International Business Finance - Case Study Example

International business finance [Insert al Affiliation] Contents Introduction 3 2.Non-financial analysis 3 2 SWOT analysis 3 2.1.1.The strengths 3 2.1.2.Weaknesses 4 2.1.3.The opportunities 4 2.1.4.The threats 5 2.2.The PESTEL analysis 6 2.2.1.Political factors 6 2.2.2.Economic factors 6 2.2.3.Social factors 7 2.2.4.Technological factors 7 2.2.5.Environmental factors 7 2.2.6.Legal factors 7 3.Financial analysis 8 3.1.The net present value 8 3.1.1.The assumptions 9 3.2.The average rate of return 9 3.2.1.The assumptions 9 3.3.The internal rate of return 9 3.3.1.The assumption 9 4.Key operational and strategic challenges 10 5.Options of sources of finance for expansion in Asia 11 6.Factors to consider when choosing the finance sources 12 8.Conclusion 14 9.References 16 10.Appendices 18 1. Introduction In the business environment, firms/companies strive to generate more profits in order to achieve their vital objectives such as profit generation and shareholders’ wealth maximisation. For such to be reality, the top level of management of the respective company should undertake a thorough investigation into various strategies available and adopt alternative strategies that are feasible. The management is, therefore, required to form a team of experts that should take the responsibility of making such analysis and prepare a pertinent report to the management for the decision to be made. The report comprehensively analyses the strategies at hand for the XP PLC multinational company and consequently recommends the best strategy/option to be adopted on the basis of financial facts. For the best alternative approach to be adopted, both financial and non-financial analyses are performed. 2. Non-financial analysis Non-financial analysis entails evaluation of the company by use of SWOT and PESTEL analyses. 2.1. SWOT analysis Entails evaluation of company’s strengths, weaknesses, opportunities and threats 2.1.1. The strengths The XP plc Company’s strengths include diversified business operations in a number of countries. The company has a holding company situated in France. However, it has a number of subsidiaries operating in foreign countries such as in Germany, Australia, Monaco, and Poland. Additionally, the firm has stable sales revenue of over 60 million Euros. This is a clear indication that the company made superior products that are tailored for its customers, hence gaining customer loyalty. The customer loyalty comes about due to the satisfaction of the customers’ preferences and choices. For a company to continue operating in a business environment, it must be in a position to yield profits to cater for company expenses, financing activities, investment purposes and maximizing the company’s value. Since the firm is trading at a net profit of 8%, it has a stable future operation in the economy. A business organisation that is incapable of financing its business activities using internal funds such as equity is compelled to borrow from external sources available. Among the external sources of funds is the debt that increases the firm’s financial leverage. Since the proportion of the debt is smaller as compared to the equity, the financial risk is reduced hence a strength to the company that could otherwise be a threat had the debt outweighed the equity capital. 2.1.2. Weaknesses The multinational company suffers from a stiff competition in the service industry. This has caused the company to at least diversify its operation worldwide to increase its products and services delivery. The company uses bureaucratic kind of management making it difficulty in making decisions faster. 2.1.3. The opportunities XP plc being a multinational company, it has a chance for diversity. The firm has diverse workforces that operate in different environments, hence giving the employees an extensive working experience and business ethics. Among the business, ethics is the ability of employees to work with others in different parts of the world. The company has an opportunity of adequately and sufficiently utilizing the resources that are the assets to increase the turnover value (Christoffersen, 2003). In relatable to note that holding other items of income statement constant, an increase in the revenue generation will consequently lead to an increase in the trading profit. The company offers a number of employment opportunities for many people globally. Nevertheless, the employees are in a position to transfer from one country to another e.g. an accountant from a subsidiary in Germany can move to another subsidiary company in Monaco. Other employees can utilize the opportunity of getting employed in firms that might not be paying handsome salaries to get in other countries. The company offers an opportunity for conflict resolution in that employees from different countries with different cultures can come together and increase the propensity to conflict resolution through mutual understanding /agreement among them. 2.1.4. The threats Threats are the uncertainties of future events that might hamper the efficient and sufficient operations of the company leading to its failure. Though it can be outwardly being seen that the company is flourishing, it faces threats that are deemed by financial analysts as the factors ‘lifting veil of business operation’. One of the threats is the foreign exchange rate (Suthar, 2010). The exchange rate is the trading of a currency in terms of the other for uniform and stable transaction. Given unfavorable movement in the exchange rates, that is an increase in the foreign exchange will result in a decrease in the net profit generation leading to a further decrease in the firm’s and shareholders wealth values correspondingly. The cost of entering into the contract is a bit high for instance if the company enters into a future contract and it is required to purchase the futures to proceed with the hedging mechanism (Capstaff & Marshall, 2005). In a scenario where the future (fixed) price falls below the spot price, the firm incurs a loss from the strategy of hedging. 2.2. The PESTEL analysis An alternative method is the evaluation of the political, economic, social, technological, environmental and legal factors (PESTEL). It entails the examination of the impacts of external factors affecting the efficient running of the business. 2.2.1. Political factors It is a factor that deals with the supply of raw materials to the company. The adherence of these elements appeals to the taking into account the future well-being of the society and the environment at large (Inkster, 2008). The company is in a position to follow such policies that give it a competitive advantage and hence a fair trade in the market environment. The regulation pressure is an impact of the following of the laws and regulations in the respective countries that where the company gets raw materials and operates. The company operates under a tax policy that exigent a tax rate of 30%. 2.2.2. Economic factors The economic factors are factors affecting the company’s revenue generation. The firm has been faced with unfavorable movement in the exchange rates hence decrease in the profit earnings. Though it is clear that the global economy is in a downturn, the company has a limited raw material that cannot afford the generation of supernormal profits. This is evidenced by the small generation of revenue as low as 60 million. 2.2.3. Social factors The aggregate population of the consumers of the company’s financial services is large. Since they have different lifestyles, they have different degrees of demand for the financial services. The social reference unit for social-cultural factor is family. The firm takes into consideration their preferences and norms. 2.2.4. Technological factors Technology has effectively increased the production of financial services in a quick, secure and reliable manner. The advancement of technology has brought in the use of automated teller machines and substantially reducing the fatigue that an employee might incur. The use of computer in keeping the records for future references has increased the disclosure of the company’s progress to the relevant parties (Downey, 2009). 2.2.5. Environmental factors Environmental factors consist of both internal and external factors. Internal factors affect the holding company and its subsidiaries. They include customers, employees and suppliers. The company pays the due debt on time to suppliers. It gives the employees a just and equitable remuneration hence in good terms with them. External factors include the creditors and the government. The company honors corporate tax and pays the creditors their debts when they fall due. 2.2.6. Legal factors These are factors which affect the business operation of a company. Since the business environment is dynamic, a number of rules and regulations do change from one period to the other. The company adheres to the corporate social responsibility and, therefore, anticipates a smooth operation of its business. 3. Financial analysis The financial analysis involves the use of data for the quantitative analysis of the company’s viable investments given an adequate finance. In the analysis, there are a number of capital budgeting techniques that are employed. Among them are net present value, average rate of return and internal rate of return. 3.1. The net present value It is capital budgeting technique that discounts the future company’s cash flows. This is so because the method takes into account factors like the time value and inflation. The future cash flows are discounted at a certain discounting rate to get the aggregate, present value (Shao, 2008). . To compute the net present value, the initial cost of investment is subtracted from the total present value to get the net present value. The NPV = {+ + .......} –Co NPV = – Co Where Co is the initial investment, C1, C2, C3…… are cash flows of the investment. The criteria that is adopted Accept any project with a net present value that is more than one otherwise decline the investment. If the net present value is zero, consider other factors because the decision maker is indifferent. Since the net present value is 5.1689M, accept the investment (appendix 1). 3.1.1. The assumptions It is assumed that the cash that is generated by an investment is reinvested at a rate equivalent to the rate of discount. The cash inflows and cash outflows occur at the end period except the initial capital outlay. 3.2. The average rate of return The technique considers the accounting profits in its calculation. At times, the method is known as return on investment. Average investment = (initial investment + salvage value)/2 ARR = (average income)/ (average investment) *100 The internal rate of return on the investment as the technique dictates is 84.7% (appendix 2). 3.2.1. The assumptions The investments are reinvested at the same rate. 3.3. The internal rate of return The method equates the expected future investment cash flows with the present value hence it is justified to say that the net present value is zero. The method uses the trial-error method to determine the internal rate of return. The IRR is 16.98% (appendix 4) 3.3.1. The assumption The method assumes that the cash flows are reinvested at the same rate. 4. Key operational and strategic challenges When the XP plc considers to re-domiciling, it is exposed to challenges that might hinder the ordinary business operations. The company will face a political risk that will change its value due to certain directives from Monaco government that is deemed to be threats. Among them are the rules and regulations governing various corporations and the tax policies that are imposed by the government of Monaco. The other challenge will be the issue of transferring the funds to Monaco taking into consideration the unfavorable movement in exchange rates. There a risk of repudiation of loans and interests due to the sovereignty of the state will affect the company. The company will experience a high labor turnover because some employees are not ready to change the working environment hence a decrease in the production of goods and services by the company. A decrease in production will consequently lead to failure of the company. The company will face a challenge in coordination of its activities. Consolidation of services allows the service providers of the company to provide a leveraged economy of scale and reusable service elements. It calls services to be delivered from a well-managed facility that gives support to all customers via a common platform of configuration. Considering the transfer of the operation, this will be affected and will be one of the greatest impediments to the success of the company. Staffing of the employees will be another challenge to the company. It has been noted that the staffing of the company depends on guidelines articulated by the company through cost containment and set up through service roadmap. When a company changes the location of operation, finding the right employees for the right jobs is somehow challenging. The challenge has a negative impact on the stability and progress of the company. The company is, therefore, required to make a thorough investigation of the required knowledge, skills, competence and expertise to the scientifically identified jobs for it to realize a smooth operation and cooperation from the staff in Monaco. The business culture is another challenge that comes up. For a company to successfully operate in Monaco, the idea to be borne in mind should be a business model change that might have served soundly in France to a model that best suits the Monaco markets. Monaco residents are deeply rooted in traditions hence the majority of firms do not adhere to the accepted international standards when accounting their business activities. Additionally, it is per se that it will be difficult if not impossible for the holding company to make it sure that its best interests are well advanced by employees and agents respectively. The management has to be flexible and do adjustments pursuant to the Monaco characteristics. 5. Options of sources of finance for expansion in Asia There are several capital sources for a multinational company. There are four categories of sources of funding available to XP plc Company. The first source is the short-term funds that are funds that are refundable in a short span period i.e. approximately less than three years. The funds are available in Eurocurrency market and foreign bond market. The permanent source of fund is non-refundable for the company pursuant to the going concern i.e. ordinary share capital from respective subsidiary companies. The other source is the external source that is money raised from outside an organization. The subsidiaries in Asia have an opportunity to get funds outside their respective companies. The internal source of capital includes raising capital from within the company. This includes the equity capital from the retained earnings of the corporation. Categorizing according to the relationship between the parties and the company, the following are the sources: common equity capital that are funds that are advanced by owners to the corporation (reserves and ordinary share capital). This is through the issue of shares through “offer of sale”. Quasi-capital is another source of capital that is advanced by preference shareholders of the subsidiaries across the Asia continent. The debt finance is another source that is provided by creditors to the branches across Asia. Other sources can be classified according to the rate of return that charged on the fund. There are capital funds that are having a fixed rate of return and they, therefore, pay a fixed return annually i.e. long-term debt. There are other funds that are paid with a variable rate of return as the economic conditions such as inflation rates dictates. They are paid at a different rate depending on the performance of the subsidiary company. 6. Factors to consider when choosing the finance sources The cost of capital: the cost of capital is the extra cost that is incurred by the company to borrow funds. A high-cost capital fund will lead to financial distress to the company and can lead to failure of the company and, therefore, it should consider a cheap source of fund. The amount of capital is also another factor that needs to be considered. When a firm requires an enormous capital for investment, it requires borrowing from the long-term funds while is if the requirement is relatively small, short-term source of finance will be adequate. The income generated is another factor. The income generation of a company justifies the finance source for restructuring in that the income garnered by the company should be adequate to pay the loans (Shapiro, 2007). If the company incurs losses, it cannot afford any financing option as it is uncertain for the respective subsidiary companies to pay back the funds. The assets of the company assets are used in generating funds. Given a financial need, they can afford funds and make collaterals as securities. The assets are pledged either as floating charges or fixed charges on the assets. The repayment terms: the period for restructuring the financing option should be considered. Financial analysts postulate that a long-term loan builds up a significant interest over the period while those of short-term require huge repayment amounts (Lee & Chang, 2007). The company should, therefore, consider the time of payment and the frequency of payment in order to adopt a feasible financing option. The company should take note of the allocation of principal and interest payments. The companies should approve loans that have higher principal distribution and Minimization of long-term costs. 7. Analysing other strategies to expand XP Direct foreign investment involves the investment of assets in foreign countries. Though the funds available are the same as those of the local firms, the company uses the international financial markets such as foreign market, Eurobond market, foreign exchange markets and Eurocurrency (Tham, & Velez-Pareja 2005). Eurocurrency markets offer loans and deposits in various currencies other than the country of origin. Foreign bank market is markets lending loans in domestic currencies to foreign companies abroad for their use. Foreign bond market issue bonds to non-resident companies in the currency of their country pursuant to the rules and regulations of the corresponding countries. Eurobond market offer bonds at a low issuance cost as compared to foreign bond markets. The rules and regulations pertaining the issue of this kind of bonds are somehow not firm. The option also offers financial derivative markets for the hedging of potential losses in future. Such markets include Sydney futures exchange, Chicago Mercantile Exchange, and London financial futures exchange. Conversely, derivatives include currency and rates swap, currency and interest rate options among others. A point of consideration here is the fact that the derivatives are used to prevent the exposure of the subsidiaries and holding companies to losses in the income generation due to unfavorable movements in the prices in the market. The mergers and acquisition are other alternative strategies to expand the operation. Mergers and acquisitions entail a business combination to gain a competitive advantage, enjoy economies of scale and synergies (Vachon, 2007). In acquisition, there is an acquiring firm and an acquired firm whereby the acquired company receives and has a full control over the other firm. Amalgamation (mergers) on the other hand is a business combination where the two companies combine into one reliable company. The companies lose their prior identities and operate under the new name. The two firms tend to pool their assets and interests. The strategy has an advantage of enabling the firm to escape the issue of hostile takeover whereby one firm purports to acquire the shares of the other firm without the consent of the board of directors (Srinivasan & Kim, 2006). The strategy has an advantage of enabling the acquiring company to expand its operations hence an increase in revenue. The approach allows the company to finance its business activities by use of equity as it becomes cheaper than the debt capital that increases the financial leverage. 8. Conclusion From the above analysis, it is clear that the company is recommended to adopt the first strategy of entering into a joint venture. This is because it is certain that the venture has a positive net present value evidenced by the NPV of 3.22M Euros. It is of great importance to consider that this amount exceeds the capital outlay of (4M) Euros. Conversely, option two should not be adopted because of information asymmetry. 9. References Capstaff, J., & Marshall, A. (2005). International Cash Management and Hedging: A Comparison of UK and French Companies. Managerial Finance. doi:10.1108/03074350510769893 Christoffersen, P. F. (2003). Elements of financial risk management. Amsterdam: Academic Press. DePamphilis, D. M. (2007). Mergers, acquisitions, and other restructuring activities. Amsterdam: Elservier/Academic Press. Downey, M. (2009). Assessing Political Risk for Foreign Investments. doi:10.2118/30033-MS Hopkin, P. (2010). Fundamentals of risk management: Understanding, evaluating, and implementing effective risk management. London: Kogan Page. Inkster, N. (2008). Assessing Political Risk. Adelphi Papers. doi:10.1080/05679320802694373 Lee, H., & Chang, W. (2007). Central bank intervention and exchange rate dynamics: A rationale for the regime-switching process of exchange rates. Journal of The Japanese and International Economies, 6, 67-94. doi:10.1016/j.jjie.2005.10.007 Mergers & acquisitions. (2011). London: Euromoney Institutional Investor PLC. Moffett, M. H., Stonehill, A. I., & Eiteman, D. K. (2009). Fundamentals of multinational finance. Boston: Pearson Prentice Hall. Shao, L. P. (2008). Capital budgeting for the multinational enterprise. Bradford: MCB University Press. Shapiro, A. C. (2007). Multinational financial management. New York: J. Wiley & Sons. Srinivasan, V., & Kim, Y. H. (2006). Payments Netting in International Cash Management: A Network Optimization Approach. Journal of International Business Studies. doi:10.1057/palgrave.jibs.8490421 Suthar, M. H. (2010). Understanding Exchange Rate Expectations in India. Tham, J., & Velez-Pareja, I. (2005). An Integrated, Consistent Market-based Framework for Valuing Finite Cash Flows. Vachon, D. (2007). Mergers & acquisitions. New York: Riverhead Books. 10. Appendices Appendix 1 Appendix 2 Appendix 3 Read More