FINANCIAL MANAGEMENT AND POLICY

FINAL EXAMINATION

BLEMBA 70
SYNDICATE 2
Akbar Russavel Navis (29123457)

SCHOOL OF BUSINESS AND MANAGEMENT

INSTITUT TEKNOLOGI BANDUNG
2024
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FINAL EXAMINATION (INDIVIDUAL WORK)

SEMESTER II 2024/2025 SESSION

COURSE : FINANCIAL MANAGEMENT AND POLICY

COURSE CODE/ CLASS : MM5006 / BLEMBA70

DATE : 26/08/2024

VENUE : HOME!

DEADLINE : 26/08/2024, 11:59 M

Questions for Students with Odd Student IDs:

1. A company has EBIT of $400,000 and is considering issuing $2 million in debt at an
interest rate of 5%. If the company's tax rate is 30%, calculate the Degree of Financial
Leverage (DFL) and discuss how it would affect the company's financial risk.
Answer:
▪ Calculate Earnings Before Taxes (EBT)

EBIT = $400,000
Interest Rate = 5%
EBT = $400,000 – ($2,000,000 x 5%)
= $300,000

▪ Calculate Degree of Financial Leverage (DFL) [1]

𝐸𝐵𝐼𝑇
𝐷𝐹𝐿 =
𝐸𝐵𝑇

$400,000
= = 1.33
$300,000

A 1% change in EBIT will result in a 1.33 % change in net income according to the DFL
value of 1.33. As a result, this suggests that the company’s revenue will rise by 33%. On
the other hand, net profit will drop by 1.33 % for every 1% decline in EBIT. The company

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is exposed to greater financial risk and will experience larger fluctuations in EBIT which
will impact net profit the higher the DFL value. A higher DFL suggests that variations in
EBIT have a greater impact on the net profit of the company. Because of this sensitivity
there is a chance that shareholders will make more money but there is also a chance that
they will lose more.

2. A company currently has a debt-to-equity ratio of 1.5 and a weighted average cost of
capital (WACC) of 8%. Calculate the impact on WACC if the company increases its debt-
to-equity ratio to 2.0. Explain how this change could influence the firm's optimal capital
structure.
Answer:

[1]

Where:
▪ E = Value of Equity
▪ D = Value of Debt
▪ V = Total Value of the Firm (Equity + Debt)
▪ rE = Cost of Equity
▪ rD = Cost of Debt
▪ T = Tax Rate

With the increase in debt-to-equity ratio to 2.0 then:

𝑉 = 𝐸 + 𝐷 = 𝐸 + 2𝐸 = 3 𝐸

This gives rise to the following new proportions:

𝐷 2𝐸
= = 0,67
𝑉 3𝐸
𝐸 𝐸
= = 0,33
𝑉 3𝐸

Then we recalculate the WACC assuming that the tax rate is 20% and the cost of equity
increases by 1%.

▪ WACC dengan Debt to Equity Ratio 1.5

𝑊𝐴𝐶𝐶 = (0.4 𝑥 𝑟𝐸) + (0.6 𝑥 𝑟𝐷 𝑥 (1 − 𝑇)

𝑊𝐴𝐶𝐶 = (0.4 𝑥 𝑟𝐸) + (0.6 𝑥 𝑟𝐷 𝑥 (0.8))
𝑊𝐴𝐶𝐶 = (0.4𝑟𝐸) + (0.48𝑟𝐷)
𝑊𝐴𝐶𝐶 = (0.4 ∗ 11%) + (0.48 ∗ 7%) = 8.16%

▪ WACC dengan Debt to Equity Ratio 2.0

𝑊𝐴𝐶𝐶 = (0.33 𝑥 1.03𝑟𝐸) + (0.67 𝑥 1.02𝑟𝐷 𝑥 (1 − 𝑇)

𝑊𝐴𝐶𝐶 = (0.34𝑟𝐸) + (0.67 𝑥 1.02𝑟𝐷 𝑥 (0.8))
𝑊𝐴𝐶𝐶 = (0.34𝑟𝐸) + (0.54𝑟𝐷)

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𝑊𝐴𝐶𝐶 = (0.34 ∗ 11%) + (0.54 ∗ 7%) =

If it is assumed that the original rE is 11% and rD is 7%, the data above shows that there
is a decrease in the WACC value when the debt-to-equity ratio becomes 2.0.

Influence on Optimal Capital Structure:

In comparison to its own capital the company uses a larger percentage of debt to
finance its operations and investment activities when its debt-to-equity ratio is
higher. The more debt there is in the capital structure of the business the greater
the effect of this condition. In this case study a rise in the debt-to-equity ratio
results in a fall in the WACC value this indicates that the capital structure of the
business is approaching the ideal range where the cost of capital is as low as
possible, and the value of the business is maximized. The financial risk to the
company increases with the amount of debt utilized. Because of this increased risk
investors will demand a higher rate of return which will drive up the cost of equity.
It should be mentioned though that there is a sweet spot when it comes to using
debt. Overusing debt can result in a significant increase in the cost of equity capital
which raises the overall weighted average cost of capital (WACC) even though it
initially lowers it.

3. Compare and contrast the benefits of a regular dividend payout policy versus an irregular
payout policy. For a company with volatile earnings, which policy would be more beneficial
for shareholders, and why?
Answer:
Table 1 Regular and Irregular Dividend Payout Policy Comparison
Regular Dividend Payout Policy Irregular Payout Policy
Shareholders receive predictable cash Provides an opportunity for the Company to
flows and dividend benefits maintain cash so as to provide more flexibility
in making investments in the next period or
expanding the business. In addition, it is also
useful for the Company to maintain in periods
when the Company's profits are lower
As an indication that the company has Especially for companies with fluctuating and
strong financial stability, it increases the unstable income levels, an irregular dividend
level of investor confidence in the policy allows dividends to fluctuate in line
company which can have an impact on with the Company's performance avoiding
increasing the company's share price. the risk of overcommitment to payments
during downturns.
Signalling to investors that management It is possible for investors to receive larger
is confident in the company's future dividends when the Company is in a period of
earnings. It is also a sign that the high profitability
company is confident in its sustainable
level of profitability.
Lack of flexibility for the Company to use There are indications of a decrease in the
cash for investment or expansion level of investor confidence due to the lack
of certainty in dividend payments, which can
affect the share price.
The company will experience pressure
from investors to maintain the same
level of dividends, even when its
financial condition is not favourable.

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Regular dividend payments are also a

way for companies to attract new long-
term investors who prefer stable returns
and lower risk.

Which Policy is More Favourable for Companies with Fluctuating Revenue?

The policy for paying out dividends is contingent upon the attributes possessed by the
shareholders. While the majority of shareholders with long-term investment
objectives view the irregular payout policy as the most profitable and
successful alternative short-term investors do expect regular dividend
payments. The company needs to invest its income in order to expand rather than
paying dividends to shareholders because it is expected by investors that the business
will grow annually. A policy of irregular dividends allows the company to reinvest the
majority of its profits even during times of high earnings towards growth projects. In the
end this could result in higher returns for shareholders and boost the company’s long-
term value. Dividend payments can be modified by companies with erratic earnings in
accordance with their financial situation. The corporation may decide to cut or even cease
paying dividends in times of low earnings in addition to paying higher dividends in times
of strong earnings. The company can now manage its cash flow with more flexibility
thanks to this.

Mining companies such as PT Adaro Energy Tbk (ADRO) and PT Bukit Asam Tbk (PTBA)
are examples of companies with irregular dividend payments. Dividend payments are
based on coal commodity price conditions. When coal prices rise and are profitable, the
company will pay dividends but when prices are low, shareholders often do not receive
dividend payments. In addition, sometimes the Company does not make dividend
payments to expand the business which will ultimately provide greater revenue and
benefit the Company. This will in turn increase the Company's share price and provide
capital gains for shareholders. [2].

4. A retailer has an average inventory level of $400,000 and an annual cost of goods sold
(COGS) of $2 million. Calculate the firm's inventory turnover ratio and suggest inventory
management techniques to improve liquidity and reduce holding costs.
Answer:

[1]

$2,000,000
𝐼𝑇𝑂 =
$400,000

𝐼𝑇𝑂 = 5 𝑥

This means that the retailer's inventory turnover is 5 times a year. To improve liquidity
and reduce storage costs, retailers can implement the following inventory policies:
▪ Accurate Demand Forecasting (Demand Forecasting)
A good market demand analysis can help companies better predict and plan inventory
needs. This allows companies to have inventory that matches actual demand,
avoiding excess, or shortage of inventory [3].
▪ Just in Time Method and Economic Order Quantity Policy
Retailers can adopt the just in time method especially for items with short life cycles
or fast expiry times. So that the inventory value becomes more optimal. However, it

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is necessary to pay attention to the lead time of each product because of course
customers do not want the goods they have not arrived for too long than expected
so that the Company also needs to calculate and analyze when and how many
products they should provide to meet customer expectations but still consider the
average inventory.
▪ ABC Analysis
Through this method, retailers can group and cluster their inventory. When each type
of inventory can be grouped, retailers can determine which policy is most effective
for each type of inventory.
▪ Inventory Management Automation
By adopting an automated inventory management system, companies can improve
accuracy and efficiency in inventory management. Some of the benefits of asset and
inventory management automation are [3]:
1. Reduce the risk of human error in recording and tracking inventory
2. Reduce the time and cost required for asset tracking and updating inventory
3. Enables real-time inventory updates and provides reports automatically
▪ Improve Product Sales
A low inventory turnover ratio can be improved by improving product sales.
Companies can implement several strategies, such as creating an effective sales
promotion plan, training employees and knowing the keys to successful sales from
other companies.
▪ Supply Chain Optimization
Companies can improve relationships with suppliers, reduce procurement cycle times,
and improve production processes to help increase inventory turns. Close cooperation
with suppliers and shortening procurement cycle time can help speed up inventory
flow.

5. Discuss the strategic reasons behind a vertical merger versus a horizontal merger. Provide
examples of recent mergers for each type and evaluate their success based on financial
performance and market positioning.
Answer:
Table 2 Vertical and Horizontal Merger Comparison
Vertical Merger Horizontal Merger
Integrate business at product suppliers Horizontal mergers occur when companies
or users to stabilize forces and users. operating in the same or similar industries
Not all companies have a complete line merge together. The goal of horizontal
of business starting from input supply to mergers is to utilize economies of scale more
marketing. In order to guarantee that efficiently, increase market power, and
the supply will run smoothly, companies capitalize on cost and revenue-based
merge with suppliers synergies [4]
The strategic reason for vertical Increase market share and reduce
mergers is to control the supply chain. competition in the industry so that the
By merging with a supplier company, Company will generate more optimal profits
the Company can have full control over
its suppliers so as to avoid dependence
on the supplier company. This condition
will certainly lead to cost optimization
and the Company can control the quality
of its products

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Business process efficiency and realizing Enhance diversification and reshape the
a lean company. The company can company's competitive scope by reducing
optimize and efficiency of the operation intense competition
process and integration between its
lines of business
Reduce transaction costs, increase Realizing economy of scope and sharing of
production efficiency, and improve complementary skills and resources
product quality

The vertical merger also allows the Leverage further economies of scale (thus
Company to provide barriers for reducing costs)
competitors to enter the business field
because the Company controls the
business supply chain

Both vertical and horizontal mergers will Both vertical and horizontal mergers will
allow the company to gain access to allow the company to gain access to new
new technologies or innovations technologies or innovations developed by the
developed by the acquired company acquired company thereby reducing
thereby reducing Research and Research and Development costs which are
Development costs which are sometimes one of the large costs incurred by
sometimes one of the large costs companies
incurred by companies

Horizontal Merger
Merger of BUMN Islamic Banks in Indonesia
In December 2020 there was a corporate action where several Islamic Banks in Indonesia
were merged, namely: BRI Syariah, Bank Syariah Mandiri, and BNI Syariah merged into
Bank Syariah Indonesia. The results of the merger of three Islamic banks owned by
Himbara (Association of State-Owned Banks) brought great benefits to BSI. Among
others, BSI successfully enlarged its business scale and significantly increased the number
of customers. After the merger, the number of BSI customers increased by more than 5
million to 20 million by March 2024. Year-on-year, BSI's asset growth reached double
digits while the industry only grew by single digits. In addition, financing and third-party
funds also increased [5]. Based on the financial statement data from 2020 to 2023, it
shows that there is growth every year in terms of revenue, gross profit and income, which
shows that the merger decision has a positive impact on the Company's performance.

Table 3 Income Statement BSI [2]

In Billion IDR 12M 2023 12M 2022 12M 2021 12M 2020

Total Revenue 22,252 B 19,623 B 17,808 B 4,347 B

Total Cost Of Goods Sold (5,993) B (4,032) B (4,379) B (1,532) B
Gross Profit 16,259 B 15,591 B 13,430 B 2,815 B
Total Operating Expense (8,857) B (10,084) B (9,423) B (2,382) B
Income From Operations 7,591 B 5,648 B 4,108 B 433 B
Non-Operating Income/Expense (2) B 9B (46) B (28) B
Income Before Tax 7,399 B 5,515 B 3,961 B 405 B
Tax Expense (1,696) B (1,255) B (932) B (157) B
Net Income For The Period 5,704 B 4,260 B 3,028 B 248 B
Other Comprehensive Income 34 B 51 B 190 B 7B
Total Comprehensive Income 5,738 B 4,311 B 3,218 B 255 B
Net Income Attributable To 5,704 B 4,260 B 3,028 B 248 B

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Furthermore, in terms of growth in total assets, market cap and share price, there is a
significant increase from the time of the merger to the current condition.

Figure 1 Market Cap, Total Asset and Stock Price of BSI [2]

Based on the graph above, it can be concluded that the merger decision of Indonesian
Islamic banks is one of the successful corporate actions, although in the future the right
strategy is needed so that BSI can be sustainable and increase its revenue and markep
cap.

Vertical Merger
PT Perusahaan Gas Negara (PGN) dan PT Pertamina Gas (Pertagas)
PT Perusahaan Gas Negara Tbk (PGN) officially took over 51% ownership of PT Pertamina
Gas (Pertagas) and its four subsidiaries with a transaction value of IDR 20.18 trillion. The
purpose of this action is of course to create efficiency in the natural gas business chain
so as to create more competitive gas prices to consumers, increase the capacity and
volume of national natural gas management, and improve financial performance. The
acquisition of Pertagas by PGN is a form of integration between oil and gas SOEs to create
efficiency in the natural gas chain, which has the potential to create more competitive
gas prices for consumers, increase the capacity and volume of national natural gas
management, and improve the financial performance of oil and gas SOE holding
companies. Through this action, the Company is expected to build and integrate gas
pipelines owned by PGN and Pertagas both in Java and Sumatra. This will certainly have
a positive impact on the Company's financial performance where it will reduce investment
costs and research and development costs because one of the companies already has the
technology [6].

Based on the financial statement data from 2018 to 2023, it shows that there is growth
every year in terms of revenue, gross profit and income, which shows that the merger
decision has a positive impact on the Company's performance. Although there was a
decrease in revenue in 2020 and 2021, which was the covid-19 period, the company
increased its performance again in 2022 to 2023.

Table 4 Income Statement of PGN [2]

In Billion IDR 12M 2023 12M 2022 12M 2021 12M 2020 12M 2019 12M 2018

Total Revenue 56,295 B 55,642 B 43,349 B 40,118 B 53,501 B 56,045 B

Total Cost of Goods Sold (44,970) B (43,471) B (34,970) B (28,239) B (36,439) B (37,082) B
Gross Profit 11,326 B 12,170 B 8,379 B 11,879 B 17,062 B 18,963 B
Total Operating Expense (2,951) B (2,937) B (2,378) B (8,709) B (8,595) B (9,618) B

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In Billion IDR 12M 2023 12M 2022 12M 2021 12M 2020 12M 2019 12M 2018

Income From Operations 8,374 B 9,233 B 6,001 B 3,170 B 8,467 B 9,345 B

Non-Operating Income/Expense (286) B (771) B 680 B (5,608) B (4,576) B (875) B
Income Before Tax 8,088 B 8,462 B 6,681 B (2,438) B 3,891 B 8,470 B
Tax Expense (2,274) B (2,204) B (1,476) B (562) B (2,320) B (3,190) B
Total Comprehensive Income 6,045 B 6,079 B 5,040 B (2,938) B 1,804 B 4,878 B

Furthermore, in terms of growth in total assets, market cap and share price, since 2018,
there has indeed been an increase in assets due to this merger process, but in terms of
share price and market cap there has been no significant increase and tends to stagnate.
However, the success rate of the merger cannot only be seen from a few aspects.
Through this action, PGN has achieved cost efficiency due to its control of the supply
chain and sharing of research and development costs, as well as increased revenue.

Figure 2 Market Cap, Total Asset and Stock Price of PGAS [2]

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References

[1] C. J. Z. a. S. B. Smart, Principles of Management Finance, 15th Edition, Pearson, 2019.

[2] https://stockbit.com/stream, "https://stockbit.com/," August 2024. [Online]. Available:

https://stockbit.com/stream. [Accessed 25 August 2024].

[3] https://www.shell.co.id/, "https://www.shell.co.id/," August 2024. [Online]. Available:

https://www.shell.co.id/in_id/konsumen-bisnis/shell-fleet-card/inventory-turnover-
ratio.html. [Accessed 25 August 2024].

[4] https://corporatefinanceinstitute.com/, "https://corporatefinanceinstitute.com/," August

2024. [Online]. Available:
https://corporatefinanceinstitute.com/resources/management/horizontal-merger/.
[Accessed 25 August 2024].

[5] https://www.bankbsi.co.id/, "https://www.bankbsi.co.id/," 11 July 2024. [Online].

Available: https://www.bankbsi.co.id/news-update/berita/bsi-targetkan-top-3-bank-
syariah-global-perjalanan-dan-tantangan-di-balik-mega-merger. [Accessed 25 August
2024].

[6] https://www.pertamina.com/, "https://www.pertamina.com/," 29 December 2018.

[Online]. Available: https://www.pertamina.com/id/news-room/energia-news/jadi-sub-
holding-gas-pertamina-pgn-akuisisi-pertagas-senilai-rp-20-18-triliun. [Accessed 25 August
2024].

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