The Sources of Finance of Emaar Plc - Term Paper Example

s Managing financial resources and decisions May 26, Table of Contents Table of Contents 2 Introduction 4 TASK 1 4 Part A 4 Internally Generated Funds 4 Long-term Borrowing 5 Venture Capital 5 Issuance of New Equity 5 Cheap or Expensive Source of Financing 6 Capital Structure 6 Urgency of Funds 6 Legal Status 7 Tax Effects 7 Dilution of Control 7 Part B 8 Cost of using debt 9 Cost of using equity 9 Long-term Loan 10 Equity Shares 10 Finance and Operating Lease 10 TASK 2 11 TASK 3 12 TASK 4 13 TASK 5 15 Comparison of Financial Statements Formats 16 Statement of Financial Position 16 Statement of Comprehensive Income 16 Statement of Changes in Equity 17 TASK 6 18 Conclusion 19 Introduction This report aims at managing various financial resources and the associated decisions. The case study of Emaar Plc. has been mainly studied during this report as a means of understanding. The first task of this report highlights the various options available to Emaar regarding the sources of finance and their relative advantages. Subsequent tasks main seek the computational elements especially how to appraise certain projects. TASK 1 Part A a) Sources of Finance Emaar Properties Plc. might have diverse selections for financing hotel venture in addition to the mentioned source of finance with regard to pre-sales of serviced apartments. The subsequent debate focuses those four extents which may add finance to the hotel venture for EP. Internally Generated Funds The primary option that any organization desires to fund a venture is the use of “internally generated funds”. Internally Generated Funds are mobilized by appropriating retained earnings. Organizations that do not distribute dividends tend to wait for such kinds of investment opportunities in order to invest in those ventures in their own individual capacity (Baker and Martin, 2011). Long-term Borrowing Long-term borrowing is an alternative that EP may utilize specifically when it measures that it can no longer obtain considerable funding through Internally Generated Funds. Nevertheless, long-term borrowing needs to be refunded at a definite future date as well as the steady and well-timed interest disbursements to the creditors. The benefit of this funding selection is that it can deliver a definite amount of interest to the creditors whereas the profits gained from hotel venture would surpass considerably in comparison with interest payments outstanding to the financiers (Brigham and Ehrhard, 2008). Venture Capital Venture capital is additional kind of funding that the respective company can follow in order to induce some huge business entities that are likely to capitalize their money to institute the business for a particular time period, including the decision making of management, making profits and then corrode the equity after the project is completed and supplied to the end consumers. Issuance of New Equity Issuance of new equity can be the least favored expanse of financing that is available to Emaar Properties Plc because the group may require further financing. Yet, it is not in the position to acquire it at the expense of dropping their control on the company or even on a specific project. This option can assist Emaar by acting as the lender of last resort but Emaar must consider this option after it has approached all other options available for financing. The following three factors must be taken into consideration by an organization before deciding the most appropriate source of financing. Cheap or Expensive Source of Financing The capital cost of all the sources of finance cannot be same because all the options possess varying characteristics such as legal status, maturity period, amount of finance etc. The lowest cost based finance for the company is internally generated funds of the company. After that comes the option of long-term borrowing which protects the company by providing it with the tax shield. Nevertheless, venture capital scheme and issuance of new capital are the most affluent sources of financing. Capital Structure Capital structure is one of the fundamental aspects that a company must study before deciding the appropriate sources of finance. Company needs to stay vigilant regarding the capital structure in order to examine whether the company can be unprotected towards high risk because of presence of tall debt into capital structure. Urgency of Funds Urgency is another aspect that an organization must consider because not all sources of finance offer immediate finance to the organization. Internally generated funds are considered as the quickest source of finance because of its readiness availability to the company, while all other types of external sources of finance require significant amount of time in availability, usability and arrangement of funds. b) Estimation of Legal Status, Tax Effects and Dilution of Control upon the decision of finance sources Legal Status The legal status associated with each are of financing counts a lot especially to the organization raising funds. Long-term borrowing creates lending claims to the investors being creditors of the company and their invested money is taken as debt. On the contrary, all other three sources of finance create ownership right to the company and their invested money is referred as equity. Tax Effects Tax helps the company in deciding the most suitable source of finance to the organization. Since payments of interests are tax deductible before the calculation of income tax liability and profits, therefore the subsequent tax liability is decreased which results in lower tax saving or tax payments. Nevertheless, with regards to equity-based sources of finance, the amounts of dividends are not tax deductible which affirms that first total profit is calculated after that the deduction in tax liability is done which results in net profit after tax (PAT). That net profit after tax is then appropriate for the distribution of dividend unlike interest costs which are subtracted from profits before calculating tax liability (Brigham and Ehrhardt, 2008). Dilution of Control The company needs to evaluate whether it would have considerable control over the process of management and decision-making of the organization or it might lose such control. Under the options of financing such as venture capital and issuance of new equity, the company would be unprotected towards the risk of dilution of control. As soon as the numbers of owners increase in the business, the risk will be diluted greatly in the company in terms of the control that it will be having over the process of decision-making and managerial operations of the business (Watson and Head, 2009). c) Assessment of Pre-Sales Serviced Apartments Apart from the other four sources of finance that Emaar currently possess, the prevailing source of finance which is in the form of pre-sales serviced apartments is certainly a trickle source of finance even before providing the occupation of the apartments of their owners. This process of making finance does not comprise any expense of raising the capital, nor does profit allocation become essential for the business to make. At the same time the business can also generate funds freely available due to which the creation of those apartments can begin a moment earlier than standard due course. However, after all the transactions of apartments are finalized, the company needs to organize other sources of finance so that the unsold remaining apartments can be built without causing any delays. In this way, this arrangement of finance through pre-sales of apartments can provide Emaar another expedient and well-timed availability of finance. Part B 1) Cost of using debt The cheapest source of funding any project is debt. This is probable because the payments of interest related to the debt are tax deductible which leads to reduction in tax liability. However, it leads to an increase in the overall risk of the company and the chances of bankruptcy may increase (Brigham and Ehrhardt, 2008). Cost of using equity Equity is the primary source of funding the project of hotel but dividends, that are its associated costs, are not tax deductible. This is reason that the company is liable to pay additional tax. However, by doing so the risk of bankruptcy is decreased. Issuing new equity to new owners involves a risk of dilution in control over the managerial decisions. 2) Significance of Financial Planning For every project, financial planning is considered as the most necessary activity as it conveys the future prospects of the business operations of the company particularly with regards to utilizing cash. The most primary statement required for financial planning is cash budget as it provides a better view of the inflows and outflows of cash over a specified period of time (Brigham and Ehrhardt, 2008). 3) Features of Information Needs There are several features of information needs applicable especially to project manager, CEO, and the construction supervisor. Those features must contain accuracy, timeliness, conciseness, appropriateness, and completeness. For example, information regarding availability of funds at particular time, with explicit terms and conditions presenting precise sum for apartments only comprise the features of accuracy, timeliness, appropriateness and completeness. 4) Impact of Various Financing Options Long-term Loan When an organization acquires a long-term loan, it upsurges the share of non-current liabilities in its financial statement. Not only this, a heavy amount of interest is also charged on the long-term loan that is documented in the statements of financial position of the company. Equity Shares Equity shares issued by the company are recorded in the equity portion of the statement of financial performance. Dividends related to share capital, is not obligatory for payment as it is actually based upon the choice of board of directors of the company. They are presented in statement of changes in equity. Finance and Operating Lease Assets attained under finance lease are mentioned in the statement of financial performance and their interest payment is mentioned in the statement of comprehensive income. Assets acquired under operating lease are not exploited and their payments are charged out in the statement of comprehensive income. TASK 2 The above-mentioned cash budget does not deliver any value-addition to the Emaar as the company may end up on a parallel note where it began in 1st Quarter. Emaar has comparatively greater cash balances in initial two quarters. Nonetheless, the forecasts of the company are quite discouraging in the 3rd Quarter. The key cause behind such receiving forecast is possibility of buying new machinery specifically when the company may not have adequate reserves. Moreover, the operating performance of Emaar might not offer a reasonable stance as the company appears to obligate the sales of nearly 80,000 but the material and labor costs sums up to nearly 95,000. In this way, Quarter 3 might present serious challenges for the management of Emaar to encounter the cash necessities and therefore might turn out in having deficit cash balance.   Quarter 1 Quarter 2 Quarter 3 Opening Cash Balance 5,000 51,000 115,000 Expected Cash Receipts   Cash Revenue 90,000 80,000 60,000 Receivables 54,000 57,000 20,000 Loan 10,000 5,000 - Total cash available 159,000 193,000 195,000     Disbursements   Material 20,000 30,000 55,000 Labor 30,000 35,000 40,000 Administrative 2,000 2,000 3,000 Machinery Purchase 45,000 - 90,000 Income Tax 11,000 11,000 12,000 Total Disbursements 108,000 78,000 200,000 Closing Cash Balance 51,000 115,000 (5,000) TASK 3 Q Ltd initiated a product which presently includes variable cost of around $1.2 and related fixed cost per unit of nearly $5. The two costs sums up to around $6.2 i.e. production cost. Though, there are selling costs also connected with the product but they are not engrossed into the definite product cost because of which they are not encompassed in unit cost of the product. Meanwhile, Q Ltd possesses additional capacity of manufacturing around 2,000 units, consequently it may agree to take the proposal from Z Plc. in case if Z Plc. agrees to charge a price of more than $6.2. Computation of unit cost can be observed in the following table: Variable Production Cost   1.2 Total Variable Cost per unit 1.2 Fixed Production Cost ÷ 40,000   Number of Units Produced 8,000   Total Fixed Cost per unit 5 Total Unit Cost 6.2       TASK 4 EPG Ltd is accounting for two ventures namely as Housing and Home. Nonetheless, the corporation has the option of embracing a solitary venture from the stated two ventures. The choice of the project is dependent upon the criterion of investment appraisal techniques. Investment appraisal is a tactic to assess the numerous investment prospects open to any organization. The above-mentioned method keeps several techniques like Net Present Value (NPV), Payback, Internal Rate of Return (IRR), Accounting Rate of Return (ARR) etc. EPG Ltd is mainly interested in acquiring the results of Net Present Value (NPV) and Payback, as the typical investment appraisal techniques to choose as to which of these ventures should be acquired (Brigham and Ehrhardt, 2008). The outcomes of NPV display that the Housing venture may end up with the NPV of nearly $52.62m as compared to Home project which may form NPV of around $32.73m. The standard used for NPV computation is to observe NPV value that must exceed zero and greater than that of other venture’s NPV. In this manner, NPV of Housing venture exceeds zero, and it is greater than the NPV of Home venture, consequently Housing venture may likely provide greater advantages as compared to other venture. Alongside NPV, another important technique used in this analysis is Payback that offers the projected time in which the capital expenditure of the venture may be recovered from cash inflows likely to be earned in future. The criterion stays with the fact that as soon as the capital expenditure is received, it will result in higher benefits. Under current situations, it might be evidently viewed that the capital expenditure of Housing venture might be recovered in nearly 3 years. On the contrary, capital outlays of Home venture might take some 3.28 years. This shows that Housing venture would recover it capital expenditure earlier than that of Home project, and because of this, Housing project should be considered for approval by the BOD of EPG Ltd. Alternative investment appraisal technique is named as IRR, which is operative as it delivers a foundation of evaluation between the two ventures that have dissimilar size of cash flows. IRR is in fact the rate that allows NPV of the venture to equate to zero. It can be stated that the variance between the cost of capital and IRR is the marginal return that financiers may earn for a specific venture. The greater the variance between cost of capital and IRR, the advantageous will be the venture. NPV and Payback of Housing and Home ventures are provided in the following table: Housing           Years 0 1 2 3 4 Capital outlay -100   Net cash flows 60 30 40 80 Residual value 10 Total cash flows -100 60 30 40 90 Cost of Capital - 15% 1.000 0.870 0.756 0.658 0.572 Discounted cash flows -100.00 52.17 22.68 26.30 51.46 Cumulative cash flows -100.00 -47.83 -25.14 1.16 52.62 Net Present Value 52.62   Payback 2.96   IRR 37.54%         Home           Years 0 1 2 3 4 Capital outlay -150   Net cash flows 60 60 60 60 Residual value 20 Total cash flows -150 60 60 60 80 Cost of Capital - 15% 1.000 0.870 0.756 0.658 0.572 Discounted cash flows -150.00 52.17 45.37 39.45 45.74 Cumulative cash flows -150.00 -97.83 -52.46 -13.01 32.73 Net Present Value 32.73   Payback 3.28   IRR 24.96%         TASK 5 Financial statements primarily entail five distinct statements in a way that all of those statements are together known as financial statements. The titles of all the types of financial statements are as mentioned below: 1. “Statement of Financial Position” 2. “Statement of Comprehensive Income” 3. “Statement of Cash Flows” 4. “Statement of Changes in Equity” 5. “Notes to the financial statements” Being a corporation, EPG Ltd is obliged to construct all the above mentioned financial statements according to the requirements of the applicable accounting principles. Statement of financial position helps in examining the overall financial position of the company. This statement reveals the value of assets positioned in the company for business operations as well as the financial position of the company in the form of equity and debt for those assets (Watson and Head, 2009). Statement of comprehensive income provides the business a mechanism to assess the performance of the company for a specified period. This statement presents the revenues that it has produced from its business operations as well as the associated expenses. The most integral component covered in this statement is the figure for profitability that shows the overall financial position of the company in a given financial year. Statement of cash flows reveals the areas from where the cash is produced as well as the areas where the cash has been put into use. The three main components upon which the cash flow statement is based include i.e. operating activities, investing activities and financing activities. Statement of changes in equity presents the variations that have been made in the side of equity which is present on the Statement of Financial Position. It includes important heads such as deduction of dividends from retained earnings, net income taken to retained earnings, etc. Notes to the financial statements is not a financial statement in actual instead it provides supporting explanation for the figures that have been resulted while preparing other financial statements. Comparison of Financial Statements Formats Statement of Financial Position Under this statement, a sole proprietor reveals capital and retained earnings. In case of partnership, distinct capital for accounts of each partner is revealed. Under corporation system, the equity portion comprises of share premium, share capital, reserves etc. Statement of Comprehensive Income In case of sole proprietorship, fundamental heads are incorporated in the statement of comprehensive income. Under partnership, profit for the investment of each partner is provided by mentioning it at the end of the statement whereas in case of corporations, earnings per share, other comprehensive income etc. are few other heads that are included in the statement of comprehensive income. Statement of Changes in Equity Sole proprietors formulate this statement by merely totaling up the net profit in balance of opening capital and deducting the drawings, if there are any. In case of partnership firms, the outcome of variations in the ratios of capital as well as with proportion of each partner’s share capital etc. are included in this statement. Corporations offer detailed disclosures in respect of appropriation of net profits, share capital, cash and bonus dividends, share premium etc. (Watson and Head, 2009). TASK 6 Financial ratio analysis has been conducted in order to assess the financial performance and position of Grappa and Merlot. The ratios revealed that Grappa has performed well and left Merlot way behind in almost every area of financial statement. In terms of ROCE, Grappa has performed 4% higher than that of Merlot. Merlot has shown better net assets turnover as it significantly higher than that of Grappa. This means that Merlot has remained more successful in generating higher level of sales with its net assets. The profitability ratios of Grappa are slighter higher than that of Merlot including Gross Profit Margin and Net Profit Margin. Liquidity concerns for Merlot are better than that of Grappa as envisaged by current ratio. Overall, efficiency ratios for Merlot are slightly better as inventory period, receivable and payable period are less than that of Grappa but low payable period may cause shortage of funds of Merlot. Capital structure of Grappa is more stable as compared to Merlot because of low gearing ratio. This implies that Merlot is in a riskier position as compared to Grappa. Merlot does not have higher level of profits in order to recoup itself with the interest expense. For Grappa, interest cover ratio shows higher level of available profits to pay off the interest expenses. Briefly, Merlot’s financial performance is compromising in comparison with Grappa, therefore, it is recommended to EPG to account for Grappa for any acquisition-based consideration. The following table compares the ratios of both Grappa and Merlot: Ratios Grappa Merlot Return on Capital Employed 14.80% 10.99% Net assets turnover 1.2 2.25 Gross profit margin 12.50% 12.20% Operating profit margin 10.50% 9.76% Current Ratio 1.2 1.28 Closing inventory holding period 70 64 Trade receivables collection period 73 66 Trade payables payment period 108 77 Gearing 35.5 81.08% Interest Cover 6 2.3 Conclusion Managing financial resources and main decision is an integral area of concern for any entity. This decision can be so essential that the organization may end up in liquidation if the decision is not rightly made. The theoretical prospects and computational areas are equally important as they contribute in making effective decisions. The above report highlighted various financial resources to Emaar Plc. as well as the computational areas in order to understand thoroughly the insights of this mainstream financial decision. References Baker, H. 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