Analysis of International Business Finance - Research Paper Example

International Business Finance Table of Contents Project A 2 Long Term Financing Structure 2 Risk and Risk Management 4 Cost of Capital 6 Financial Goals 8 Project B 10 The Strategic Fit 10 Synergies 11 Finance 11 Premium to Shareholders 13 References 14 Bibliography 15 Project A Long Term Financing Structure The two of the most important components of finance to any company are that of shareholder’s equity and debt. The share-holder’s equity is also known as the owned capital as shareholders are the true owners of a limited company. The debts, on the other hand, are borrowings for the company and are known as the loaner’s fund. The shares of the company are traded at the stock exchanges and therefore the market value of the shares gets changed every day according to the market scenario and investors valuation. In case of debt or loan, it is the balance sheet valuation. The Sony Group is a global leader in the segments like electronics, games, entertainment and financial services. As the company announces that their aim is to leverage their uniqueness to carry out their strategy aggressively, the same is true for the debt-equity structure of the company. The debt-equity ratio of a company defines the leverage that the company has initiated in terms of funds. Debt-equity ratio is calculated by dividing the total debt by the equity fund. Sometimes, it is also calculated on the basis of the long term borrowings and not the entire debt. The long term borrowings of the Sony Group for the accounting year ended on March 31, 2008 was ¥ 729,059 millions and the short term borrowings was figured out to be ¥ 63,224 millions. Apart from the two headings of liabilities, there was also the current portion of long term borrowings of ¥ 291,879 millions. Therefore, the total debt of the group was ¥ 1,084,162 millions. The equity of the company on the same date was ¥ 3,465,089 millions. Therefore, the debt-equity ratio for the group as on 31st March, 2008 was approximately 0.313. The result shows that the company did not leverage much as around 31% of the entire fund is raised through loan. Comparing the debt-equity ratio of the company with the previous year i.e. 2007, it was 0.325! The market value of shares of Sony as on March 31st, 2008 was ¥ 3.99 trillions i.e. 3990000 millions. Therefore, the debt equity ratio as per the market value was 0.27 which was even lower than the book value. The analysis reveals that the company is moving away from being leveraged more as it has decreasing trend of debts. Among the debts, the components of interest bearing debt have also reduced from the previous year by 1.1% i.e. ¥ 12.3 billions. The maturity of the long term debt is always above one year. The analysis shows that the company is reducing the long term debt over the years. The current portion of long term debt is the amount of debt that had matured with in the financial year. The balance sheet as on 31st March, 2008 reveals that in 2008 higher portion of long term debt matured (¥ 291,879 millions) compared to 2007 (¥ 43,170 millions). In case of short term loans, it is found that the company has increased short term borrowings in 2008 (¥ 63,224 millions) than in 2007 where it had ¥ 52,291 millions of loans to be repaid with in one year. Apart from these, other factors important for analysing debt structure are the currency in which debts are raised. If it is in the foreign currency like US$, then the international exchange rate also comes into play. The debts if taken in the fixed rates of interest, then it have to be paid at the same rate of interest. In case of variable rates, the interest rate can be different at different times. Risk and Risk Management Being a global player in the truest sense of the words, Sony Corporation is exposed to very high risks of currency and interest rate fluctuations. Though the company is from Japan and the consolidated income statements and the balance sheet is prepared on the Japanese currency, Yen, yet the fact is that only around 23.2% of the total sales and operating revenue for the accounting year that ended on 31st March, 2008 was recorded in Japan. The practice that the group follows while preparing financial statements is that at the outset, it prepares the statements on the basis of the local currencies and then converts them to Yen as per the monthly average currency exchange rate at the end of every fiscal year. So, the financial statements of Sony can be referred as local currency denominated results. As the group has large proportion of revenue attributing from outside Japan, so it would be fatal for the company if Yen strengthen against the globally accepted currencies like US Dollar (on 31st March 2008, $1 was equal to ¥ 113.3, 2.4% increase y-o-y basis) or the Euro (at the fiscal end of 2008, €1 was equal to ¥ 160, 7.1% lower y-o-y basis). To minimise such risks of currencies or that of exchange rate and interest rate fluctuations, the group uses risk management techniques like derivatives and hedging. Derivative is a type of financial instrument which has value written to some underlying assets. Hedging is the technique of minimising the risk of financial loss arising out of exchange rate fluctuations or other international financial factors. Derivative is a technique to hedge away the risk. Sony Corporation and all its subsidiaries that have international currency exposures, enter into commitment with Sony Global Treasury Services, Plc (SGTS) based at London. On behalf of the entire group, SGTS hedges the net foreign exchange exposures. On the other hand, SGTS enters into transactions with the globally reputed financial institutions for the foreign exchange transactions. The entire procedure is based upon the estimated exposure and the perceived risk well before the actual transaction takes place. Generally, it is done three months before the transactions gets shape but at times when the sales-cycle is shorter, it can be just before a month. The usage of complex derivatives to hedge risk is limited only to the financial segment. For the purpose of managing the interest rate fluctuations in the financial segment, Sony uses ‘Asset Liability Management’ method. To hedge risk in the electronics segment, the company tries to manufacture the goods locally i.e. where the goods are to be sold. If the hedged transactions manipulate the earnings of the group, the net change in the fair values of the derivatives is classified as earnings (if it had been under any other heads). The option contracts or the future contracts that do not qualify as hedged funds are marked-to-market with changes. The group had practised the system very effectively for both the fiscal years of 2007 and 2008. Cost of Capital The cost of capital is the charge that the company bears to raise the funds that it requires for both the long term as well as short term purposes. For the loan funds (borrowings), it is the interest charged to the company and for the owner’s capital i.e. equity, the profit distributed is the cost. As owners or the shareholders bears the maximum risk and are entitled to profit after all the parties are cleared off, so the notion is they charge the highest cost. The cost of capital of the company is denoted as Weighted Average Cost of Capital or WACC. The widely used formula to calculate WACC is as follows: WACC = Cost of Equity * Equity + Cost of Debt * Debt (1 – t) / (Equity + Debt) Where, t = Tax Rate (it is important because the companies are entitled to tax shield on the interest paid on loans taken. Cost of Equity (Ke) can be derived as follows: Ke = (Dividend per Share / Current Market Value of Stock) * Growth Rate of Dividends Ke = (351.10 / 3970) * 1.92 Ke = 0.169 = 16.9% The cost of debt is always lower than the cost of equity as the company has to keep certain underlying assets or financial papers as mortgage for the debt. Let us assume that the cost of debt to be 10% per annum. The basis of such assumption is that the company is a big brand and so it should not be more than 10%. To find the cost of debt, the long term borrowings and the current portion of such borrowings are only considered. The rate of effective tax for the annual financial year of 2007-08 had been 43.6% WACC = 0.169 * 3,465,089 + 0.1 * (729,059 + 291,879) (1 – 0.436) / (3,465,089 + 729,059 + 291,879) WACC = 14.34% Financial Goals The motive of doing business by taking all the pains is to earn return. The financial goals of the companies vary upon two broad headings i.e. corporate wealth maximisation and the share holder wealth maximisations. Traditionally, the sole objective of doing business was to earn return for the owners. The share holders of a company are the original owners. Therefore, shareholder’s wealth maximisation has been an important financial goal of the companies. Shareholder’s wealth of the company can be measured by measures like EVA (Economic Value Added). But in recent times, apart from wealth maximisation of the share holders, another model which talks about the financial goal of the companies is that of Corporate Wealth Maximisation. The Corporate Wealth Maximisation is a broad head which includes other parties related with the company apart from the share holders like that of suppliers of materials, customers of end products, human capital (employees or the work force), external parties like government and the bankers. There is no such method to measure the corporate wealth of the company (Watkins, n.d.). In case of Sony Corporation, it is found that the company has definitely cared for share holder’s wealth maximisation as the diluted dividend declared had been doubled in 2008 compared to the previous fiscal year of 2007, from ¥ 120.29 (in 2007) it went up to ¥ 351.1 (in 2008). Also, it had declared cash dividends for three consecutive years. Sony Corporation, a global brand in its own right, has also taken number of measures to benefit its stakeholders. Corporate social responsibilities initiated by Sony include environmental initiatives like reducing emission of green house gas and reducing power consumption. To fight the threat of global warming Sony has initiated global seminars. Along with IBM, Sony has formed EICC (Electronic Industry Citizenship Coalition) to implement shared efficiencies and code of conducts among the suppliers. To promote young talents, Sony had initiated Sony Student Project Abroad (China). Also, it had denoted digital cameras to UNICEF under Eye See Project. Sony is also partner to the soccer federation of the world, FIFA! All the above initiatives and measures make the company more attractive to the external parties and a dream company for the prospective employees. Therefore it can be said that the company maintains fine balance in between the two types of financial objectives of share holder’s wealth maximisation and the corporate wealth maximisation. Project B In the recent past, there has been an increasing trend of mergers and acquisitions throughout the world. As the business environment has become competitive and there has been constant change in the process, the mergers and acquisitions are becoming increasingly important for the major players to reduce competition and mutually benefit each other to efficiently use resources. The acquisition of Arcelor by Mittal Steel in 2006 was such a case. It was the industry leader acquiring the second largest producer of steel. The Strategic Fit Both the individual companies i.e. the Mittal Steel as well as the Arcelor were into the same industry of steel producing. Mittal Steel was owned by LN Mittal (his family held 88% shares), a non-resident Indian and the company was head-quartered at Rotterdam of Netherland, operated from London. The Arcelor Steel operated from France where as the government of Luxembourg was a stakeholder at the company. Though at the outset, the European governments were cynical about the deal and even the management of Arcelor tried to portray their aptness as individual company, the auditors of Arcelor Steel maintained the acquisition was in the best interest of the company. The deal provided a high boost to the research and development of the merged entity and to develop their core competencies. Arcelor-Mittal has more than 1300 fulltime researchers and 14 research centres all over the world. Also, the acquisition helped to reduce competition and so cost. Synergies The objective of any merger is to develop synergies for both the companies. The case of Arcelor-Mittal was also no different. There were numerous advantages attached with the merger. The combination of both the companies made them much ahead of their nearest competitor. Arcelor-Mittal as a joint company would have a huge array of products both in terms of value as well as quality as Arcelor generally produced high end products where as Mittal Steel concentrated on volume. Arcelor had a huge base in the European market and so has Mittal Steel in America. The enhanced geographical reach was also an important synergy. The merged entity also had higher bargaining powers in the industry. As it was way ahead of its nearest competitors, it could dictate the external forces of marketing, manufacturing and purchasing. Finance At the outset, Mittal Steel offered $ 22.7 billions to Arcelor share holders (8 Questions, 2006). But the management of the Arcelor was initially hostile towards the bid by Mittal Steel as they thought it to be the company for Indians. The French government was also hostile as it was not sure about the future of the employees with Mittal Steel taking over. But later, as Mittal Steel increased the bid to $ 32.2 billions. According to the CFO, Aditya Mittal the deal price was re-estimated as the forecasted production of Arcelor increased and also the outlook of the steel industry was stronger at the time of the deal compared to the earlier bid date (Knowledge @ Wharton, 2006). Premium to Shareholders The shareholders of Arcelor rejected to be acquired by the Russian company, Severstal which was a sort of imposed proposal for merger by the Arcelor management to get rid of Mittal Steel. As the talks began in January, 2006 Mittal Steel made a bid of $ 22.7 billions and it proposed to pay the shareholders of Arcelor would have obtained 4 shares of Mittal Steel along with € 35 for every 5 shares of Arcelor. But as in June, after six months of intense negotiations, raised the valuation to $ 32.2 billions, the share holders of Arcelor were entitled to 13 Mittal shares and a cash of $ 188.93 for every 12 shares held of Arcelor. The acquisition made the merged entity to explore huge potentials. The Mittal family has the shares of more than 43% of Arcelor Mittal. The company holds around 10% of the global market for the steel industry. References 8 Questions, 2006. Arcelor Mittal Controversy. 8 Questions. [Online] Available at: http://8questions.wordpress.com/2006/11/23/5/ [Accessed 23 June 2008]. Knowledge @ Wharton, 2006. Aditya Mittal: 'Arcelor and Mittal Steel is the Best Combination within the Steel Industry'. University of Pennsylvania. . [Online] Available at: http://www.wharton.universia.net/index.cfm?fa=viewArticle&id=1197&language=english [Accessed 23 June 2008]. Watkins, No Date. Corporate Governance Models. San Jose State University. [Online] Available at: http://www.sjsu.edu/faculty/watkins/corpgov/sld007.htm [Accessed 23 June 2008]. Bibliography Arcelor Mittal, No Date. History. About. [Online] Available at: http://www.arcelormittal.com/index.php?lang=en&page=15 [Accessed 23 June 2008]. Financial Analysis Revised, No Date. Cost of Debt and Equity Capital. Washington State University. [Online] Available at: http://cbdd.wsu.edu/kewlcontent/cdoutput/TR505r/page27.htm [Accessed 23 June 2008]. IIPM Editorial, No Date. Rise of the Indian Machines For once, the western world blinks first, and in defeat; Mittal rules like none before. IIPM. [Online] Available at: http://www.iipm.edu/iipm-editorial-203.html [Accessed 23 June 2008]. Sony, 1999. Sony Announces New Group Architecture for Network-Centric Era. Press Release. [Online] Available at: http://www.sony.net/SonyInfo/News/Press_Archive/199903/99-030/index.html [Accessed 23 June 2008]. Sony Corporation, 2008. Annual Report 2008. Japan : Sony Corporation. Sony Corporation, No Date. Investor Relations. About Sony Group. [Online] Available at: http://www.sony.net/SonyInfo/IR/ [Accessed 23 June 2008]. Read More