Applications in Corporate Finance. Buildalot - Essay Example

? Applications in Corporate Finance Table of Content Introduction 4 Background of the company 4 Business environment analysis 5 Market economy 5 Market competition 5 Equity capital structure of the company 6 Divisional business analysis 6 Major construction projects 6 Office building construction 7 House building construction 7 Business operational issues 8 Mayo project issues 9 Corporate social responsibilities 10 Financial statement analysis 11 Trend analysis 11 Ratio analysis 11 Recommendations 12 Referencing 14 Bibliography 15 Introduction This is a business report which deals with business analysis in corporate finance perspective. The name of the company is Buidalot which is an Ireland based Construction Company. This study will assess the major issues of this business from different areas of its business. Prioritisation of major issues is the first objective of this study. Detailed analysis of those issues will be conducted to evaluate the causes. Then appropriate recommendations will be provided for those issues. This study will also evaluate financials of projects of the company through business strategy techniques and financial strategy techniques like re-forecasting, cost of capital, net present value and business valuation. Background of the company Buildalot is a 50 years old construction company of Ireland. The company was incorporated 30 years back as a group of companies. This consists of many wholly owned subsidiaries that operate in different segment of construction industry. Three segments where company’s business operates are major construction projects, house building construction and office building construction. Subsidiary that operates in major construction project is based on types of undertaken projects. Office building subsidiaries undertake projects related to office constructions. It operates in Europe and Middle East along with successful penetration in the home country of Ireland. The company House building subsidiaries also operate in internationally. The company initially used to engage in residential house building in Ireland started these constructions in these major segments after incorporation in 30 years back. . Business environment analysis Market economy The company operates maximum in domestic market i.e. Ireland. Therefore, this market has substantial influence on this business. Age of democracy and age of the company is similar. So, the company has experienced gradual growth of expenditure of people of this country over the years. Inflation rate in this economy has remained 4% annually over last few years and GDP of this country has been expected to grow 4% annually for next few years. Countries in European Union are the main trading partner of this country. Market competition The extent of competition among the firms in construction industry in this market is high. Eight large companies have been leading the construction market in Ireland. There three other companies including Buildalot who are highly involved in construction work in domestic market as well international markets. According to company’s annual financial data of 2010, it constructed 12% of total new units during this financial year. But, in case of international operation, its business is very small compared to other international companies. The company has generated substantial market share in Ireland especially in office construction segment. Construction projects subsidiaries also awarded many contracts in foreign markets also. Therefore, the company has successfully developed competency and brand value in domestic as well foreign markets. Equity capital structure of the company Buildalot is public limited company which has 441.6 million shares in issue out of total 800 million shares. Issuing price of share is ?0.50. Company’s shares price rose up all time high at ?13.82 at 30th June, 2011. This is a good indicator of company’s growth and it was because of its more than expected results in 2010 financial year. Institutional shareholders have maximum stake than individual shareholders on issued shares of the company. Divisional business analysis Major construction projects It is one of the three major segments of subsidiaries of the company. This division of the company has five major ongoing projects. These are sport stadium in Middle East with forecasted profitability of ?78 million over four years; a motorway in Middle East with forecasted profitability of ?380 million over 2.4 years; a road and motorway construction in home country with forecasted profitability of ?220 million; another construction work in Ireland with forecasted profitability of ?270 million and a major of the company i.e. motorway and bridge construction in Northern Ireland. Though the company is currently involved in these projects with huge amount of projected profitability but, it does not have any activity in foreign market in this segment of major project construction. Therefore, it is one of the major issues of this division of its business which is totally deepened on the domestic market demand and any macro environmental factors would have major impact on this business. Therefore, risk is high. Another important issue in this business is projected loss of ? 35 million in motorway project of Northern Ireland due to heavy rainfall during the construction process. The company has been continuing argument with the Government authorities for compensation regarding this unforeseen rainfall damage. It would harm the relationship among the company and the government which might affect assignment of future projects from government. This has become one major issue of management of the company. The top management and the board of directors have started arguments among themselves regarding this loss and concession from governments. This is a big issue of this division as well as for the company as a whole. Office building construction Office building construction is one of the leading subsidiaries of the company which involves in office building related construction in Ireland and foreign markets also. Revenue has been raised in last seven years i.e. from ?732 in 2003 to ?768 in 2010. But this is very much negligible growth rate of the company as the duration for this small amount of increase of revenue is 7 financial years. This is because of profitability decline in some of the current projects of the company. Though this business has started expanding and revenue is expected to be increase in substantial amount in 2011 but size of this subsidiary is very small compared to other two subsidiary of the company. This subsidiary has contributed only 12% of the total revenue of Buildalot group. This is one major issue of this company subsidiary as it do not have strong capital by own investment in more new projects at a time. House building construction This subsidiary is the largest among all three subsidiary of Buildalot group and it has been divided into three geographical divisions for domestic operation, USA operation and UK operation. Financial base of this subsidiary is also stronger than other two. It also acquired one US based small construction company for expanding its US operation. It helped the company to acquire the innovative designs of the acquired company. This subsidiary use foreign exposure in the area of cost effective business operation in the foreign markets. The company has started focusing on multiple activities at a same time. It is the oldest business of Buildalot and has been enjoying profitability over the years. Profitability of the overall group of companies can be evaluated by evaluation of return of capital employed. But, the company has found this measure misleading at the time comparing the value among the three subsidiaries of this company. The main reason behind this mismatch or misleading of profitability calculation is major increase in purchasing cost of one of the three division of this subsidiary. This is one key financial issue of the company. One influence behind this issue is size of this subsidiary company. Generally, small construction project provides much lower return than large development project. Therefore, larger housing complexes or apartments give higher return on capit5al employed to the company than small or medium one. Another influence is type of apartment i.e. designs, location and many other factors which has substantial impact on the return on capital employed of the company. Business operational issues Generally, construction companies use mix of local subcontractors and own employees for business operation. Buildalot also use this strategy for its business operation. The company use subcontractors for construction work and employees for internal business activities like marketing and sales. Subcontractors also recommend the company for any necessity of extra employees of them as well for the company. This helps the company higher extent of flexibility and reduction of wage cost. But, operation management of the company has been facing some issues regarding subcontractor management (Sage & Rouse, 2011, p.599). Though the company uses same subcontractors repeatedly for its construction work, they are unable to meet the project deadlines due to numbers of unskilled workers or them. This leads to major delay in initial level of a project and also faults are identified. This is one of the major issues of the company. Subcontractors generally recruit unskilled and workers in their team in low wage rate and it is the main cause of this issue. They use incentive based labour management based of faster completion of work which leads to rushed work and sometimes quality of work become very bad. Buildalot use own employees in office building construction and major project management divisions. To over this major issue related to subcontractor management, the company needs to less dependence on them. For this purpose, it needs to hire own specialist who will track the day to day activities of subcontractors and also thorough quality check of their work (Neeraj & Neeraj, 2008, p.139). Mayo project issues Government has decided development of a countryside area of Ireland named Mayo. There has been much news from media regarding tendered construction company for this large project. Finally, Buildalot has been awarded for this project by Irish government at final price of ?830 million which is ?70 million lower than estimated price for this project. The company has invited domestic as well as international companies to take part in this high profile project of Irish government. Though the company has been able to sell 51% of the total plot to other construction companies but it could not find any major construction company who is interested to buy the rest part of the land for construction of office buildings. Thus it has increased the inventory level of the company which is major issue of the company. The company has expected total cost for this project for years would be total ?5000 million and it has managed to get loan of ?900 million with 9% interest rate annually. Therefore, the company needs to depend on the internal cash inflow from this project. But a substantial amount of its total investment remains as inventory in the unsold plots of this area (Nevitt & Fabozzi, 2000). Loan amount ? 900,000,000.00 Tenure(months) ? 60.00 Interest per month ? 0.01 Monthly repayment ? 18,682,519.70 Quarterly repayment ? 74,730,078.81 From the above table it can be said that the company needs to generate a minimum return of ?74,730,078.81 per quarter for five year period from the initiation of bank loan. This is possible only the company is able to sell its completed house buildings and office buildings in a regular basis. But, the company is also expecting to cover the working capital cost from the cash flow. Therefore, the cash inflow from this project need to more which might be difficult for the company as inventory level is very high (Ehrhardt & Bringham, 2010, p.256). Corporate social responsibilities Corporate social responsibility is a major factor for this kind huge project. The company have to remove plants in the Mayo area to start the construction work. Bad publicity behind this project has been affecting the demand of their house buildings and office buildings. There would be a large number of trees cut down by the company for this project which has become the major issue. This lobbyist has been raising these issues and they are inspiring the local people to stop the project. This is a major issue of the company and it needs to develop alternative plantation of trees in this area to counter this kind of corporate social responsibility issue. This leads to more increase in the projected cost of the company for this project. Financial statement analysis Trend analysis Trend analysis examines historical pattern of change of quantitative data like financial statements. It provides information about the historical pattern of change in financial parameters to the investors. It also predicts future pattern of key financial indicator of a firm so that investors can predict future performance of a firm. Financial trend analysis of Buildalot includes trend of key financial indicators of the company. Revenue has increased only 6.97% in 7 years which is very bad growth for this kind of large construction company. As, operating cost has increased 5.00% only, net profit has increased 16.03% which is better compared to revenue growth rate. But it is also not good growth rate as the duration is very long. Liability has increased nearly 3 times more than asset which is also a bad indication of financial structure. Ratio analysis Current Ratio: Current ratio represents the working capital position of the company as it is one of the important indicators of liquidity of a company. It measures the performance of the company regarding its ability in terms of quick payment of short term obligation of the company. Standard current ratio for positive investment decision is 2:1. Current ratio of the company is very high than standard value which is a major strength of the company. Quick ratio: Quick ratio or acid test ratio indicates that the company has enough short term assets to pay its current liabilities or not. If this ratio is less than 1 then the company cannot pay its current liabilities without the help its inventory. The company is very much dependent on its inventory to pay its current liabilities as its current ratio is less than 1 which is bad liquidity status of the company (NDU, 2012, p.1). Fixed asset Turnover: Fixed asset turnover ratio indicates the company’s ability to generate revenue from the investment on fixed asserts. Higher the ratio better is the effective asset performance of the company. This ratio is very high and it is also a major strength in terms of efficient asset management. Total Asset Turnover: It shows that how the company efficiently use current and fixed asset to generate adequate revenue. It also shows the asset performance of the company. Higher the ratio better for the company. It also indicates effectiveness of pricing strategy of the company. If asset turnover is less than 1 then the company has been generating higher profit margin. This ratio is very low compared to fixed asset turnover and it is weakness of the company. Total Debt to Equity: Debt to equity ratio determines capital structure of the company. It shows that contribution of total liability and total equity in the total capital of a company. This ratio shows that the company has equal influence by the creditors and shareholders of the company as current debt to equity ratio is nearly 1 (JMU, 2010, p.1). All three profitability ratios show good profitability potential of the company as all the ratios are much higher than standard value. Recommendations Therefore, from the financial and non financial analysis of Buildalot, some major issues have been identified. First, the company needs to be less dependent on subcontractors and needs to recruit own employees more. This will help to meet the project deadlines and also to ensure good quality work. Secondly, inventory is the most important and very critical problem of the company. It should highly focus on faster liquidation of its huge amount of inventory which can be reinvested in new projects. For this purpose, it must need to sell the total land office building in Mayo area. It has increased the inventory level in major percentage. Referencing Bragg, M. S. 2012. Business Ratios and Formulas: A Comprehensive Guide. John Wiley & Sons, 2012. Ehrhardt, M.C. & Bringham, E.F. 2010. Corporate Finance: A Focused Approach. Cengage Learning. JMU. 2010. Financial ratio analysis. [Pdf]. Available at: http://educ.jmu.edu/~drakepp/principles/module2/fin_rat.pdf. [Accessed on November 9, 2012]. Lermack, B. H. 2003. Steps to a Basic Company Financial Analysis. [Online]. Available at: http://faculty.philau.edu/lermackh/financial_analysis.htm. [Accessed on November 9, 2012]. NDU. 2012. Financial Ratio Analysis. [Online]. Available at: http://www.nd.edu/~mgrecon/simulations/micromaticweb/financialratios.html. [Accessed on November 9, 2012]. Neeraj, J.K. & Neeraj, N.K. 2008. Construction Project Management. Pearson Education India. Nevitt, P.K. & Fabozzi, F.J. 2000. Project Financing. Euromoney Books. Sage, A.P. & Rouse, W.B. 2011. Handbook of Systems Engineering and Management. John Wiley & Sons. Vinter, G.D. & Price, G. 2006. Project Finance: A Legal Guide. Sweet & Maxwell. Bibliography Atkin, B & Brooks, A. 2009. Total Facilities Management. John Wiley & Sons. Balsara, Nauzer J. 1992. Money Management Strategies for Futures Traders. John Wiley and Sons. Bragg, M. S. 2012. Business Ratios and Formulas: A Comprehensive Guide. John Wiley & Sons. 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