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ACC00716 Business Case Study

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ACC00716 Business Case Study

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Course Code: ACC00716
University: The University Of Sydney

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Country: Australia

Describe about the Business Case Study For Overall Industry Context.

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The first part of the paper deals with six questions which are answered below. Detailed calculations are shown in the appendices. 
Company XYZ should invest $171.08 now to ensure that it has sufficient funds to repay the given debt upon maturity.  
EAR of each investment option is as below:
Investment A: 7.12%
Investment B: 7.18%
Investment C: 7.15%
Therefore, if the Company XYZ has to choose, it should choose Investment B to get the maximum return. In this context, it is interesting to note that the stated annual rate is lowest for Investment B in comparison to other two 
Company XYZ will have to make a monthly payment of $4.68 on the given loan (Appendix 3). 
Risk and Return Analysis 
The section focuses on the given case study of Fly Safety Limited, a fictitious company operating in the airline industry of the country.
Analysis of risk and return from the securities of a company may be considered to be a tricky affair for the investors as the process of such evaluation may consider lots of factors that are both internal and external to the business (Marfè, 2012). The instant report, in the subsequent sections, attempts to analyze the company’s position in the overall industry context in terms of risk and return from the securities. Such analysis is carried out in the backdrop of the theoretical framework of risk and return relationship and also the implication of debt structure on the risk framework of the business.
The overall industry context in relation to the risk profile of the company
As per the given case study, the company, Fly Safety, is operating in the industry for last 10 years and has gained shareholders’ satisfaction by way of providing average 5% returns in last six years. However, an analysis into the year-wise break up of average shareholders returns (ASR) of the company may reveal that there have been major fluctuations in the ASR figures for the company as compared to its competitor Always Reliable Limited, which is a well-established company in the industry for many years. Though the ASR for Always Reliable Limited is 8%, just 3% above than that of the firm, the standard deviation (SD) of the ASR figures of the said firm is just 1.70%, as compared to Fly Safety’s 4.52%. In other words, the return from the share of Fly Safety is highly unstable and fluctuating. The subsequent section will analyze the comparative position of both the companies in more details.
Risk and return theory: The mutual relationship and trade-off
In investment studies, the concept of risk and return is highly critical. There have been underlying risks in each and every investment in line with its return. However, the investors need to identify and asses the implications of each and every risk and return of the investment, failing of which the basic purpose of the investment may be vitiated (Salvador and Aragó, 2011). The risk of investment may be measured through SD and beta, as discussed in the paper. Similarly, the return may also be calculated through ASR. There are lots of other techniques as well; however, the assessment is crucial and the mutual trade-off between the risk and return is the primary target of the investors. An ideal investment should have a balanced trade-off between the risk and return by way of diversification and mitigation
The meaning and relevance of beta in risk analysis
Beta is defined to be the sensitivity of a company’s security in relation to the change in the market. If the market, for example, increases by 10% during a specific period and the stock increases by 20%, the stock may be considered to have a beta of 2. In other words, the stock is extremely sensitive to the changes in the market and hence, highly volatile. Since beta is computed considering the market index and its fluctuations with respect to the stock value change, it is considered to be an authentic measure of risk (Byrne and Sakemoto, 2018). In the given case, the stock of Fly Safety is more volatile than that of Always Reliable Limited in terms of the sensitivity of the stock movement to the market change. Investors generally refrain from investing in high beta stock as there seems to be more risk of fluctuations in return.
The relationship between company risk and the cost of debt
The debt is considered to be the comparatively less costly source of the fund than equity. Additionally, it may also be observed that the interest cost is an admissible cost in taxation purpose and hence, the firm may enjoy a tax shield on the interest component (Robbins, 2018). The inclusion of debt in the capital structure of a firm, however, increases the risk of insolvency in the long-run as there remains the fixed payment liability towards the finance costs. Therefore, it may be asserted that the business should strategize the debt policy in such a way that it does not hamper the bottom line and create a cash crunch for the firm. Simultaneously, there should also be a conscious effort to leverage the debt benefit in order to bring down the overall cost of capital for the purpose of future expansion and growth (Mencia, 2009).
Based on the discussion and analysis performed in the preceding sections of the report, it may be construed that the company has been able to achieve profitability for the past several years. Since the company is intending to acquire bank finance, it may be advised to reconsider the plan and avail a mixed financing approach where the part of the requirement may be financed through own equity as well. The reason is the WACC of the firm is high and hence, it may not be feasible for the firm to meet the shareholders’ expectation with such a high capital cost. However, since the debt is a comparatively cheaper source of the fund than equity, the management should definitely include debt component in the capital structure to make the same competitive in the industry. Finally, it may be concluded that well-designed financial strategies with respect to the financial risk-return trade-off will significantly contribute towards the attainment of the corporate goal of sustainability in the long-run (Team, 2018). 
Marfè, R. (2012). Realized Expectations and the Equilibrium Risk-Return Trade Off. SSRN Electronic Journal.
Team, R. (2018). Risk-Return Tradeoff. [online] Investopedia. Available at: https://www.investopedia.com/terms/r/riskreturntradeoff.asp [Accessed 8 Dec. 2018].
Robbins, P. (2018). Risk and Return – How to Analyze Risks and Returns in Investing. [online] Corporate Finance Institute. Available at: https://corporatefinanceinstitute.com/resources/knowledge/trading-investing/risk-and-return/ [Accessed 8 Dec. 2018].
Mencia, J. (2009). Assessing the Risk-Return Trade-Off in Loans Portfolios. SSRN Electronic Journal.
Byrne, J. and Sakemoto, R. (2018). Risk-Return Trade-Off on the Currency Portfolios. SSRN Electronic Journal.
Salvador, E. and Aragó, V. (2011). The Risk-Return Trade-Off in Europe: A Temporal and Cross-Sectional Analysis. SSRN Electronic Journal.

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