Consider a Hedge: Coffee Bean Prices for our chain of coffee shops

The hedging strategies help the corporation to reduce the level of risk. The hedging strategies such as Future contracts allow the corporations to mitigate the financial loss which organizations can experience from change in the prices. The marketing head in DDR should understand the importance of the heading strategies and how these can help the company to manage the increasing cost. As the finance department has predicted that the prices of the commodity will increase in the upcoming year it will be evident that the organization will need a strategy to mitigate the risk of rising cost of goods (Jonathan, 2010).

As coffee beans are the main ingredient for making coffee the rise in price of coffee beans will increase. The cost of the business will increase, and unfortunately if anything is not done then the price of the coffee would have to change to manage the cost. The sudden change in coffee prices might affect the sales as well because customers do not want to purchase products at high prices. To avoid this situation the corporation should perform hedging by using future contracts. With future contracts the company can avoid increasing prices of Coffee beans. With future contract the organization agreed on predetermined price at specific time in future. With this agreement the company will have to pay the price on which the company has agreed upon whether the price of the coffee increase or decreases (Jonathan, 2010).

Therefore it can be said that future contract is a good idea for managing the increasing prices of coffee beans. Below is the graph of coffee bean prices, and it can be seen that each month, the prices have experienced change. After May the prices have experienced significant amount of increase. The futures contracts are for every three, and the company should perform future contracts for reducing the risk of increasing prices. In the last quarter of 2019 it can be seen that the prices of beans have grown significantly from October to December, so future contracts can help the business to reduce rising prices. It is recommended to the DDR to utilize future contract.

Question No. 2 the Bond Question

The details are available regarding the six different types of bonds. Each bond will be analyzed in order to make an investment decision. There are several things that must be analyzed before adding the bond into the investment portfolio, such as yield of the bond, level of risk and the price of the bonds, etc. The ratings of the bonds will also be analyzed to get brief overview regarding the performance of the bonds. The first bond is the Federal Farm CR, which is a government bond. The type of debt is Unsecured and offering a yield of 3.70%, the face value of the bond is $100, and Coupon rate is fixed.

The original maturity size of the bond is 23,000.00. The credit rating agency Moody’s have given the rating of Aaa whereas Standard & Poor has given the rating of AA+. From the year 2012, the price of the bond is indicating increasing trend which means that in the upcoming years the price of the bond will experience growth. The second bond is Federal NATL, which is also a government bond and with an unsecured Strip debt type. This bond is a zero-coupon bond. The yield of the bond is 0.000%. There is no information available regarding the rating provided by Moody’s and Standard & Poor’s credit rating agency. From the year 2011 the price of the bond has experienced significant growth. The price of the bond was near $40.00 in the year 2011 however in the year 2019 the price of the bond has reached near $80.00 (Jonathan, 2010).

The third bond is Connecticut ST Health, which is a municipal bond. The coupon type of the bond is fixed which indicates that it is a fixed coupon bond. The face price of the bond is $97.75. The yield of the bond is 3.69%. The credit rating agency Moody’s have given the rating of Aa3, whereas the Standard & Poor have given the rating of AA-. From the year 2014 to 2019 the price of the bond has faced fluctuations however the overall trend of the price of the bond is positive, which means the price has experienced growth from the last several years despite fluctuations. The fourth bond which is going to be analyzed is Trumbull Conn, which is another municipal bond.  The price of the bond is $101.69. The yield of the bond is 1.70%. Standard & Poor have given the rating of AA+ to this bond. Over the past several years the bond price has experienced decline.

The fifth bond is Verizon Communication, which is a corporate bond. The price of the bond is $100, and yield of the bond is $4.00%. The credit rating agency Moody’s have given the rating of Baa1, whereas Standard & Poor has given the rating of BBB+ rating. The price of the bond of the years has experienced significant amount of increase. The last bond is of Royal Bank of Scotland which is another corporate bond. The yield of the bond is 5.00%, and the price of the bond is $100. Moody’s have given the rating of Baa2 (Jonathan, 2010).

Now, if all the bonds are analyzed critically than it can be said that the Royal Bank of Scotland bond has the highest yield of 5.0%. As an individual investor it has been decided to invest in Federal Farm CR which is a government bond and In Royal Bank of Scotland bond which is a corporate bond. Both bonds are providing higher yield which means that it will allow the investor to get significant amount of return. Government bond has lower level of risk which result is lower return, but corporate bonds come up with larger risk with higher returns. With this investment strategy the investors will not only able to earn higher return but also higher risk of corporate bonds will be balanced with lower risk of government bonds.

Question No. 3 Short Choice “B”: Real Options

WACC (Weighted Average cost of Capital) evaluates the total cost of capital of the corporation. All the sources of financing, which include equity and debt financing included in the calculation of WACC. The WACC of the organization increases when the rate of return on equity increases. The rise in WACC indicates higher risk and lower valuation of the corporation. The higher risk means that the investors require more return for balancing the increased amount of risk. As the GA has the WACC of 15% it means that there is significant amount of risk associated with GA line of business (GUPTA, 2017).

The higher WACC of the project means a decline in valuation and increase in risk. Due to increase in WACC the line of business has become less attractive. The Increased WACC reduced the value of the organization which is not a good sign at all. The weighted average cost of capital should be lower because low WACC increases the value of the organization. With lower risk lower amount of return has to be given to the investors. The low WACC of the company means that the corporation has financed its project or assets efficiently. If the corporation has optimum capital structure, then the cost of capital remains lower.

The three-year extension contract with ABC has become less valuable now because the risk associated with GA business line is higher. The High WACC has reduced the value of GA business therefore it can be said the contract now is less valuable as compared to when it is first written. The WACC is considered by many loan providing institutions. For financing the operations of the business the organization requires loan, and with higher WACC the corporation cannot purchase loans easily. The organizations try to keep their WACC lower so that it can obtain loan from the financial institution.

Now for considering whether to extend the contract or not the profitability of the GA business should be analyzed. As WACC is used as the rate for discounting cash flows of the project the higher discount rate results in low NPV of the project. It means that the NPV of the business has declined due to the higher WACC. Furthermore the IRR of the GA business must be higher than WACC. If IRR of GA line of business is lower than WACC than it would not be a good decision to extend the contract because the GA line of business will no longer bring profitability to the corporation (GUPTA, 2017).

It has been decided to not use the option to extend the contract because of the GA line of business no longer profitable for the business because of high amount of competition in the market. Higher WACC will reduce the NPV of the business which indicates low profitability in future. Therefore it would be a good decision to not extend the contract because pursuing such project, which results in financial loss, is not a good decision.

Question No. 4 Short Choice “C”: Dividend Preference

The organizations that are experiencing growth does not pay a dividend to the shareholders because they reinvest the amount so that the business can experience growth and the overall value of the company increase. When the business experiences growth, the cash flow of the corporation increases which also increases the value of the stocks. There are many organizations in the world which implement this method and does not pay dividend to the shareholders. The organizations which adopt this policy are newly established and want to grow their operations quickly. The organizations that have become mature did not adopt this policy and provide dividends to the shareholders because they did not need excess funds for growth (Fridson & Alvarez, 2011).

There are many arguments which are against and in favor of the dividend payout policy. Many financial analysts believe that the organization should have no dividend payout policy so that the money can be reinvested in the corporation so that the stock prices and the overall value of the firm can grow. However, some financial analyst believes that the corporation should pay dividend so that the organization can attract investors and the corporations’ goodwill will increase. The organizations that pay dividend on regular basis experience growth in their stock prices.

Therefore it is recommended to the corporation to start paying the dividend to the shareholders. When the organization starts paying a dividend to the shareholders, then the first thing that will happen is that the goodwill of the organization will increase. The people and investors consider that corporation good, which pays dividend to the people on regular basis. The dividend also helps the company to maximize shareholder wealth. Through dividend payout the corporation can attract different investors, which means that the company will able to finance its assets more efficiently. The corporations that do not pay dividends face difficulty in attracting investors.

The investors want to invest in such corporations that provide significant amount of return on the investment. When the investors see that the company pay significant amount of dividend on the shares than the investors will definitely invest in the corporation. With dividend payment policy the company share prices also experience growth. Such corporations that pay dividends able to create good reputation in the market in terms of financial performance. The people consider those corporations financially strong who pay significant amount of dividends on the stocks. In other words the dividend payout program indicates the financial wellbeing of the company.

David’s Diesel Junkyard should be dividend payout program if it wants to expand its business. With dividend payout program the company will able to get financial assistance from various investors through which it can finance its operations more efficiently. The reputation of the company will increase in the market that will grow the revenue of the company. When the revenue of the company increases the profitability of the company also increases as a result. This policy will also have good results on the value of the company, and the shareholder wealth will maximize.

Question No. 5. The Question about AutoZone Stock in early 2012

Autozone organization has implemented the stock repurchase strategy. Due to the implementation of stock repurchase strategy, the EPS (earnings per share) of the corporation increases because the volume of the shares decreases. Due to stock repurchase the prices of the stocks also increase because the supply of the stock decreases from the demand. Stock repurchase also results in increase in cash in hand which means that the current assets of the corporation increases. Stocks that the company repurchases are tax differently than dividends therefore the organization can get tax benefits a well. However the main drawback of this strategy is that it provides artificial indication of high earnings of the company (Kurowski & Sussman, 2011).

The stock repurchase strategy of Autozone has increased the earnings per share of the organization, which can be seen in the financial statements of the organization. The ROA of the corporation has also increased which indicates high performance of operations of the company. The high ROIC is indicating the organization has efficiency invested the capital. It can be said that due to the repurchase strategy of the organization the financial performance of the company is indicating positive signs. If the financial statements are analyzed critically than it can be said that the strategy of the corporation has boosted the earnings of the company artificially.

It is recommended to Johnson to liquidate his shares in the AutoZone. Johnson should liquidate his investment in AutoZone until the organization creates an optimal capital structure again. The current stock performance and high earnings of the company are due to the stock repurchase strategy. The financials of the company are manipulated through stock repurchase program which means that in reality the firms’ profitability is not as much higher as it seems. Therefore it is recommended that Johnson think about liquidating its investment in the AutoZone organization (Kurowski & Sussman, 2011).

The reason behind for liquidating the shares is that the financials which is indicating high earnings are manipulated by repurchase strategy. The organization should pay its debt and perform optimal capital restructure. After that, Johnson can rethink about investing in the organization. If the organization created optimal capital structure which means that 40% debt and 60% equity than Johnson can think of investing back in the company. The repurchase strategy is not good for sustainable growth therefore in the current situation, liquidating the stake in the corporation is a rational decision. The company will have to restructure its capital structure if it wants to grow the business is sustainable way.

References of FINANCIAL MANAGEMENT

Fridson, M. S., & Alvarez, F. (2011). Financial Statement Analysis: A Practitioner's Guide. John Wiley & Sons.

GUPTA, A. (2017). PROJECT APPRAISAL AND FINANCING (illustrated ed.). PHI Learning Pvt. Ltd.

Jonathan, B. (2010). Financial Management. Pearson Education, India.

Kurowski, L., & Sussman, D. (2011). Investment Project Design: A Guide to Financial and Economic Analysis with Constraints (illustrated ed.). John Wiley & Sons.