Financial Regulations and Its Implication on Microsoft Corporation - Case Study Example

Financial theories Introduction Financial theory is a set of pragmatic, conceptual and hypothetical principles that help to form a general framework for maintaining accounting transactions in a systematic way. Accountants or the financial analysts of companies use and apply many financial theories and models for effective financial and investment decision making for the firm. Financial theories can also be termed as coherent systems that focus on the interrelated objectives of an organization and relevant fundamental strategies which help to achieve the financial goals and also help to maintain a consistent financial standard within company. These theories prescribe about the valuation of company’s asset for the purpose of reporting procedure to the external parties. Management of a company can estimate the power of the group of stake holders for more amounts of capital inflows by applying financial theories. Managers also can forecast the future revenue and profitability of the business and according to it they can make salary and bonus structure for the employees of the organization (Weil, Schipper and Francis, 2012). Here, for this research study, selected organization is Microsoft which is a famous American multinational corporation. The company manufactures, develops, supports, sells and licenses consumer electronics, personal computer, computer software and related services to its customers. Thesis Statement: Financial regulations and its implication on Microsoft Corporation Financial Information of the Company In the year 2014 (Q4) the company has earned $ 23.38 billion in revenue and $ 4.6 million in net income. Company’s operating income is $ 6.5 million in the current fiscal year. As per financial records this can be observed that company is in financially stable situation than the previous quarter in the year 2014 and all the quarters in the previous year 2013 especially in terms of revenue but this amount of earning will not give any surprises to the company. Few reasons are behind this amount of earning and those are decline of traditional personal computer sales and mobile phone sales, windows revenue declined in 3 % etc. Revenue has increased 11 % from the previous year. Microsoft has acquired Nokia which can provide profitable opportunities to this company (Rigby, 2014). Financial Theories Applied by the Company The company also uses some financial theories to run the business procedure in proper way and management of this company can also predict about the future scenario of business which will help to generate more revenue and profit from the activities of organization. The applied financial theories are as follows. The financial theories that will be discussed in this paper are accounting rate of return, asset allocation, capital asset pricing model, dividend growth rate, dividend payout etc. Accounting Rate of Return Microsoft uses accounting rate of return (ARR) theory in its business practices. Accounting rate of return is rate of return or profit that the company can expect from it’s per of investment. It helps to divide the amount of average profit which is nothing but the difference between initial investment and the amount of return which is expected by management. Management of the company can easily compare potential profits for newly launched or upcoming projects, investments and products. Straight-line method is used for computing ARR and through this process management of this company can gather all the qualitative information (Brigham and Ehrhardt, 2011). But ARR does not consider time value of money and so business faces some problem by using this particular method. Management cannot understand the amount of return will be less worthy than the present value of investment or not. Asset Allocation Financial professionals of Microsoft use this theory as allocation of financial assets is an important part in the business which will give maximum benefit. Proper and accurate allocation is required to invest money in cash & cash equivalent, bonds, stocks etc. This is observed that Microsoft invested 40.15 % of its total investment in general bond, 15.68 % in US equity [Fidelity Growth Company K (FGCKX)], 14.27 % in US equity [Vanguard Value Index Instl (VIVIX)] and rest 29.90 % of its total investment in international equity. It is very clear that the management of this company prefer to invest more in general bonds as they think that maximum return the company can earn from this investment (Copeland, Weston and Shastri, 2005). Such kind of proper asset allocation or portfolio allocation also minimizes the probable risk factors. Here Microsoft faces only 40 % risk factors from the above mentioned portfolio and all the risky assets are also equally weighted by defaults which are selected for the portfolio (Danthine and Donaldson, 2005). This is also clear that the company has selected two top performing assets for getting maximum return from its total amount of investment. Capital Assets Pricing Model (CAPM) The management of this company also uses capital asset pricing model which is a very popular financial theory applied by all large companies. This model generally calculates required return or expected return based on the measurement of risks. A risk multiplier which is also known as beta coefficient is used to calculate the amount of required return. Three major factors are indicated by this CAPM model and these factors are systematic risks estimation, rate of return and expected rate of return (Deegan, 2009). Management of this company has to do certain assumptions as capital assets pricing model depends on these assumptions. These assumptions are as follows. All the investors who are related in the same market have equal and similar. expectations No transaction costs are there. No taxes are there. Any investor’s activity does not influence the market price. Investors can lend or borrow unlimited amount at zero risk rate. All the investors want to maximize their wealth and so they will select such kind of investments which are based on standard deviation and expected return. Short sale of any financial assets can be done in simple and easy way (Deegan, 2010). Financial assets can be sold out at any time in the market place. Beta coefficient is nothing but the risk measurement factor. It is already defined that whole security market has a beta coefficient of 1. Individual companies calculate beta coefficient on the basis of market beta and comparative analysis between market beta and individual company’s beta indicate the probable risk factors. If any company’s beta coefficient in more than 1 that indicates higher risk factors than the average market risk factors (Nel, 2011). On the other hand if any company’s beta coefficient is less than 1 then that indicates less risk factor than the average risk in the market place. In the year 2014 beta coefficient of Microsoft is 0.68 which indicates less risk than the market average and it is a positive sign for the financial health of business. Microsoft also uses security market line formula or CAPM formula to access risk factors. This formula is r * = kRF + b (kM – kRF). Here, r * = required rate of return, kRF = risk free rate, kM = average market return and b = beta coefficient of securities (Hoque, 2006). Dividend Growth Rate Dividend growth rate is one of important financial theories. This theory is also a useful key factor in dividend discount model. A particular stock’s price can be determined and future dividend can be estimated by using this theory. The growth rate of dividend can be analyzed over a period of time. According to the financial records of Microsoft, this can be said that the company’s dividend per share for the 3 months ended in March, 2014 was $ 0.28 and 3 years dividend growth rate was 19.60 % whereas in the previous year 2013 the dividend growth rate was 18.60 %. So this can be analyzed that in the current year growth of dividend has been increased than the previous year which is a good sign for business (Kimmel, Weygandt and Kieso, 2010). But if a comparative analysis can be conducted with the other competitor brands in the market then this can be observed that Oracle Corporation (ORCL) has gained more 3 years dividend growth rate than Microsoft and their 3 years dividend growth rate is 31.7 %. So from this comparative analysis this can be said that Microsoft should give more concentration to increase the dividend growth rate to attract more potential investors and to retain its existing and loyal shareholders who have maintained a long term relationship with the company expecting high dividend growth every financial year. During the past 13 years, business activities Microsoft faced highest 3 years average dividend per share growth rate which was 62.00 %, median was 5.05 % and lowest was 0.00 % (Guru Focus LLC, 2014). Dividend Payout This theory is generally used to measure and determine the percentage of company’s total earning which will be paid out as dividends. It is calculated by dividing last dividend per share by earning per share of the company. This also indicates the reinvestment pattern of the company. In March, 2014, Microsoft has gained dividend payout ratio which was 0.41. Calculation of dividend payout ratio of Microsoft is – 0.28 [Dividend per share as per March, 2014] / 0.68 [Earnings per share as per March, 2014] = 0.41. During last 13 years highest dividend payout ratio of the company was 1.14, median was 0.28 and lowest was 0.18 (Neave, 2009). Dividend Yield This theory indicates how much amount a company pays out in form of dividends every year relative to the share price of that particular company. Dividend yield is calculated by dividing per share dividend paid by present share price. In March, 2014 dividend yield of Microsoft was 2.39 %. Current share price of Microsoft is $ 44.83 and company’s full year dividend per share is $ 1.07. So $ (1.07 / 44.83) = 2.39 %. From the above analysis this can be said that stock dividend yield of Microsoft Corp. is close to 3 years low which a sign of warning to the business (Overton, 2007). Corporate Finance Corporate finance theory indicates a department or division of a company which is primarily concerned to maximize the value of share holders through short term and long term financial planning and implementation of related financial strategies. Under the corporate finance area all the financial activities are included such as investment banking, capital investment etc. In this context this can be said that Microsoft Corp focused on the industry solutions and multi channel integration by high touch sale, no touch fix connectivity, low touch e commerce etc. Asset Turnover Asset turnover indicates how quickly company can turnover its assets through sales. In March, 2014 asset turnover of Microsoft was 0.13 (quarter ended figure) and 0.55 (fiscal year ended figure). Asset Turnover is calculated as revenue of business divided by total asset of the organization. In March, 2014 revenue of Microsoft Corp was $ 20, 403 Million and valuation of total asset of this company was $ 156, 119 Million. Generally the companies which have low profit margin then have high asset turnover. Conclusion From the above analysis about concepts of different financial theories and their implications on Microsoft, it can be concluded that Microsoft is a big brand name in the international market and uses more than one financial theory in their financial activities. Some of those theories are dividend payout and dividend yield, corporate finance, dividend growth rate, accounting rate of return, capital assets pricing model and asset turnover. After applying the above mentioned theories this can be analyzed that the company is in a stable situation but more improvement is required on certain fields like dividend yield of the company is in a danger position which needs to be improved and management should take more initiative on this particular field. Again this can be said that beta co efficient of this company is in satisfactory situation and company can face less risk factor in the market than the other competitor brands. References Brigham, E. and Ehrhardt, M. (2011). Financial Management: Theory and Practice. Boston: Cengage Learning. Copeland, T., Weston, J., and Shastri, K. (2005). Financial Theory and Corporate Policy. New Delhi: Pearson Education India. Danthine, J. and Donaldson, J. (2005). Intermediate Financial Theory. Massachusetts: Academic Press. Deegan, C. (2009). Financial accounting theory (3rd ed.). North Ryde: McGraw-Hill Irwin. Deegan, C. (2010). Australian financial accounting (6th ed.). North Ryde: McGraw-Hill Irwin. Guru Focus LLC. (2014). Microsoft Corp; 3-Year Dividends Growth Rate. Retrieved from: http://www.gurufocus.com/term/dividend_growth_3y/MSFT/Dividend%2BGrowth%2BRate%2B3y/Microsoft%2BCorp. Hoque, Z. (2006). Methodological Issues in Accounting Research: Theories, Methods and Issues. London: Spiramus Press Ltd. Kimmel, P., Weygandt, J. and Kieso, D. (2010). Financial Accounting: Tools for Business Decision Making. Beijing: John Wiley & Sons. Neave, E. (2009). Modern Financial Systems: Theory and Applications. Beijing: John Wiley & Sons. Nel, W. (2011). The application of the Capital Asset Pricing Model (CAPM): A South African perspective. African Journal of Business Management. Vol. 5(13). Overton, R. (2007). An Empirical Study of Financial Planning Theory and Practice. Michigan: ProQuest. Rigby, B. (2014). Microsoft sees end to Nokia losses, shares rise after hours. Retrieved from: http://in.reuters.com/article/2014/07/22/microsoft-results-idINKBN0FR2B920140722. Weil, R., Schipper, K. and Francis, J. (2012). Financial Accounting: An Introduction to Concepts, Methods and Uses. Boston: Cengage Learning. Read More