Graduates Brain-box

Difference between Basic and Applied Research

Basic research	Applied Research
Purpose	purpose
- Expand knowledge of business process and management	- Improve understand of particular business or management problem
- Results in universal principles relating to the process and its relationship to outcomes.	- Results in solution to problem
- Finding of significance and value to society in general	- Finding of practical relevance and value to manager(s) in organisation(s)

Context	Context
- Undertaken by people based in universities	- Undertaken by people based in a variety of setting including organisations and universities
- Choice of topic and objectives determined by the researcher	- Objectives negotiated with originator
- Flexible timescales	- Tight timescales

Financial Management- Capital structure

What is gearing?

• The mixture of debt finance relative to equity finance that a company uses to finance its business operations

• Gearing ratios assess financial risk:

• Debt/equity ratio: D/E

• Capital gearing: D/(D+E)

• Market values preferred to book values

• Should D include short-term debt?

Implications of High gearing

• Increased volatility of equity returns arises with high gearing since interest must be paid before paying returns to shareholders.

• Increased risk of bankruptcy also occurs.

• Stock exchange credibility falls as investors learn of company’s financial position.

Short-termism moves managers’ focus away from maximisation of shareholder wealth

Optimal capital structure

Key question:

• Does the mix of debt and equity finance used by a company affect its weighted average cost of capital?

• Is there a mix of debt and equity that will minimise the average cost of capital?

• Minimum cost of capital will maximise market value of company and hence maximise shareholder wealth.

Simplifying Assumptions

• No taxes exist.

• Financing choice is between ordinary shares and perpetual debt.

• Capital structure changes incur no cost and entail replacing debt with equity or vice versa.

• All earnings are paid out as dividends.

• Business risk is constant over time.

Earnings and hence dividends are constant

Traditional approach

• Cost of equity increases as gearing increases due to rising financial risk and, later, bankruptcy risk.

• Cost of debts rises at high levels of gearing due to bankruptcy risk.

• As company starts to replace expensive equity with cheaper debt, WACC falls.

• As gearing continues to increase, cost of equity and cost of debt increase, offsetting the benefit of cheap debt.

Miller and Modigliani 1 (1^st Proposition)

• Capital markets are assumed to be perfect.

• No risk of bankruptcy so cost of debt curve is flat.

• Linear increase in cost of equity due to increasing financial risk.

• As company gears up and replaces equity with debt, benefit of cheaper debt is exactly balanced by the increasing cost of equity.

No optimal capital structure is found

Example

Assume you own 1% of B’s shares:

(1) Sell your shares for £77.27

(2) Borrow £30 to copy B’s gearing

(3) Buy 1% of A’s shares (surplus of £7.27)

• Return on B’s shares: 11% × £77.27 = £8.50

• Return on A’s shares: 10% × £100 = £10

• Less interest: £30 × 5% = £1.50 leaves £8.50

• Same return but you now have £7.27 surplus

Arbitrage proof using companies A and B:

A B

Net income 1000 1000

Interest at 5% Nil 150

Earnings 1000 850

Divide by cost of equity 10% 11%

MV of equity 10 000 7 727

MV of debt Nil 3 000

Total market value 10 000 10 727

NB:

• Selling will cause B’s share price to fall and buying will cause A’s share price to rise.

• Return on B’s shares will rise and return on A’s shares will fall.

• WACC of A (10%) will fall and WACC of B (9.3%) will rise, and WACCs will converge until any arbitrage opportunity is eliminated.

• The claim that identical business risk will have an identical WACC is shown to be true.

Miller and Modigliani II (2^nd Proposition)

• M&M adjusted their first model to reflect the tax deductibility of interest payments.

• Tax efficiency implies that gearing up by replacing equity with debt gives benefit of a tax shield, increasing the value of company.

• Cost of debt curve falls from before-tax to after-tax level, so WACC curve slopes downwards.

This implies an optimal capital structure does exist: i.e. gear up with as much debt as possible

Market Imperfection

• M&M relaxed assumption of perfect capital market by considering corporate taxation.

• If we relax perfect market assumption further by considering bankruptcy risk, an optimal capital structure emerges.

• Companies have to balance the tax efficiency of debt with the risk of bankruptcy.

Conclusions:

• Traditional approach: Optimal Capital Structure (OCS) exists

• Miller and Modigliani I: no OCS is found

• Miller and Modigliani II: OCS is 100% debt

• Market imperfections: OCS exists

In practice, rather than one optimal capital structure existing for each firm, a range of optimal capital structures may exist.

QUESTIONS FOR CRITICAL REVIEW OF PUBLISHED PAPERS

Hello guyz,

i would like to share with you these questions which are useful when providing a critical review of a published paper.

when you are doing a critical review of a published paper you should make sure you answer all questions based on the paper you are criticising.

Why is this article interesting/important?

Are the outcomes important?

What has motivated the authors to write this article when the did?

What is the research problem/question?

What theory or theoretical framework underpins the research?

What are the key motivating literatures on which the study depends?

Which research method has been chosen?

How has the sample been selected?

How have questions of validity been addressed?

How has the data/evidence been analysed?

Are the conclusions and recommendations consistent with the findings?

Management accounting- Pricing

A pottery has to quote for a special order of clay pipe fittings to be made in its two departments, Blunging and Extruding. Details are as follows:

Blunging Extruding

Standard direct wage rate per hour £5 £3

Standard variable overhead per hour £2.50 £2

Standard fixed overhead per hour £6 £4

Direct labour hours per unit for the first

1000 clay fittings 12 6

Direct labour hours available per period 40,000 30,000

Expected rate of learning curve, applied

per block of 1000 units 80% 70%

Cost of clays used in Blunging are as follows:

Level of output Cost per clay fitting

(fittings) £

1000 36.00

2000 32.40

8000 27.00

No overtime premium has been included in the calculation of overhead, but overtime is paid at time and a half.

The special order involves special tooling to be used in Extruding at a total cost of £6,000, chargeable to the customer.

In arriving at selling prices, the company adds profit mark-ups of 20%.

If the order is for 2000 clay fittings or fewer, it will need to be done during period 5 which already has a workload of:

Blunging 25,600 direct labour hours

Extruding 14,000 direct labour hours.

Required:

a) Recommend the price to be charged for clay fittings made entirely within the company for an order of:

(i) 1000 clay pipe fittings

(ii) 2000 clay pipe fittings.

b) Assume that an order for 2000 clay pipe fittings has been placed as in a) (ii) above, recommend the lowest price the company could charge for an additional order of 600 clay pipe fittings in the following conditions:

(i) The company wished to treat this as an incremental order but did not wish to make a loss on it;

(ii) the additional work would be done when there were no capacity constraints for either department; and

(iii) the materials suppliers would charge the price at the 8000 level.

Solution

Blunging Extruding

Direct labour hours for order of 1,000 units 12,000 6,000

Current workload 25,600 14,000

Total hours with order of 1,000 units 37,600 20,000

===== =====

Direct labour hours for order of 2,000 units

2,000 x 12 x 0.8 19,200 (2,000 x 6 x 0.7) 8,400

Current workload 25,600 14,000

Total hours with order of 200 units 44,800 22,400

===== =====

Overtime hours required 4,800

Overtime premium (x £2.50) £12,000

= £6 per unit

a) Assuming that the order is to be costed as part of the normal business of the company and will therefore be required to absorb the full amount of fixed overhead.

(i) Order of (ii) Order of

1,000 units 2,000 units

Blunging £/unit £/unit £/unit £/unit

Direct wages 12 x £5 60.00 x 0.80 48.00

Variable overhead 12 x £2.50 30.00 x 0.80 24.00

Fixed overhead 12 x £6 72.00 x 0.80 57.60

Overtime premium 0 6.00

162.00 135.60

Extruding

Direct wages 6 x £3 18.00 x 0.70 12.60

Variable overhead 6 x £2 12.00 x 0.70 8.40

Fixed overhead 6 x £4 24.00 x 0.70 16.80

54.00 37.80

Direct materials (clays) 36.00 32.40

Special tooling £6,000 ÷ 1,000 6.00 £6,000 ÷ 2,000 3.00

258.00 208.80

Profit Margin (20%)

51.60 41.76

Recommended price per unit 309.60 250.56

b) If the company wishes to treat the order as incremental only those costs which are incurred as a direct result of the order would be included in the estimate. assuming that fixed overheads will not increase, they are excluded from the calculations.

Since the company wishes to charge the lowest price possible without making a loss, no profit margin will be added.

A further order of 600 units in addition to an initial order for 200 would bring cumulative volume to 800 units. this means that the original volume of 200 fittings would be doubled twice.

2,000 fittings 8,000 fittings

£/unit £/unit

(from a(ii))

Direct wages and variable

overhead

Blunging 72.00 x 0.8 x 0.8 46.08

Extruding 21.00 x 0.7 x 0.7 10.29

Direct materials 32.40 27.00

125.40 83.37

===== ====

Incremental cost of 8,000 units 8,000 x £83.37 666,960

Less incremental cost of 200 units 200 x £125.40 250,800

Incremental cost of 6,000 units 416,160

======

= £69.36 per unit

The lowest unit price that the company could charge for an additional order of 600 units is £69.36.

BP set to pay first dividend since Gulf oil disaster

Bob Dudley, BP 's chief executive, is set to announce a resumption of dividend payments on Tuesday as a signal to investors that the UK oil group is recovering after last year's Gulf of Mexico spill .

BP was one of the biggest dividend payers in the UK before the accident, distributing about £7bn to investors in 2009. It suspended the pay -out for the first three-quarters of last year as part of a series of steps to stabilise its financial position in the wake of the mounting costs from the oil spill on April 20 2010 . Any pay -out, however, will be at about half the previous level with analysts expecting the fourth quarter dividend to be 7 cents a share.

The reinstatement will be a key element of Mr Dudley's inaugural presentation to the investment community alongside BP 's full-year results and an update on strategy. The company's profits will have been buoyed by strong oil and natural gas prices, with analysts forecasting clean replacement cost profit, which strips out changes in the value of oil inventories and exceptional charges, of $4.9bn for the fourth quarter, up 11 per cent on the same period in 2009.

Mr Dudley is expected to give an update on the cost of the accident to BP . It has so far made provisions of $39.9bn but still faces a number of claims and potential lawsuits. It has raised about $21bn (£13.2bn) from disposals, close to its $30bn target set after the spill to help pay for claims.

The market will be keen to hear how Mr Dudley sees BP 's future in the US, which before the accident had been its principal strategic focus. Analysts said they did not expect a radical departure from BP 's current strategy but more emphasis on how it will be a smaller, faster-growing company with an increased focus on exploration and production. Jon Rigby, analyst at UBS, said he believed "the core business contains one of the most attractive asset portfolios in the integrated industry".

Investors are also keen to hear more about BP 's alliance with Russian state oil company Rosneft. BP 's billionaire partners in its other Russian venture, TNK- BP , have claimed the UK group has breached the conditions of their shareholder agreement.

One person close to the situation said the partners, represented by AAR, believed BP may have failed to disclose to the Russian government and to Rosneft the terms of its shareholder agreement with AAR for TNK- BP . "There is a question about how forthcoming BP has been with [Igor] Sechin [the Russian deputy prime minister] about their obligations over TNK- BP ," the person said.

Speaking at the World Economic Forum in Davos on Thursday, Mr Sechin, who also chairs Rosneft, said BP had assured Rosneft there were no problems with its contract with AAR.

Additional reporting by Catherine Belton in Moscow

Source: Financial Times(UK)