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Example:

The partners of Packitup Partnership are considering the decision to convert to the corporate form of business organization. During your discussions with them, you determine that they have only the vaguest ideas about the relationship between corporate debt and equity.

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Prepare a memo to the partners of Packitup Partnership describing the concept of solvency, the two main components of corporate capital, and how capital structure decisions affect the risk profile of a firm.

Type your communication below the line in the response area below.

REMINDER: Your response will be graded for both technical content and writing skills. Technical content will be evaluated for information that is helpful to the intended reader and clearly relevant to the issue. Writing skills will be evaluated for development, organization, and the appropriate expression of ideas in professional correspondence. Use a standard business memorandum or letter format with a clear beginning, middle, and end. Do not convey information in the form of a table, bullet point list, or other abbreviated presentation.

To: Packitup Partnership Re: Solvency and capital structure

Level 5 Example To: Packitup Partnership Re: Solvency and capital structure

Solvency is a firm’s ability to pay its noncurrent obligations as they come due and thus remain in business in the long run (this is in contrast to liquidity, which is the ability to remain in business in the short run). The key ingredients of solvency are the firm’s capital structure and degree of leverage. A firm’s capital structure includes its sources of financing, both long- and short-term. These sources can be in the form of debt (external sources) or equity (internal sources).

Debt is creditor interest in the firm. The firm is contractually obligated to repay debtholders. The terms of repayment (i.e., timing of interest and principle) are specified in the debt agreement. As long as the return on debt capital exceeds the amount of interest paid, the use of debt financing is advantageous to a firm. The return is often enhanced due to the fact that interest payments on debt are tax-deductible. The tradeoff is that an increased debt load makes a firm riskier (since debt must be paid regardless of whether or not the company is profitable). At some point, either a firm will have to pay a higher interest rate than its return on debt or creditors will simply refuse to lend any more money.

Equity is the ownership interest in the firm. Equity is the permanent capital on an entity, contributed by the firm’s owners in the hopes of earning a return. However, a return on equity is

uncertain because equity embodies only a residual interest in the firms assets (residual because it is the claim left over after all debt has been satisfied). Periodic returns to owners of excess earning are referred to as dividends. The firm may be contractually obligated to pay dividends to preferred stockholders but not to common stockholders.

Capital structure decisions affect the risk profile of a firm. For example, a company with a higher percent of debt capital will be riskier than a firm with a higher percentage of equity capital. Thus, when the relative amount of debt is high, equity investors will demand a higher rate of return on their investments to compensate for risk brought about by the high degree of financial leverage. Alternatively, a company with a relatively larger proportion of equity capital will be able to borrow at lower rates because debt holders will accept lower interest in exchange for the lower risk indicated by the equity cushion.

1.

Bowers & Boots Partnership, your client, has recently undertaken extensive foreign operations. The partners have been shocked to see how much the firm’s earnings have been impacted by changes in the exchange rates of foreign currencies.

Prepare a memo explaining the three types of exposure to exchange rate risk and the steps needed to address each.

Type your communication in the response area below.

REMINDER: Your response will be graded for technical content and writing skills. Technical content will be evaluated for information that is helpful to the intended audience and clearly relevant to the issue. Writing skills will be evaluated for development, organization, and the appropriate expression of ideas in professional correspondence. Use an appropriate business format with a clear introduction, body, and conclusion. Do not convey information in the form of a table, bullet-point list, or other abbreviated presentation.

2.

Lamson Legerdemain, your client, has been surprised by the volatility of some of his investment securities. As you confer with him, you discover that he remembers the term “sigma” from his statistics classes.

Prepare a memo to Lamson Legerdemain describing how standard deviation and coefficient of variation can be used to assess investment risk.

Type your communication in the response area below.

REMINDER: Your response will be graded for technical content and writing skills. Technical content will be evaluated for information that is helpful to the intended

audience and clearly relevant to the issue. Writing skills will be evaluated for development, organization, and the appropriate expression of ideas in professional correspondence. Use an appropriate business format with a clear introduction, body, and conclusion. Do not convey information in the form of a table, bullet-point list, or other abbreviated presentation.

3.

Rudder Co. wants to raise capital for a new product line. The CFO has requested your advice, as the company’s controller, on two alternatives being considered: the issuance of convertible debt or the issuance of redeemable preferred shares.

Prepare a memo to the CFO outlining and discussing the issues that the company wil need to consider for each of the two alternatives for raising additional capital.

Type your communication in the response area below.

REMINDER: Your response will be graded for technical content and writing skills. Technical content will be evaluated for information that is helpful to the intended audience and clearly relevant to the issue. Writing skills will be evaluated for development, organization, and the appropriate expression of ideas in professional correspondence. Use an appropriate business format with a clear introduction, body, and conclusion. Do not convey information in the form of a table, bullet-point list, or other abbreviated presentation.

4.

Susan, an individual with primarily consumer debts, has experienced significant financial trouble in the current year. She is considering filing for Chapter 7 bankruptcy but does not know whether she meets the requirements to file. She has asked the managing partner at Accountants LLP, Kristy, to explain to her the requirements that must be met to qualify for this type of bankruptcy. Kristy has asked you, a second-year staff member, to type a memo for Susan with the information requested.

Write a memorandum on the availability of Chapter 7 (liquidation) bankruptcy. The emphasis should be on the eligibility of an individual debtor with primarily consumer debts.

Type your communication in the response area below.

REMINDER: Your response will be graded for technical content and writing skills. Technical content will be evaluated for information that is helpful to the intended audience and clearly relevant to the issue. Writing skills will be evaluated for development, organization, and the appropriate expression of ideas in professional correspondence. Use an appropriate business format with a clear

introduction, body, and conclusion. Do not convey information in the form of a table, bullet-point list, or other abbreviated presentation.

5.

The CFO of your company is considering the implementation of a payment policy that will capture all cash discounts offered by vendors. Currently, your company’s policy is to pay all invoices 60 days from receipt of a vendor’s invoice.

The CFO has asked you to prepare a memo summarizing key issues to consider prior to the implementation of a payment policy that captures all cash discounts offered by vendors, including any advantages and disadvantages of the policy.

Type your communication in the response area below.

REMINDER: Your response will be graded for technical content and writing skills. Technical content will be evaluated for information that is helpful to the intended audience and clearly relevant to the issue. Writing skills will be evaluated for development, organization, and the appropriate expression of ideas in professional correspondence. Use an appropriate business format with a clear introduction, body, and conclusion. Do not convey information in the form of a table, bullet-point list, or other abbreviated presentation.

6.

FoodForm is a fruit farming company that grows oranges. The owner of FoodForm is planning to build a new warehouse to store harvests in the coming years. After a discussion with a bank manager, the owner of FoodForm is required to draft a plan for the investment, which should include a calculation of an investment criterion using net present value (NPV), internal rate of return (IRR), or payback period.

The owner has asked you, the accountant of FoodForm, to explain NPV, IRR, and payback period so that he can decide which investment criterion to present. Prepare a memo explaining NPV, IRR, and payback period and their advantages and disadvantages.

Type your communication in the response area below.

REMINDER: Your response will be graded for technical content and writing skills. Technical content will be evaluated for information that is helpful to the intended audience and clearly relevant to the issue. Writing skills will be evaluated for development, organization, and the appropriate expression of ideas in professional correspondence. Use an appropriate business format with a clear introduction, body, and conclusion. Do not convey information in the form of a table, bullet-point list, or other abbreviated presentation.

  • Level 5 Example

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