Financial Management: XP Plc - Assignment Example

Fresh XP – 95%% - Deadline: 04-15 (Wed)11:54 PM, 11 pages (NMT 3000, 15 soruce, UK har International Business Finance 138 words for question, 123 for intro, conclusion is 185 =446 extra. The most important is that I have to put the 15 references first. Name of Student Name of Professor Name of Subject Date Introduction This paper seeks to accomplish the following: (1) to evaluate the proposed joint venture for XP Plc using financial and non-financial analysis; (2) to advise XP Plc and senior management team (TMT) on the key operational and strategic challenges that they face when considering re-domiciling the French parent company to Monaco; (3) to clearly state what options of sources of finance the multinational corporation has to fund the proposed expansion across Asia and to state the factors that the company should consider when deciding what sources of finance to access to fund the restructuring of the company; and (4) to analyse other strategies XP can expand to Asia, such as Foreign Direct Investment (FDI). Questions and Answers Q1. Evaluate the proposed joint venture using financial and non-financial analysis. Clearly state which capital investment appraisal method you have used and it appropriateness. Clearly state any assumptions and show all workings and calculations in the appendices of your report. (35 marks) To evaluate the proposed joint venture using financial analysis is to determine whether it would increase the wealth of shareholders. Several investment appraisal methods or techniques are available to determine the same including the NPV methods, accounting rate of return (ARR) method, payback period method and internal rate of return (IRR) method (Khan & Jain, 2007). For the purpose of this paper, the NPV method is used to appraise whether the proposed joint venture is acceptable or not. The decision to use this method is done after finding the other methods to be less superior. The ARR method and Payback methods do not consider the time value of money and therefore less scientific than NPV method. The IRR method measures the project in terms of the rate internally computed by trial and error. The acceptability of the project using IRR is when the computed rate would exceed the cost of capital for this project. The limitation of this method assume that cash flows are reinvested at the IRR and not the cost of capital as used in NPV method In using the method only relevant cash flows will apply. The cash inflows of the project would include the following: first, the amount investment in year 0 is 60% €2,000,000 or €1,200,000 and the remaining 40% or €800,000 will be spent in year 1. The total of €2,000,000 for XP is 50% of the proposed joint venture project. Second, the Euro inflow will come from given €1,200,000 for year 0 and the same would be increased by 2% per year, hence, the results are €1,344,000, €1,505,280 and €1,685,913.60 for year 2, year 3 and year 4 respectively. Pound inflows from U.K. are £620,000, £694,400, £777,728 and £871,055.36 for year 1, year 2, year 3 and year 4 respectively. The operational costs is € 235,000 for year 1 and this is increased by 2% per year to produce €239,700, €244,494 and €249,383.88 for, year 2, year 3 and year 4 respectively. The operating costs in Euros is deducted from Euro Inflows and the results for each year are 1,585,000, 1,798,700, 2038,514, and 2,307,585.08 for year 1, year 2, year 3 and year 4 respectively. See Appendix A for the summary. The Pound to Euro conversion divides the Pound amount by spot rate of £0.7320/€ to get the amounts of €846,994.54, €948,633.88, €1062,469.95 and €1,189,966.34 for year 1, year 2, year 3 and year 4 respectively. Only the Net Euro Inflow is subjected 30% tax as the UK pound was already, net of tax and presence of double treaty taxation between U.K. and Germany should result to not subjecting to tax again. See Appendix A for the summary. The Net Euro inflow is added to Pound Conversion and total to the total the two is reduced by tax paid and the resulting figure is Net cash flow before depreciation. From the latter amount, depreciation per year of was added back in order to get the net cash flow. The net cash flow per year is multiplied by present value factor using the discount rate of 7.84%, to get the net present value of cash flow per year. Summing up all the present value from year 0 to year 4 will produce the net present value of €5,919,475.21. See Appendix A for the summary. Why the discount rate used was 7.84% is justified as the computed weighted average cost of capital (WACC). To estimate the WACC of the company, the cost of equity at 10% based is used on the case fact that under Note 1 that XP plc has an alternative to make its investment at a yield of 10%. On the other hand, the cost of debt is also given at 6% as interest paid on debt on alternative investment. To compute for WACC, this paper assumes said capital structure of XP to be the same at that of its German subsidiary which provides for total debt of €7 million and equity of €13 million or debt to equity of 13:7 or 0.54 or 54%:46%. Using said capital structure, it is now possible to estimate WACC under the following formula: WACC = (Cost of Debt X debt percentage to total capital) + (Cost of Equity X equity percentage to total capital ) = (6% X 54%) + (10% X 46%) = 7.84% The computed WACC of 7.84%and to get the discount factor is from the following formula: , where n is the year applicable. The non-financial analysis that would be used in evaluating the proposed joint venture would answer the question: Will the joint venture result to increase market share, employee satisfaction, labour productivity and long-term perspective of shareholders and managers for the company? If the answers to this question is more likely than not, then proposal should be accepted if the financial analysis will support the same. Because of the increase number of customer from the joint venture because it is in the nature of expansion into new markets, the said proposal is believe to more likely increase market share in the industry. It will also increase labour productivity since it would have less time to learn the business because of its long experience in the consultancy industry. It will then increase employee satisfaction as they found themselves serving more extensive number of customers from different part of the world. The chance of increased long-term perspective of shareholders and managers for the company appears to be expected because of the expected increase in shareholder value and more strategic view for the future. It is better than re-domiciling, which may be construed as an act of retreat. Question 2). Advise XP Plc and SMT on the key operational and strategic challenges that the company face then considering re-domiciling the France parent company to Monaco. (15 marks) What are the expected cash flows and operational advantages from re-domiciling? Given that the company faces certain problems such as the need to enter into a joint venture, will the decision to re-domicile cause the forfeiture of certain projects? These questions must be answered by the company. If it would result to a step change into having better way of doing business as a whole, or would put the company in a better financial position to ensure good financial leverage and friendlier business environment in terms of taxes and regulations in the attainment of its corporate goals, then it is worth considering to have company re-domiciled from France to Monaco. It is best to prepare projected cash flow and see the effect in terms of increased market capitalization as proof of more strategic and increased shareholder value. Rushing up re-domiciling without sufficient financial and strategic justification may cause more problems because of the alternative use of resources which should have been used for other projects. The amount of 5 million Euros has an alternative source to fund others or support in the financing of some. Beside investors to the company either in terms of equity or debt are always on the search for justification for any corporate action. This happened in the case of Devro plc where its stocks suffered a fall after its net profit gets affected because of the need to restructure its operations (Devro plc, 2015). Accounting standards may require the recognition of certain restructuring cost as a result of re-domicile of the parent from France to Monaco. The effect on cash outflow could be higher than 5 million Euros since a need could arise to write off some costs already incurred in France and the effect would necessarily be reflected in the financial statements in terms reduce the earnings per share of the company because of higher operating cost and lower net income. Such lower EPS is material accounting financial information in the valuation of stocks. As to whether the increased restructuring cost may be made tax deductible in France is also an important question. Although higher expenses may increase tax shield, they could still affect the bottom line in terms of the financial statements (Kieso et al., 2007; Johnson et al., 2003; Stice & Stice, 2011). Thus aside from projected cash flow for the next five years, projected income statement and projected balance sheet should also be prepared to have better way of looking at the effects of re-domiciling. Every corporate move must result to higher shareholder value in the long-term. 3) Clearly state what options of sources of finance the multinational corporation has to fund the proposed expansion across Asia. State the factors that the company should consider when deciding what sources of finance to access to fund the restructuring of the company. (25marks) Corporate decisions on sources of financing whether as multinational or not should maximize the shareholder value? The options would include the following: internal courses, from the big balance of retained earnings, financing from equity and financing from debt. Initially, the company has to check whether it has a large amount of retained earnings in their balance sheet, which could be used for reinvestment rather than giving them as dividends to shareholders. This is a good source of financing for any investment it may consider like the joint venture or the possible re-domiciling from France to Monaco. Giving them as dividends and asking investors to reinvest would be unfavourable to investors because of tax consequences and same would be more costly to the company. Given the targeted amount of investment the source of financing could now come from either equity or debt financing or a mixture of these. The choice of mixture is dependent on what will minimize cos of capital and what will maximize shareholder value. The only question now is where the source the equity financing or debt financing. Sourcing equity in locally from the host country is possible and there are advantages of doing the same. The same thing can be said about debt financing Under equity the financing, some advantages are notable including greater decision-making to owners and better management flexibility (Shapiro, 2005). Although creditors are shareholders they could actually set conditions with company such as restricting distribution of dividends to shareholders, or requiring the debtor-company to use its assets as security for the debt (Brigham & Ehrhardt, 2010). Shareholders decide through the board of directors as owners and they have a voice on who would sit as member of board of directors. The board of directors would choose the executive officers including the chief executive officer, chief financial officer and chief operating officer to make strategic and operation decisions by the company as approved by the board. Another is advantage of full equity is the chance of earning higher returns without giving any fixed interest expenses in case it borrows from the bank loans or in case of issued bonds. However as stated earlier the chance to received dividends depends on profitability (Brigham & Ehrhardt, 2010). As to whether Biz could provide dividends every year in the next five years, the same still depends partly on chance and therefore is subject to risks, as nothing is 100% percent in the world of business and nobody can perfectly know the future. Debt financing, on the other hand, could provide tax savings in terms the deductibility of interest expense in case of more debts as compared with dividends are given to shareholders under equity financing (Brigham & Ehrhardt, 2010). Such debt financing at a certain optimum level could actually increase profitability and cash flow positon of the company. But the moment debt financing is too much the company is exposed to risk of bankruptcy in case of financial tsunamis when forecasted revenues would not be realized because changing conditions in the economy and the industry. Thus doing one extreme of equity or debt financing may do harm than good to the company. As such the idea of optimum capital structure must be attained in order to minimize cost of capital and maximize shareholder value for the company. It must be noted that both debt financing and equity financing could be XP or in the country where it may possibly have a FDI, joint venture or another form of suitable financial arrangement. Thus choosing a combination of the three sources of finance --internal, equity and debt -- can be viewed as strategic in building long-term shareholder value as long as it will attain an optimum capital structure. 4) Analyse other strategies XP can expand to Asia, such as FDI (M&As and Greenfield). What are the advantages of foreign direct investment (FDI). Referring some academic articles to support your arguments. (25 marks) Case facts provide that the company is considering expansion in Asia, namely China and India, as there is much growth in these regions over the last few years. It has been estimated that 50 million Euros will be needed to fund the proposed expansion in the next five years. Compared to the proposed joint venture which would require only 2 million euros, this is rather a very big project the XP may serious consider. Investing directly in Asia via FDI may be too risky for the company to adopt immediately. There other less risky alternative to entering a new market at the earlier part of the game for MNC. In the case of FDI with manufacturing facilities in the another country, a parent company may start first in export, then joint venture with local companies in the host country until it will eventually go into FDI as risk assessment is improved with experience (Jacque, 1997). XP may have to start entering first into joint venture as that done in earlier proposal by KE plc based in Germany. Should it decide to go FDI the following are the notable advantages. FDI entail more access to the market, more access to revenues, and the chance reduction in the cost of productions because of economies of scale and further diversification. With the advantages of expanding into foreign countries with growing markets, the company could actually compete better in terms prices and better management of its resources. Note that the nature of the companys business is consultancy and base from case facts, it has been generating revenues and good profitability for the past years and thus the company has all the chance to further improve the same. However figures must carefully studied and analysed before any decision should be made. FDI is mode of transferring domestic competitive advantages abroad. It is of course assumed that one going for FDI must have shown capacity to generate good profitability and that it has built shareholder value over time (Hicks, 2000; Higgins, 2007). Cash facts provide that company has been generating revenue growth and profitability for the past years which implies certain presence of competitive advantage base on its experience. It does not mean however for the company to close its eyes to possible problems overseas including the level of competition and the other factors that may affect its profitability (Fridson & Álvarez, 2002; Gitman, 2006; Helfert, 2011). Disadvantages for the company of expansion to foreign countries may include unstable and unpredictable foreign economy, unstable political systems, and undeveloped legal systems (Brigham and Houston, 2002). These factors could actually increase risks of expansion and increase the cost of capital accordingly (Brigham and Houston, 2009). To meet challenges, the company must chose not to make decisions without studying carefully the pros and cons and quantifying things so that risks could be reasonable estimated (Kapila & Hendrickson, 2001). It should not use FDI immediately since the same could be too risky after investing so many assets, but only to stop operation. By starting with less risky ones like exporting, the same could be followed setting up foreign sales subsidiary. This could then be followed a licensing agreement and eventually FDI if it has passed to less risky arrangement and more revenues would be really coming coupled with cash flow to justify further expansion (Shapiro, 2005). By expanding to foreign countries, MNC can reduce risk by diversification. It is asserted that there are financial market imperfections that can be taken advantage by MNC by putting up investments abroad using FDI. They can reduce taxes to increase cash and they can even circumvent currency control that may actually lead to greater cash flows and lower cost of funds (Shapiro, 2005). Conclusion This paper has evaluated the proposed joint venture and found the same to be acceptable using both financial and non-financial analysis. XP Plc and SMT are hereby advised to weight things out on the key operational and strategic challenges that the company face then considering re-domiciling the France parent company to Monaco. It may defer the same if there is better use of money unless there is compelling reason to save cash flow if the same is not done immediately. The clear options of sources of finance that the multinational corporation has to fund the proposed expansion across Asia include internal sources, equity financial and debt financing, which were explained well in the paper together with the advantage and disadvantages as part of the factors that the company should consider when deciding what sources of finance to access to fund the restructuring of the company. This paper has also analysed other strategies including FDI that XP can use in its expansion to Asia in relation advantages of FDI and other arrange including increased market share and for diversification of risk that could maximize shareholder value. References: Brigham, E. & M. Ehrhardt. 2010. Financial Management: Theory and Practice. Boston: Cengage Learning Brigham, E. and Houston, J. 2002. Fundamentals of Financial Management. London: Thomson South-Western Brigham, E. and Houston, J. 2009. Fundamentals of Financial Management, London: Thomson South-Western Devro plc. 2015. 2014 Annual report. Available at: http://www.devro.com/investors/annual-report/. Accessed 15th April 2015 Fridson, and Álvarez. 2002. Financial statement analysis: a practitioners guide. New Jersey: John Wiley and Sons Gitman, L. 2006. Principles of Managerial Finance. New York: Addison Wesley Helfert, E. 2011. Techniques of Financial Analysis: A Mode. U.P: McGraw Hill Education (India) Pvt Limited Hicks, A. 2000. Managing Currency Risk Using Foreign Exchange Options. Amsterdam: Elsevier Higgins. 2007. Analysis for Financial Management, Eighth Edition. New York: The McGraw-Hill Companies Johnson, et al. 2003. Financial Accounting. U.P.: Tata McGraw-Hill Kapila, K. and Hendrickson, C. 2001. Exchange Rate Risk Management In International Construction Ventures, Journal of Management In Engineering. Vol. 17, No. 4, pp. 186-191 Khan, M. & Jain, P. 2007. Financial Management. Uttar Pradesh: Tata McGraw-Hill Education, Kieso et al. 2007. Intermediate Accounting. New Jersey: John Wiley and Sons Shapiro, A. 2005. Foundations of Multinational Financial Management, Fifth Edition. New Jersey: John Wiley & Sons, Inc. Stice, E. & Stice, J. 2011. Intermediate Accounting. Boston: Cengage Learning Appendices A – Project Cash Flows with NPV and IRR result Read More