Principles of Finance

PRINCIPLES OF FINANCE 6

Principlesof Finance

Principlesof Finance

Thesection 302 of the Sabanes-Oxley Act requires the disclosure ofaccurate set of internal procedures adopted to obtain the financialinformation presented by a company. Material information of thecompany and all its subsidiaries should be disclosed. The act alsorequires the off-balance sheet disclosures that require a company todisclose any material information about the firm that may have afinancial impact to the company, whether positively or negatively(Kimmel et al, 2011). Moreover, the act requires disclosure of anycriminal penalties or anticipated criminal suits against the firm asit relates to the financial statements.

Thegrowth rate provides the measure of the financial and economic growthof a business or an economic unit expressed as a percentage of theprevious performance. It is the measure of increase that a variablehas recorded in comparison to the previous record. The discount rateon the other hand is the rate of interest applied to convert thefuture cash flow in terms of present value (Brigham &amp Ehrhardt,2013). The difference between growth rate and the discount rate isthat the latter considers the time value of money to determine thepresent value while the former does not. Discount rate also considersthe risk and uncertainty factor, which is not a consideration of thegrowth rate.

Presentvalue is used to establish the real value a financial asset byfactoring in the element of time value for money. To accurately valuean asset, the cash flows are discounted to the present time. Thisoperation incorporates the chages in the value of money with time.Tovalue an asset, the present value allows the determination of thevalue of the cash flows emanating from the asset in current terms.Therefore, the present value is important in determining the value ofan asset in present value of establishing the difference between itscurrent cash inflows and cash outflows.

Aseries of payments involves regular cash outflows on periodical basiswhile an annuity involves cash outflows on an annual basis (Brigham &ampEhrhardt, 2013). The other difference is that a series of paymentforms a structured payment for bonds while annuities are common forinvestment firms and insurance companies. Despite the difference,there are characteristics of the series of payments that make themannuities. First, the characteristic of equality of payment on annualbasis makes the series of payments to become an annuity. The secondcharacteristic is the number of periods in the series of payments. Ifthe number of periods is finite, the series of payments is made anannuity.

Thecycle of money is the movement of money from the lenders to theborrowers and back again to the lenders through the facilitation offinancial intermediaries. This movement creates a cycle thatcontinues as long as the flow of money is continuous due to thecontinuity of businesses and investment in the businesses (Soto,2009).The three main participants of the cycle are the lenders, thefinancial intermediaries and the borrowers. The concept of the cycleof money is based on the demand for money and the supply of moneythat is a consequence of interest rates. Therefore, the mainobjective is to balance the demand and the supply to provide capitalto businesses.

Thecredit shocks affect the cycle of money by drastically reducing theamount of loans available for the lenders to offer. According to Soto(2009),credit shocks affect borrowers by reducing their uptake of loans dueto unavailability or high cost of credit. Moreover, the credit shockshrinks the level and amount of the money in circulation around theeconomy since the banks tighten their credit and money supply reduces(Soto,2009).Consequently, consumers reduce their spending, which reducesunemployment and a spiraling domino effect roll over the economy.During such times, alternative financing options like plaguing backprofits and trade credit are the best alternatives for a businessenterprise.

Anannual bond has its interest payment accrue on a yearly basis while asemi-annual bond has its interest payments payable twice a year, onhalf year periods. Another of the difference between the two bonds isthat they vary in terms of the returns that an investor gets on eachof the bonds. This is because investors benefit more by gettinginterest semi-annually than annually. To find the price of thesemi-annual bond, changes should be made to the rates in order tomake them annual. This is important in order to compare the rates ofthe semi-annual bond and the annual bond.

Todetermine whether a certain project is worthwhile or not, a companycan use discounting methods. One of the main methods is the NetPresent Value method. In this method, the present value of all cashoutflows from the project or product are calculated and subtractedfrom the total cash inflows of the project to get the Net PresentValue (Brigham &amp Ehrhardt, 2013). Other methods include theInternal Rate of Return (IRR) that uses weighted average cost ofcapital, and payback period method.

Acompany can raise capital using either from a debt or from equity.The main sources of debt capital include loans and mortgages. Thesetwo are debts that give a company funds or assets on credit, and on along term basis to be repaid with interest as a charge. Other creditsources include trade credit and personal credit. On the other hand,equity sources of capital include issuance of new shares to existingor new shareholders (Brigham &amp Ehrhardt, 2013). The issuance ofshares can also raise capital through a rights issue or bonus shares.Moreover, a company can raise capital using a less expensive methodof re-investing back its profit into the business (Brigham &ampEhrhardt, 2013). All these sources of capital do not charge the samerate because of different costs of capital for each.

References

Brigham,E., &amp Ehrhardt, M. (2013). FinancialManagement: Theory &amp Practice.Stamford,CT:Cengage Learning

Kimmel,P.D., Weygandt, J., &amp Kieso, D.E. (2011). FinancialAccounting, 6th Edition.New York: John Wiley &amp Sons, Incorporated

Soto,H. D. (2009). Money,Bank Credit, and Economic Cycles. Auburn:Ludwigvon Mises Institute