Various Aspects of Corporate Finance - Coursework Example

1.0. INTRODUCTION Corporate finance is a very comprehensive part of finance providing businesses with an opportunity for assessing different finance related a matter of the business. Some examples include project and performance evaluations, sources of funds and different capital structure, etc. (Ross, Westerfield, and Jordan, 2009). In the similar context, the underlying report is consisting different measures to analyze different companies in order to help management to take right decisions at right time. SECTION A: RATIO ANALYSIS 2.0. ROLE OF RATIO ANALYSIS IN MANAGEMENT DECISION-MAKING FINANCIAL RATIOS: 2.1. FINANCIAL RATIOS Financial ratios are among different tools for analyzing the performance of the firm (Ross, Westerfield and Jordan, 2003). Using ratios business can also produce the future forecasting for the business (Delen, Kuzey, & Uyar, 2013). Set of different ratios, as well as vertical and horizontal analysis, provide management with an opportunity to undertake improvement measures for the future (Besley& Brigham, 2007). 2.1.1. Liquidity ratio: The liquidity ratio is that ratio that measures the position of the company after paying off short-term liability (Johnson, Scholes, and Whittington, 2008). There are two types of liquidity ratios given below: 1. Current Ratio: assess the liquidity performance of the company after paying all short term liability (Bhattacharya, 2007). 2. Quick Asset Ratio: is almost same as current asset ratio, but is stronger performance measure than current asset ratio as it excludes inventory impact from the current assets. Business cannot always depend on the sale of inventory for paying off its debts, as inventory sales are also affected large number of factors (Machiraju, 2001). 2.1.2. PROFITABILITY RATIO: Profitability ratios measure the profitability performance of the company. It is simply the savings of the firm from the firm after meeting different expense incurred for the business (Heisinger, 2009). 1. Gross Profit Margin Ratio tells the percentage of the funds remaining in hands from sales/ revenue after excluding the direct cost of sales (Tracy, 2012). 2. Net Profit Margin: Gitman, (2003) explains it the percentage savings from revenue with the business after paying off all operating and other expenses as well as adding other income. 2.1.3. EFFICIENCY RATIO: It measures the efficiency and effectiveness in the utilizing its assets for the revenue generation. (Ross, Westerfield, and Jordan, 2009). 1. Asset turnover: It is the measure of company’s tendency to utilize its assets for generating revenues. When asset turnover is decreasing, it is leaving the bad impact of the company and vice versa. 2. Inventory turnover determines the level of efficiency with which the firm is replenishing its inventory level (Hilton, 2010). 2.1.4. LEVERAGE RATIO: It indicates the position of the capital structure of the firm in terms of equity and debts for operating its functions (Weil, Schipper, and Francis, 2012). Leverage taken by the business is assessed from different perspectives. Widely used leverage ratios are: 1. Debt-to-asset ratio is the percentage of the assets that have been financed through debts. The percentage implies the level of assets that be utilized for paying off creditors in case the firm is liquidated. 2. The debt-to-equity ratio refers to the balance of the funds that are financed through the debts and equity. 2.2. NON-FINANCIAL RATIOS: Non-Financial measures as the name states put forward information related to the business without accounting the financial performance of the business. For example, balance scorecards provide a combination of financial and non-financial measures for assessing the company performance. There are different non-financial measures for measuring the quality improvement and customer satisfaction, etc. (Griff, 2014). Assessment of management is critical to the long-term success and is among the most important non-financial measure. Another important nonfinancial measure is the customer satisfaction. Indexes such as American Customer Satisfaction Index play an importance role in defining the aspects where a company lacks behind its competitors. Hence, the company can take measures for improving its performance in the similar aspects. 3.0. FINANCIAL ANALYSIS OF THE APPLE INC Assessment of the performance of the business from different perspectives such as efficiency in operation returns generation, profitability and leverage are analyzed using financial ratios (Brigham, and Houston, 2011). Following are the financial ratios that have been analyzed by the financial advisor to guide the investor in order to invest in Apple Inc. 3.1. LIQUIDITY RATIO The current and quick ratio of the Apple is as follows: Despite the decline, the company is still in a strong position of paying off its short-term liabilities. Both the ratios are showing the same trend of decline. This implies that Apple Inc does not hold too much inventory that can influence the position of its current assets. Sound liquidity position encourages the supplier in providing company the products on credit (Saleem, and Rehman, 2011). However, on the other hand, when the company has more assets available to pay off its debts, it is considered to be a good financial position for a firm. However, high current ratio is not always advantageous as it reflects that business is keeping idle cash, and it is not investing it potential revenue generation avenues (Bhattacharya, 2007). This aspect is well implemented by Apple Inc as the company has started paying dividend to investors as the most valuable utilization of cash (Ghosh, 2012) 3.2. PROFITABILITY RATIO Different levels of profitability assessment reveal the percentage of the revenue taken up by different levels of expenses. The above graph shows the profitability ratios of the Apple Inc remained consistent and then declined in the recent past three years. The similar trend of both ratio ratios depicts that impact is due to the rise in the cost of goods sold. The decline in gross margin is due to revamping of the product design, and the impact is in line with the analyst anticipation. However, it is also anticipated that decline will be recovered in the coming years (Hughes, 2014) 3.3. EFFICIENCY RATIO The efficiency in business is considerable important in the growing competitive environment. Hence, efficiency ratios indicate the position of the company related to utilizing or managing its resources (Haber, 2004) The above graph shows the asset turnover of the Apple Inc that has declined in the past three years. The decline indicates that investment in assets is yet to be efficiently capitalized by increasing sales. Efficiency ratio that determines that investment in the assets for business has been a curse or a blessing. (Leach and Melicher, 2011). As noted above company have revamped its product (mobile) therefore, the decline can be due to the similar case. Moreover, as depicted it will rebound its margins, it can anticipated that company will recover its turnover sales level and so asset turnover as well. Therefore, efficiency ratios of Apple have apparently affected the level of revenue and profits that business is adding by investing in assets; however, rebounding of the revenue will prove the revamping of the products fruitful investment in assets. The above graph shows the contrasting trend in the inventory turnover of the Apple Inc. Businesses have to strike a right balance between the level of inventory it shall maintain based on the sales trends, expenses in driving inventory to sales point and the cost of holding, etc. Hence, there is no rule of thumb and industry trends and business model specification determine the results (Kang, and Kim, 2012). However, it had been noted in the past scenarios also that Apple Inc has not proven an effective inventory manager. The company ran short of stock when it debuted its some models of smartphone sales. Stocks often ran out even within an hour of the sales start and then Apple Inc give delayed shipping dates to the clients (Keizer, 2013 and Keizer, 2014). 3.4. LEVERAGE RATIO The debt ratios are important as debt and equity both incurs a different level of risk and cost for the business. Leverage ratio of Apple Inc indicates an interesting position of the firm about a portion of debt in the capital structure. The above chart of Long-term debt to equity ratio indicates that Apple haven’t taken any debt in previous years. However, from 2013 onwards the Apple Inc has added debt to its capital structure. Different industries and business have different policies concerning the debt acquisition. It has been found that the capital-intensive companies are more debt oriented as compared to other industries (Hackbarth, Mathews, and Robinson, 2014). Following this debt orientation Apple Inc has generated produced a positive impact on the performance of the Apple Inc. Among other factors increase in debt has increased the ROE of the company from 30.64% to 33.61%. Also, in line with study results, the company has also improved massively on its payout ratio (Gill, Biger, and Tibrewala, 2010). Hence, these ratios reflect the changing impact of the debt composition of Apple Inc which in turn defined strategies and plan for improving performance in those areas for increasing savings. However, it is also important to understand and determine the future plan of Apple Inc related to debt, as excessive debt can affect the solvency position of the company (Poletti‐Hughes and Ozkan, 2014). 3.5. INVESTMENT RATIOS The investment ratios are the percentage of returns that a company pays back to its shareholders Dividends policy of the company gives considerable information about the company performance (Rehman and Takumi, 2012). Apple Inc was not paying dividend initially. It was a cautious approach adopted by a business as it was high growth firm. However,since 2012, Apple Inc have started paying a dividend to its shareholders. Now the company have maintained a level and their payout ratio is almost stable and had a small decline from 28.48% to 28.03%. The dividend declaration is now regarded as the best value for the idle cash that has been maintaining (Ghosh, 2012). Performance of chosen non-financial ratios The role of non-financial measures is equally important in providing the information to the business for the decision-making. Therefore, must be complimented with the financial measures in defining the overall performance of the business. For the non financial ratio that assesses the performacne of the management of Apple Inc has produced important results. The company under the management of Steve Jobs is rated high as the it saved the company was saved from the bankruptcy (Zulfiqar, 2013). On the other hand, the management under the new CEO Tim Cook has also proved to be an effective manager for the company. As a matter of fact, there was immense pressure of performacne on Tim Cook. However, Tim’s success in maintaining the performance of Apple Inc has led the companyto new heights. Apple Inc has the world’s largest market capitalization of $700 billion (Vally, 2014) and the Tim is awarded as the CEO of the year by CNN (Peel, 2015). Hence, reflect the success of the company on management aspect. Another measure for assessing the non –financial performance is measuring customer satisfaction. In this context, recent reports reveal that Apple Inc has left behind by its cut-throat competitor Samsung on ranking of 100 points (Mogg, 2014). Hence, such measures now provide an opportunity for Apple to review its performance in the areas where customers are more satisfied from competitors. 4.0. SECTION FOUR: LIMITATIONS OF THE FINANCIAL RATIOS Despite fact that ratios are widely used, the technique also has some limitations. Some of them are listed below: Financial ratios being relative measure do not provide complete results. The results required comparable value and benchmarks for assessment. Standalone ratios do not carry any significant information (Keith, 1998)  Every company and every industry have different nature and their financial ratios depend upon the nature of industry or company. Therefore, the comparative performance of the two different businesses can be misleading. Therefore, it is important to analyze alongside factors that that result in variation in ratios (Keith, 1998). Financial ratios completely based on the financial statements. When the quality of financial statement is not good, accurate ratios cannot be determined (Keith, 1998). The financial position of any company does not only base on its financial statements. There are many other internal and external factors that affect the financial position of the company. But it cannot be determined by the financial statements. That means financial ratios based on financial statements does not show the mirror position of the company (Lesáková, 2007) SECTION B: CAPITAL BUDGETING TECHNIQUES The capital budgeting techniques of the corporate finance provides business with an opportunity of making investment decision using different techniques. Businesses use different capital budgeting techniques for selecting the investment avenue that can best generate value for business finance (Bierman and Smidt, 2012) 5.1. CALCULATION OF PROJECT VIABILITY 5.1.1. Payback period Year Cash Flows £ Cumulative cash flows £ 　 A B A B 0 -100000 -100000 -100000 -100000 1 35000 64000 -65000 -36000 2 25300 32500 -39700 -3500 3 24000 3000 -15700 -500 4 28000 15000 12300 14500 5 5000 15000 17300 29500 Therefore, the payback period for Type A and Type B are: Type A: 4 + (15700/28000) = 4.56 years Type B: 4 + (500/15000) = 4.03 years 5.1.2. Net present value (NPV) NPV of Type A: Year Cash flows £000 Discount factor (10%) Present value £000 0 -100000 1 -100000 1 35000 0.909 31815 2 25300 0.826 20897.8 3 24000 0.751 18024 4 28000 0.683 19124 5 5000 0.621 3105 NPV -7034.2 NPV of Type B: Year Cash flows £000 Discount factor (10%) Present value £000 0 -100000 1 -100000 1 64000 0.909 58176 2 32500 0.826 26845 3 3000 0.751 2253 4 15000 0.683 10245 5 15000 0.621 9315 NPV 6834 5.1.3. Accounting Rate of Return (ARR) ARR of Type A: Average annual operating profit before depreciation over the five years is £23,460 (that is £000(35+25.3+24+28+5)/5). The annual depreciation charge will be £20,000 (that is £ (100,000 /5)). Therefore, the average annual operating profit after depreciation is £3,460 (that is £23,460 - £20,000). Average investment = £100,000 /2 = £50,000 Therefore, ARR = (£3,460/£50,000)*100% = 6.92%. ARR of Type B: Average annual operating profit before depreciation over the five years is £25,900 (that is £000(64+32.5+3+15+15)/5). The annual depreciation charge will be £20,000 (that is £ (100,000 /5)). Therefore, the average annual operating profit after depreciation is £5,900 (that is £25,900 - £20,000). Average investment = £100,000/2 = £50,000 Therefore, ARR = (£5,900/£50,000)*100% = 11.8%. 5.2. RELATIVE MERITS OF CAPITAL BUDGETING TECHNIQUES 5.2.1. Relative merits of Payback Periods: Payback period shows the numbers of years in which a company will recover its initial investment. It is easy to understand and simple because it provides the complete period that a company will need to get its initial investment (Shim, and Siegel, 2007). Payback period handles the risk of investment very efficiently and effectively. It also works as a risk indicator and sometimes it is very quick to select the profitable project with the help of payback period (Lavelle, 1995). The disadvantages of the method is that it does not include the concept of time value of money and also does not consider the role and impact of cash flows after the payback period. It is also relative and does not have any specific system for selection (Kapil, 2011) 5.2.2. Relative merits of Net Present Value: NPV is the Net Present Value of any project. It compares the discounted future cash flows with the initial investment of the project (Shim, and Siegel, 2007). The biggest advantage of net present value is that it consider the time value of money whether, on the other side, payback period does not consider the time value of money. Comparatively, it provides more fruitful results than others. The NPV method is more consistent and hence, contributes in the objective of wealth maximization for shareholders (Moyer, et al., 2011).Despite being widely used, this method is faced with the challenge that it uses fixed rate for discounting whereas the cost of capital varies across the period. The future cash flows are estimated on the basis of past track record and the assumptions, which may not appear as presumed. Hence, the results can be deviate (Kapil, 2011) 5.2.3. Relative merits of The Accounting Rate of Return: Accounting rate of return is the simple method of accounting that indicates the profitability of a project (Drury, 2008). This method is also easy to calculate, and it also involves the numbers that relate to the financial statement presentation. In depreciation, it considers the full useful life. This return helps in evaluating the management performance so, many shareholders uses this ratio for the evaluation process (McLaney and Atrill, 2010). This method is also faced with the disadvantage that it does not use cash blow but relies on profit only. Additionally, this method also does not account the concept of the time value of money which limits its performance and usefulness (kapil, 2011). 5.3. PROJECT ACCEPTANCE DECISION Different Capital budgeting measures are used to identify the best project to be invested. The payback period, NPV and ARR were used to analyze the projects for this underlying paper. Project A has 4.56 years of payback period. On the other side; Project B has 4.03 years of payback period. Project B is acceptable because the initial investment made by project B will be recovered soon as compare to Project A. However, Project A has a negative NPV while project B has a positive NPV. This also implies that the Project B would be selected because positive NPV is only acceptable. Project A has a lower ARR as compared to Project B. The higher ARR is acceptable because it reflects higher returns. Therefore, Project B is selected because it has higher ARR i.e. 11.8%. Hence, using all the measures, project B is more viable. SECTION C 6.1. DIFFERENCE BETWEEN BUDGET AND FORECAST: Budget and forecast are two different things, but mainly managers gets confused between them. The budget covers the whole business plan whereas forecast is limited to some extent. Forecast for future anticipation is prepared once the budget is developed. Budget is mainly developed for an accounting period whereas forecast is take too long time. The main areas of the budget are related to business whereas forecast can be done in other parts too (Rao, 2011). Hence, the forecast is different from the budget. However, it is important to understand that both are important for business and must be developed for making financial decisions. 6.2. BUDGET VARIANCE ANALYSIS: Variance is the gap between the actual results and the budgeted results. The variance presents the difference between the budgeted profit and actual profit. It is the most important part of budgeting to meet the targeted budget with the targeted profit. Any difference between them either positive or negative will cause variance between them. There are two types of variance that include favorable variances and adverse variances. The positive variance is a favorable variance, and a negative variance is adverse. A favorable variance should be encouraged, and adverse variances should be eliminated or controlled ((McLaney, and Atrill, 2010). Flexing a budget means revision of the budget. The budget should be revised to match the real outcomes. In flexing the budget, companies revise the value and assumed another output values. Budgets are usually flexed to match the real output (Atrill, McLaney, and Harvey, 2014). 7.0. CONCLUSION The above paper has determined various aspects of the corporate finance. 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