Additional Finance for XX Chemical - Assignment Example

Report Table of Content Answer a) 3 Answer b) 5 Answer c) 10 References 11 Answer a) XX chemical is medium sized organization. Currently, the companyneeds raising additional finance as the director has been considering possibility of running projects in abroad. The director of the company has decided to raise additional fund through right issue. To conduct this strategic financial activity the company needs assistance from investment banks which offer service of raising finance through rights issue. Raising finance for the business expansion through rights is very popular business activity which the first step of capital investment. Medium sized businesses like XX chemical that wants to diversify into foreign markets and start their business activity there, need to invest huge amount of capital in foreign markets. These types of businesses are the main target customers of leading investment banks across the world (Ritter, 2003, p.278). Medium sized companies generally target the emerging markets for foreign direct investment. They prefer issuing rights for raising fund as rights issue is one of the most efficient to raise fund. Investment banks are recognized for expertise in this service. Rights issue refers to corporate invitation by the companies to the existing shareholders of the companies to buy more shares of the companies. The companies offer shareholders to purchase the new shares at a discounted market price than the current market price of the share of the company. Investment banks provide this service to the businesses like XX chemical and it is called underwriting service of investment banks (Chemmanur & Fulghieri, 1994, p.57). Underwriters are those who issue new share as initial public offering or secondary public offering of companies that need additional fund for strategic business activity. Banks disclosed the purpose of issuing rights and the shareholders analyze the potentiality of proposed investment plan or business activity by the company and decide to invest in the form of purchasing issued rights of the companies through investment banks. Investment banks provide opportunity to the shareholders of the companies to increase their financial exposure as he shareholders can purchase companies new shares at discounted price. The bank acts as financial agent between shareholders and company and providing financial benefits to both for some percentage of underwriting fees on the total share issued. The investment banks conduct necessary legal and regulatory activities for issuing right of the company on behalf of the company gets paid by the companies only but not from the shareholders for this financial service. The shareholders are allowed to trade issued shares after completion of initial or secondary public offering. Then the investment banks do not intervention on the traded shares of the company. Rights Investment banks prefer to provide underwriting services to the private limited companies than public limited companies. This means they prefer initial public offering than secondary equity offering of public limited companies. Rights issue is also carried out by self offering by the companies. Public limited companies issue rights in the form of public offering as rights are issued to the general public. Existing shareholders or the new potential investors can buy public offering from a public limited company. But a private limited company can issue rights in the form of issuing more shares to only the existing shareholders of the firm. From companies’ view point raising finance is through rights issue or equity issue is more preferable and also financial beneficial than debt issue. Risk retiring back to the raised capital is less in equity issue whereas the company is liable for paying the debt or credited amount to the creditors (NYU, 2012, p.68). Therefore, XX companies should raise finance in its need of finance through rights issue but not through lending from banks or other financial insinuations. Therefore, investment banks are more and more concentrating on this service rather than lending services. They always suggest their corporate client i.e. businesses for issuing equity and they are expertise in this underwriting service (Morrison & Wilhelm, 2007, p.9). XX chemical also may directly offer rights to its existing shareholders for purchasing issued shares of the company. But, here risk of the company is higher as the total needed fund may not be raised as all shareholders may not accept the proposal or may not satisfy with the purpose of raising fund by the company. But, investment bank will assure the company in terms of selling all the issued shares of the company otherwise they need to buy and hold the remaining shares until any individual or institution buy agrees to buy this. Therefore, the company will be secured to get the required fund for its proposed business activity (De, 2001, p.28). The company has the right to fix the transferability of shares at the time of issuing new shares. The shareholders are may allowed to transfer the purchased share to other privately or for public limited companies shareholders can trade it publicly or sometimes they can do any of the both. Rights issued by the company to its shareholders are made on a return of tax free dividend of a particular ratio with net earning of the company. The investment banks ensure this by conducting detailed research on the proposed activity of business for which the company needs additional finance. This is because, the company will receive required fund from the shareholders with a exchange of issued shares. Therefore, rights issue would be efficient source of capital of XX chemical and this activity can be assisted by an investment bank (Anson, 2011, p.84). Answer b) To separate the financial responsibilities a new trend has come up among the leading Multinational Corporations, which is a separate finance department and a separate treasury. By this change in the organization structure the companies are expecting of higher capital budgeting and spending. These two departments will divide the whole financial roles and activities among themselves. Today the multinational organizations’ central role in company finance is being held by the Treasury department. Liquidity management is the key role of treasury department by which company can hold the Maximum cash position to manage several operations of particular business. Although these are the key responsibilities of treasury department then also this treasury department has huge financial responsibilities to fulfill unless the goal of company cannot be achieved by the separation of treasury department. Forecasting cash: The primary role of treasury department is cash forecasting. All daily records which are maintained by the accounting executives such as the day to day financial transactions such as the disbursement activities and cash receipt are being evaluated by the treasury professionals. For the short term as well as long term cash forecasting this evaluation is needed. There are three important sub activities of cash forecasting. The necessity of cash in upcoming quarter or in next financial year need to determine by the staffs of treasury department, it will help this department to take a decision if there is a need of financing through debt or equity or else if there is a need to concentrate upon liquidity. If there is cash surplus then also the need to do a good investment plan, moreover to reduce the foreign currency translational risk the department has to make a plan for hedging. Working capital management: To determine the efficiency of any company managing of working capital is the key financial activity. Maximum cash amount is used in this important activity. This activity comprises of changes in current assets and current liabilities with respect to current sales. To identify the necessary requirements, working capital trend need to be determined by the treasury professionals and moreover the treasury professionals have to report about proposed policy’s impact to their management regarding the short terms basis working capital management. Management of cash: Combination of Working capital management and cash forecasting known as cash management. For the operational needs of any company the treasury professionals have to ensure the sufficient cash position. Investment management: If in current quarter or in current financial year there is a cash surplus in treasury department then the professionals have to think about the proper identification of effective investment opportunities for the betterment of the company. Managing investment comprises of three vital objectives which are; the cash requirement of any company has to match with the proposed investment maturity, the return on investment should be higher than the bank’s general interest rate and lastly investment with lesser risk to get the return with zero risk rate of interest (TSU, 2012, p.4). Treasury risk management: By proper hedging strategies the treasury professionals also manage the financial risk. By this strategy the treasury department can easily minimize the return of investment from the investment which company does under the diversified financial instruments. Regarding reduction of treasury risk this department must follow three key objectives. Firstly they have to make sure about the efficiency of the company regarding debt interest whether there is a rise in debt interest in future. The next objective is they have to ensure about the stability of the company in case of the transactions of the foreign currencies, because the company’s financial position can badly affected by the decline of the transaction rate of foreign currencies in future (Polak & Klusacek, 2010, p.23). Relationship with credit rating agencies: To pool money from the market if the company issue debt in market then the treasury department’s activity should be providing the proper financial information about the financial position of the company. If in future to determine the credit rating of the company’s financial position, the credit rating agencies ask about those information then those activity will help them. So the treasury department should act fast to get the proper information about the financial position which may be required by any external stakeholders. Good relation with creditors: A good corporate relationship with the creditors most importantly with the bankers for a long term may help to get the financial solution and banking service. It will help the company to get the rapid co-operation in any kind of financial problem. The treasury professionals have to maintain the relationship with them to get the information about financial position and moreover if in future if there is cash requirement by this good relationship company can get help. This repo will also help to know about other important areas like banks’ fee structure, transaction of foreign exchange, hedging, cash pooling, wire transferring and most importantly it will help the company in terms of debt requirement that time debt can be granted by the bank. Raising fund: To manage the particular amount of finance for the company’s business requirement, the treasury department does this important tactful activity. To manage everything at first the treasury professionals have to maintain a good strong relationship with the investment community who are potential, to propose about the investment on the particular company. Investment banks are one of the potential investors. They help to sell the company’s debt and equity holdings to the investors who are potential. Moreover the investment banks sell the debts and equities to the pension funds and many more potential sources of cash. As a result gradually they want to buy the debt and equity which are being offered by company. So the main task of the treasury department would be market condition analysis frequently time to time, it will help to locate the different potential investors which can source finance on the basis of interest rate and maturity period. Moreover the treasury professionals represent the valuable proper logic to select a particular potential source of finance. As a result the company shareholders can easily convinced by the management and it is their right to get the right information about the strategic financial decision of the company. If the company decides to set up a separate finance department then the finance department would be very much aware about their roles and responsibilities. This is the different role and responsibilities what the treasury department does. At first the accounting professional has to do proper bookkeeping by which the company’s capital spending track properly recorded. They have to keep watch on the profit and loss statement analysis. They have to identify the financial strength and weakness of the company so that the internal weakness can be changed into strengths. The finance managers should be knowledgeable about the recent financial market information and the activities and moreover they have to evaluate cost of the new product development. Just like opposite to the treasury department the major role of the finance department should be doing fruitful effective financial activities. The finance professionals have to play a key role in equity financing, in other case the treasury department should concentrate properly on debt financing. Retained earnings amount which is based on the strategic business decision of the company is measured by the finance department. The finance professionals also help to determine the dividend amount to the company’s existing shareholders. To determine the proper financial budgeting the finance department should do a proper budgeting as it is a key role of finance department. An efficient financial budgeting is plotted on the future forecasted report of research and development and sales department. The determination of credit collection efficiency of the company should be actively done by the accounts, payable and receivable management of the finance department. From the detailed study it is almost visible that the role of finance department and the roles of treasury department are interconnected but the company can lead to a better capital budgeting and spending with the separate roles and activities. Answer c) There is substantial impact of inflation of an economy on the return on foreign direct investment or foreign institutional investment. Companies make capital investment in foreign countries for running projects in foreign markets. They analyze the feasibility of an investment by estimating the cost of capital of a project. It is estimated considering market rate of return. But, inflation of the economy has substantial impact on the market rate of return because market rate of return decreases with increase of inflation arte. If nominal rate of return is consider in estimation of cost of capital or future cash flow then risk of inflation can be reduced because nominal rate of return equals to market return minus inflation. This implies that market cost of capital does not represents the real cost of borrowing or capital investment. Therefore, real rate of return determines the actual rate of return needed from an investment if inflation rises (Dayananda, Irons, Harrison, Herbohn & Rowland, 2002, p.22). If inflation rises higher return needed to main increased cost of operation or managing inflated working capital. It also affects businesses by increasing cost of raw material, wage rate and equipment costs. Therefore, rise of inflation arte leads to overall increase in cost of operation which might not be afforded by the company through its internal rate of return if real rate of return is not considered at the time feasibility analysis of an investment. So, impact of inflation can be neglected if real rate of return adjusted in forecasting future cash flow of a project (Baker & Powell, 2009, p.58). References Anson, M. J. P. (2011). Quantitative Investment Analysis. John Wiley & Sons. Baker, H.K. & Powell. G. (2009). Understanding Financial Management: A Practical Guide. John Wiley & Sons. Chemmanur, T. j. & Fulghieri. (1994). Investment Bank Reputation, Information Production, and Financial Intermediation. [Pdf]. Available at: https://www2.bc.edu/~chemmanu/phdfincorp/MF891%20papers/chemmanur%20and%20fulghieri%201994.pdf. [Accessed on 17 December, 2012]. Dayananda, D., Irons, R., Harrison, S., Herbohn, J. & Rowland, P. (2002). Capital Budgeting: Financial Appraisal of Investment Projects. Cambridge University Press. De, S. (2001). Capital Raising under Securities Board of India Guidelines: An Economic Examination of Capital Market Reforms in an Emerging Market. [Pdf]. Available at: http://www.isb.edu/caf/docs/SankarDe.pdf. [Accessed on 17 December, 2012]. Morrison, A. D. Wilhelm, W. J. (2007). Investment Banking: Past, Present, and Future. Retrieved from http://gates.comm.virginia.edu/wjw9a/Papers/JACF%20Morrison%20Wilhelm%20Final%20version.pdf. NYU. (2012). CAPITAL STRUCTURE: OVERVIEW OF THE FINANCING DECISION. [Pdf]. Available at: http://pages.stern.nyu.edu/~adamodar/pdfiles/acf3E/book/ch7.pdf. [Accessed on 17 December, 2012]. Polak, P. & Klusacek. (2010). Centralization of Treasury Management. Retrieved from http://aei.pitt.edu/14063/1/BOOK_final1.pdf. Ritter, J. R. (2003). INVESTMENT BANKING AND SECURITIES ISSUANCE. [Online]. Available at: http://bear.warrington.ufl.edu/ritter/publ_papers/investment%20banking%20and%20securities%20issuance.pdf. [Accessed on 17 December, 2012]. TSU. (2012). The Role of Treasury Management. Retrieved from http://www.business.txstate.edu/users/wc10/fin4320/lectures/fin4320_lecture_1_the_role_of_treasury_management_2.pdf. Read More