Systems and Credit Risk Management †Free Samples to Students

Question: Discuss about the Systems and Credit Risk Management. Answer: Introduction: The company drafted 10 years plan for new plant expansion. ANB Automobile Berhad need to compute the amount of money coming in and amount of money going out so as to determine the feasibility level of this particular business. There is no point of investing huge amounts of money without determining whether the business will generate more revenue and reserves than what was initially invested (Combs, Clapp-Smith Nadkarni, 2010). For that purpose, the company need to carry out cash flow analysis so as to determine whether cash inflow is greater than cash outflow. If cash outflow is more than cash inflow, then the project under consideration is not worth investing since the company will incur loses. If the cash inflow is more than cash outflow, then the project is worth investing since the company is making profits. If the cash inflow is equal to cash outflow, then the company is indifferent on whether to invest or not (Cocca Alberti, 2012). From the beginning of 2017, ANB Automobile B erhad Company placed an initial investment of RM 37 million in research and development (R D). This implies that the first cash outflow occurred in year 2017 amounting to 37 million. Again ANB Automobile Berhad Company decided to purchase piece of land worth 3 million. This is a cash outflow because money is moving out of the company. Cost of construction will 28.5 million. This amount was splinted into two payments. First payment was done at 20.5 million on 31 December 2018. That falls under cash outflow. Second payment was done at 8 million on 31 December 2019. Again that is cash outflow. Second payment of RM 8 million made to the contractor on 31 December 2019. This was the second payment to construction process (Chopra, 2012). This amount was also a cash outflow. Again, the company had to offer commission and pay for transport and equipment. Installation of equipment will be completed at the middle of 2019 and payment is expected to be made at 31 December 2019. Total cost includes RM 15 million for equipment and transportation. For commission, ANB Automobile Berhad Company spent RM 300,000. These amounts will be reflected in cash outflow column in cash flow d iagram. The company also need to put the cost of operation into consideration. From first year, 2017, the operational cost was 950,000. Thus for 2018, operation cost was 104% 950,000= 988,000. For year 2019, operation cost will be 104% 988,000= 1,027,520. Therefore, the total operation cost for ANB Automobile Berhad Company by the end 2019 will be 950,000+988,000+1,027,520= 2,965,520. To consider the cash inflow that the company will generate, then we consider year 2017 as a base year for a span of 3 year up to 2019. Overall revenue of the company has decreased to RM 30 million at first year and predicted to increase 5% each year. Thus, the revenue in year 1 = 30 million. For year 2 will be 105% 30 million= 31.5 million. For year 3, 105 31.5=33. 075. Events Description year Cash outflow 000 1 Initial investment of RM 37 million in research and development (R D).This was done in the beginning of 2017 2017 37,000 2 Cash used to purchase a new piece of land for expansion. Extension of the new plant requires a piece of land cost RM 3 million. 2018 3,000 3 First payment of RM 20.5 million made to the contractor on 31 December 2018. This was the first payment to construction process. 2018 20, 500 4 Second payment of RM 8 million made to the contractor on 31 December 2019. This was the second payment to construction process. 2019 8,000 5 Installation of equipment will be completed at the middle of 2019 and payment is expected to be made at 31 December 2019. Total cost includes RM 15 million for equipment and transportation. 2019 15,000 6 RM 300,000 for commissioning. 2019 300 7 Operation costs year 2017 2017 950 Operation costs year 2018 2018 988 Operation costs year 2019 2019 1027.52 Totals 86,765.52 From the above computation, we realize that the company spend RM 86,765,520 in the project for expansion. This cost has been made as payment to various expenditures for a span of 3 years. That is, 2017 to 2019. On the other hand, the same company will generate total revenue of 30 + 31.5 + 33.075= 94.575 million for a span of 3 years. Since the cash inflow in there years is greater than cash outflow in three years, then the business is worth investing. That is, cash flow= cash inflow-cash outflow= 94.575-86.76552=7.80948 million. With the aid of Present Worth and Future Worth analysis, explain the feasibility of the proposal if Minimum Attractive Rate of Return (MARR) is 20%. The net present worth (NPW) or present worth or net present value (NPV) of given series of cash flow is the equivalent values of the cash flows at the end of year zero. That is, at the beginning of year 1. Net present worth = equivalent present worth of future cash flow initial investment (Daft, 2015). Under NPW method, PW of all cash inflows are compared with PW of all cash outflows. The difference between these PVs is called the net present value. This is the difference between the present value of cash inflows and the present value of cash outflows of a project. To get the present values a discount rate is used which is the rate of return or the opportunity cost of capital (DeTombe, 2012). The opportunity cost of capital is the expected rate of return that an investor could earn if the money would have been invested in financial assets of equivalent risk. Hence its the return that an investor would expect to earn. When calculating the NPV the cash flows are used and this implies that any non-cash item such as depreciation if included in the cash flows should be adjusted for (Arnold, 2010). Cash flows of the investment should be forecasted based on realistic assumptions. If sufficient information is given one should make the appropriate adjustments for non-cash items. Identify the appropriate discount rate (Fletcher, 2012). For this project the rate of return is provided at 20%. Compute the present value of cash flows identified in step 1 using the discount rate in step2. The NPV is found by subtracting the present value of cash out flows from present value of cash inflows. Mathematically this is represented as follow. Net Present Value (NPV) or present worth This is defined mathematically as the present value of cash flow less the initial outflow. Where Ct is the cash flow K is the opportunity cost of capital Io is the initial cash outflow n is the useful life of the project Decision Rule using NPV The decision rule under NPV is to: - Accept the project if the NPV is positive - Reject the project if NPV is negative Note: if the NPV = 0, use other methods to make the decision. Thus, if we compute the present worth of the company at rate of return of 20%, then we discount the cash flows for three years. That is from 2017 to 2019. We discount the revenue of 30 million at 20% rate of return (Gogu, 2017). However, since the engineering department has drafted a 10 years plan including of expanding a new plant to accommodate the production of this new range of cars, the present worth can be computed for a period of 10 years. Present worth = ((30, 000,000 (1+0.2)) + ((30, 000,000 (1+0.2)2) + ((30, 000,000 (1+0.2)3) +..+ ((30, 000,000 (1+0.2)10) 86,765,520 = 275,000,000 Future worth. Net Future Value measures the surplus in an investment project at time zero. Net future worth measures the surplus or equivalent worth or value of a project at the end of the investment period (Heranz, 2010). For the project under consideration, the future worth of the project will be compounded at a rate of return given as 20%. Mathematically, FW= A0(1+I)10 + A1(1+I)9+ A2(1+I)8+ .+ A2(1+I)1 . This formula will calculate the future worth for a period of 3 years. That is, from 2017 to 2019. However, since the engineering department has drafted a 10 years plan including of expanding a new plant to accommodate the production of this new range of cars, the future worth can be computed for a period of 10 years. Future worth = 30,000,000 (1+0.2)10+ 30,000,000 (1+0.2)9+30,000,000 (1+0.2)8+ . + 30,000,000 (1+0.2)1 = 342,000,000. From the computed values of present worth and future worth of the company at Minimum Attractive Rate of Return (MARR) of 20%, the project under consideration is feasible for the following decision. The present worth of ANB Automobile Berhad Company is positive (Lee, 2016). This implies that the project has a positive net present value. In that case, the project is worth investing hence feasible. From future worth, we find that the value of future worth of the project expansion is greater than present worth of the project (Kanungo Manuel, 2014). This is a positive indicator that the project is worth investing hence feasible. Prepare a plot of PW versus i estimate the break even rate of return for the proposal. Sensitivity analysis is a variation of the break-even analysis (Marylene, 2014). In sensitivity analysis we are asking; for example, what shall be the consequences if volume or price or cost changes? This question can be asked differently: How much lower the sales volume can become before the project becomes Unprofitable? To answer this question we shall require the breakeven point. A plot on pw verse i can be given when i represent rate of return for the project. Recall that present worth = net present value. If i2 = 20% then: PW (I) 2 = 275 PW (I) 1 - PW (I) 2 PW (I) 1 0 Continuing with the above example, let us compute the level of units variable costs above which the PW is negative. PW = Annual cash flows x PVIFA 20%, 10 yrs. - 86,765,520 Annual cash flows = Revenue Let break even rate of return be V Annual cash flows = (30,000,000 - 100 (V) Therefore NPV = [(300,000,000 - 100 V) At Breakeven point PW = 0 Therefore (165,000 - 50 V + 15,000) 6.145 = 86,765,520 1,106,100 - 30,725,000 v = 86,765,520 30,725,000 V = 86,765,520-1,106,100 V = 2.78793881% Thus, the required break even rate of return for the proposal is 2.78793881%. Propose the price of the car and minimum production unit per year needed to generate the annual revenue that breakeven the cost for R D and setting up the new plant. Assume that the company is expected to breakeven the cost after 5 years at Minimum Attractive Rate of Return (MARR) 20%. NPV = Annual cash flows x PVIFA 20%, 5 yrs. - 86,765,520 Annual cash flows = Revenue - variable costs - Fixed costs - depreciation - Tax + depreciation. Let variable cost per unit be V. for this case, depreciation and taxation are not provided. Thus, we compute the value of one unit or rather one car as follows. Annual cash flows = Revenue - variable costs - Fixed costs The operating cost for the project = variable costs +fixed costs Annual cash flows = Revenue operating costs. Operation cost for five years = 950,000+ 950,000 104% + 988,000104% +1,027,520 104% +1,068620 104% = 5,145,505 Revenue for 5 years= 30,000,000(1+0.05)5= 127,575,000 Annual cash flows = 86,765,520 Therefore NPV = 275,000,000 At Breakeven point NPV = 0 Therefore, Annual cash flows = Revenue operating costs. 86,765520 V = 275,000,000 + 127,575,000 V = 4.6939 million. Therefore the point above which the variable cost per unit will cause the NPV to be negative is about 4.6939 million. This will be the price of the car. Suggest some strategies to be used in penetrating the current automobile market that is highly competitive. A market is allocatively efficient if it directs savings towards the most efficient productive enterprise or project. In this situation, the most efficient enterprises will find it easier to raise funds and economic prosperity for the whole economy should result (Maslow, 2013). Allocative efficiency will be at its optimal level if there is no alternative allocation of funds channeled from savings that would result in higher economic prosperity. To be allocatively efficient, the market should have fewer financial intermediaries such that funds are allocated directly from savers to users, therefore financial disintermediation should be encouraged. This concept relates to the cost, to the borrower and lender, of doing business in a particular market. The greater the transaction cost, the greater the cost of using financial market and therefore the lower the operational efficiency (McGregor, 2012). Transaction cost is kept as low as possible where there is open competition between broker and other market participants. For a market to be operationally efficient, therefore, we need to have enough market makers who are able to play continuously. This reflects the extent to which the information regarding the future prospect of a security is reflected in its current price. If all known (public information) is reflected in the security price, then investing in securities becomes a fair game (Christopher, 2011). All investors have the same chances mainly because all the information that can be known is already reflected in share prices (Richard, 2013). Information efficiency is important in financial management because it means that the effect of management decision will quickly and accurately be reflected in security prices. Efficient market hypothesis relates to information processing efficiency. It argues that stock markets are efficient such that information is reflected in share prices accurately and rapidly. Creative Accounting strategy In an efficient market, prices are based upon expected future cash flow and therefore they reflect all current information (Clardy, 2013). There is no point therefore in firms attempting to distort current information to their advantage since investors will quickly see through such attempts. Studies have been done for example to show that changes from straight-line depreciation to reducing balance method, although it may result to increasing profit, may have no long-term effect on share prices (Ryan Deci, 2017). This is because the companys cash flows remain the same. Other studies support the conclusion that investors cannot be fooled by manipulation of accounting profit figure or charges in capital structure of company. Eventually, the investors will know the cash flow consequences and alter the share prices consequently. It compels the decision maker to identify the variables which affect the cash flow forecasts. This helps him in understanding the investment project in totality. It indicates the critical variables for which additional information may be obtained (Thabet, 2017). The decision maker can consider actions which may help in strengthening the "weak spots" in the project. It helps to expose inappropriate forecasts and thus guides the decision maker to concentrate on relevant variables. Competitive advantage strategy. The company need to market the automobile products to wider area so as to outdo the competitors. Again, the company may decide to absorb other companies dealing with automobile products via mergers, acquisition and amalgamation (Thomas, 2009). This will create a monopoly in the market hence achieving competitive advantage to the company. References. Arnold, J. (2010). Coaching Skills for Leaders in the Workplace: How to Develop, Motivate and Get the Best from Your Staff. How to Books. Chopra, S. (2012). Supply Chain Management. Pearson Education. Christopher, M. (2011). Logistics and Supply Chain Management. FT Press. Clardy, A. (2013). A General Framework for Performance Management Systems: Structure, Design, and Analysis.Performance Improvement,52(2), 5-15. Cocca, P., Alberti, M. (2012). A framework to assess performance measurement systems in SMEs.International Journal of Productivity and Performance Management,59(2), 186-200. Combs, G., Clapp-Smith, R., Nadkarni, S. (2010). Managing BPO service workers in India: Examining hope on performance outcomes.Human Resource Management,49(3), 457-476. Daft, RL (2015). Management. South Western College Pub. DeTombe, D. (2012). Complex Societal Problems in Operational Research.European Journal of Operational Research,140(2), 232-240. Fletcher, F. (2012). Business Problem Solving. Routledge. Gogu, M. (2017). Emergency situations, adaptive management and national health strategies.Global Journal of Sociology: Current Issues,6(2), 29. Heranz, J. (2010). Network Performance and Coordination.Public Performance Management Review,33(3), 311-341. Kanungo, R.N., Manuel, M. (2014). Work Motivation: Models for Developing Countries. Sage Publication put. Lee, S.S. (2016). Critical analysis of the educational community discussion: Focusing on the conceptualization.Journal of Educational Innovation Research,26(1), 45-69. Marylene, G. (2014). The Oxford Handbook of Work Engagement, Motivation and Self-Determination Theory. OUP USA. Maslow, A.H. (2013). A Theory of Human Motivation. Start publishing LLC. McGregor, D. (2012). The Human Side of Enterprise. New Yolk, 21. Richard, A. (2013). Job Satisfaction from Herzbergs Two Factor Theory Perspective. Grin publishing. Ryan, R.M., Deci, EL. (2017). Self-Determination Theory: Basic Psychological Need in Motivation, development and Wellness. The Guilford press. Thabet, A. (2017). Theoretical Framework Measures Management Accounting Systems and Credit Risk Management Policies and Practices towards Organizational Performance in Palestinian Commercial Banks.Account and Financial Management Journal. Thomas, K.W. (2009). Intrinsic Motivation: What Really Drives Employees Engagement. Berret-Koehler publishers.