Corporate Finance

PROPOSAL1: Diversify the business operations of Muscat Traders

(A)

NPV for New Machine of Muscat Traders

particular Year one Year two Year three Year four year five
Sales receipts 100*1.05 105*1.05 110.25*1.05 115.76*1.05 121.55*1.05
=RO 105 = RO 110.25 = RO 115.76 = RO = RO 127.63
121.55
Materials CPU 30*1.03 30.9*1.03 31.83*1.03 32.78*1.03 33.76*1.03
= RO 30.9 = RO 31.83 =32.78 =33.76 =34.77
Labour CPU 30*1.03 30.9*1.03 31.83*1.03 32.78*1.03 33.76*1.03
= RO 30.9 = RO 31.83 = RO 32.78 = RO 33.76 = RO 34.77
Additional overheads 10*1.03 10.3*1.03 10.61*1.03 10.93*1.03 11.26*1.03
CPU = RO 10.3 = RO 10.61 = RO 10.93 = RO 11.26 = RO 11.60
Contribution RO 32.9 RO 35.98 RO 39.27 RO 42.77 RO 46.49

Annual Contribution 32.9*30500 35.98*35500 39.27*35500 42.77*35500 46.49*35500

= RO = RO = RO = RO = RO
1003450 1277290 1394085 1518335 1650395
Aggregate fixed costs RO 300000 RO 300000 RO 300000 RO 300000 RO 300000

Total cash flow RO 703450 RO 977290 RO 1094085 RO 1218335 RO 1350395

Particulars Year 0 Year one Year two Year three Year four year five
Capital 1550000* 1550000*30
introduced 70% %

=(108500 =(465000)
0)

Changes RO(32025) RO(39138. RO(41094. RO( 43150 RO(45308.

regarding 75) 8) .25) 65)
working
capital
Cash flow 703450 977290 1094085 1218335 1350395
movements

Net cash RO RO 206425 RO RO RO RO

flow effects (1085000) 938151.25 1052990.2 1175184.7 1305086.3
5 5

Discounting 1 0.901 0.812 0.731 0.659 0.593

factors

Computed RO RO RO RO RO RO
PV (1085000) 185988.925 761778.81 769735.83 774446.75 773916.20
5 6 6

Net Present
Value=RO773916.206+RO774446.75+RO769735.836+RO761778.815+RO185988.925-
RO1085000=RO2180866.53

Regarding Muscat Traders and the decision criteria about the new machinery, it is very
clear that the computed value of Omani riyals 2180866 is an excellent amount in terms
of being a positive figure that indicates substantial return is being generated from this
new machinery is expected to be positive for Muscat Traders. Therefore, definitely
Muscat Traders should proceed with the investment.

(B)

CAPM, has a crucial and important position not only within Finance and economics but
also it is critical to the field of investments and for corporations. In particular, CAPM is
can be explained as a financial model or metric that is used for valuation purposes.
More specifically, CAPM is based on a simple conceptualization that for any given
asset/security the expectation of return that can be made on it will be the sum of the
existing risk-free rate of return for securities as added to the risk premium applicable to
the given security. As a result, if the computer expected return through the application of
CAPM yields a rate that is above or surpasses the rate that is expected then definitely
the given item or project may be approved (Hillier, 2012).

CAPM is critical to every corporation is specially regarding financial or economic

decision-making since it specifically considers risk. It categorizes risk into
subcomponents differentiated on the basis of being able to be reduced or not and
therefore it highlights to what extent the corporation may take certain actions that would
reduce business risk of their operations or an investment choice. Moreover,
corporations using CAPM can make appropriate business decisions wherein diversified
portfolios of assets are held by them and therefore the control and manage their
financial risk by specifications and guidance under CAPM (Lubben, 2014). Additionally,
corporations can also beneficial in make use of CAPM to support much more accurate
and elaborate equity valuations in terms of computing the applicable ‘cost of equity’
since under this model the specific risk element is factored into the decisions and often
it is regarded to be superior than the case of using weighted average of capital for
computational purposes (Hillier, 2012).

C)

Economic Probability Project Project Expected Return Deviation from Mean

State A B
A B A B

Strong 0.35 RO750 RO950 RO RO332.5 RO232.5 RO478.5

state Note:0.35*750 Note:750-
517.5

Normal 0.45 RO500 RO220 RO225 RO99 RO(17.5) RO(251.5)

state
Weak 0.20 RO150 RO200 RO30 RO RO(367.5) RO(271.5)
state
Grand RO517.5 RO471.5 RO(152.5) RO(44.5)
total

Economic State Variances for the projects

A B

Strong state RO18120 RO80137

Note:(232.5)2*0.35

Normal state RO138 RO28463

 Weak state RO27011 RO14742

Grand total RO45269 RO123342

Regarding the risks of investing within the projects, it does seem that investing in
Project A is likely to make good profits in terms of the expected rate of return but the
deviations indicate the higher possibility of risks since it shows the possibility that it is
returns will be more highly variable than the other companies. However, when viewed
from the perspective of variance it can be seen that project a has a lower degree of
variance and therefore these may also provide evidence that it is of significantly lower
risk when contrasted to the possibility of Project B having an amount of 123342.

D)

“Diversification” is regarded as an important financial tactic and strategy whereby

amount of available funding is split up into different shape components and invested
into multiple category of items or assets. Diversification also envisages the prospect
whereby investment is made but in alternative category of investments. This means that
opposite positions are sometimes taken as a means of diversification. For Muscat
Traders, the potential for diversification involved moving away from the current model of
kitchenware items into a new business (McCrary, 2012). This means that because of
excessive competition occurring in kitchenware business of Muscat Traders it can
support many losses but if it is present in upcoming businesses like photocopying
machines and Google Nexus smartphones then even if it is suffering under kitchenware
business it can still make profits and other additional photocopying/smartphone
business in Oman. Therefore, rather than taking a chance of only suffering losses if the
business condition for the current main business of kitchenware changes diversified
resources of funds available for Muscat Traders would be a better and important choice
(Watson, 2012) .

In order for Muscat Traders to reduce risks of its potential investments, Muscat Traders
needs to do careful market study and research prior to undertaking any potential or
possible set of business investment. Only after studying previous trends that were seen
in relation to a given asset and the investment returns that it generated and comparing it
with the existing future expected trends in generating return should Muscat Traders
press ahead with the new proposed investment (McCrary, 2012). Likewise, careful
monitoring and analysis by Muscat Traders is needed for each investment category and
maybe it can also get some feasibility reports on economic and technical level within
Oman to aid in gauging what would be the implications of starting either one of the
kitchenware or otherwise alternative businesses of photocopying machines/smart-
phones (Solomon, 2015).

PROPOSAL2: Buying and Selling of Shares of Muscat Traders

A)

1. Net Asset valuation for Muscat Traders shares

Net Asset=(Non-current assets+Current assets)–(Current Liabilities+5%Bonds+7%

Debentures)=(1011+1188)–(2426+300+100)=2199–2826=Net assets=(627)

Net asset value for Muscat Traders has to be adjusted in light of the earnings that are
required to be given to the preference shareholders of Muscat Traders

Value per share= (Net assets – Preference share)/(Number of equity share)=(-627-

500)/1000= 1.127
2. P/E basis

P/E ratio = (Stock price per share/earnings per share)=(1.75/0.036)=48.61

EPS of Muscat Traders =(36/1000)=0.036

3. Dividend-yield-(no-growth)

= (Annual dividend per share/stock price)=(0.052/1.75)=3%

DPS of Muscat Traders =(52/100)=0.052

4. Dividend yield((With-Growth):

P=D/K–g=0.144/15%-3%=1.444/0.12=12.033

(B)

Muscat Traders should be aware of key differences arising amongst different competing
proposals that are made available for investment purposes are right from the four
different techniques that are presented above and that show potential computations of
share in Muscat Traders in terms of the values that are presented.

Net Asset Value: this is suitable to Muscat Traders from the perspective that it is having
heavy expenditure and amounts that are currently invested into the different sets of
machinery items of its trading business meaning that it is a highly tangible business and
so computing the net assets will give scope to identify and get the valuation on the basis
of how much investments in tangible assets have been made by Muscat Traders so it is
quite simple and straightforward type of computation (Lubben, 2014). Alternatively,
computation of Muscat Traders’ share prices will be misled by the fact that book values
are attempted to be connected to the market value of Muscat Traders by net assets and
even in the given case of the corporation has been found to have a negative net asset
value so the competition arrived at is quite difficult and meaningless since a negative
value is obtained for Muscat Traders (Pareto, 2016).
P/E basis: in the case of Muscat Traders, computations that are based on P/E ratio
when used to arrive at the shared values will produce calculations and computations
that are strictly based on the prices of the shares of the company and also how much
earnings Muscat Traders has made for the year 2015 that are to be subsequently
distributed to the shareholders (Lubben, 2014). So many company that is purchasing
Muscat Traders, considering P/E ratio may be much more meaningful since the
potential buyer will be able to estimate direct earnings from kitchenware or other
businesses taken up by Muscat Traders in the near future. Yet however, the underlying
computations for P/E ratio may be often modified and it is a technique that is based on
estimations incorporating certain subjective elements that the results will be carried
forward. This produces a very high share valuation for this corporation which is 48.61
solely on the basis that it has currently being paying good amount of returns and
therefore it should be likely to continue (Watson, 2012).

Dividend valuation(no growth) here and unclear amount of 3% or 0.03 is produced as

the return from the given shareholding of Muscat Traders. This computer Oman for
Muscat Traders although appears to be unclear is actually indicating a very low amount
will be paid out. However, for Muscat Traders and related investors such an amount is
based on what it can reasonably expect to get in the future and so definitely the
computed amount does hold some value (Pareto, 2016).

During valuation (perpetual growth) for Muscat Traders, computed perpetual growth
models used to value its trading business as well as outcomes of photocopying and the
GSM business produces a moderate figure an amount of Omani riyals 12.033. This is a
more moderate value then net assets or even P/E ratio computed for Muscat Traders so
it gives a clear meaning and picture of what exactly those who are proposing to invest
into shares of the given corporation can expect after taking all possibilities of share
value growing into effect (Watson, 2012).
(C)

For Muscat Traders, the portfolio of proposed shares is likely to produce multiple
different valuations according to which the management of Muscat Traders can make
the choice of appropriate portfolio within which to consider each of the given investment
choices that are made available for Muscat Traders

Discounted
Corporation P/E valuation Earnings PEG
dividend
OUI 22.15/2.5=8.86 2.5/22.15=0.112 8.86/0.112=79.11 0.25/.09=2.778
Renaissance 15.75/0.5=31.5 0.5/15.75=0.032 31.5/0.035=984.375 1.25/0.15=8.333
Al Anwar 1.50/0.75=2 0.75/1.50=0.5 2/0.5=4 0.10/0.10=1

Al madina 11.25/1.65=6.82 1.65/11.25=0.147 6.82/0.147=46.40 0.90/0.13=6.923

Galfar 0.75/2=0.375 2/0.75=2.667 0.375/2.667=0.141 0.05/0.11=0.454

(D)

Regarding the given portfolio investments suggested for Muscat Traders, many
categories of tools may be chosen and implemented to estimate how the identified
portfolio of companies in Oman are going to perform as per the portfolio chosen by
Muscat Traders (Pareto, 2016). Firstly, Muscat Traders may first choose to perform
expected return to find out what exactly how much the portfolio of shares chosen by
Muscat Traders are likely to generate. It can use additional techniques of “Portfolio
Benchmarking” under which the level and extent to which Muscat Traders’s portfolio has
performed as compared to other portfolios of market securities in Oman may be easily
compared to understand which one has done better than the other.

“Sharpe’s Ratio” is one of the effective tools that is often used to study and evaluate
stock valuation and the resultant outcomes. In particular, use of this ratio for Muscat
Traders would indicate how well the aggregate portfolio of the assets contained within
the given measures are holding out in contrast to other possible asset investments that
would have been included. “Treynor Ratio” may also be another choice available to
Muscat Traders under which total and systematic risks are aggregated and related to
the expected portfolio returns in order to gauge whether or not it has outperformed or
whether it has performed in line with expected portfolio aggregate performance
(Watson, 2012). It may often be attempted using the simple formula of (PortfolioReturn–
Risk-FreeRate)/Beta. Finally, Muscat Traders may attempt “Jensen Ratio” which is a
simplistic measure under which the ability of the management working with Muscat
Traders to provide the aggregate return of a portfolio that is above expected average
returns after adjusting for risk is computed. Therefore, if the portfolio of Muscat Traders
is valued under the Jensen ratio then definitely its measure of as far can be taken as a
gauge of whether Muscat Traders from its the investments in various companies within
Oman has been successful to deliver Muscat Traders with positive results or no
(Pareto, 2016).

3)

Summary Report

Muscat Traders, is having the choice of exercising two particular choices regarding what
it plans to do in the future. The decision criteria for the choice of Muscat Traders is
definitely the economic and financial gain that should be made by the chosen option
much more than what is possible from the alternate option.

Clearly, it is the new machine with generates a NPV of Omani riyals 2180866, under
which it is not only positive but also of substantial amount. Comparatively, the purchase
of shares on part of Muscat Traders do not yield any conclusive forms of indicating
whether or not Muscat Traders will make a return. On another level, considering the risk
among the two options, investing in machinery or the plan of diversification is an aspect
wherein Muscat Traders can reliably estimate many business related factors as
compared to the situation of investing in shares that are often highly volatile. As Muscat
Traders is already facing significant uncertainty regarding its main kitchenware
business, the investments into shares may also have potential to further magnify the
existing business risks of Muscat Traders because under the shares of Muscat
Traders’s business would be exposed to multiple possible trends and patterns of share
price movements.

Therefore, Muscat Traders should definitely select diversification business options.

Muscat Traders Should Consider Following Factors before implementing
financing choice;

 Primarily, Muscat Traders should be specifically aware that different choices it

makes regarding financing of the proposed diversification or shares will affect its
overall cost of capital and particularly different categories of cost will arise such
as debt borrowings by Muscat Traders will create interests whereas
implementation of equity sources will create dividend payment (Lubben, 2014).

 The attitude and approach of Muscat Traders’ management is also an important

implication because choice of equity shares would mean that Muscat Traders’
main trading business would have to share ownership controls with other new
partners or share investors as compared to that borrowings under which such
implications about control of the business will not be faced (Lubben, 2014).

 Business income and more importantly cash flows should be duly noted by
Muscat Traders’s management since this directly impacts choice of debt or
borrowed capital because this will affect whether or not Muscat Traders can
service and make the repayments from its trading income or else it may face high
amounts of business risks and legal action from Oman’s legal body if it does not
have sufficient cash flows to service the interest or debt amounts (Lubben,
2014).
References

Books

Hillier, D. 2012. Corporate finance. Sixth edition. London: McGraw-Hill

Lubben, J. 2014. Corporate finance. Fourth edition. London: SAGE

McCrary, A. 2012. Principles and practices of corporate finance. Sixth edition. New York:
Wiley

Watson, D. 2012. Essential Elements of Corporate Finance. Fourth edition London: FT

Press.

Website

Pareto, C 2016. Measure Your Portfolio's Performance [ONLINE] Available at:

http://www.investing.com/articles/08/performance-measure.asp [Accessed 7/6/2016].

Solomon, K. 2015. Five Steps to Reducing Investment Risk [ONLINE] Available at:
http://www.forbes.com/sites/erikkobayashisolomon/2015/09/01/five-steps-to-reducing-
investment-risk/#6540a1bd232b [Accessed 7/6/2016].