Corporate Finance Of The Organization - Myassignmenthelp.Com

Question: Discuss about the Corporate Finance Of The Organization. Answer: INTRODUCTION In todays management system of organisations, capital budgeting plays an important part as all long term risks in investments and expenditures can be calculated by applying different techniques and analysis(Creative Commons, 2012). By making a proper planning and evaluation, overall costs of operations in company are reduced and avoids under or over investments. Capital budgeting provides an essential tool for the management and gives a wide scope for managers to make analysis of project costs and their significance for the company. There are several techniques which are considered by managers while making capital budgeting for the company(Edupristine, 2017). Some of the traditional and modern ways those are followed while budgeting are shown in the following figure. Figure: Techniques for Capital budgeting Source: (Kumar, 2016) Capital budgeting techniques is essential tool while making analysis of larger projects. Some limitations have been identified by researchers while following traditional methods and to manipulate unfavourable projects, superior tools are required. While evaluating projects, evaluators may arise to ask questions relating cash outflows following payback dates and time required to recover those cash flows or what shall be the NPV after calculating discount rates. Thus well improved and related evaluation techniques has to be considered to make appropriate assumptions like Sensitivity analysis, scenario analysis, simulation techniques and break-down analysis. These are few modern techniques which are used by the financial management of todays business and to understand these tools, a detailed research have been made in this paper to provide assistance to managers while preparing capital budgets for the company(Lawrence, n.d.). SENSITIVITY ANALYSIS Sensitivity analysis is one of the management tools that are used to analyse organisations scenarios to evaluate crucial and non crucial variables on the net profits of the company. Sensitivity analysis is also used by management while decision making to ascertain possible relationship between components of proposed ventures involvement in profitability, liquidity and working capital of the company. To determine the receptiveness of net present value (NPV) to variables those are utilised for calculating it is the main task of sensitivity analysis along with measuring risks. This is due to the process of evaluating investment prospects using NPV is supported by assumptions based on forecasting, therefore making it tentative. Sensitivity analysis can also measure the changes in variables and assumptions that can bear force on bottom lining of cash flow and profiteering of venture. Managers can have an idea about ventures success for the business while evaluating the assurance of resour ces for new project. Some professionals also assumes sensitivity analysis as risk assessment tool and claims that since this method is based on assumptions, ambiguity into investments is probable while incorporating this tool in decision making(Pannel, 2017). Sensitivity analysis carries simple features and uncomplicated theory unlike other accounting theories where there is a need for detailed study. This theory identifies crucial areas while attaining organisational goals as stated in vision of the company statement and thus helps managements in concentrating while discharging duties to the employees. It also helps in identifying susceptible areas which can be directly scrutinized. The data processed while making analysis can enable professional judgement while allocating managerial responsibilities. Sensitivity analysis softwares that are available in the market can perform calculations in simpler and fast manner by putting in the variables and getting results that can help in making quick decisions. Thus by evaluating future results, the management can give attention in implementing eminence control to determine the success in their investment on ventures. The weakness sensitivity analysis contains is that it is not fundamental in nat ure as it judges only changes made in variables. Taking into account the possibility of changes in variables are not made in analysis. Thus sensitivity analysis alone cannot judge and make final decisions in budgeting and provides only the informations that can be interpreted in further analysis(Chinweike, 2013). BREAK-EVEN ANALYSIS Break-Even analysis is one another important tool used by managers to evaluate economic viability of new venture. The point in which profits are equal to costs is called the breakeven point and at that time no profit or loss is assumed. It can also be interpreted in sales i.e. break even sales unit required to cover overall costs. Sales which are found below cost levels are resulted losses and sales above cost levels are deemed profits made by company. Not always breakeven point is determined in producing products to cross sales level but sometimes certain profit returns are desired in investments. If it is not realised then selling substantial amount of products may result in assuming loss for the company(Holland, 1998). Thus breakeven can prove an effective tool in making decisions regarding quantity of goods to be produced in new venture to gain revenue. Fixed costs and variable costs are utilised in making break-even analysis in which fixed costs are those overhead costs those ar e invariable and does not change even if there is a change in output level. Variable costs are opposite in nature and changes with level of outputs and are inconstant and frequently settled on per unit base. The meeting in breakeven point after assuming fixed selling price and fixed variable costs determines the actual profits and cost of production by deducting selling price and variable costs. The regular shifting in costs relating sales and variables makes inconstant results in calculating break-even points which makes the process difficult at decision making stage. Thus break-even shall be calculated on customary basis so that any reflection in costs and prices is recognised and maintained immediately by adjusting the process. The following graph can explain the actual breakeven point meeting. Figure: Break-Even Point Source: (Linda, 2017) In the above figure the horizontal lines shows fixed costs that are constant and lines on the top are variable costs that relates volume and increment and decrement in production and sales. Total costs can be summed up by adding them and the revenue line that starts from zero depicts the sales figure at certain price and quantity. The point at which total costs and revenue lines meet is the break-even point. Many new ventures face losses at the early stages when the breakeven points are on below level and to know the price and quantity it is important to evaluate critically during the decision making time so that losses are analysed before handed. This analysis can help in evaluating short term companys goals and since cost analysis is mandatory it focuses in keeping association between manufacturing and selling. One drawback that breakeven analysis is that claim is supposed to be inelastic and states that high price will make profit curvature steeper and lesser the breakeven point. There are times when customers agrees in paying high rates but the conditions may depend on other factors like alternative availability and cost of switching products. Therefore break even analysis is helpful in assuming the volume of sales and revenues but not demand in products or services of new venture(Tsorakidis, n.d.) SCENARIO ANALYSIS Scenario analysis is a strategic tool to analyse decisions after considering several factors and probable outcomes. This tool is not a prognostic method but an analytical management tool to manage business ambiguity. For example it can reflect how NPV would fluctuate under elevated or stumpy inflations by investments. It can also help managers to make out actual amount of outcomes that can be realised. Scenario analysis can be further differentiated into three scenarios i.e. base case, worst case and best case that depends on the circumstances of the scenarios. Decision making is a complex process and to make investment budget decisions is the most delicate and significant part as long term implications depends entirely on it(Brzakovi?, 2016). On other hand it can also be said that budgeting process is unpredictability of cash flow of ventures while relating to cash flow expectation. The major risk factors associated in budgeting are determined in scenario analysis as any sensitivity to change in major factors and possibility of their changes are analysed. If the factors in venture is of interdependent nature, an insight into its amalgamation of factors are provided by scenario analysis that also shows how can the venture look dissimilar in other scenarios. Thus it is widely utilised by several companies to evaluate projects budget decisions. It allows allocating possibilities to different cases, as mentioned above, and find out the expected result and paradigm in divergence of ventures NPV for getting enhanced knowledge of risk that are related to venture. The stages while making scenario analysis is shown in the following figure that are used by managements while making budget decisions. Figure: Stages in scenario analysis Source: (Jackson, 2010) Scenario analysis allows altering variables and can generate several combined effects while making amendments on NPV and hence can bring in the likelihood of changes among key factors. The initial base analysis shows that the venture is satisfactory but when multiplied by different scenarios, the possibility of NPV for each scenario by adding to the product is expected to be higher than the NPV of the base case scenario. Wide range of possibilities is and considered while making initial budgeting and any negative value recommends that the venture is risk oriented. Since scenario analysis normally shows higher risks, to accept the venture or not becomes questionable for the managers. Thus simulation analysis shall be carried to find acceptable answer. SIMULATION TECHNIQUE Simulation techniques utilises numerical data to stature the standard outcome of scenario analysis. Different statistical inputs like inflation rate, market risk, etc. are distributed and estimated by running simulations to check the way they changes according to their distributions and ultimate affects. The estimated output is found out after averaging the statistical data outputs. Simulation techniques are used widely where multiple inputs changes constantly which can also be unrelated. Simulation analysis are also used for estimating bond prices but are majorly used while making initial budgeting i.e. the base case(DENT, 2012). Management utilises statistical methods when accounts becomes complex and all interconnected factors those affects financial outcomes becomes inflexible. This method deciphers problems by stimulating the highlighted processes and calculates the average outcome of the method(Ray, 2014). Simulation technique can be further divided into two phase in which fact ual system is build and then research is made on that model. The phase of modelling can prove useful as it helps in gaining enhanced perceptive of the formation and its process in complex systems. The experimental phase of simulation technique is also beneficial as inter related and sequential aspects of complicated methods can be integrated in the model. Simulation techniques does not solves models like other linear and dynamic programming techniques and thus this technique is not used for defining process of most favourable operational strategy. This technique can stimulate several sources of improbability like market changes, default risk, inflation, etc. which affects the company portfolio or budget investments and estimates a representative value. On the other hand it can also be said that this technique helps in finding the average outcome after alteration is made in the inputs. For using simulation techniques, many computer software packages are utilised by the managers in wh ich NPVs are calculated by picking randomly selected variables and then calculates mean and standard deviation. This mean or standard deviation value is used by managers to determine the expected NPV of new venture and risk associated in them. This technique is more precise as compared to sensitivity analysis as sensitivity analysis utilises restricted number of cases(Montazer, 2003). CONCLUSION Thus by utilising different techniques and analysis tools, managers can gain the opportunity of reducing risks and revaluate decisions about their ventures. It helps managers to decide whether to invest in new projects or to terminate any existing unprofitable project. In this research paper the techniques utilised for risk determination in capital budgeting and to evaluate future prospects of projects have been stated(Karanovic, 2010). These can give managers a platform to make a selection of alternative techniques according to their project. By predicting cash flow values, mangers can predict analysed risks and also make out decisions after applying different project values to change the estimated risks. Thus they are enabled to decide whether to take a project or not since observations regarding risks and probability are made before implementations(Chambers, 2017). REFERENCES Chinweike, 2013. What is Sensitivity Analysis? [Online] Available at: https://www.accountantnextdoor.com/what-is-sensitivity-analysis/ [Accessed 12 September 2017]. Creative Commons, 2012. Capital Budgeting Decision Making. [Online] Available at: https://2012books.lardbucket.org/books/finance-for-managers/s13-capital-budgeting-decision-mak.html [Accessed 12 September 2017]. DENT, A.W.a.J.B., 2012. THE APPLICATION OF SIMULATION TECHNIQUES TO THE STUDY OF GRAZING SYSTEMS. 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