TABLE OF CONTENTS
TABLE OF CONTENTS…………………………………………………………………………………………………………………….3
PREFACE……………………………………………………………………………………………………………………………………..8
COURSE DESCRIPTION AND CONTENT…………………………………………………………………………………………….9
LESSON ONE………………………………………………………………………………………………………………………………13
CAPITAL BUDGETING ………………………………………………………………………………………………………………….13
1.0 Introduction ……………………………………………………………………………………………………………………..13
1.2 Learning Objectives……………………………………………………………………………………………………………13
1.3 Investment Decision Rule …………………………………………………………………………………………………..14
1.4 Capital budgeting ………………………………………………………………………………………………………………15
1.5 Investment Appraisal Techniques………………………………………………………………………………………..17
1.6 The Post Audit…………………………………………………………………………………………………………………..25
1.7 SUMMARY………………………………………………………………………………………………………………………..26
1.8 SELF TESTING QUESTIONS…………………………………………………………………………………………………..27
1.9 Further Reading………………………………………………………………………………………………………………..28
LESSON TWO……………………………………………………………………………………………………………………………..29
PROJECT CASHFLOW ANALYSIS AND CAPITAL BUDGETING ……………………………………………………………..29
2.0 INTRODUCTION…………………………………………………………………………………………………………………29
2.1 LEARNING OBJECTICES……………………………………………………………………………………………………….29
2.2 ESTIMATING A PROJECT’S CASH FLOWS……………………………………………………………………………….29
2.4 TAX EFFECTS……………………………………………………………………………………………………………………..37
2.4 Evaluating capital budgeting projects………………………………………………………………………………….38
2.4.1 Replacement analysis…………………………………………………………………………………………………..38
2.4.2 Projects with unequal lives…………………………………………………………………………………………..40
2.4.3 ABANDONMENT ANALYSIS …………………………………………………………………………………………..43
2.5 Capital Rationing……………………………………………………………………………………………………………….47
2.6 SUMMARY………………………………………………………………………………………………………………………..50
2.7 ACTIVITIES ………………………………………………………………………………………………………………………..50
2.8 SELF TESTING QUESTIONS…………………………………………………………………………………………………..51
LESSON THREE……………………………………………………………………………………………………………………………52
CAPITAL STRUCTURE DECISIONS…………………………………………………………………………………………………..52
3.0 INTRODUCTION…………………………………………………………………………………………………………………52
3.1 LEARNING OBJECTIVES……………………………………………………………………………………………………….53
3.2 Equity and Debt Finance …………………………………………………………………………………………………….53
3.3 Business and Financial Risk …………………………………………………………………………………………………53
3.4 Operating leverage…………………………………………………………………………………………………………….55
3.4 CAPITAL STRUCTURE THEORY……………………………………………………………………………………………..61
3.4.1 Debt-equity Mix and the Value of the Firm…………………………………………………………………….62
3.4.2 Irrelevance of Capital Structure NOI approach and MM hypothesis without……………………..68
3.4.2 Costs of Financial Distress…………………………………………………………………………………………….75
3.4.3 Optimum Capital Structure:………………………………………………………………………………………….77
3.4.4 Cash Flow Analysis Versus EBIT–EPS Analysis………………………………………………………………….81
3.5 SUMMARY………………………………………………………………………………………………………………………..83
3.6 ACTIVITIES ………………………………………………………………………………………………………………………..83
3.7 SELF TESTING QUESTIONS…………………………………………………………………………………………………..83
3.8 FURTHER READING…………………………………………………………………………………………………………….85
LESSON FOUR…………………………………………………………………………………………………………………………….86
DIVIDEND POLICY DECISIONS……………………………………………………………………………………………………….86
4.0 INTRODUCTION…………………………………………………………………………………………………………………86
4.1 LEARNING OBJECTIVES……………………………………………………………………………………………………….86
4.2 Dividend Decision and Valuation of the Firm. ………………………………………………………………………87
4.3 Dividend policy………………………………………………………………………………………………………………….88
4.4 Effects of dividend policy on cost of equity …………………………………………………………………………..91
4.5 Forms of stability of dividends…………………………………………………………………………………………….92
4.6 SUMMARY………………………………………………………………………………………………………………………..97
4.7 ACTIVITIES ………………………………………………………………………………………………………………………..97
4.8 SELF TESTING QUESTION ……………………………………………………………………………………………………98
4.9 FURTHER READING…………………………………………………………………………………………………………….98
LESSON FIVE: DIVIDEND THEORIES ……………………………………………………………………………………………….99
5.0 INTRODUCTION…………………………………………………………………………………………………………………99
5.1 LEARNING OBJECTIVES……………………………………………………………………………………………………….99
5.2 The Theories……………………………………………………………………………………………………………………..99
5.2.1 Dividend Irrelevance Theory……………………………………………………………………………………….100
5.2.2 Dividend Relevance:…………………………………………………………………………………………………..103
5.3 Establishing the dividend policy in practice…………………………………………………………………………105
5.4 SUMMARY………………………………………………………………………………………………………………………111
5.5 ACTIVITIES ………………………………………………………………………………………………………………………111
5.6 SELF TESTING QUESTION ………………………………………………………………………………………………….112
5.7 FURTHER READING…………………………………………………………………………………………………………..112
LESSON SIX: WORKING CAPITAL MANAGEMENT…………………………………………………………………………..113
6.0 INTRODUCTION……………………………………………………………………………………………………………….113
6.1 LEARNING OBJECTIVES……………………………………………………………………………………………………..113
6.2 WORKING CAPITAL MANAGEMENT……………………………………………………………………………………113
6.2.1 Operating cycles or cash cycle …………………………………………………………………………………….116
6.2.2 Solvency VS profitability …………………………………………………………………………………………….118
6.2.3 Financial Ratios …………………………………………………………………………………………………………119
6.3 Multiple Discriminant Analysis (MDA)………………………………………………………………………………..120
6.4 SUMMARY………………………………………………………………………………………………………………………122
6.5 ACTIVITIES ………………………………………………………………………………………………………………………122
6.6 SELF TESTING QUESTION ………………………………………………………………………………………………….122
6.7 FURTHER READING…………………………………………………………………………………………………………..123
LESSON SEVEN: INVENTORY MANAGEMENT………………………………………………………………………………..124
7.0 INTRODUCTION……………………………………………………………………………………………………………….124
7.1 LEARNING OBJECTIVES……………………………………………………………………………………………………..124
7.2 Inventory………………………………………………………………………………………………………………………..124
7.3 SUMMARY………………………………………………………………………………………………………………………128
7.4 ACTIVITIES ………………………………………………………………………………………………………………………128
7.5 SELF TESTING QUESTION ………………………………………………………………………………………………….129
7.6 FURTHER READING…………………………………………………………………………………………………………..129
LESSON EIGHT: CASH MANAGEMENT………………………………………………………………………………………….130
8.0 INTRODUCTION……………………………………………………………………………………………………………….130
8.1 LEARNING OBJECTIVES……………………………………………………………………………………………………..130
8.2 Cash management …………………………………………………………………………………………………………..130
8.3 SUMMARY………………………………………………………………………………………………………………………137
8.4 ACTIVITIES ………………………………………………………………………………………………………………………137
8.5 FURTHER READING…………………………………………………………………………………………………………..137
8.6 SELF TESTING QUESTIONS…………………………………………………………………………………………………138
LESSON NINE: ACCOUNTS RECEIVABLE MANAGEMENT…………………………………………………………………139
9.0 INTRODUCTION……………………………………………………………………………………………………………….139
9.1 LEARNING OBJECTIVES……………………………………………………………………………………………………..139
9.2 Credit Policy …………………………………………………………………………………………………………………..139
9.3 Efficiency /Turnover Ratios……………………………………………………………………………………………….141
9.4 SUMMARY………………………………………………………………………………………………………………………143
9.5 ACTIVITIES ………………………………………………………………………………………………………………………143
9.6 SELF TESTING QUESTIONS…………………………………………………………………………………………………144
9.7 FURTHER READING…………………………………………………………………………………………………………..145
BAC 204: Business Finance II Notes
