Gulf Finance Assignment Help With Solution
1. What are the limitations of financial ratios?
2. What do liquidity ratios measure? Activity ratios? Leverage ratios? Profitability ratios? Market ratios?
3. Determine the effect on the current ratio, the quick ratio, net working capital (current) assets less current liabilities), and the debt ratio (total liabilities to total assets) of each of the following transactions. Consider each transaction separately and assume that prior to each transaction the current ratio is 2X, the quick ratio is 1X, and the debt ratio is 50%. The company uses an allowance for doubtful accounts. Use 1 for increase, D for decrease, and N for change.
Current QuickNet Working Debt
Ratio Ratio Capital Ratio
(a) Borrows $10,000 from bank on
(b) Writes off a $5,000 customer account
(c) Issues $25,000 in new common stock
(d) Purchases for cash $7,000 of new equipment
(e) Inventory of $5,000 is destroyed by fire
(f) Invests $3,000 in short-term marketable
(g) Issues $10,000 long-term bonds
(h) Sells equipment with book value of $,6000
(i) Issues $10,000 stock in exchange for land
(j) Purchases $3,000 inventory for cash
(k) Purchases $ 5,000 inventory on credit
(l) Pays $2,000 to supplier to reduce account payable
Carson Company is a large manufacturing firm in California that was created 20 years ago by the Carson family. It was initially financed with an equity investment by the Carson Family and 10 other individuals. Over time, Carson Company obtained substantial loans from finance companies and commercial banks. The interest rates on the loans is tied to market interest rate and is adjusted every six months. Thus Carson’s cost of obtaining funds is sensitive to interest rate movements. It has a credit line with a bank in case it suddenly needs additional funds for a temporary period. It has purchased Treasury securities that it could sell if it experiences any liquidity problems.
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Carson Company has assets valued at about $50 million and generates sales of about $100 million per year. Some of its growth is attributed to its acquisitions of other firms. Because of its expectation of a strong U.S economy, Carson plans to grow in the future by expanding its business and by making more acquisitions. It expects that it will need substantial long term financing and plans to borrow additional funds through loans or by issuing bonds. It is also considering issuing stock to raise funds in the next year. Carson closely monitors conditions in financial markets that could affect its cash inflows and cash outflows and thereby affect its value.
Carson Company may need to increase its production capacity by about 5o percent over the next few years to satisfy demand. It would need financing to expand and accommodate the increase in production. Recall that the yield curve is currently upward sloping. Also recall that Carson is concerned about a possible slowing of the economy because of potential Fed actions to reduce inflation. Carson currently relies on commercial loans with floating interest rates for its debt financing.
4. Flow of Funds (Stock Offering and Investor Monitoring)
a. If Carson issued a stock now, it would have the flexibility to obtain more debt and would also be able to reduce its cost of financing with debt. Why?
b. Why would an IPO result in heightened concerns in financial markets about Carson Company’s potential agency problems?
c. Explain why institutional investors, such as mutual funds and pension funds, that invest in stock for long term periods (at least a year or two) might prefer to invest in IPO’s rather than to purchase other stocks that have been publicly traded for several years.
d. Given that institutional investors such as insurance companies, pension funds and mutual funds are the major investors in IPOs, explain the flow of funds that results from an IPO. That is, what is the original source of the money that is channeled through the institutional investors and provided to the firm going public?
5. Flow of Funds (Stock Valuation and Risk)
a. At the present time, the price-earnings ratio (stock price per share divided by earnings per share) of other firms in Carson’s industry is relatively low but should rise in the future. Why might this information affect the time at which Carson issues its stock?
b. Assume that Carson Company believes that issuing stock is an efficient means of circumventing the potential for high interest rates. Even if long-term interest rates have increase by the time it issues the stock, Carson thinks that it would be insulated by issuing stock instead of bonds. I s this view correct?
c. Carson Company recognizes the importance of high stock price at the time it engages in an IPO (if it goes public). But why would its stock price be important to Carson Company even after the IPO?
d. If Carson Company goes public, it may be able to motivate its managers by granting them stock as part of their compensation. Explain why the stock may motivate them to perform well. Then explain why the use of stock as compensation may motivate them to focus on the short-term goals even though they are supposed to focus on maximizing the shareholder wealth over the long run. How can a firm provide stock as motivation but prevent its managers from using a short-term focus.
6. Flow of Funds (Market Microstructure and Strategies)
a. In some cases, a stock’s price is high or too low because of asymmetric information (information known by the firm but not by investors). How can Carson attempt to minimize asymmetric information?
b. Carson Company is concerned that if it issues stock, its stock price over time could be adversely affected by certain institutional investors that take large short positions in a stock. When this happens, the stock price may be undervalued because of the pressure on the price caused by the large short positions. What can Carson do to counter major short positions taken by taken by institutional investors if it really believes that its stock price should be higher? What is the potential risk involved in this strategy?
7. Flow of Funds (Financial Futures Market)
a. How could Carson use futures contracts to reduce the exposure of its cost of debt to interest rate movements? Be specific about whether it would use a short hedge or a long hedge.
b. Will the hedge that you described in the previous question perfectly offset the increase in the debt cost if interest rates increase? Explain what drives the profit from the short hedge, versus what drives the higher cost of debt to Carson, if interest rates increase.
8. Flow of Funds (Option Markets)
Carson Company would like to acquire Vinnet, Inc., a publicly traded firm in the same industry. Vinnets’s stock price is currently lower than the prices of other firms in the industry because it is inefficiently managed. Carson believes that it could restructure Vinnet’s operations and improve its performance. It is about to contact Vinnet to determine whether Vinnet will agree to an acquisition. Carson is somewhat concerned that investors may learn of its plans and buy Vinnet’s stock in anticipation that Carson will need to pay a higher premium (perhaps 30 percent premium above the prevailing stock price) in order to complete the acquisition. Carson decides to call a bank about its risk, as the bank has a brokerage subsidiary that can help it hedge with stock options.
a. How can Carson use stock options to reduce its exposure to this risk? Are there any limitations to this strategy, given that Carson will ultimately have to buy most or all of Vinnet stock?
b. Describe the maximum possible loss that may be directly incurred by Carson as a result of engaging in this strategy.
c. Explain the results of the strategy you offered in the previous question if Vinnet plans to avoid the acquisition attempt by Carson.
9. Write a 5 to 8 paper (APA) on the following;
There is a recent event that to date has proven to be catastrophic and that is the BP oil leak in the Gulf of Mexico. Specifically how have our financial and government institutions managed this crisis?
To help you begin thinking about the overall effects, some initial thoughts:
• Imagine if you were a seafood supplier of Gulf coast products to the Delmarva Peninsula, in what ways might your business be affected?
• From a BP shareholder viewpoint, what now happens to the value of the company and the shareholder value? If bankruptcy occurs, then what?
• What if you worked for a financial institution that financed fishing boats, marinas, and equipment for the fisherman who could no longer work and thus repay their loans?
• Will the financial sector (insurance & finance) be more careful in assessing risk of deep water off shore drilling?
• Does the government provide repayment? Should they?
These thoughts represent only a few of many questions asked to date for which answers may not yet exist. Do a little research and really think about how this may affect each of us, thousands of miles away. Other items of discussion include unemployment in the region, tourism, and perhaps the creation of regional recessions as many folks will now not travel to the Gulf States.
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