Finance Assignment Example | Topics and Well Written Essays - 2250 words

Finance - Assignment Example A firm with more contractual obligations i.e debt but insufficient cash or marketable securities to repay the debt definitely faces liquidity problems. The circumstances turn grimmer with more and more liquidity crisis in the organization when the firm becomes completely unable to repay its obligations, thus the firm in such situations become insolvent or faces solvency problems. Thus with more amount of liquidity crisis with not much fresh cash or marketable securities in the system, the firm tends to borrow more from the banks and financial institutions thereby increasing its obligations of repayment more. But with high debt to equity ratio sometimes it becomes difficult for organizations to obtain debt from the financial institutions. This definitely hampers the operational activities of the organization. In such a situation with deep crisis of liquid cash to carry out business and with difficulty in getting loans from the banks, the sustainability of the firm in the long run gets hampered. In certain cases the firm becomes insolvent and may go out of business. (Burnside, 2005, pp.87-90; Course material, pp.112-118) Different approaches to Financial Asset Valuation: One of the major approaches designed in the financial valuation process includes valuation of Equity. The major forms of equity valuation include- 1) Dividend discount modeling- Under this method of valuation, the valuation of the firm is determined by the dividends paid out by the firm. Using the  projected growth rate in dividends in the next 5 years with an estimated growth rate and then using a constant growth rate for the rest of the years, discounted by the required rate of return by the shareholders’  the valuation of the firm is determined. 2) 2) The free cash flow modeling approach- The valuation method is performed using the free cash flow. The free cash flow is the cash flow available to the firm after meeting the necessary capital expenditures and necessary short-term worki ng capital requirements. In this method also, the valuation is performed using the projected free cash flow in the next 5 years using a projected growth rate and then a constant rate for the rest of years after the 5-year period, discounted by the required return for the shareholders. 3) 3) Price earning model- This equity valuation method is a market based method which calls for the market price an investor wants to pay for 1 rupee earning by the company. Higher Price-Earnings ratio designates that the company is overvalued in terms of its market compared to its earnings. Besides equity valuation, we have valuation for fixed income securities like bonds. Bonds, which have fixed coupon rate attached to them, pay fixed interest every year. The fair value of the bond is calculated by the annuity approach which is calculated by the summation of the net present value of the fixed coupon interest over the maturity of the bond with a discount rate as required by the bond holders. (Pinto, Henry, Robinson & Stowe, 2010, p.1) 1B)   On the Capital and Liability side of the Balance sheet of different organizations, the different types of capital and liabilities have different features. These are categorized under the major head ‘Financial capital’. The different classifications include the following: 1) Senior debt, 2) Mezzanine debt, 3) Subordinate debt, 4) Preferred Stock and 5) Common Stock. In case a company goes bankrupt, the company has to first pay back its obligations to the debt holders and finally to