ACC 515 - 3 - Assignments. PDF

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ACCOUNTING & FINANCE ACC 515 ASSIGNMENT 3

Sameera Jayaweera 11621166

Part A Capital budgeting is the process of generating or initiating investment proposals, evaluating, ranking and selecting the best alternatives, monitoring and making follow up on investments mode. Capital budgeting process through in five stages which involves, initiating, analysing, ranking, implementing and monitoring & making follow-up. [ CITATION Lin06 \l 3081 ] Before to the particular decision is being taken, consideration of effects (benefits and drawbacks) will arises to the rest of the society if the organization decided to proceed with capital budgeting decision, is simply explained as ethical consideration in capital budgeting process.

Ethics plays a vital role in the capital budgeting process. Any actions that violate ethical standards can have a negative impact on the image of the firm and as well as future cash flows of the company. Ethics of capital budgeting is an important to certain reasons. They are,  Ethical consideration determines the future survival and growth of the company. Capital investments are crucial to the success of the business. And un-consideration in ethics in capital budgeting process sometimes lead the business driven out from the market.  Corporate Social Responsibility (CSR) – Ethics consideration in capital budgeting decision making process also contributes towards to the CSR policy of the firm.

 Improve Organization Reputation – When ethics are considered in the capital budgeting decision making process it automatically improves the firm’s reputation within public.

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 Key to Solving National & Social Problem – Ethical consideration in capital budgeting decisions would be a key to solve national un-employment, speed up local development etc. For an instance, ethical consideration in capital budgeting process can be shown as follows. Suppose An energy company is considering build an electric generating power plant in Melbourne and electric power generating from the plant is going to sold in the Cranbourne area where the electric power is needed badly. The energy company have a legal permit to build this plant. However, if the plant build up there is some water pollution. Company also have an alternative option spend additional $10 million at the start of the project to mitigate the environmental damages. With or without of this additional cost the project would generate positive NPV figure at the end of its life time. And, the through this project the energy company has a chance to generate over 500 new employment opportunity in Cranbourne area. The energy company give prioritise ethical effects such as environmental damages and generate of employment opportunities rather than to the NPV figure in the capital budgeting process we can say that company operate within high ethical standard.

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I.

Categorise Medigard’s Capital Structure into debt and Equity

II.

After-tax Weighted Average Cost of Capital Normal View

Formula View

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Notes  Market rate of return and Beta are calculated for the MGZ ltd financial period which is 7/1/2015 to 30/06/2016.

 Cost of notes and borrowings are calculated based on the MGZ Ltd. financial report as per the reference of page 44 (note 17) and page 49 (note 25).

 Rm value is negative under falling of all ordinary market index. Therefore, both required rate of return(RR) and cost of equity become negative under the CAPM model. This is happened due to the deficiency of CAPM model and I recommend alternate model like Arbitrary Pricing Theory (APT) to use for calculation of cost of equity. III.

Alternative capital structure would that I recommend lowering the cost of capital for the company There are some certain recommendations which I would able to give which would result lower cost of capital for the Medigard Limited (MGZ).  The company need to focus more debt in the capital structure. Currently, Medigard Limited (MGZ), consist of 8.42% and 3.87% for convertible notes at fair value through profit or loss and borrowings respectively. It’s almost 12.29% of debt from the whole capital structure of the company. But, the company has 87.71% of equity in their ST JAYAWEERA

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capital structure. By comparing debt and equity we can come up with Medigard Limited (MGZ) debt equity ratio of 14.01% ([475,553+218,586]/4,953,560). Convertible notes at fair value through profit or loss and borrowings have a cost of 8% cost of before tax and 5.6% cost of after tax. Borrowings also represent the 7.5% cost of before tax as well as 5.25% cost of after tax cost respectively. By focusing more in borrowings in capital structure company will able to benefit 2 things. Get Some tax benefit – When the company increase the borrowings in the capital structure financial cost (interest) will rise. Because of borrow more debt profit before interest and tax (PBIT) tend to be lower than to the previous. But, as a consequence of lower PBIT company will beneficial in paying lower tax amount than to the previous capital structure. This is a situation where that company transform its tax portion to the interest. Buy Back Shares – Borrowing money is also used to buy back shares of the company. Because of it the company can reduce the number of equity shares holds by outsiders. Since, the number of equity shares is going to reduce in here there will be a positive impact to rise in the earning per share (EPS).  Company need to focus on replace their old debt with new debt. If a company able replace old debt with a new debt at a lower cost then, the cost of capital is going to be lower. The new cost of debt, should be lower than to the existing convertible notes at fair value through profit or loss and borrowings rates of 8% and 7.5% respectively.  Company should focus on converting existing convertible notes to ordinary shares. Company is currently holding existing convertible notes of$475,553. The notes are unsecured and are redeemable 24 months after issue. These notes can be convertible in to shares. If Company able to convert this notes into the ordinary shares then company is going to beneficiary in reduction in financial cost. (i.e. interest payment for notes) Because of reduction of financial cost relating to convertible notes there will be positive impact on the company’s overall profitability.

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Part C (a) Payback period Normal View

Formula View

(b) Discounted payback period Normal View

Formula View

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(c) Net present value Normal View

Formula View

(d) Profitability index Normal View

Formula View

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(e) Internal rate of return (IRR)

Normal View

Formula View

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(f) Should this project be accepted? Since,  the project generates positive NPV of $21,443.95 of its 5 years’ life time,  the profitability index ratio is greater than to the 1 (1.40>1)  Discount payback period below to the target period of project (3.61...