Dynamic Capital Structure Choice - Case Study Example

FINANCIAL ANALYSIS OF A FIRM: SUPER RETAIL GROUP By Student’s Name Code + Course Name Professor’s Name University Cite, State Date Executive Summary Super Retail Group is focused more on equity financing as opposed to debt. This is a likely positive phenomenon since it allows the company to utilize the amount without the commitment of repaying it. This has enabled the company focus on developing larger capital projects that have, in turn, ensured a steady increase in both sales and profits. This means that the immediate shareholders are likely to benefit from the operations of the company. Notably, the firm deploys the risk management team that ensures risks are mitigated at almost all-levels of operations. Thus, it will be fair that potential investors make investments with the company due to its rapid growth and effective business models deployed to improve sales growth over the years. Introduction The focus of this assignment is on analyzing the imminent activities of Super Retail Group. This company focuses on individual investors who participate in external tax-exempted share acquisition plans. It should be noted that the company’s share acquisition is open to both foreign and domestic based investors. Subsequently, the firm allows separation of management and ownership through the adoption of a limited liability company (Super Retail Group Limited, 2013). The firm’s management base are tasked with the responsibility of ensuring the maximization of shareholders wealth while owners duties are depicted in regards to selection and recruitment of both managers and the board committee. In regards to risk, Super Retail Group maintains a Risk Committee that ensures the practicability of good governance. Furthermore, the firm recognizes the existence of both material business and financial risks. It is assumed that all of the business operations are conducted in an ever-changing environment that is marred with ultimate change and uncertainties (Super Retail Group Limited, 2013). However, the management of potential risks is executed in respect to constant review and minimization by way of embarking on corporate governance-based principles. Some of the sources of the firm’s immediate risk profile include activities involving; first, global-based competitions given that the Retail is now focused on online shopping and overseas trading where competition is uncertain and stiff,. Second, the immediate proliferation of sales and marketing –based channels will likely create a risk profile that can inhibit growth of customer loyalty base (Super Retail Group Limited, 2013). Third, the possible meltdown of conventional business models is likely to catapult competition based risks as well as cost pressures. Other sources of risks include: the ever-changing customer expectations, workforce base demographics as well as a possibility of increase in the regulatory requirements within the business operations (Super Retail Group Limited, 2013). Financial Analysis The company has adopted both debt and equity finances for purposes of financing its immediate business operations. It is important to note that the business has adopted both long and short-term borrowings for purposes of ensuring that their respective operations are conducted without the possibility of foreclosure (Super Retail Group Limited, 2013). In regards to the mix of both debt and equity, the debt-to-equity ratio will help analyze the situation as below; Debt-to-equity ratio= total debt/ total stockholder’s equity For 2013: (3.3+348.3)/542.3= 0.65 This low ratio value is an indication that the company has focused more on funding its operations with shareholder’s resources as opposed to debt (Benninga and Oded,1997). In doing this, the company enjoys a substantial number of advantages and disadvantages. Advantages of Equity Financing First, the firm is not bound by any form of requirement to repay the amount secured. This is ascertained to the fact that the potential investor will only buy a certain proportionate share of the business and thereby expect either profits or losses made (Covas & Haan, 2006). In the event that the investor seeks to exit the operations of the firm, they are allowed to sell shares to other interested parties while the firm will not be bound to repay the investment value at all. Second, equity enhances the aspect of immunity given that the existing investors are expected to share either losses or profits in times of economic down turn however; the Retail is likely to be shielded against possible loss (Fisher, Heinkel and Zechner, 1989). Third, Super Retail Group, through continuous dependent on equity finance, will enjoy good credit ratings that are mostly attributed to a higher investor base that provides a perception that it possesses sufficient funds to repay debtors in cases of liquidation. Fourth, the Group will enjoy a better form of performance since the rather larger investor base is likely to keep management team on their toes in order to conduct activities at their best. Fourth, through the use of equity finances, the firm will enjoy better corporate governance structures. This is because the law requires AUX listed companies to avail records for possible scrutiny as well as hold annual meetings as well as adhere to other forms of accounting standards. This, in turn, has the effect of catapulting the quality-level of professionalism and corporate governance (Kokemuller, 2012). Disadvantages of Equity Finance First, the Group is likely to suffer from the loss of decision making powers given that the existing shareholders are bound to nominate both the directors and management team. Similarly, any capital investments will only be executed after the approval of the shareholders (Kokemuller, 2012). Second, the Group will likely suffer from increased level of costs due to regulatory compliance that require it to hold AGM, file annual reports as well as adherence to standardized corporate governance. Third, the use of equity finance by the Group will lead to a life-long commitment (Green and Hollifield, 1999). This is based on the fact that adoption of investors is considered to be a permanent obligation given that the investors are bound to enjoy profits forever. This feature is contrary to debt financing that allows a company to end commitment when the loans are repaid in full (Green and Hollifield, 1999). Advantages of Debt Financing First, in the event that the Group uses debt, it will enjoy holistic utilization of the resource since they will be required to repay it in full. Second, the Group will benefit from tax advantage provision allowed for business given that interest expense is a deductible income expense (Graham, 2000). Third, there are little or no chances of dilution in regards to control and ownership of the company and thus, most of the decisions are affected by the immediate management team. Fourth, the Group will likely benefit from the short-period needed to secure a loan as opposed to seeking funds through an IPO. Thus, the emergency needs of the Retail will likely be met at a recommendable period. Disadvantages of Debt-Financing First, the Group will likely be inhibited in its operations due to the mandatory obligation to repay the loan and the accrued interest costs attributed to the financing. This will limit its cash flows needed for day-to-day operations of the firm’s immediate activities (Kokemuller, 2012). Second, in the event that the Group fails to repay the loan on time, it might suffer from distorted credit ratings as well as accrued penalties that will adversely affect the operations of the firm. Risk Profile Evaluation The use of these finance sources might attract financial risks that are bound to affect the numerous activities of the Retailer. Notwithstanding, the firm maintains a management program that focuses on hedging such other associated risks as market risks as well as fair-value interest rate risk through the utilization of derivative financial instruments like foreign exchange contracts as well as interest rate swaps. While it is ascertained that Super Retail Group does not focus on credit risk, the evaluation of liquidity risk is imperative (Super Retail Group Limited, 2013). Relative liquidity risks mitigation ensures that the firm enjoys a sufficient cash-resource base as well as imminent marketable securities. Effective and efficient credit lines are made available through the Groups initiative of enhancing flexibility. Investments Super Retail Group, which operates as a commercial retail chain in three countries that include Australia, China and New Zealand, engages in capital projects that include the development of other large businesses. Such businesses include; Supercheap Auto, Amart Sports as well as BCF Camping Fishing and Rebel. These projects have helped increase the firm’s sales growth and profits. These projects are considered successful in the future given the adoption of different mechanisms of conducting businesses like the implementation and incorporation of effective information systems as well as launching of customer-based programs aimed at improving loyal base (Super Retail Group Limited, 2013). In regards to Sustainability, the firm is engaged in numerous charitable funds that include raising funds for the children among others. Conclusions and Recommendations From the above discussion, it can be noted that the firm is operating under a much favorable business environment. This is reflected by the manner for which it is able to mitigate the numerous risks associated with operations. Notwithstanding, the lower ratio value for debt-to-equity means that the firm is focused more on utilizing equity funds as opposed to debt. The major recommendation is for any investor to make investments with the company given its current good credit ratings as well as profitable investments like Rebel and Supercheap Auto that are bringing in enough profits needed to pay dividends. References List Benninga, S, and Oded S, 1997, Corporate Finance: A Valuation Approach, McGraw-Hill, New York Covas, F & Haan, W, J. 2006. The Role of debt and equity finance over the business cycle, Bank of Canada Working Paper, Retrieved on May 21, 2014 from http://www.bankofcanada.ca/wp-content/uploads/2010/02/wp06-45.pdf Fisher, E, Heinkel, R and Zechner, J. 1989, Dynamic capital structure choice: Theory and tests, Journal of Finance, 44, 19–40 Graham, R, J.2000. How big are the tax benefits of debt? The Journal of Finance, vol.LV, no.5: pp 1901-1942. Green, R and Hollifield, B. 1999, The personal tax advantages of equity, Working Paper, Carnegie Mellon University. Kokemuller, N. 2012.The advantages and disadvantages of debt and equity financing, Chron. Retrieved on May 21, 2014 from http://smallbusiness.chron.com/advantages-disadvantages-debt-equity-financing-55504.html Super Retail Group Limited. 2013. Annual report. Retrieved on May 21, 2014 from http://www.superretailgroup.com/investors-and-media/reports-and-publications/ Read More