Assignment 2: Business Financing and the Capital Structure



Assignment 2: Business Financing and the Capital Structure

1. Explain the process of financial planning used to estimate asset investment requirements for a corporation. Explain the concept of working capital management. Identify and briefly describe several financial instruments that are used as marketable securities to park excess cash.

Processes used to estimate asset investment requirements

The Payback Method: The payback method is the easiest forms of methods which are used by the managers and investors in order to determine the paying back period of the investment. This method does not inculcate the time value of money concept. This is mainly used by the managers who are risk averse and are concentrating on paying back of the investment rather the investment horizon and useful life of the investment.

Rate of Return: Rate of return calculates the amount of money invested by the investor against the return generated on the investment. This method is very simple in its nature however it does not include the concept of time value of money. It also doesn't include the actual span of time for which the investment has been carried out.

The Accounting Rate of Return: This method uses to calculate the returns on investment by dividing the investment against the profits earned by the company. However the method is inaccurate because those profits are not actual returns as they include several non-cash charges.

NPV (Net Present Value): Net present value uses the discounted cash flows technique in order to determine the value the investment over the period of time. By discounting the cash flows the time value of money concept is incorporated into the investment appraisal. The Net Present Value helps in determining the actual cash return which a business has generated after adjusting for inflation or opportunity cost of capital. Net present value is considered to be the most accurate and precise method for calculation the returns on investment. Firstly in includes the cash flows not the profits, secondly it includes the time value of money factor due to which the amount is adjusted against the inflationary pressures or other alternative opportunities which could earn a business similar or a higher return (Carmichael, 2011).

Working Capital Management

Working Capital is the bloodline of the business and functions as a heart of the business. It functions similar to that of heart. As heart pumps blood across the body regularly, working capital is used to finance the immediate finances across the company. Working capital management includes the investment of funds across the company on immediate basis. Working capital requirements are needed to finance the daily business operations. Working Capital Management includes the management of credit terms from the creditors, negotiations of higher payment terms will lead to excess cash left at business disposal. Inventory management also falls under the umbrella of working capital management. The company needs to assess the inventory levels regularly in order to ensure adequate levels of inventory in the company which should be equivalent to the demand of the ...