Cash Flow Analysis and Evaluation in International Business and Finance - Assignment Example

INTERNATIONAL BUSINESS AND FINANCE (Word Count: 2995 words) Question Cash flow analysis and evaluation Through a joint venture, XP Plc. will engage into an agreement with KE Plc. to engage into a business for a period of four years. Through this relationship, these entities will contribute equity equally and they will thus share the realised revenues and expenses. In evaluating the strategies available for XP Plc., this report used the net present value approach as a project appraisal method. This refers to the difference between the present value of cash inflows of a project and its present value of cash outflows. In order to determine investments present values and to cater for the uncertainties due to forecasting, a discount rate is used (Grossman & Livingstone, 2009). (Grossman & Livingstone, 2009)This technique was preferred as it considers the time value of money, risks and return, and valuation concepts in selecting capital investments that are consistent with the entity’s goals of maximizing owners’ wealth. In addition, net present value break-even can also be calculated. According to Edwards (2003), for the NPV break-even to be attained, the projects NPV is equated to zero. The NPV break-even analysis is said to lead to better decisions, unlike the accounting break-even. Before the determination of the net present value, this report first established the weighted average cost of capital. As indicated in Appendix I, the WACC for XP Plc. was established to be 8%. Then, the cash flows were analysed in euros. In cases where the cash flows were projected in pounds, this report used the expected exchange rate between the pound and the euro, 0.732. From the calculations done by this report, the revenues are expected to be €1.2 million, €1.344 million, €1.667 million, and €2.267 million in year 1, 2, 3 and year 4 respectively. The operational costs of this joint venture will be €0.299 million, €0.305, €0.317 million, and €0.336 million in year 1, 2, 3 and year 4 respectively since they are anticipated to grow at a rate of 2% per annum as illustrated in Appendix II. When computing the operational costs, this report deducted depreciation since it is a non-cash item. After subtracting the operating costs from the annual revenues, earnings before interest, tax and depreciation was obtained as shown in Appendix III. Then the depreciation was deducted to get the earnings before interest and tax. This report further established the interest charge expense on the outstanding debt of €7 million and was €0.175 million. After subtracting the tax, depreciation was added back, and the net cash flows were €0.516 million, €0.612, €0.830 million, and €1.236 million in year 1, 2, 3 and year 4 respectively. These net cash flows were discounted, and the initial capital outlay subtracted to arrive at the discounted cash flows as indicated by Appendix IV. This report established that, this strategy was viable since it will give XP Plc. positive cash flows of €2.081. The use of NPV techniques was preferred because: it considers the time value of money, risks and return, and valuation concepts in selecting capital investments that are consistent with the entity’s goals of maximizing owners’ wealth. However, even though this project evaluation technique was used, it suffers some setbacks because it uses estimates which are uncertain and the required rate of return fails to represent the project’s actual return. By using the local currency, XP Plc. will be saved the conversion charges and the foreign exchange fluctuation risks. XP Plc. stands to benefit from the dealings in foreign currency because of its universality aspect. Therefore, this report proses that XP Plc. uses the foreign currency because of its internationalisation. Nonfinancial analysis The planned investment in the joint venture was also evaluated based on the non-financial measures through SWOT and PESTEL model. Though the SWOT model, the strengths, weaknesses, opportunities and threats were analysed while the political, economic, social, technological and legal as well as environmental factors were analysed through the PESTEL model. The smooth operations of this venture are likely to be influenced by the credit availability, and the housing market and commodity costs. The global downturn that has been experienced over the recent periods has negatively continued to impact on these companies sales and profits. Technological factors will also affect the running of XP Plc. XP Plc. must embrace the new technology so as to be able to process its transactions and manage its customers information. Political factors will also greatly affect the operations of XP Plc. especially due to the uprising that is being experienced in the Asia. In addition, the political goodwill will help in creating conducive environment for doing business. Therefore, political risks exist from certain governmental actions (Blumental, 1998, p. 272). Social challenges are real and XP Plc. will need to consider the social aspects of the target market. For instance, the different cultural contexts regarding the workforce may affect the relocation (Gartside et al., 2015). Question 2: Operational and strategic challenges that XP Plc. stands to face Before starting the business in Monaco, XP Plc. will be required to seek governmental authorisation. Through the help of the Chamber of Economic Development, XP Plc. will be able to get the start-up advice and administrative procedures. Just like any other multinational organisations that relocate their headquarters, XP Plc. will also be subject to some constraints, even though, there are the location drivers. In order to fully harvest the available opportunities, XP Plc. will face strategic challenges in trying to invest in line with its long-term strategy in order to secure long-term competitiveness (Klein et al., 2014, p. 256). XP Plc. should carry out these investments in order to augment its previous commitments and existing asset bases. The XP Plc. may be faced with some information challenges, thereby affecting its information transfer optimisation because information is the most basic input as well as the product of the headquarter. Another challenge that may be encountered by XP Plc. is a lack of supply of business services that would act as support services such as accounting, legal and advertising services. The structural model for the XP Plc.s corporate headquarters might pose challenges with respect to the degree to which the performance management responsibilities are shared by geographic sector heads or are centralised to the corporate headquarters. XP Plc. should also be concerned about the roles of the sector executive levels. Another key organisation element that should be of concern to XP Plc. is the degree to which staff functions should be provided centrally. XP Plc. might also face operational challenges in its organisational approaches for overseeing as well as adding value to the foreign and domestic subsidiary or the business unit strategy development. In designing its headquarters, XP Plc. should review at least four broad variables. In the first instance, it should consider the value potential as well as performance management challenges of its core business. This may include the subsidiary value creation profile and the degree to which the corporate portfolio needs to be rejuvenated. The second instance is the relationship and interdependency of domestic and foreign business units such as the core skills and an evaluation of whether they seem superior and whether functions should be shared for competitive advantage. The third operational challenge related to the capacity of XP Plc.’s management to offer performance management oversight while the fourth challenge will arise from the capability and the experience level of the subsidiaries management teams. Question 3: Financing Sources The business in Asia is important for companies intending to internationalise their operations as is the case with XP Plc. However, there are challenges being faced mainly emanating from the shifting regulatory conditions, heightened local contribution and the slowing economic growth. The various available sources of funds that XP Plc. can use to finance its intended expansion projects include both the internal sources of funds and the external sources of funds. However, it is before choosing a particular financing source, XP Plc. must consider some factors including repayment terms, financing requirement, interest and fee structures, and other requirements. Equity Finance This is largely composed of ordinary share capital as well as the reserves, which include capital and/or revenue reserves. Equity issuance As an international organisation, XP Plc. should work in tandem with investment bankers that will help it in analysing conditions on the global equity markets, determining the appropriate time to issue stock and figuring out better means of preventing money problems in the future. As noted by Codjia (2015), given its global presence, XP Plc. can use domestic capital markets and international equity markets to issue new shares and raise money overseas. The domestic capital market that XP Plc. can use is the London Stocks Exchange while internationally; it can use the Hong Kong Stock Exchange. To raise capital through share issuance, XP Plc. will be required to have been listed. This approach forms a permanent source of finance as shareholders or owners cannot recall the amount paid unless under liquidation. It is on this base that other funds are raised. This capital has no fixed returns. It is these shares that carry the voting rights and influence the companys decision-making process at the AGM. They also carry high risks due to uncertainties surrounding their returns, have residual claims and there is no assurance of refund. Retained earnings From its past operations, XP Plc. has had been retaining a certain part of its net earnings as retained earnings. XP Plc. can, therefore, use these retained earnings to finance its expansion strategies. These include the revenue reserves that were formed from undistributed earnings. Through revenue reserves, XP Plc. will be able to make up for low profits in order to sustain the acceptable risks and to plough it back to sustain growth. In addition, it will boost XP Plc.’s credit rating and help in lowering its gearing ratio. XP Plc. can also use capital reserves that it created after issuing some shares at a premium, revalued its assets and from a sinking fund. Preference share capital XP Plc. also has the option to raise the needed capital by issuing preference shares. They are also referred to as quasi-equity as they have both equity and debt characteristics. However, XP Plc. should know that these shares will have an initial claim, unlike the ordinary shares in dividend payments and proceeds from assets. Their returns are fixed, and they do not carry voting rights. In this case, XP Plc. can issue preference shares of different categories which include redeemable, irredeemable, non-participative, cumulative, noncumulative, convertible and non-convertible preference shares. Debt Finance XP Plc. can raise extra finances by selling debt products. The management of XP Plc. needs to have an understanding of the international credit markets, the risk appetite of investors and the regulatory procedures that it will be required to follow in registering its bonds before selling them. This option is however mostly used when an entity has a strong equity base. Using the global markets as platforms for bond issuance, XP Plc. will borrow a certain amount and agree to pay back the entire amount after the agreed upon period of time. XP Plc. will be required to be making some periodical payments to the lenders in the form of interest at a certain interest rate (Bechtel, 2015). As a global business, XP Plc. can also fund its expansion project by selling the commercial paper. Private sources To cope with the commercial tedium, this report advises XP Plc., as a multinational organisation, to rely on private sources of funds to finance the planned expansion project. According to Codjia (2015), through private sources, XP Plc. will also be able to comprehend the operational magnitude of temporary cash crunch as well as figuring out the best avenues to master the competitive currents within its sector or country. XP Plc. can reach out to private lenders, including banks and insurance companies. From its international footprint, XP Plc. can negotiate a loan or a line of credit arrangement with the management of home country banks to follow up with the financial institutions’ local branches. This report also advises XP Plc. to raise the required funds through private equity funds, hedge funds, and asset management companies. Lease Finance A lease arises when the lessor, who is the owner of an asset, enters into a contract with the lessee giving the lessee the right to use the asset but no legal ownership over it. In return, the lessor is paid periodic rent charges. This report advises XP Plc. to use this strategy in its expansion into India and China where it can lease out buildings for its offices. This source of financing will be ideal as the company’s funds will not be tied up in these assets, the lease charges will be chargeable against the profits thereby reducing the taxable profit and XP Plc. will be given an option to buy these buildings. Overdraft Finance This report asks XP Plc. to use an overdraft facility to finance its short-term liquidity hurdles, particularly in financing their working capital in its expansion drive. This will be useful especially in times of financial crisis as a result of a sudden fall in profits. XP Plc. should prefer it because it might not require collateral, and it will, therefore, be secured on goodwill. In addition, it will be faster to raise for investing in urgent ventures as no much formalities are involved and has no effect on the companys gearing level. However, XP Plc. should be might find it unfavourable as the interest charges are higher than the bank loan rates and the use of overdraft might be construed as having poor financial management policies. Question 4: Other strategies that XP Plc. can use to expand its operations to Asia There exists a wide gamut of avenues that an entity wishing to internationalize its operations can adopt and have it a presence in various parts of the world. In the pursuit of its expansion goal, this report presents alternative strategies that XP Plc. can adopt. The XP Plc. can approach this market through foreign direct investment, which, according to Financial Times (2015) and Advameg, Inc. (2015), it is the investment from one country into another and entails establishing operations or acquisition of tangible assets. In doing this, XP Plc. has several strategies that it can use to have its presence in the foreign market, India and China. These strategies include the mergers and acquisition and the Greenfield, which have drawn a lot of attention from the international business arena. This report asks the management of XP Plc. to make a decision on which strategy to implement. XP Plc.s management will, first of all, be required to choose between the equity entry modes1 and non-equity entry modes2. According to Harzings (2001, p. 2) study, there are many factors that the management of XP Plc. will have to consider in making this decision focusing on three alternatives, namely the licensing, wholly owned subsidiaries and joint ventures and usually underpinned by either the ownership-location-internationalisation framework or the transaction cost theory. The factors that the management must consider include the research and development intensity, the cultural distance, the level of foreign experience, the degree of diversification, the time of entry, and the foreign direct investments size relative to the size of XP Plc. If the management of XP Plc. chooses the equity mode of entry into the foreign market, the issue of when to acquire an already existing firm or setting up a completely new enterprise has to be decided. According to National Informatics Centre (2014), acquisitions are strategic decisions taken by an entity for maximization of its growth by enhancing its production, as well as marketing operations. Acquisitions have their usage across an array of fields such as telecommunications, information technology, and business process outsourcing in order to cut competition, gain strength, expand the customer base or enter into a new product segment or market. An acquisition, as defined by National Informatics Centre (2014), is where one entity acquires effective control over the assets or management of another entity but without combining. This implies that, under acquisitions, two or more entities may remain autonomous, separate legal entities, though there may be a variation in the control of the entities. There are instances when the acquisition is forced to take place; a condition called a takeover. This is a case of an unwilling acquisition, and the target entitys management is usually opposed to a move of being taken over. Therefore, an acquisition in its strict meaning is the friendly takeover where the management of the target and acquiring entities mutually and willingly concur for the takeover. As aforesaid, an acquisition does not, however, necessarily entail full legal control because an entity can also be exercising effective control over another entity by holding a minority ownership. Advantages of foreign direct investment Santos et al. (2011, p. 9) state that entities engage in acquisitions in order to accelerate their growth, particularly when their internal growths are constrained by the scarcity of resources as internal growth requires that an entity develops its operating facilities. Such as manufacturing, researches, marketing, inter alia. But inadequacy or lack of resources and time necessary for internal development constrains an entitys pace of growth. Acquisitions, therefore, enable an entity to acquire production facilities and other resources from outside. Specially, entering new markets or products, an entity may be lacking technical skills, making it require special marketing skills as well as an extensive distribution network to reach different segments of the markets. An entity can acquire an existing entity or entities with requisite infrastructure and skills for a quick growth. Foreign direct investment through, acquisitions also enhance profitability because the combined entities may result in synergism, efficient utilization of resources and cost reduction leading to the realization of more than average profitability. Additionally, an entity is able to diversify its risks, particularly where the acquisition is for those businesses whose income streams differ from those of the acquirer, leading to growth (Santos et al., 2011, p. 7). This diversification results in total risk reduction as there is a substantial reduction of operations cyclicality. The resulting combined management and other systems help in strengthening the capacity of the conglomerate entity to withstand the unforeseen economic factors severity that could otherwise endanger the individual entitys survival. On the same vein, an acquisition helps in limiting the severity of competition as the entity’s market power is increased. There is also the aspect of improved financing in the sense that companies facing financial problems may be forced to look for others that are financially stable to acquire them instead of going out of business or taking bankruptcy. The merger causes the firm to expand which makes it easily get access to debt and equity financing which was initially beyond its reach. Tax advantages – mergers enjoy tax advantages in the form of a tax loss carry forward. This arises where one of the merging firms has previously made losses that are offset against the profits made by the other. This is particularly valuable where the merging firm is anticipating that it will enjoy operating profits in future to benefit from this tax shield. Economy of scale- XP Plc. may merge with another company to lower the cost of doing its business (The World Bank Group, 2015). This gives rise to a win-win situation as the reduced cost of doing business by the newly merged firm will also be passed on to the customers who pay less. In addition, a merger results in operating economies where the small organisations business functions are much expensive for them but affordable for the combined firm. References Advameg, Inc., 2015. Encyclopaedia of Business, 2nd ed.- Multinational Corporations. [Online] Available at: HYPERLINK "http://www.referenceforbusiness.com/management/Mar-No/Multinational-Corporations.html" http://www.referenceforbusiness.com/management/Mar-No/Multinational-Corporations.html [Accessed 27 April 2015]. Bechtel, J., 2015. Sources of Capital for Multinational Corporations. [Online] Available at: HYPERLINK "http://www.ehow.com/info_8669559_sources-capital-multinational-corporations.html" http://www.ehow.com/info_8669559_sources-capital-multinational-corporations.html [Accessed 27 April 2015]. Blumental, D., 1998. 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Appendices Appendix I calculation of WACC WACC Formula = ( E/V) * Re + (D / V * Rd (1 - TC) WACC = (13/20)*10% + (7/20*6% *(1-0.3) = 8% Appendix II Operational costs Year 1 Year 2 Year 3 Year 4 Inflation factor 1 1.02 1.04 1.06 Operational costs 0.2992 0.305184 0.317391 0.336435 Appendix III Determination of the net cash flows Year 0 Year 1 Year 2 Year 3 Year 4 Expected exchange rate £/€ 0.732 0.732 0.732 0.732 Revenue 1.200 1.344 1.667 2.267 Operational costs 0.299 0.305 0.317 0.336 EBITDA 0.901 1.039 1.349 1.930 Less: Depreciation 0.026 0.026 0.026 0.026 EBIT 0.875 1.013 1.323 1.904 Less: Interest Expense 0.175 0.175 0.175 0.175 EBT (Earning before tax) 0.700 0.838 1.148 1.729 Less: Tax (30%) 0.210 0.251 0.345 0.519 Net income after tax 0.490 0.587 0.804 1.211 Add back depreciation 0.026 0.026 0.026 0.026 Net cash flows 0.516 0.612 0.830 1.236 Appendix IV Net Present Value Net present values Year 0 Year 1 Year 2 Year 3 Year 4 Initial investment -0.0012 -0.0008 0 0 0 Net cash flows 0.5158 0.61241 0.82966 1.2363 Total annual cash flows -0.0012 0.515 0.61241 0.82966 1.2363 Discounting factor 1 0.926 0.857 0.794 0.735 Discounted cash flows -0.0012 0.47689 0.52484 0.65875 0.90868 NPV=NPV(8%, E34,F34,G34,H34)+D34 2.081 Read More