Since managers have discovered that they could gain a competitive edge by going globally, more and more companies today are performing internationally in order to achieve the above mentioned goal. Developing business in foreign markets can be distinctly different from local markets and that creates a number of serious difficulties and barriers for companies to go internationally. However, today, there is a tendency towards reducing or removing barriers; thereby, firms are encouraged to pursue international business, which creates opportunities for improving their cash flows. As a result, many firms have evolved into multinational corporations (MNCs), which are defined as firms that engage in international business.

At present, while thinking of business, even more of international business, the first image that comes up is a suspected by the society, limited by the government, a monster-size company called MNC, which strives to tap any possible coin from its resources. These high stake players along with smaller firms are now enjoying the consequences of globalization. As globalization intensifies, economies and, therefore, business become heavily interdependent, making international business operations an alluring source of profit.

However, what we see today is another part of a golden coin. We are witnessing the severest ever world-wide global economic crisis and the question is who is in charge for this: either inefficient financial markets or poor management of MNCs or their mutual interdependence? Though it is quite sophisticated to give a precise answer to the question because the crisis is still there, the purpose of this essay is to demonstrate that international business and financial markets are mutually dependent and both are responsible for the current crisis.

The above mentioned statement predetermined the structure of the work. First, the definition and forms of international business are discussed; this is followed by the description of financial markets. The theoretical base is then supported by real world examples leading to conclusion summarizing the while discussion. International Business International Business is the economic system of exchanging goods and services between specific entities, such as multinational companies (MNCs) which engage in business between multiple countries. (Businessdictionary.com)

Like consumption, production and sales of goods have also been globalized. Today MNCs are producing goods in countries other than parent, across the globe. The main reason behind this is lower costs of sales and higher revenues or profits which can be achieved in a foreign market than in a parent market. No product in today’s market can be classified with a single country of origin. For example the parts of IBM computers are produced in different countries such as China, Taiwan, Korea, US and etc. (Eun & Resnick, 2007). Today we can distinguish several forms of IB: export and import operations, foreign investment, licensing, franchising, management contract and etc.(Griffin &Pustay,2006) As we focus in this work on relation between IB and financial markets we should concentrate further on the first mentioned forms of International Business, namely export and import operations and foreign investments.

According to the definition from Investopedia, export is “a function of international trade whereby goods produced in one country are shipped to another country for future sale or trade” (Investopedia, 2008). In contrary, import is a purchase of goods, produced in one country, with further use or resale of them on the territory of other country. The export and import trade plays an important role in the life of many countries.

Trade relations between different countries are based in particular of these operations. As far we are speaking about International Business, it’s obvious that in such kind of trade many things are depended from the financial markets of the countries, which are parties of this process. Other form of International business is foreign investments. Other words it means delivering capital from the resident of one country to the residents of other country for further use by them of this capital.