Appraise the logic of the Finance Vice President's proposals and analysis. In doing so, you should...

Question

Appraise the logic of the Finance Vice President's proposals and analysis. In doing so, you should address somewhere along the way the following issues, in specific terms: 1. His assessment of the respective "costs" of each of the various individual sources of capital available to the firm-- i.e., debt, retained earnings, common stock. 2. The appropriate procedure for weighting those individual costs, to come up with an over-all cost of capital for the firm. 3. The determination of the degree of leverage which the firm should have in its capital structure, and the criteria which would bear on that decision. 4. Whether the firm's cost of capital should be expressed as a before-tax or an after-tax figure. 5. How the firm should decide whether to
	
Document Preview: Finance for Managers

Critique the analysis and proposals made by the Vice President for Finance of 
Adheron, Inc., as described in the attached case.  Specific assignment questions to 
guide that critique are listed on page 5.  Feel free, however, both to integrate your 
responses to those various questions and to go beyond the particular issues they 
raise, in order to develop a coherent capital structure, cost of capital, and investment 
decision framework for the firm, according to what you consider to be the correct 
conceptual approach to such matters.  Thus, do not be reluctant to display the full 
range of your talents, even if they do not fit neatly into the guidelines provided.  
Assume that the reader of your critique will be knowledgeable in the relevant areas, 
but is interested in finding out whether you are.  Limit your written response to 6 
pages (one side), including any exhibits you may wish to provide; this is a firm limit, 
not merely a suggestion.  You have four hours in which to complete your analysis.

ADHERON,  INCORPORATED

In early 2008, the Vice President-Finance of Adheron, Inc., completed a study 
of the company's existing capital budgeting and financing procedures and was 
preparing to recommend major policy changes to management and the Board of 
Directors.  Prior to presenting his ideas formally, however, he planned to review 
them with several of his colleagues who would be most affected by the changes he 
had in mind. 
 
 Adheron was a leading manufacturer of adhesives, pressure-sensitive papers, 
and packaging and household tapes.  It had been founded in the late 1950's on the 
basis of several proprietary adhesives innovations, and had grown steadily--and 
profitably--since.  By 2008, it had plant locations in 12 states and 4 foreign countries,and employed nearly 15,000 individuals.  Annual revenues were comprised 
approximately 75 percent of sales to other manufacturers and 25 percent...

Robert · Accepted Answer

[Type the 
document 
title] 
March 12 
2015 
[Type the abstract of the document here. The abstract is typically a 
short summary of the contents of the document. Type the abstract of 
the document here. The abstract is typically a short summary of the 
contents of the document.] 
[Type the 
document 
subtitle] 
2 | P a g e  
 
The solution as laid down by the company’s vice-president, regarding the cost of capital is 
very much recommended for the company as it will help the company in generating more of 
profits along with the benefits for the company or the incorporation. It will be significant for 
the company or the incorporation to show the interest rate along with the tax rate at a 
relatively lower rate. This will indicate that the tax as provided by the company on the 
dividend is low. 
As per the financial management of a company, each and every capital sources have a cost, 
which is to be borne by the company as per the rates as decided by them at the time of 
agreement. The tax rate as mentioned in the approach of the vice-president is 7.5% which is 
``long-term borrowings of the company will be listed in the “A” category. As the current rate 
of income tax is 40%, the after tax cost of debt will be 4.5% which will be very much 
convenient for the incorporation. Chartered Accountants are appointed by the company for 
the purpose of accurate and proper cost determination of the debt. Therefore, with the help of 
this approach it will become much easier for the company to survive in the long run as the 
costs of debts are very less. The approach as suggested by him will also help in maintaining a 
proper common stock as the earning per share and also the number of equity shares. 
Also if the approach and proposals as said by the vice-president is followed, it will help in the 
cost of retained earnings as well. The cost of these earnings will also be reduced which will 
go in favour of the incorporation as well. The total cost as incurred regarding the retained 
earnings will be reduced to 3.5%, which is a very good amount or rate for the company to 
incur the cost. 
The Weighted Average Cost of Capital for the incorporation should be either 5% or more, 
after taxes. As suggested by the vice-president, it is favourable for the incorporation if they 
are having 5% as the cost of capital. In general terms, it is appropriate for all the companies 
3 | P a g e  
 
to maintain the rate 5% or above. It can be observed from the given exhibit that the weighted 
cost of capital should be positive and if it is more than 5%, then no matter what the source of 
capital for the company is, it will be beneficial for the company to survive in the long-run as 
well as stabilize all its activities. 
The incorporation should be financing its capital in such a way that it helps them in the long-
run. Generally, it is stated that the leverage of the company forms the most important part as 
it helps in determining ratio of the source of capital with the assets of the company. It is with 
the help of leverage that the company will be able to decide what kind of decision is to be 
taken regarding the future activities of the company. If the leverage is in favour of the 
company, then it will not decide to change the approach towards its activities, but on the 
other hand, the company will have to make decisions accordingly. The operational activities 
of the company are also determined with the kind of investment as done by them.

Appraise the logic of the Finance Vice President's proposals and analysis. In doing so, you should address somewhere along the way the following issues, in specific terms: 1. His assessment of the...

Solution

Answer To This Question Is Available To Download

Related Questions & Answers