Funding for TNA Investment in Vietnam - Case Study Example

Executive Summary Globalization is a key factor for any business aiming at increasing and expanding its revenue streams to the benefit of shareholders. The globalization agenda is the current issue facing TNA Company having been offered an opportunity to expand into Vietnam by acquiring a local firm. However, TNA has to evaluate the possible sources of funds to finance the proposed acquisition since a substantial amount of money is required in expanding to the Vietnamese market. In so doing, TNA should aim at securing funds through the financing sources that are least expensive. In addition, TNA ought to appraise the proposed takeover in a bid to ensure that it will result in future profitability for the business if accepted. The takeover offer is priced at $10 million as the initial capital outlay. Thus, this report uses net present value in conducting the financial feasibility for the takeover. The report will also analyze the project using $7 million as the assumed initial capital outlay. The report will finally give recommendations on whether the project should be accepted and if so the price at which TNA should accept the takeover proposal. Table of Contents Executive Summary 1 Introduction 4 TNA is an Australian company willing to expand its operations abroad in order to take advantage of emerging opportunities and hence boost its returns to the investors/shareholders. Its agent in Vietnam has advised it on a takeover opportunity in a small firm that deals with manufacturing equipments for the food processing and packaging industry. The takeover opportunity looks attractive but a lot of initial cash investment is required and this may not be immediately available to the company. 4 Companies like TNA need adequate funding in order for them to take advantage of such emerging opportunities and hence be able to develop and hence generate more income for their owners or shareholders. There exist various funding options which such companies can take advantage of in their quest to grow. The sources of funding are broadly classified into two classes including internal sources of funds which is largely equity and external sources of funds which is largely debts. Debt refers to the money that such companies borrow to repay later with interest. On the other hand equity refers to selling shares or part of the company to potential or existing members at a fee thus raising funds for the company. Already established businesses can also raise funds through their retained earnings. Funds can be secured either domestically within the country’s host country or even internationally. It is also worth noting that once funds have been secured, it is vital that they be put into proper use if they are to be of any help to the company. In this regard, a company should only invest the secured funds in a project that is economically viable in terms of being profitable for the company. In other words, the company should realize value for the invested funds. This report discusses the various sources of funding available for TNA to fund the proposed purchase of the small local firm. In addition, the report performs an evaluation of the proposed investment with an aim of gauging the viability of the project. The report concludes that the project is viable as a result of the appraisal and hence the company should undertake it on securing the needed funds. 4 The funding options available to TNA 4 Internal funding 5 External funding 5 Project appraisal and analysis 8 The situation if the investment required was only $A7 million 12 Discussion 13 Conclusion 13 Introduction TNA is an Australian company willing to expand its operations abroad in order to take advantage of emerging opportunities and hence boost its returns to the investors/shareholders. Its agent in Vietnam has advised it on a takeover opportunity in a small firm that deals with manufacturing equipments for the food processing and packaging industry. The takeover opportunity looks attractive but a lot of initial cash investment is required and this may not be immediately available to the company. Companies like TNA need adequate funding in order for them to take advantage of such emerging opportunities and hence be able to develop and hence generate more income for their owners or shareholders. There exist various funding options which such companies can take advantage of in their quest to grow. The sources of funding are broadly classified into two classes including internal sources of funds which is largely equity and external sources of funds which is largely debts. Debt refers to the money that such companies borrow to repay later with interest. On the other hand equity refers to selling shares or part of the company to potential or existing members at a fee thus raising funds for the company. Already established businesses can also raise funds through their retained earnings. Funds can be secured either domestically within the country’s host country or even internationally. It is also worth noting that once funds have been secured, it is vital that they be put into proper use if they are to be of any help to the company. In this regard, a company should only invest the secured funds in a project that is economically viable in terms of being profitable for the company. In other words, the company should realize value for the invested funds. This report discusses the various sources of funding available for TNA to fund the proposed purchase of the small local firm. In addition, the report performs an evaluation of the proposed investment with an aim of gauging the viability of the project. The report concludes that the project is viable as a result of the appraisal and hence the company should undertake it on securing the needed funds. The funding options available to TNA As stated above, various funding sources are available to TNA and hence the choice of the most appropriate form of funding will depend on the availability of such funding and the cost of financing among other factors. The various forms of financing that may be available to TNA are discussed below; Internal funding This is funding from the company’s internal resources and would not require approval apart from directors or the company’s management. This is mainly from retained earnings and is achieved from the profits not distributed to shareholders as dividends. The cost of this capital is also limited as there are no costs required while the amount of returns therefrom is certain (Orij, 2016). The main uses of such funds would include financing of operational activities, capital investment, debt settlement and acquisitions. However, in the current scenario, there is no information on TNA’s retained earnings meaning it may not be a recommended source of finance for the acquisition. However, this does not been that retained funds cannot be used if any were available. External funding Forms of external funding are diverse but would require shareholders’ approval. They are broadly classified as debt and equity funding. For TNA, these potential sources are analyzed below; a. Equity financing As pointed out, this is a form of financing whereby the firm loses a portion of its shares and worth to the lender or the issuer of the funds. From that moment, the issuer becomes an owner of the company in that he owns a portion of it which is represented by the shares that he bought. In the case of TNA, it has this offer on the table. Through the use of the equity source of financing, it will lose some part of the ownership to the financers who will become the new owners. The company through this will also have to share the profits that it makes with the shareholders in terms of dividends at the end of every financial year. This will also limit the speed of action as the decisions that will be made will have to be unitary in that they involve the new owners. Through this therefore, it will be a slow and tedious process. The company based on the fact that it intends to make further investments, it should not embark on this form of financing. This is because it will derail the growth and expansion process of the company. The second argument that has been used in this is that the company is intending to make further investments. Through this, all the returns that will be made from the investments will have to be divided between the shareholders. This reduces significantly the total amount that is ploughed back to the business for further growth and expansion. As a result of this, the business should aim at seeing to it that it has put in place adequate measure to see to it that all the revenues that it makes are channelled back to the business without sharing them out and remaining will scraps only. This is the reason behind the recommendation that the business should use the debt form of financing rather than the equity. This is because it is at its initial stages of its growth and by being indebted; it would result to its failure in the short or in the long run of its operations. b. Debt financing TNA could also finance the acquisition using debt financing. This would however necessitate the establishment of a contract between the lender and the company so as to set the conditions of the loan including loan rate and interest and principle repayment obligations. Debt financing will also call for the company to make a security deposit by pledging certain asset (fixed charge) or making a pledge on all its assets (floating charge). One form of debt financing available to TNA would be the Term loan where the bank and the company will agree on the conditions that will suit the company. In this case, TNA would have an opportunity to take a term loan and negotiate the loan repayment terms including the interest rate and period of payment. TNA could also take a mortgage loan where the loan will be pegged on the basis of a freehold property. The property will be pledged as security and will fulfil laid down criteria including non-perishability, ease of selling and stability of value. One advantage that TNA will have by taking such a loan is that it can be expanded for a long period up to 25 years. TNA could also finance the acquisition through a loan stock by issuing a debenture or a bond. This is where the loan will be divided into small units and investors will have an opportunity of purchasing as many units as they will afford. This form of debt financing is issued in a similar manner to equity financing with the interest rate depending on the issuer’s credit rating as well as the specific debenture. In this case, it is the public as opposed to the bans that will be lending money to TNA for certified fixed rate of interest. TNA will also benefit from this form of debt financing in that it will not require pledging any collateral or security. TNA could also issue a convertible loan stock that is a mixture of debt and equity financing meaning that investors may be able to convert the debt into equity at a certain point of time in future (Sumhr.com, 2016). Before this however, the investors will still earn interest and will remain the company’s lender. However, TNA will have a chance to liquidate the loan by converting it into equity while offering low interest to the investors due to their expectation to benefit from the company’s future profits. However, TNA will need to be registered in the ASX to trade in the loan stock despite the loan stock being highly cost-intensive. In choosing whether to use equity or debt financing, TNA ought to carefully analyse the advantages and disadvantages of each and hence choose the best. These are analysed below; Advantages of equity financing to debt financing a. The equity amount does not have a payable period or date unlike the debt amounts (Findlaw.com, 2016) b. The equity amounts does not increase as a result of interests c. Equity is less restrictive as compared to debt financing d. Interests payable acts as high risk areas in times of financial constraint Disadvantages of equity financing over debt financing a. Dent financing requires no periodic reporting procedures as compared to the equity financing b. Equity financing is characterised by slow decision making processes as decisions of owners must be incorporated. c. Tax returns payable by the company can result to reductions in the interest amounts payable. d. In debt financing, the relationship between the lender and TNA lasts as long as the loan is due and ends after it is cleared. No further costs are incurred in the future e. Equity financing is characterised by many complexities in the doing of things such as IPOs and other similar activities which are absent in debt financing. Based on the above analysis, the following table summarizes the financing options together with the recommendations for TNA. Form of financing Type Highly recommended (1) Recommended (0) Not recommended (-1) Internal financing Retained earnings 1 Short term internal funding -1 External funding Shares 0 Private equity 1 Mortgage loan 1 Loan stock 0 Term loan 0 Finance lease -1 Sale and Lease-back -1 Short term external funding -1 Project appraisal and analysis In order to determine whether the project is financially feasible and hence the company should invest in it or not if otherwise, the project appraisal has been carried out. In so doing, the project duration has been assumed to be five years and the Net Present Value has been used as the project appraisal method (publicspendingcode.per.gov.ie, 2016). It is to be noted that the appraisal is based on Australia’s financial year starting from 1st July 2017 and ending 30th June 2022. The following table summarizes the sales growth figures for the five year period. Description Year 0 Year 1 Year 2 Year 3 Year 4 Year 5 Financial year   July2017 June2018 July2018 June2019 July2019 June2020 July2020 June2021 July2021 June2022 sales growth rate per annum 0% 20% 30% 30% 20% 10% Australia Inflation 2.31% 2.31% 2.31% 2.31% 2.31% 2.31% Vietnam Inflation 5.31% 5.31% 5.31% 5.31% 5.31% 5.31% We determine the sales revenue per year. This is based on the fact that the existing contracts from the Vietnamese company will provide underpinning revenue equivalent to $200,000 per month at current exchange rate (Central Intelligence Agency,2016). As such, revenue per year is calculated as follows; The sales per month = $200,000 The sales per year = $200,000*12 = $2,400,000 +additional food processing and packaging business revenue Additional food processing and packaging business However, the company expects to rapidly gain additional food processing and packaging business owing to the superiority of their new equipment. As such, they will experience differing rates of sales growth per year and these have to be factored in in determining the level of sales per year. The annual sales growth rates have been outlined in the table above. For the first two years, the annual sales are arrived at as follows; Year 1= = $2,400,000 + ($2,400,000)*20% = $2,880,000 Year 2 = Year 1 sales + 30% additional growth = $2,880,000+ ($2,880,000)*30% = $3,744,000 The sales in the rest of the years are computed in a similar manner depending on the additional sales growth rate. Thus, the total annual sales for the new project will be as shown in the table below; Financial year Annual sales growth rate Annual revenue A$ 2016/17 (Year 0) 0% 0 2017/18 (year 1) 20% $2,880,000 2018/19 (Year 2) 30% $3,744,000 2019/20 (Year 3) 30% $4,867,200 2020/21 (Year 4) 20% $5,840,640 2021/22 (Year 5) 10% $6,424,704 We then calculate the associated cost which is expected to be 60% in the first year and 50% during the other years. For the first two years, the cost is calculated as follows; Annual cost = Annual revenue * proportion percentage Year 1 = $2,880,000*60% = 1,728,000 Year 2 = $3,744,000*50% = 1,872,000 Financial year Annual costs in A$ 2016/17 (Year 0) 0 2017/18 (year 1) 1,728,000 2018/19 (Year 2) 1,872,000 2019/20 (Year 3) 2,433,600 2020/21 (Year 4) 2,920,320 2021/22 (Year 5) 3,212,352 We then determine the net cashflow from the new acquisition annually. This is achieved by subtracting the annual costs from the annual sales (Central Intelligence Agency,2016). For example in year 1 and 2, the cashflow will be given by; Annual net cashflow= total revenue-total cost Year 1 = $2,880,000-$1,728,000 = $1,152,000 Year 2 = $3,744,000-$1,872,000 = $1,872,000 Financial year Annual costs in A$ 2016/17 (Year 0) 0 2017/18 (year 1) 1,152,000 2018/19 (Year 2) 1,887,000 2019/20 (Year 3) 2,433,600 2020/21 (Year 4) 2,920,320 2021/22 (Year 5) 3,212,352 We then compute the net present value (NPV) for the project. The project’s NPV is attained from the following formula; Where n = year number (0, 1, 2, 3, 4, 5) And t = TNA’s weighted average cost of capital (10%) and other discount rates. However, in computing the project’s NPV, we have to factor in the effect of inflation labour discount rate and capital cost discount rate. The following table details out the above discounts. Time Cash flow (A$) Labour discount rate (1/1+1)n Capital cost discount rate (1/1+c)n Inflation discount rate (1/1+i)n PV (A$) Initial investment 1 -10,000,000 1 1 1 -10,000,000 Initial investment 2 -7,000,000 1 1 1 -7,000,000 Year 1 1,152,000 0.995 0.909 0.950 989,836 Year 2 1,872,000 0.990 0.826 0.893 1,367,013 Year 3 2,433,600 0.985 0.751 0.848 1,526,586 Year 4 2,920,320 0.980 0.683 0.813 1,589,161 Year 5 3,412,352 0.975 0.621 0.772 1,595,024 In computing the above rates, we assume an annual increase in labour rate of 0.5%. The Australian inflation rate is expected to be 2.31 for the next five years with that of Vietnam being 3% higher every year. On the other hand, the weighted average cost of capital for TNA has been given as 10%. NPV computation This is given by multiplying the future cashflows with the various discounting factors to give us the present values for each year. The present values for the first two years have been computed as shown below; Present value = Future net cashflow value* discounting factors = Future net cashflow value* Labour discount factor* Capital discount rate* Inflation discount rate Year 1 =$1,152,000*0.995*0.909*0.950 = $989,836 Year 2 = $1,872,000*0.99*0.826*0.893 =$1,367,013 The present values for the rest of the years are summarized in the table below; Sales growth 20% 30% 30% 20% 10% Total sales revenue( A$) 2,880,000 3,774,000 4,867,200 5,840,640 6,424,704 Costs proportion 60% 50% 50% 50% 50% Total costs (A$) 1,728,000 1,872,000 2,433,600 2,920,320 3,212,352 Residual value 200,000 Net cash flow 1,152,000 1,872,000 2,433,600 2,920,320 3,412,352 Increased labour cost (%) 0.5% 0.5% 0.5% 0.5% 0.5% Labour discount factor (1/1+1)n 0.995 0.990 0.985 0.980 0.975 WACC (%) 10% 10% 10% 10% 10% Capital discount rate (1/1+c)n 0.909 0.826 0.751 0.683 0.621 Inflation rate difference 3% 3% 3% 3% 3% Australia inflation rate 2.31% 2.31% 2.31% 2.31% 2.31% Vietnam inflation rate 5.31% 5.31% 5.31% 5.31% 5.31% Inflation discount rate (1/1+i)n 0.950 0.893 0.848 0.813 0.772 Present value (A$) project 1 989,836 1,367,013 1,526,586 1,589,161 1,595,024 Present value (A$) project 2 989,836 1,367,013 1,526,586 1,589,161 1,595,024 Initial investment 1(A$) -10,000,000 Initial investment 2 (A$) -7,000,000 NPV (A$) project 1 `-2,932,380 NPV (A$) project 2 67,620 As can be seen from the table above, the Net present value for each initial investment in the project is arrived at by adding the total present values for all the years to the initial cash investment bearing in mind that the initial investment has a negative sign as it is the money TNA must incur in the takeover. For instant, where the initial investment is A$ 10,000,000, the NPV is calculated as follows; NPV = Initial investment+ total annual net cashflows (-A$10,000,000)+989,836+1,367,013+1,526,586+1,589,161+1,595,024=-A$-2,932,380 Since the company to be acquired is in Vietnam, these figures have to be converted to Vietnamese currency the Vietnamese Dong. Thus, the NPV will be; NPV in Vietnamese Dong = NPV in Australian dollars * the current exchange rate =-A$- A$-2,932,380*16237.85 = VD$ (47,615,546,583.00) The NPV decision rule is that a project would be chosen if it has a positive NPV while it would be avoided if it has a negative NPV (Colin, 2015). In this case, the NPV is negative and hence it is not financially feasible. As such, TNA should not accept the project. The situation if the investment required was only $A7 million Changing the initial investment cost does significantly affect the NPV though the net cashflows remain the same since the level of sales as well as the related costs is not affected. From the table above, the NPV in this case has been calculated as follows; (-A$7,000,000)+989,836+1,367,013+1,526,586+1,589,161+1,595,024= A$67,620 Converting this to Vietnamese Dong gives us the NPV to be; A$67,620*16237.85 = VD$1,098,003,417.00 The NPV in this case is positive and hence according to the decision rule, the project is financially feasible and hence TNA should accept it. Discussion In determining whether to accept or reject the project, there are multiple factors that ought to be considered so as to ensure that if chosen, the project succeeds and hence delivers profitability for the company. For instance, it is important that the company acquaints itself with all the relevant trading environments in Vietnam including legal, economic, political and technical environments. Other factors to be considered would be whether the company has enough expertise to trade with the products the would be subsidiary trades with. The above analysis has just been helpful in gauging the financial feasibility of the project (Jones, 2012). It has been decided that the company should only accept the takeover proposal if the initial capital outlay remains $7 million as opposed to $10 million. Based on the NPV decision rules, this is the only time that the company stands to benefit financially from the project. However, if other factors as outlined above are not considered, then the company might end up failing on the project. It is also worth noting that the cost of financing the project has not yet been factored in the analysis above. As such, the company ought to ensure that the sources of finance adopted involve the most minimum costs so as to ensure that the company’s shareholders eventually benefit from the maximum NPV from the project. Conclusion This report has discussed the various financing options that TNA can utilize in financing the proposed takeover. From the analysis, the best financing options for the company have been seen as retained earnings, private equity and mortgage loans. Being a private company, these finance sources were seen as the easiest and least cost options and hence the best for TNA. However, other options may be considered should the company fail to secure funds through the most recommended ways. The report has also performed a project appraisal on the proposed takeover. With an initial capital investment requirement of $10 million, the project has been noted to yield a negative NPV after five years. As such, it has been deemed unattractive and not financially feasible for the company. Thus, the report has recommended that TNA should reject the project in this case. However, at a reduced initial investment cost of $7 million, the project has been found to be attractive for the company and hence financially feasible since it has a positive NPV. As such, it has been recommended that TNA accepts the takeover at these factors. However, other factors that are not financial also ought to be considered so that the maximum amount of risk can be avoided in accepting the project. References: Orij, P2016, Advanced financial management, New York, Taylor & Francis. Sumhr.com, 2016, The top 10 performance appraisal methods of start-ups & small businesses. [cited on 25 May 2016]; Available from: https://www.sumhr.com/top-performance-appraisal-methods-startups-small-businesses publicspendingcode.per.gov.ie, 2016, The public spending code: D. Standard analytical procedures overview of appraisal methods and techniques. [cited on 25 May 2016]; Available from: http://publicspendingcode.per.gov.ie/overview-of-appraisal-methods-and-techniques/ Colin, H2015, Cost-benefit analysis and project appraisal, London, Rutledge. Findlaw.com, 2016, Debt vs. Equity :Advantages and Disadvantages. [cited on 25 May 2016]; Available from: http://smallbusiness.findlaw.com/business-finances/debt-vs-equity-advantages-and-disadvantages.html. Jones, D2012, Strategic Finance for Criminal Justice Organizations (1st ed.). Boca Raton, Florida: CRC Press.pp. 53–54. Central Intelligence Agency,2016, [cited on 25 May 2016]; Available from: https://www.cia.gov/library/publications/the-world-factbook/geos/as.html. Cenctral Intelligence Agency,2016, [cited on 25 May 2016]; Vietnamese economy]. Available from: https://www.cia.gov/library/publications/the-world-factbook/geos/vm.html. Read More