Available Sources of Financing That TNA Pty Ltd Can Explore - Example

Name: Course: Tutor: Date: 1. Introduction An organization may seek to grow its business through internal expansion or through external expansion. TNA has chosen the latter by acquiring a small company in Vietnam. An external expansion means the acquiring of a running business and grows it through corporate combinations of the enterprises synergies. The corporate combinations, which may involve mergers or acquisitions, are increasingly becoming important features of organizations restructuring. The acquisitions have been playing a significant role in the external growth of many business organizations in the world as a mean of entering new markets. The acquisitions are also popular because of breaking trade barriers, enhancing competition, and increasing the free flow of capital among nations. In the wake of diversification of markets, TNA, an Australian company dealing with food appliances, has sought to acquire a small food appliance company in Vietnam as a way of increasing its footprints in the global market. Acquisitions and mergers have been a significant market and expansion entry strategy. An acquisition is the acquiring of ownership of an existing company by the purchase of the controlling interest of the share capital of the company being purchased. The acquisition that TNA seeks to engage in is often referred to as a horizontal acquisition which is essentially a combination of two enterprises in the same industry with the aim of obtaining economy of scale in production. However, TNA is undecided on the sources of financing; therefore, this paper seeks to discuss the various available sources of financing that TNA can explore. 2. TNA Pty, Ltd Acquisition An organization that seeks either to diversify or expand the business would not only be concerned with what markets to penetrate but also on how to enter the market. Often companies enter new markets through organic growth; however, an alternative is to buy a business that is already in operation. According to research, the choice of entry to a new market is dependent on the choice of entry mode which is often determined by the resource base of the enterprise as well as the resources needed to acquire the new company. Of significance, is the need to exploit the synergies between the two companies because the two companies operate in the same industry. TNA Pty Ltd is a global leader in food processing and packaging industry. The company supplies turnkey solutions to the global food market which often include innovative packaging solutions as per client demands. The company professionalism in design and installation has given the enterprise a commanding competence in the global arena. Currently, the enterprise has footprints in Europe, America, and the Asian sub continent. The company has been able to have a competitive edge over the completion by adopting a strategy that accommodates customer demands including flexibility and consistency in delivering customized projects to the satisfaction of the customers. The company’s product are priced with the customer in mind, hence, the costing of their products is on the lower side. Recently, the company has expressed interest to buy a company that makes similar products in Vietnam which would serve as a gateway to the Asian market. The Asian market is a lucrative market niche TNA has desired to enter for a long time. They have now identified a company that is available as a going concern. However, the financing of the takeover has caused the directors at TNA Pty Ltd some concern. Ordinarily, the company relies on its retained earnings and a little borrowing from the bank to fund its operations. The purchase price of the new acquisition is estimated at $A 10 million. The dilemma is getting financing that would be at a lower cost. According to the purchase estimates, $A 6 million would go to the direct purchase while the remainder $A 4 million would go to rehabilitating the old machinery. 3. Sources of funding A business can raise investment capital from various sources, however, each source has it unique characteristics, which need to be understood in order for a company to choose the best available source. Investment analysts, however, observe that there is no single source that is best for all organizations; it all depends on the circumstances, purpose, risk, and cost. If an enterprise, such as TNA wants to raise finance for fixed capital needs, it would be prudent to go for long-term funds which can be either from owned or borrowed funds (Wilson and Adler, 2012). There are several ways that a company can source for funds to finance its buyout or investment, however, a lot depends on the nature of the company’s business processes. The large organizations have more and better access to finance than small enterprises. The financial growth life cycle model can be used to identify the various options available to a company as it grows. The model highlights the changes in availability of nascent information and collateral. According to financial matters authorities, it is easy to conventionalize the pattern of funding based on the information opacity. As enterprises expand, they are able to access trade credit, angel finance, and later external debt as well as equity capital. Well established firms can also access large amount of funding from equity markets or public debts. Suffice to say; choosing the appropriate source of funding requires an understanding of the business, which TNA does, the business environment, and most significantly, the characteristic of the funder. The fund sources are either internal, which TNA may not be willing to pursue or external sources, which may be deemed appropriate. 3.1 Internal and external funding Internal funding of an enterprise refers to the funds sourced internally as capital such as retained earnings. The company could also get financial capital by disposing some of its assets as well as shareholders contribution. The internal source of finance may not be suitable for TNA since the company may not be inclined to use its retained funds or seek help from the shareholders. The external funding, on the other hand, is financial arrangements with external lenders who may include equity funds or borrowing from the banks. Guariglia, Liu, and Song (2011), the financiers offer two options, short-term and long term financing. TNA Pty Ltd can consider the two choices; however, the company seems to be inclined to a short period type of financing since the directors’ projection is to have the loans settled by the end of the fifth year. The choice of financing will also take cognizance of the flexibility and cost of the options taken. 3.2 Retained earnings The organization’s dividend policy is viewed as its long-term financial strategy. The policy spells out what part of the earning can be paid out as dividend and what should be retained for investment. Many enterprises prefer to retain a larger part of the earning because it does not attract much capital gain taxes while the taxes on dividend are high and are taxed as soon as they are received. The retained earnings form a significant source of financing the organization growth and expansion. A look at the level of the retained earnings conveys information regarding the enterprise capacity and prospects for growth. Often, companies with many growth opportunities tend to pay low dividend. Growth or expansion, therefore, lays a greater demand on the internal funds. In an ideal situation growth opportunities, like TNA purchase of the company in Vietnam, should be financed with retained earnings or with equity instead of direct debts (Guariglia, Liu and Song, 2011). 3.2 Cost of retained earnings Retained earnings do not attract any cost, however, there is an opportunity cost related to unutilized retained earnings. What is of concern, is whether TNA can raise the required sum of $A 10million dollars from its internal sources and particularly from its retained earnings. The amount is considerable, therefore, TNA must explore further for possible alternative sources. 3.4 Retained earnings advantages and disadvantages The major advantage of utilizing the retained earnings is that the cost low than other forms of financing such as equity funding. For instance, when an organization decides to utilize its retained earning it saves on the floatation expenses. Compared to acquiring the funds through the floatation of equity; which is slow and the investors may be hesitant, the retained earning capitalization does not depend on outside influences. Besides, the retained earnings boost the organization’s financial position by forcing capital appreciation and the market value of listed company. The disadvantage of utilizing the retained earnings is that the management does not have to consult the shareholders. Some critics have argued that utilizing the retained earning denies the shareholders the enjoyment of the enterprise earnings and many shareholders may be aggrieved which may lead to some volatility in the stock market. 3.5 Short-term internal financing An organization may obtain short-term funding for the investment internally through trade receivables, inventory, prepayment, and prudent financial management. The money that is tied in the receivable could be collected diligently including prudent credit plan that would ensure that the organization collects the overdue payments and reduces the chances for bad debts. The enterprise would also need to improve on the accounting practice with monthly account aging being practiced vigorously and the outstanding payments being captured quickly for immediate action. Suffice to say, the faster an organization can liquidate the receivables, the faster the funds for investment would be realized. For TNA, this route may not be available because it would affect its revenue and its operating capital at the parent company. However, the company can establish a prepayment policy whereby the clients are encouraged to make payments before delivery, perhaps with a little incentive such as a modest discount. Such measures often generate adequate liquidity that could make needed funds available. On the other hand, the company can also encourage the employees to invest in the mother company which they know and have confidence with its growth strategies. 3.6 Prudent Inventory Control Prudent inventory control allows an enterprise to retain some money that can be used for investment. Prudent inventory control means that the organization maintains only the necessary stock levels that can quickly be sold instead of tying money in obsolete stocks. Prudent stock control ensures that only the needed stocks are availed based on the market needs. Such practice helps the company to manage its cash flow and financial flexibility. 3.7 Floating of stocks The consideration of floating of shares or stocks is another source of funds; however, it is long-term source of capital. The shares are often traded in either as ordinary or preference shares. 3.7.1 Ordinary shares In order to raise funds through ordinary shares the company should first be listed with the stock exchange. The trading in shares or stock is a regular source of funds to a company. The permanency of the source of finance is guaranteed because the shareholders have no way of recalling their contribution so long as the company is operational (Thirumalaisamy, 2013). The benefits to the shareholders are realized through the occasional dividends. The shareholders also have the voting rights though which they get to influence the company major decisions during the annual general meetings. According to Thirumalaisamy (2013), the ordinary shares are viewed as carrying risks because of the uncertainty of returns. It is noted that TNA is not yet listed on the Australian stock exchange, therefore, they can only benefit from the trading with shares if they floated an IPO to enable the shares to be traded on the stock exchange. The advantage with the ordinary share capitalization is that it can be a source of long-term investment. 3.8 Trade Credit Trade credit is used by enterprise for short term financing. Trade credit is viewed as a credit given to an enterprise by another to purchase merchandise. The trade credit offers facilitation of the acquisition of supplies that would be paid for at a later date. Often, the trade credit is availed to the customers who are credible and are viewed as having strong financial standing. The terms of credit varies from one industry to another. The trade credit may not suffice for TNA as a source of financing the purchase of the Vietnam plant because the larger amount needed is a lump sum payment for the direct purchase of the company totaling to $A 6 million. 3.9 Private Equity In finance management, private equity is described as an asset of class that is made of equity securities and debt in mostly in companies that are not listed on the stock exchange. Often, a private equity financing may be availed by equity firms, venture capital, or, in some circumstances, by an angel investor. Private Equities are investors who have pulled their financial resources to provide capital to an enterprise for the purpose of expanding their business operations, company restructuring, or expansion (Guariglia, Liu and Song, 2011). The equity funding would be a reasonable source of the funds for the acquisition of the Vietnamese company. The private equity has the benefit of being run by financial professionals who are at hand to advice on investment and the management of the entities that they fund. 3.10 Lease financing A lease is viewed as a contractual agreement where the owner of an asset allows the leasing party the use of the asset for a periodic payment. The owner of the asset is the lessor. The lessee is supposed to pay the lease rental for the use of the leased asset. At the end of the contractual period, the asset reverts to the lessor. The lease financing offers organization the ability to diversify and modernize their operations without incurring large costs. The leasing ventures are prevalent in the acquisition of assets that have a short lifespan due to the constant evolution of technology. The lease finance may be a source of financing that TNA could consider especially because they intend to modernize some of the operating machinery as to maintain a competitive edge and recoup their investment in the shortest time possible. 3.11 Bank overdraft Yakhshibaev (2011) observes that a bank overdraft is in all sense and purpose a modest financial instrument for short-term funding and an active business can access for daily operation. An organization would have to approach a bank for the facility to be allowed. In essence, the organization is allowed by the bank to overdraw the account for a small fee. The advantage with overdraft is that it avails needed finances that fund the company in times of shortages or crisis. Often, the overdraft facility is offered on the strength of the organization goodwill. The overdrawing of an account also attracts a heavier overcharge than normal borrowing from the bank (Frey and Düwel, 2013). The facility is attractive because it is easy to access and is flexible depending on the needs of an organization. However, overdrafts are expensive financial instruments and cannot support a capital investment. In financial management circles, the use of overdrawing an account is viewed as poor financial management practice (Yakhshibaev, 2011). Overdrawing of an account may not be a way of financing a capital acquisition. Should TNA consider such a move, it would soon realize how overdrawing of the account can be expensive and the acquisition would soon flounder for lack of financing. 3.12 Overdraft as a debt Debt factoring is a financial instrument which allows an enterprise to offer its account receivable for sale at a discount. It is as simple as the description. However, it is not a viable financial instrument for a progressive organization because it shows the organization has poor management systems. It is advisable that TNA should not even conceive of such financial idea. Nevertheless, some financial advisers have opined that overdraft can offer a business a source of fiancé during times of financial difficulties. The rule of investment is for an enterprise never to risk a financial difficulty especially in time of crisis (Frey and Düwel 2013). The financial instrument is easy to access and it is also expensive to maintain. The unfortunate thing is that the bank that is offering the facility can recall it at their whims, often at short notice. The instrument does not have many precondition arrangements. TNA would be well advised to steer clear of such banking arrangement for the simple reason, the overdraft is an expensive funding instrument and its charges are high and paid on the time they fall due. 3.13 Debt factoring Another way of getting some financial relieve is considering debt factoring which in essence means that an enterprise can offer its account receivables to another entity for a discount consideration. It often means that a given entity is collecting an organizations debt for a fee. It may be possible that TNA may consider such a move; however, it does not have the capacity to produce the kind of finance that TNA requires to make a company takeover. Debt factoring is often taken as an easy source of funds; however, such a view ignores the factor that led to such a debt. In the opinion of many financial practitioners, debt factoring cannot support a capital venture. The source of finance: a Factor analysis Retained earnings Short-term internal funding Shares Private equity funding Loans Loan stocks Mortgage loan Finance Lease Sale and lease-back   Risk to the firm 0 0 0 0 0 0 0 0 0 0 Cost to the firm 0 0 1 1 0 0 0 0 0 -1 Efficiency 0 0 0 0 0 0 -1 -1 -1 -1 Ease of access 0 0 -1 -1 1 -1 -1 0 -1 -1 Viability -1 -1 -1 1 1 -1 0 -1 -1 0 TOTAL -1 -1 -1 1 2 -2 -2 -2 -3 -3 Table 1: the source of finance: a Factor analysis Key: 1: strongly recommended 0: Recommended -1: Not recommended Private equity funding seems to be the viable option, therefore, the most preferred source of funds for TNA Pty Ltd.   Year 2017 Year 2018 Year 2019 Year 2020 Year 2021 Estimated growth (%) 20% 30% 30% 20% 10% Current revenue before Takeover ($A) 200,000 200,000 200,000 200,000 200,000 Annual Revenue 2017 ($A) (200000)+(0.2*200000) (240000)+(240000*0.3) (312000)+(312000*0.3) (405600)+(405600*0.2) (486720)+(486720*0.1) 240,000 312,000 405,600 486,720 535,392 Total Cost as a % of revenue 60% 50% 50% 50% 50% Total Cost 60% of 240,000 50% of 312,000 50% of 405,600 50% of 486,720 50% of 535,392 144,000 156,000 202,800 243,360 267,696 Table 2: cost calculations Purchase of Equipment Cost: = A$ 400,000 Residual value: = A$ 200,000 Net gain: = A$ 400,000-A$ 200,000 = A$ 200,000 Calculation of NPV with discount rates Time Cash Flow ($A) Inflation discount rate (1/1+i)n Capital cost discount rate (1/1+c)'n PV ($A) Initial investment 1 (10,000,000) 1 1 -10,000,000 Initial investment 2 (7,000,000) 1 1 -7,000,000 Year 1 96,000 1 0.909 87,264 Year 2 156,000 1 0.826 128,856 Year 3 202,800 1 0.751 152,303 Year 4 243,360 1 0.683 166,215 Year 5 467,696 1 0.621 290,439 TOTAL PV 825,077 Table 3: calculations of NPV with discount rates Calculation of NPV   Year 2017 Year 2018 Year 2019 Year 2020 Year 2021 Total revenue 240,000 312,000 405,600 486,720 535392 Total cost 144000 156000 202800 243360 267696 Cash inflows before residual value 96,000 156,000 202,800 243,360 267,696 Residual value - - - - 200,000 Cash inflows after residual value 96,000 156,000 202,800 243,360 467,696 WACC 10% 10% 10% 10% 10% Capital discount rate (1/1+c)'n 0.909 0.826 0.751 0.683 0.621 Inflation rate difference (%) 3% 3% 3% 3% 3% Inflation discount rate (1/1+i)n 0.769% 0.769% 0.769% 0.769% 0.769% Present value (A$) with Investment of A$ 10 mill 87,264 128,856 152,303 166,215 290,439 Table 4: calculations of NPV Total NPV (with $A 10 million investment) = (87,264 +128,856+152,303+166,215+290,439) A$ = $A 825,077 Adjust for inflation in Vietnam =($A 825,077) * 1 (1+0.3)* (1+0.3)* (1+0.3)* (1+0.3)* (1+0.3) = $A 825,077* 0.269 = $A 222,217 Total Cost = (144000+156000+202800+243360+267696) $A = $A 1,013,856 NPV1= Total PVCIF – PVCOF = $A 222,217- A$ 1,013,856 = $A -791,639 = $A -791,639*16237.85 = (12,854,511,687.97) Vietnamese Dong = -$A 4,000,000 + $A 1,013,856 = = $A 2,986,144 The takeover is not a viable venture The take over with an investment of $A 7 million: Investment =$A 7 million Cost of equipment = $A 7 million- A$ 6 million =$A 1 million NPV2 = -$A 1,000,000 - A$ 1,013,856 = -$A 13, 856 According to all the evaluation of the variables, the investment does not seem to be viable, perhaps the enterprise can consider another evaluation of the estimates and take care of the variables. 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