Managerial Finance in a Company - Essay Example

Question Titanic Plc’s revenue has shown a sharp decrease of 29% from £61.7M in to £43.6M in The sharp decline in sales can be due to a fall in the volume of sales as well as due to the fall in the selling price of beers, soft drinks and spirits. The volume has fell due to the ban on smoking that was recently imposed. This ban has reduced the number of people who visit the bars and which in turn has led to a reduced level of volumetric sales of the company. Moreover, cheaper availability of alcohol in super markets must have resulted in a fall in price of alcohol. This has led to a fall in the prices of products sold by Titanic Plc. Consequently, due to a fall in volumetric sales and price of beer; Titanic Plc’s sales have plunged by 30%. 2012 2011 2010 Profitability Ratios: Gross Margin 39.4% 42.6% 46.4% Operating Profit Margin 2.3% 14.1% 18.0% Net Margin 0.5% 8.9% 10.9% ROA 0.5% 10.5% 11.9% ROE 0.9% 24.7% 32.8% The above table shows that the margins of the company have also eroded due to fall in selling prices but no subsequent reduction in the costs. The gross margin fell from 46.4% in 2010 to 39.4% in 2012, which can be attributed to the fall in selling prices due to increase in competition in the industry. The operating profit margin and net margin fell drastically as the company could not control its distribution and administration expenses in the period of falling sales revenue. The directors of the company feel that the company is experiencing financial distress. A company is in a financial distress when it faces liquidity issues and has difficulties in paying off its obligations when they are due. Financial distress increases when a company’s revenues move with the economy. Such cyclical companies are prone to fall in profitability due to an economic downturn. Liquidity Ratios: 2012 2011 2010 Current Ratio 1.94 times 1.03 times 1.01 times Quick Ratio 1.13 times 0.66 times 0.61 times The above table shows the liquidity ratios of the company. Company’s liquidity has improved from 2010 to 2012 as shown by an increase in the current ratio as well as the quick ratio of the company. Although the cash of the company fell from £10.6M from 2010 to £9.8M in 2012, the decrease was offset by an increase in inventory and receivables of the company. However, the current liabilities of the company fell drastically by 46% from £19.9M in 2010 to £10.8M in 2012 owing to lower trade payables and dividend payable. The ratios indicate that the company’s liquidity position is adequate. The above table shows the asset efficiency ratios for Titanic Plc. Days in inventory has increased substantially from 89 days in 2010 to 122 days in 2012 indicating that the company’s inventory is piling up. This piling up of inventory is due to the fall in sales of the company. Titanic Plc has to take steps to improve this ratio since piling up of inventory can lead to increase in cost and obsolescence of the inventory. Days Receivables has also increased from 10 days in 2010 to 20 days in 2012 indicating that the customers are taking more time to pay for the products bought on credit. The cash cycle indicates the number of days it takes to convert inventory into cash. The company’s cash cycle deteriorated from 1 day in 2010 to 34 days in 2012 indicating that it takes more time for the company to convert inventory into cash and a high cash cycle may result in significant reduction in the cash flow of the business which in turn may lead to liquidity problems for the company. Hence, Titanic Plc needs to take steps to improve its cash cycle. The asset turnover ratio shows the amount of sales generated by investing £1 in assets. The company’s asset turnover ratio has also fell from 1.1 times in 2010 to 1 times in 2012 owing to a significant fall in the company’s sales. 2012 2011 2010 Debt to Equity 0.92 1.35 1.76 Debt Ratio 48% 58% 64% Interest Coverage 1.25 times 10.88 times 8.92 times The above table shows the solvency ratios of the company. The debt to equity ratio and debt ratio of the company has improved from 2010 to 2012 owing to a fall in liabilities of the company and improvement in equity due to higher retained earnings. The company is not highly leveraged as indicated by the 48% debt ratio in 2012 and can take long term loans from banks to expand its operations. The interest coverage of the company has fell significantly owing to the fall in operating profit of the company. This is a worrying sign for the company and its long-term lenders. 2012 2011 2010 Shares (in M) 20 20 20 EPS (£) 0.01 0.275 0.325 Share Price (£) 2.27 3.41 4.55 P/E ratio 227 12.4 14 The above table shows the market analysis ratios of the company. The company’s EPS has fallen from £0.325 per share in 2010 to £0.01 per share in 2012 due to a fall in the profitability of the company. The P/E ratio of the company is very high which signifies that the company’s share is overpriced and the share price might fall further if steps are not taken to improve the profitability of the company. Titanic Plc has to take steps to improve its profitability. The company’s profitability has fallen drastically from 2010 to 2012 owing to a significant fall in the revenue of the company. The company should deal with the stiff competition in the industry and this can be done through product extension. The company can enter into food market and augment its revenue by serving high quality food to its customers. Since the company is not highly leveraged, additional investment can be done through using financing from banks. If the food business is successful, the sales of drinks will also increase since drinks serve as a complementary good for food. Moreover, Titanic Plc can employ effective marketing strategies to increase its customer base. Customer service should be of very high quality. The bars and public houses should be furnished according to the needs and demands of the customers. Targeting the upper segments of the society will help titanic Plc in creating a niche and hence will enable them to charge higher prices which will result in better margins and resultantly in higher profitability. Titanic Plc should ensure that the environment of the bars and public houses is conducive to social networking and social gathering. People will not buy cheaper alcohol from super markets if Titanic Plc provides them with a whole social experience. Question 2: a) Alpha: Payback Period: The net outflow is £120 at year 0. Payback period= 1.67 years Accounting Rate of Return= Beta Payback Period: The net outflow is £95 at year 0. Payback period= 3.08 years Accounting Rate of Return= Gamma Payback Period: The net outflow is £80 at year 0. Payback period= 2.33 years Accounting Rate of Return= Omega: Payback Period: The net outflow is £160 at year 0. Payback period= 2.89 years Accounting Rate of Return= Summary Table: Proposal Payback Period ARR NPV ($) Alpha 1.67 years 6.5% 21400 Beta 3.08 years 23.2% 49100 Gamma 2.33 years 17.5% 35800 Omega 2.89 years 23.8% 67900 b) Omega should be selected since it has the highest NPV of $67900 and will be the most profitable for the company. Moreover, Omega has the highest accounting rate of return of 23.8% and hence is the most profitable venture for the company. Although Alpha has the lowest payback period, the NPV of Alpha is lower than the other projects. Since the payback period does not consider time value of money and cash flows after the payback period, it will not be appropriate to choose Omega on the basis of payback period. Although Omega requires a very high initial investment of $160,000, the NPV of the project of $67900 if the expected cash flows are realized will add value to the firm and hence on the basis of the above cash flows, Panopticon Plc should select Omega. Question 3: Rights Issue: A rights issue is a means for a listed company to raise additional capital for different reasons. The company may be in financial distress and requires a fresh injection of capital to remain afloat and reduce leverage or a company might be looking towards financing its capital expenditure through a rights issue. A rights issue is unique in equity financing in that it gives its existing shareholders the right to subscribe to new shares being issued by the company based upon the terms of the rights issue. These terms determine the proportion of new shares that will be issued based on the prior holding of the companys shares. The company must set a price for the new issue at a discount that will attract investors into subscribing for the additional shares, but avoid setting a discounted price that is too low which dilutes the earnings per share to a greater extent. It is up to the investors discretion whether he/she is willing to exercise their right to subscribe to the new issue or if they want to trade their rights in the open market. A rights issue can affect the companys share price and market standing in a number of ways. A rights issue does have a diluting effect in the companys earnings per share as the equity base of the company increases and as a result puts downward pressure on the share price. However, the investor must be aware of the reason the rights issue is being proposed; if the company is looking towards expansion, the market will look upon a rights issue favorably and share price might increase in the long run and hence the rights issue will be a profitable proposition for the investor. (a) (i) Terms of the rights issue These terms state the ratio in which new shares are issued in proportion to the shares already held by the investors. Hence, terms of 1 for 2 indicate 1 new share to be issued for every 2 shares held prior to the rights issue. Current market price per share: £6 Current number of shares: £70 million / £0.5 = 140 million 25% discount Suggested price after discount: £4.5 (£6 * 0.75) Number of shares to be issued to finance £250 million: 250 / 4.5 = 55.6 million => 55.6 / 140 = 0.4 or 2:5 Therefore, terms of share issue is 2 for 5, and raises funds of £250.2 million (55.6 m * £4.5) 40% discount Suggested price after discount: £3.6 (£6 * 0.6) Number of shares to be issued to finance £250 million: 250 / 4.5 = 69.4 million => 69.4 / 140 = 0.5 or 1:2 Therefore, terms of share issue is 1 for 2, and raises funds of £248.8 million (69.4 m * £3.6) (ii) Theoretical ex-rights price per share (TERP) The TERP is the price of the share price after the effects of the rights issue has been taken into account, including the discount on the share price proposed and the number of additional shares to be issued in the rights issue. 25% discount Terms of rights issue is 2 for 5 => 2 shares at £4.5 and 5 shares at £6 = (2 * 4.5 * 4/3 ) + (5 * 6) =£42 Therefore, 7 shares now cost £42, TERP = £6 40% discount Terms of rights issue is 1 for 2 => 1 share at £3.6 and 2 shares at £6 = (1 * 3.6 * 4/3) + (2 * 6) = £16.8 Therefore, 3 shares now cost £16.8, TERP = £5.6 (b) Impact of Rights Issue on shareholder’s Wealth: The arguments put forth by both directors regarding the proposed rights issue are invalid. One director favors the 25% discount as she feels it will have a lesser negative impact on the value shareholder wealth. The following argument shows that both discounts will have the same impact on shareholder wealth: Lets say a shareholder holds 10 shares. His/her value of shareholding before the rights issue is £60 (10 * £6). Now taking each discount in turn, we need to calculate the shareholder value after the rights issue. With the 25% discount and TERP of £6, shareholder value is: Existing shares value: £6 * 10 = £60 New shares (2 for 5 => 4 new shares): £6 * 4 = £24 Capital needed to buy shares: £4.5 * 4 = £18 Therefore, value of shareholding = £60 + £24 - £18 = £66 Similarly, with the 40% discount and TERP of £5.6, shareholder value is: Existing shares value: £5.6 * 10 = £56 New shares (1 for 2 => 5 new shares): £5.6 * 5 = £28 Capital needed to buy shares: £3.6 * 5 = £18 Therefore, value of shareholding = £56 + £28 - £18 = £66 As is evident from the calculations above, the shareholding value is the same post rights issue regardless of the discount chosen. However, it must be noted that a 25% discount results in a TERP of £6, which is equal to the share price before the rights issue, whereas a 40% discount results in TERP falling below £6 to £5.6, which might affect perceptions regarding the company as a fall in price is looked upon negatively in the market. The marketing directors recommends the 40% discount as he argues it will improve take up of the rights issue. On theoretical grounds, this argument fails since a greater discount would inadvertently increase the number of rights needed to be issued without having any impact on the total funds generated. However, the psychological effects of a greater discount might come into play which can interest shareholders and increase the take up. It must be noted that the company has proposed the rights issue to finance its capital expenditure in order to expand its production capacity. There are a number of factors that might affect the companys share price before and after the press statement regarding the rights issue. The company has been performing well in the recent past as is evident from the increase in its share price from £5.6 to £6 in the past three months, along with increased demand for its products and improving future revenue. Since the rights issue is not intended to reduce the companys leverage and is expected to increase the companys asset base by capital expenditure, share price can possibly increase prior to the press statement on the back of positive expectations. The extent to which the share price is affected after the press statement will depend on the degree to which the market agrees with the projects net present value and future cash flows projected by the company. If the investors consider the rights issue to be part of the companys asset base expansion and a precursor to greater profitability, the share price might increase. Subsequently, as updates upon the projects progress are provided, the share price will adjust accordingly. Also if the rights issue is fully taken up by the investors, it will reflect positively in the share price, as this sends a signal that the rights issue is being received well by the market. Conclusion: Finally, the efficiency of the market will determine the extent to which the share price will change. Since most markets are considered to be semi-strong, the public information distributed through the press statement will be reflected immediately in the companys share price depending on how positively or negatively the market regards the information. However, if the market is of weak form, then the share price will change very slowly to the information regarding the rights issue provided and the subsequent progress of the project. Appendix: Formulas used: 1) Profitability Gross Margin = Net Margin= Operating Profit Margin = ROA= ROE= 2) Liquidity: Current Ratio= Quick ratio= 3) Asset Efficiency: Days in inventory= Days receivables= Days payables outstanding= Cash Cycle= Days in inventory + Days receivables – Days payables outstanding Asset Turnover= 4) Solvency: Debt Ratio= Debt to Equity= Interest Coverage= 5) Market Analysis Ratios: EPS= P/E= Vertical Trend Analysis Income Statements Titanic PLC 2012 2011 2010 Revenue 100.0% 100.0% 100.0% Cost of sales 60.6% 57.4% 53.6% Gross profit 39.4% 42.6% 46.4% Distribution & Administration costs 37.2% 28.5% 28.4% Operating profit 2.3% 14.1% 18.0% Finance costs 1.8% 1.3% 2.0% Profit before tax 0.5% 12.8% 16.0% Tax 0.0% 3.9% 5.0% Profit for the period 0.5% 8.9% 10.9% Horizontal Trend Analysis Income Statements Titanic PLC 2012 2011 2010 Revenue -26.7% 3.7% 100.0% Cost of sales -17.2% 11.0%   Gross profit -37.7% -4.7%   Distribution & Administration costs -4.1% 4.1%   Operating profit -90.7% -18.7%   Finance costs -33.3% -33.3%   Profit before tax -97.9% -16.8%   Tax -100.0% -20.0%   Profit for the period -96.9% -15.4%   Vertical Trend Analysis     2012 2011 2010 Non-current assets   52% 60% 63% Total Non-current assets   52% 60% 63%         Current assets Inventory 20% 14% 14% Receivables 6% 3% 3% Cash   23% 22% 19% Total current assets   48% 40% 37%           Total assets   100% 100% 100% Equity and liabilities Ordinary share capital (50p shares) 23% 19% 18% Retained earnings   29% 23% 18% Total equity   52% 42% 36% Current liabilities Trade payables 18% 31% 16% Tax payable 5% 6% 13% Dividends payable 0% 0% 5% Interest payable   2% 2% 2% Total Current Liabilities   25% 38% 36% Non-current liabilities – loans   23% 19% 27% Total Non-current liabilities   23% 19% 27%           Total liabilities   48% 58% 64%           Total equity and liabilities   100% 100% 100% Horizontal Trend Analysis (using 2010 as the base year):     2012 2011 2010 Non-current assets   -36% -9% 100% Total Non-current assets   -36% -9%           Current assets Inventory 13% -5% Receivables 50% 6% Cash   -8% 10%   Total current assets   5% 4%             Total assets   -21% -4%   Equity and liabilities Ordinary share capital (50p shares) 0% 0% Retained earnings   28% 26%   Total equity   14% 13%   Current liabilities Trade payables -9% 91% Tax payable -69% -58% Dividends payable -100% -100% Interest payable   -33% -33%   Total Current Liabilities   -46% 2%   Non-current liabilities – loans   -33% -33%   Total Non-current liabilities   -33% -33%             Total liabilities   -40% -13%             Total equity and liabilities   -21% -4%   Accounting Rate of return calculation: Alpha Beta Gamma Omega Depreciation: 24 18 16 24 Accounting Income Year 1 56 -8 14 6 Year 2 36 22 24 26 Year 3 15 22 14 66 Year 4 -4 42 14 56 Year 5 -64 32 4 36 Average accounting income 7.8 22 14 38 NPV Calculation: Alpha Beta Gamma Omega Year 0 -120 -95 -80 -160 Year 1 72.8 9.1 27.3 27.3 Year 2 49.8 33.2 33.2 41.5 Year 3 30 30 22.5 67.5 Year 4 13.6 40.8 20.4 54.4 Year 5 -24.8 31 12.4 37.2 NPV 21.4 49.1 35.8 67.9 Read More