TNA Company Management - Case Study Example

INTRODUCTION TNA Company is a large company in Vietnam which has got a potential of growth. After a strong business analysis, its agent has advised the management to consider investing in acquiring a small local manufacturing company in Vietnam which is conveniently located close to the ports and transport routes and has a loyal and hardworking workforce. However, the factory has out-dated equipment and a relatively high cost structure and the firm is increasingly falling behind its competitors. The acquisition of the small local manufacturing will enable TNA company to to establish a production facility in the heart of Asia without the problems and lead time involved in developing a Greenfield facility. Financially, this investment will result in TNA Company making revenue of A$ 200,000 monthly from the beginning of the year 2017 when the acquisition shall be complete and the replacement of the old equipment facilitated. TNA company management is confident of rapidly gaining additional food processing and packaging business because of the superiority of their new equipment that will actually produce quality products that will satisfy the customers and retain them as well as attract other new customers who may be in need of equipment for food processing and packaging. The revenue of the TNA company s expected to grow in 5 years consecutively at these rates;20%,30%30%20% and 10% respectively. The investment requires a total capital of 10 million Australian dollars; the 6 million Australian dollars will be used to purchase 100% of the Vietnamese company from its shareholders and the 4 million Australian dollars will be used by the TNA company management in the capital replacement of the old equipment of the Vietnamese company so as to as make it efficient and able to reach the projected revenue of 200000 Australian dollars per month. SOURCES OF FUNDS TNA Company’s investment plan of acquiring the small local manufacturing firm will require funds worth 10 million Australian dollars as capital. The acquisition of the small local manufacturing company by TNA Company is a long-term investment that requires a huge amount of capital to facilitate the entire exercise of acquisition. In any investment it’s advisable for the management to use a cheaper source of funds to finance its investment. This kind of capital can only be raised by use of the long term sources of funds that can support the investment for a period that is over one financial period i.e one year. TNA can use the following options to source funds that will facilitate the new investment (Damodaran, 2010). 1. Retained earnings This source of fund generally entails the earned profits of the company that were reserved over the previous financial periods are re-invested bank into the company investments so as to increase the dividends paid to the current shareholders. The retained earnings can be one of the sources of funds for TNA Company to facilitate the acquisition of the small local manufacturing firm. This source of funds is the cheapest because it doesn’t have debt cost and dividend payment to the shareholders. TNA Company can invest 40% of its retained earnings in the acquisition of the small local manufacturing company and retained the 60% of its retained earnings to avoid putting the company at a risk of insolvency. Most companies tend to retain most of its profits earned in the reserves for purposes of speculation for investments. Any investment that is fully financed by the retained earnings is considered to be cheaper since there are no major capital costs that are accompanied such as dividends and interests (Ehrhardt, 2008). The use of the retained earnings to finance viable investments of the company by the management indicates that the management is acting to the interests of the shareholders that is wealth maximization since the reserves of the organization are being ploughed back to the business operation which in results generates the optimum profits of the organization due to the low cost of capital making the management able to maximize the profits of the organization which is to the interests of the shareholders. 2. Loan/Debt TNA Company can opt to source its funds from a bank by taking a loan. Such loans will be entitled to a certain interest rate in percentage at a specified period. However this type of fund will require TNA Company to pay debt costs in form of loan interests to the banks periodically until the entire debt is settled. The interests can be at a fixed interest rate annually or on a semi-annual term. In addition this type of fund is subjected to taxation when determining the debt cost. In this case, if TNA management decides to fund the entire investment using bank loan, they will be required to take a loan of 10 million Australian dollars from a bank with a cheaper interest rate. (Henderson, 2015) The bank loan that the management settles for should be favorable to the interests of the shareholders since the management is the agents of the shareholders. Any loan taken by the management should be of the lowest interest rates possible and have payment terms that are not risky to the continuous survival of the company .The loans should also be attached to securities that may lead to the complete close down of the company just in case the company becomes unable to pay all its debts and the banks wants to take the assets that were used as security on the loan (James, 2015). The management may decide to cut the finance costs further by financing the investment by using two sources of funds which are the retained earnings and debt at a given ratio .For the amount required to invest which is 10 million, the ideal ratio of funding will be 40% financed by the debt while the 60% will be financed by the retained earnings since the cost of retained earnings is always known to be lower. This kind of funding is favorable because the management shall have cut the cost of debt for the organization by 60% since the debt contribution to the investment will only be 40% of the amount of capital required for the acquisition of the small manufacturing company (Ehrhardt, 2008). 3. Share capital issue The share capital is a source of capital that TNA Company can use in order to be able to venture into the new investment opportunity. Share capital can be raised through two major avenues, namely: i) Issuing of new ordinary shares: TNA can issue new shares to the existing shareholders and new shareholders at a fair market price in order to raise enough capital to facilitate the acquisition of the small local manufacturing firm. The issue price must be higher than the nominal value. This method of raising capital is seen to be the fastest mainly for the companies that are known to be having a good reputation to the public. TNA company having had a good reputation and the small manufacturing that had the a good location with loyal work force the sale of the new ordinary shares will be easy due to the potential growth that can be seen by the investors mores especially after the renovations. ii) Issuing of Preference shares: These are shares that are issued at a fixed percentage dividend before any dividend is paid to the ordinary shareholders .TNA can use this option for sourcing funds that will facilitate the acquisition of the small local manufacturing firm. Most people will invest highly on this type of shares because of the preferences that they have when it comes to the payment of dividends to the preference shareholders. The good public image of TNA company will promote in the attraction of the preference share investors to the company (King, 2006) 4. Debentures This is a long-term debt capital that TNA can optimize on at a debenture interest that can be paid semi-annually at a fixed rate. This source will enable TNA raise the funds very fast provided that the terms are favorable and attractive to the debenture holders. Debentures with an attractive interest rate will generate a lot of capital for the organization since of the investors will invest a lot of their funds. The debentures can either have a fixed charge or a floating charge. i) Debentures with fixed charge: TNA Company can issue dentures which have a fixed debenture interest rate that will require the organization to pay the debenture holders with debentures interests as per the specified period in the debenture contract. This kind of debenture is assigned a specific security ii) Debentures with floating charge: This is a kind of debenture without a specific assigned security and its interest rate keeps on changing depending on the rate of inflation and the performance of the company. This another nice option that TNA company can use to raise funds from the debenture holders in order to be able to fully acquire the small local manufacturing company. 5. Asset securitization TNA Company can utilize the option of asset securitization in the acquisition of the small local manufacturing company. In this option, the management of TNA Company will enter an agreement with the management of the small local manufacturing company where they will acquire the company on credit with a condition of asset securitization since it’s a long-term investment. TNA company management will then identify assets that are worth the capital amount of 10 million Australian dollars .The assets will be used as security for the credit purchase of the small local manufacturing company since the acquisition amount will be paid in bits as per the agreement. Default in payment of the periodic payment by TNA Company then the assets that have been used as security will be taken by the small local manufacturing to cover the amount that has not been paid (William Petty, 2015). 6. Hire purchase finance Since the acquisition of the small manufacturing company is a long-term investment that requires a lot of capital, the management of TNA Company can use the hire purchase option in the acquisition of the company. The TNA company will pay a deposit for the first time in order to get the rights of ownership of the small company, then it will be required to pay some specific amounts of monthly installments within a specified periodical time till all the acquisition amount is paid and the new equipment paid. All hire purchase finance options come at a cost to the buyer pays the purchase price in bits spread within a given period. This source of finance comes with a cost of financing it because the cash purchase cost is lower than the hire purchase cost. The longer the hire purchase period the high the hire purchase interest thus increasing the investment cost. This source of finance can only be adopted when the company does not have any retained earnings that can fund the investment. 7. Sale of fixed assets TNA Company can take an initiative of selling some of its fixed assets that are not directly beneficial to the day to day operations of the organization such as building sand land in order to raise funds for acquiring the small local manufacturing company. However this source of funds is likely to negatively affect the goodwill of the company and creditworthiness of the company because it will lead to poor liquidity and asset ratios (Shi, 2001). This type of option is ideal when the company’s creditworthiness is poor, it does not have a good reputation that can attract investors to buy new ordinary shares and preference shares and low retained earnings then selling of the company’s fixed assets that of no good use can help in raising funds for use in investing in the acquisition of the small local manufacturing company. This is the last option source of funding the organization of the investments of the organization. This is because it lowers the creditworthiness making it impossible for the company to borrow from its lenders in future and it also discourages the investors from injecting their funds into the organization. Sale of fixed assets is only accepted for those companies with strong fixed asset base and after the sale of the fixed assets, the total assets of the company should not be lower than the total combination of capital and equity because failure to adhere to that, the company’s ratios will not be ideal hence making the company to be non-going concern company. 8. Sale of current assets Some companies tend to have current assets of high value than the non-current assets due to the nature of their business operations or the preferences of their management for efficient management so as to avoid having idle money. If TNA Company has got a huge amount of current assets, the management can dispose some of them such as bills receivables and stocks. It’s easy to liquidate the current assets in order to get the cash that will enable the TNA management to fully acquire the small manufacturing company 100%.These proceeds will help in the acquisition of the small local manufacturing company. As much as the TNA company can utilize this option of source of funds, the total current assets should not be lower than the total current assets of the company in whatsoever way is because the liquidity level of the company shall be adversely affected thus discouraging the creditors from trading with the company due to the risk of not being paid in good time (Damodaran, 2010). CAPITAL BUDGET EVALUATION a).Capital budget when required capital for the acquisition is 10million Australian dollars TNA COMPANY CAPITAL BUDGET YEAR 1 2 3 4 5 GROWTH RATES 20% 30% 30% 20% 10% REVENUE 2880000 3744000 4867200 5840640 6424704 COSTS 1728000 1872000 2433600 2920320 3212352 PROFIT 1152000 1872000 2433600 2920320 3212352 Residual value 0 0 0 0 200000 Net cash flow 1152000 1872000 2433600 2920320 3412352 Discounting rate 10% 0.9091 0.8264 0.7513 0.683 0.6209 net discounted cashflow 1047283.2 1547020.8 1828363.68 1994578.56 2118729.357 Total discounted cashflow 8535975.597 Less initial cost 10000000 NET PRESENT VALUE -1464024.4 NREJECT THE PROJECT BECAUSE THE NPV IS NEGATIVE COST OF CAPITAL 0.1 CURRENT REVENUE PER MONTH 200000 NUMBER OF MONTHS PER YEAR 12 From the capital budget above, the takeover is not a good investment if TNA Company needs to raise capital worth 10 million Australian dollars in order to acquire the small local manufacturing company, the investment will not be viable. This is because the investment has a negative net present value of 1464024.4 Australian dollars hence the investment should be rejected by the management of TNA Company. A negative net present value means that the company will not be able to recover its investment cost within the first five years because of the low cash inflows. The investment will be unprofitable both in the short run and in the long run thus it’s not advisable for anyone to venture into such kind of business due to the high probability of low returns. TNA company management should not invest any funds in the acquisition of the small local manufacturing company because if they invest in that business venture they will not attain shareholders wealth maximization and profit maximization hence going against the interests of the shareholders which is wealth maximization and profit optimization (William Petty, 2015). b.) Capital budget when required capital for acquisition is 7million Australian dollars Funds to be raised 7000000 TNA COMPANY CAPITAL BUDGET YEAR 1 2 3 4 5 GROWTH RATES 0.2 0.3 0.3 0.2 0.1 REVENUE 2880000 3744000 4867200 5840640 6424704 COSTS 1728000 1872000 2433600 2920320 3212352 PROFIT 1152000 1872000 2433600 2920320 3212352 Residual value 0 0 0 0 200000 Net cash flow 1152000 1872000 2433600 2920320 3412352 Discounting rate 10% 0.9091 0.8264 0.7513 0.683 0.6209 net discounted cash flow 1047283.2 1547020.8 1828363.68 1994578.56 2118729.357 Total discounted cash flow 8535975.597 Less initial cost 7000000 NET PRESENT VALUE 1535975.597 ACCEPT THE PROJECT BECAUSE THE NPV IS POSITIVE The takeover is a good investment for TNA Company because if TNA Company will be required to raise a capital of 7million Australian dollars only, the investment project will be viable because the net present value is positive of 1535975.597 Australian dollars. A positive net present value indicates that the returns from the investment within that period will enable the investor recover the full amount that he/she has invested in that project. For instance, TNA Company will be able to recover the initial cost of 7 million Australian dollars within the period of five years. Thus TNA Company management should accept acquisition of the small local manufacturing company. This is because by investing in the acquisition of the small local manufacturing company, the shareholders wealth shall be maximized and the profit of the organization optimized hence safeguarding the interests of the shareholders. Such kind of investments highly attracts new investors and even encourages the existing shareholders to invest more funds into TNA company (Damodaran, 2010). CONCLUSION In conclusion, from the above capital budgeting, the investment in the acquisition of the small local manufacturing company will only be viable if the capital required is 7 million Australian dollars because it has a positive net present meaning that TNA Company can now utilize the new opportunities that will see it expand. The capital of 10 million will make the investment unviable due to the high negative net present value. I would recommend for the TNA company management to fully fund the investment if 40% of the retained earnings is enough to fully fund the acquisition of the small local manufacturing company. If that is not possible then the management should consider combining the sources of finances in funding the investment by giving priority to the sources hat have low capital costa and considering that the amounts that are invested in the acquisition do not affect the financial rations of the organization in any way because if in any case the ratios get affected, there will be adverse impacts to the operations of the company such discouraging investment by the investors, low creditworthiness of the organization ,low liquidity levels and insolvency of the company the will indicate non-going concern of the company. Reference list Damodaran, A. (2010) Applied Corporate Finance - Page 552, New York: Cingage Learning. Davies, H. (2013) Global Financial Regulation: The Essential Guide. Ehrhardt, M. (2008) Corporate Finance: A Focused Approach - Page 554, london: Cingage Learning. Hacioglu, Ü. (2013) Managerial Issues in Finance and Banking: A Strategic Approach, London: Cingage Learning. Henderson, S. (2015) Issues in Financial Accounting - Page 991, London: Cingage learning. James, W. (2015) Financial & Managerial Accounting - Page 992, London: John Wiley. Kaoma, K. (2006) Legal Aspects of Financial Services Regulation . King, A. (2006) Fair Value for Financial Reporting: Meeting the New FASB Requirement, London. Shi, J. (2001) Handbook of Financial Analysis, Forecasting, and Modeling - Page 311, London. William Petty, ‎.T. (2015) Financial Management: Principles and Applications - Page 705, London: Springer. Read More