Financial Management of a Company - Coursework Example

? Financial Management Table of Contents Answer a) 3 Answer b) 5 Answer c) 9 References 12 Answer a) As a medium size company, XX Chemical needs finance for its foreign investment in projects. Capital investment is one of the most critical strategic business activities of multinational businesses. These companies have to invest huge amount of capital in foreign markets for global expansion business through emerging markets. Rights issues is one of the efficient way of raising funds required for capital investment in projects. Investment banks are the expertise of this service for the middle and large scale companies. Rights issue by the companies refers to a corporate invitation to the existing shareholders of the company to buy additional new shares of the company. Cash-strapped companies generally turn to rights issue for raising finance from market for investments in business activates. The companies grant shareholders chance to buy new shares at a discount rate than current market of share on a pre mentioned future date. Investment banks do this activity for business for some percentage of banking percentage on total amount of issued fund. By issuing share, the companies give opportunity to the shareholders to increase their financial exposure by purchasing companies’ stocks at a discounted price. Investment banks conduct the necessary legal activities to issue new shares on behalf of the companies by taking banking fees. The can trade the issued rights on market in similar way they trade ordinary shares through stock exchange until the new shares are bought back by the companies. Theoretically, some traditional and efficient methods are used to evaluate capital investment in domestic as well as emerging foreign markets by businesses. But, capital investment is highly risk associated strategic business activity and the company needs to focus beyond the traditional methods of evaluating capital investments like net present value, internal rate of return, payback period etc. Emerging financial businesses like investment banking and financial research companies offers flawless capital investment solutions to many leading multinational organizations and they follow several advanced methodologies for evaluating proposed capital investment practices by the MNCs especially in emerging markets. The main objective to use beyond the traditional methods is to reduce future risk i.e. these methods helps to identify the maximum extent of risk possibilities and provide alternative solution to reduce the possible risk in substantial extent. One of the efficient methodologies for evaluating capital investment is Salomon-Smith-Barney Model. This methodology is widespread and efficient method used by leading investment banks to evaluate capital investments especially in the emerging markets for reducing risk of investment. This is one of the most recent developed methodologies for international capital investment and it was developed in 2002 by Zenner and Akaydin for leading US investment bank Salomon Smith Barney (Anson, 2011, p.488). This model is risk adjusted and modified extension of G-CAPM approach of capital valuation. In this methodology, different global factors and are considered with a high importance and regional factors are recommended as useless due to market inefficiency. This model mainly focuses on how risk possible risk can be identified in maximum extent and how it can be minimized. As this methodology is modified extension of G-CAPM approach, therefore, it has focused on key shortcomings of the approach. Having a main objective to reduce risk of foreign investment especially in emerging economy perspective, this methodology has focused on a key fact that emerging markets are not totally harbor specific and integrated restraint and complications which can justify a risk premium. The developer of this methodology added an idiosyncratic risk premium into the G-CAPM approach and extended that approach in a new form with high capability of risk indication and reduction. This methodology has adjusted the country risk premium by the overall risk level of a specific capital investment. Country risk premium is generally referred by many capital investment models as it is unadjusted risk political premium of the target country. This is qualitative measure which might not be real valued and incorporated in a valuation model. But this methodology use sovereign bonds yield spread in place of political risk premium which is based on high approximation and highly overestimates required rate return from the capital investment in foreign markets. Thus, this methodology can adjust the most debated country risk premium that can be depending on cash flow from highly risky projects or investments and different individual risk characteristics of specific projects with full premium. Answer b) It is a new trend in leading Multinational Corporation to set up separate treasury and finance department for separating financial responsibilities and companies expect that this change in organization structure leads to better capital budgeting and spending. The overall financial activities and roles of finance department will be divided among these two departments. Treasury department holds the central role in company finance in modern multinational organizations. Major responsibility of treasury departments is liquidity management so that company has sufficient cash position for managing business operations. But, only this responsibility cannot meet the goal of a company for separating the treasury department. Therefore, treasury department should have wide range financial responsibilities. Cash forecasting: This is the first role of treasury department. Opposite to the accounting executives who maintain records of daily financial transaction like cash receipt and disbursement activities, the treasury professionals need to evaluate all daily records done the accounting executives to generate cash forecast for short term or long term period. Cash forecasting consist of three main sub activities. Treasury staffs need to determine the necessity of cash in next quarter or next financial year. This will help them to decide whether they need to concentrate on liquidity or financing through debt or equity. They also need to plan for investment if they find surplus of cash. They also need to plan for hedging to reduce foreign currency translational risk. Managing working capital: Working capital management is important financial activity of a company which determines efficiency of a company. Major amount of cash is used in this activity which is the main components of cash forecasting. Working capital management involves changes in current liabilities and current asset with respect to current sales. The treasury professionals need to determine working capital trend so that they can identify necessary requirements and report to the management about the impact of propo9sed policy regarding working capital management in short terms basis. Cash management: Cash management is combination of cash forecasting and working capital management. Treasury professionals need to ensure sufficient cash position for operational needs of the company. Managing investments: If treasury department finds out cash surplus in current quarter or current financial year then the treasury staffs need to identify efficient investment opportunities for the company. Investment management consists of three major objectives. These are matching the cash requirements of company with the proposed investment maturity, higher return on investment than general interest rate of banks, investment associated with lower risk to ensure return with risk free interest rate. Managing treasury risk: The treasury professionals also responsible for managing financial risk through effective implementation of hedging strategies. It is most important tactics that the treasury department need to follow to minimize the return on investment from company’s investment in diversified financial instruments. Treasury department need to follow three main objectives regarding efficient management of treasury risk. They need ensure company’s efficiency in terms of interest on debt if market interest rate on debt rise in future. Second objective is they need to ensure company stable position in terms of foreign currency transaction because sudden decline of foreign currency exchange rate affects the company’s financial position in substantial extent. Corporate relation with credit rating agencies: If company issue marketable debt to raise finance from market then the treasury department need be ready to provide detailed financial information about company’s financial position if credit rating agencies require these information for assigning credit rating of company’s financial condition. Therefore, treasury department should respond fast with the detailed information about the company financials anytime required by any external stakeholders. Relationship with creditors: Long term corporate relationship with the creditors especially with the bank which provide banking service and financial solution to the company is very much important for getting faster cooperation from the bank in any financial difficulties. The treasury professionals need to often meet with the bankers and discuss about current financial position and its suture requirements of cash. They also need to discuss frequently about some other important areas of banking activity like banks’ frees structure, foreign exchange transaction, debt granted by the bank to the company, cash pooling, hedging, wire transfers etc. Raising fund: It is one of the most important activities of the treasury department. To ensure sufficient finance in meet any business requirements of the company, the treasury professionals need to maintain excellent relationship with the potential investment community for proposing investment on the company. One potential member is there in investment community i.e. investment banks that assists the company to sell some percentage of company’s debt and equity holdings to the potential investors, pension funds and other potential sources of cash in the market that generally want to buy company’s debt and equity offering. Therefore, the treasury professionals need to analysis the market condition frequently to identify the excellent sources of finance on the basis of interest rate and maturity period. They also provide efficient logic and benefit for the company for selecting a particular source of finance so that management can convince the current the shareholders of the company as they are also need to inform about company’s strategic financial decisions. If the company sets up separate finance department then the roles and responsibilities of finance department would be very specific and different from treasury department’s responsibilities. Bookkeeping is the first role of finance department where the finance professionals need to track on capital spending of the company. Profit and loss statement analysis is another responsibility of finance professionals. The3y need to ensure the financial strengt5h and weakness of the company. The finance mange3rs also need to be updated about the most recent financial market information so that they can determine bets financial decision in terms of investment in different financial instruments. They also need to evaluate cost of a new product development. Opposite to treasury department, one major role of finance department is effective financing. Finance professionals play an integral role in equity financing whereas the treasury departments focus on the debt financing more. Finance department also determine the retained earnings amount based on strategic business decision by the management and also determine the amount dividend to the existing shareholders of the company. Budgeting is another key important role of finance department. It is responsible for efficient financial budgeting based on the forecasted report of sales and research and development department. Accounts and payable and receivable management also responsibility of finance depart which determines credit collection efficiency of the company. Therefore, though finance and treasury departments’ roles and responsibilities are interlinked to each other but separation of roles would lead to better capital budgeting and spending. Answer c) Inflation makes up the market rate of return in the economy. But, capital investment decision is generally made after estimating the cost of capital using market rate. But inflation has substantial impact on market rate of return as rising inflation leads to rise in market rate return. But real rate of return is market rate of return minus current inflation and it has not any impact of inflation. Now, if inflation suddenly raises market rate of return or cost of capital decreases. Therefore, market capital cost does not represent the real cost of capital of borrowing funds. Inflation is a difficult factor for capital investment especially in developing countries. If inflation rate increases, the investors requires higher real rate of return to efficiently manage the working capital or minimum cash flow requires sustaining business operations. Inflation also affects the outcome of capital budgeting in many other ways than real rate of return. It increases cost of goods and services raw material, equipment and wage rate. Overall increase of these lead to high cost of operation and this cannot be afforded by internal rate of return from the project. Impact of inflation can be removed from return on capital investment by evaluating the proposed capital investment in a specific manner. If analysis of capital investment is done by considering the real rate of return in future cash flow calculation of a proposed project. So, if real rate of return is adjusted then impact of inflation can be neglected. Adversely current inflation including growth of inflation can be adjusted with the future cash flow from a project and thus impact of it can be neglected (Dayananda, Irons, Harrison, Herbohn & Rowland, 2002, p.22). Sensitivity analysis is a major strategic business practice by the companies in their capital investment decision making process. It will help the company to analyze change in output from an investment with respect to any possible change in one of the variables. The objective of sensitivity analysis is to identify the sensitive nature of a capital investment i.e. the difference between extent changes in output with respect to extent of change in any of the inputs. Therefore, XX Chemical can identify the sensitivity of its capital investment in different countries. There are different methods to conduct sensitivity analysis to identify financial and economic effect on capital investment. But, all aims to estimate the future possibility of return from an investment if the assumption and forecasted variables turn out to be unreliable. Therefore, it helps the mangers to decide all possible outcomes in different changes of variable so that they can make changes in the assumption and even the amount and place of investment (Baker & Powell, 2009, p.285). XX Chemical can better analyze its proposed investment in many emerging market across the world and can identify less sensitive investment region. Sensitivity analysis will help the company to evaluate internal rate of return and net present value for three major assumptions like optimistic, pessimistic and expected. This will bring a major competitive advantage for the company in its sector of business so that the company can select best possible investment opportunity in global emerging market. To increase the internal capacity of investment in XX Chemical needs to invest more in this country so that it can achieve high economies of scale in terms of output compared to increase in input. It help the company to receive high cash flow from investment with lower increase in input i.e. investment. But, this strategy can not implemented in global expansion of projects because overall risk will be high with increase of investment in new target markets. In developing countries risk of capital investment more than increase of investment. Therefore, achieving economy of scale cannot feasible in global expansion strategy of the company. References Anson, M. J. P.2011. Quantitative Investment Analysis. John Wiley & Sons. Baker, H.K. & Powell. G. 2009. Understanding Financial Management: A Practical Guide. John Wiley & Sons. Dayananda, D., Irons, R., Harrison, S., Herbohn, J. & Rowland, P. 2002. Capital Budgeting: Financial Appraisal of Investment Projects. Cambridge University Press. Read More