Vodafone Plc as a British Multinational Company - Term Paper Example

Financial Management Contents Contents 2 Introduction 3 Financial structure 4 Investment appraisal 6 Funding 9 Conclusion 11 References 13 Introduction The modern business world has become significantly competitive in nature. Under the environment of cut throat competition financial management has high degree of significance. Vodafone Plc is a British multinational company which has global business footprint. In 2014 revenue of the organization has slipped by 1.9% and has become £43.6bn. The company has performed well in the emerging markets but due to the saturated situation in European markets the performance of the organization has faced significant challenges. EBITDA margin of the British multinational has declined by 1.1%. Annual report of the organization is showing that the company has performed pretty well in the Asian markets. It means sluggish business operation in the European region has declined the profitability of the organization. The report will discuss various financial aspects related with the company. In this report financial structure, investment appraisal and funding of the organization will be analyzed on the basis of various aspects. The report will be significantly helpful for the newly appointed directors of the organization. The report will provide various kinds of inputs to the directors on the basis of which they will be able to take future strategic decisions for the company. It is highly important for the organization to maintain financial stability and long term business sustainability. That long term sustainability can be achieved with the help of proper financial analysis. The study will follow a step by step approach which will provide a clear cut direction to the directors of the company. At the end of the study a suitable conclusion will be drawn on the basis of the whole discussion and analysis. The study will include a critical evaluation of all the aspects. The study will focus upon both theoretical and practical aspects related with the financial management. Financial structure Gearing is all about company’s debt related with the equity funding of the organization. Gearing is an important indicator on the basis of which organizational ownership pattern can be analyzed. Gearing provides the required measurement related with the organizational financial leverage. This ratio identifies the fact that whether the organization is controlled by the funds of shareholders or lenders. Gearing ratio indicates the vulnerability of the organizational financial system. If the gearing ratio is high for any company that means the organization has high degree of vulnerability with the economic down turn. Gearing ratio indicates that up to which level activities of the organizations are being funded by the creditors and owners. High gearing ratio is not at all desired for the organizational financial management. It involves high risks for the companies. Here in this case it has been observed that Vodafone Plc has high equity capital than the borrowed fund. Historically the organization is an equity funded company and it has always been controlled by the fund of the share holders. Over the years the organization has successfully controlled the debt fund. In 2014 equity fund decreased but debt of the organization also decreased. The British telecom giant has always kept the gearing ratio under the control. Here in this case gearing ratio of the organization in 2014 is 0.29. On the other hand in 2013 gearing ratio of the organization was 0.38. It means the organization has able to reduce its gearing ratio significantly in one year. Real ownership of the organization is being judged on the basis of its financial structure. In other words how the activities of the organizations are being funded by the shareholders or lenders. As the organization has low level of debts, it means the company has less responsibility for the purpose of debt repayment. Gearing ratio is an indicator which showcases the ownership pattern of the company. Here in this case ownership pattern of the company is highly equity oriented. It means the organization has less risk exposure in front of the economic downturn. Gearing ratio of company measures the financial leverages or risks. The company has low financial leverages (Robinson, Henry, Pirie and Broihahn, 2012). It indicates that the organizational activities are significantly dependent upon equity funding. It has been observed that, analysts across the world give significant importance towards the gearing. They give high degree of importance towards the debt and equity funding ratio of the company. Activities of the organization are significantly dependent upon funding. Calculated funding is utterly important for the business profitability. Gearing ratio is the proportion of company’s debt to the equity of the company. Gearing ratio indicates the financial risks in front of which a particular business is exposed of. In the current case of Vodafone Plc, it has been observed that the company is using equity funding for the purpose of the organizational operation. The financial structure of the company has been designed in such a way that the company is significantly prepared for the purpose of easy debt repayment. Gearing ratio certainly points out towards the ownership pattern of the company. It indicates how the business operations of the organization are being run by the funds of owners and lenders. That is why analysts consider this ratio as the evidence of ownership pattern of a company (Fridson and Alvarez, 2011). All the above discussions and arguments are indicating that gearing ratio is a significantly important factor. It helps the organization to make their strategic decisions. This ratio gives clear picture about the leverage of the company. It showcases how the company is prepared for the risk mitigation purpose. Organizational activities are significantly dependent upon the organizational funding. The ratio has high degree of significance for understanding the pattern of ownership. Here in this case Vodafone Plc is a company which is significantly funded by the equity capital. That means business operations of the organization are being controlled by the shareholders not by the creditors. Investment appraisal There are several investment appraisal techniques are available in the context of financial management. Adjusted present value is a modified form of net present value. Net present value does not consider the risks associated with a project. On the other hand adjusted present value does consider the risk associated with it. It means as an investment appraisal technique adjusted present value is far more improved than the net present value. NPV helps the organization to maximize their organizational values. NPV provides significant focuses towards the net present value of money. One of the significant disadvantages of the NPV is it is difficult to implement. Calculating appropriate discount rate is also a problem related with this investment appraisal technique. Adjusted present value provides high degree of flexibility to the organization. NPV is basically focused towards the visible items related with assets and liabilities. APV is significantly focused towards the real costs also which are directly related with the organizational operations. APV does not consider agency costs. It is a serious disadvantage of this technique. APV is significantly dependent upon M&M theory and the theory overlooks bankruptcy and tax exhaustion. Accounting rate of return is an investment appraisal technique where return is being considered out of an investment. On the other hand payback period is a time within which a project pays back the money. Payback period does have significant time consideration. On the other hand accounting rate of return is much more return oriented. If accounting rate of return is high then the project is highly suitable. On contrary if payback period of project is high then that project is not at all suitable for the purpose of investment. Payback period has definite disadvantage as far as the reflection of the total return is concerned. This investment appraisal technique does not consider cash inflows after the completion of payback. It means with the help of this technique, total return cannot be identified. On the other hand with the help of ARR comparison between two companies is highly complex in nature. Payback period is a widely used method and the method has high degree of simplicity. It is a serious advantage of the technique. Time value of money is not being recognized in the case of payback calculation. It is a serious disadvantage of the method. Payback period does consider risk associated with it. On the basis of this technique investments can be made for a particular project. In case of discounted payback period time value of money is being considered. Discounted payback period is much more equipped and provides more detailed analysis than the payback period does. Payback period does not consider opportunity costs but discounted payback period considers opportunity costs. Payback period does not recognize risk associated with it. As far as the liquidity measurement is concerned, payback is highly advantageous. IRR is significantly important for the purpose of measuring the efficiency of capital investments. IRR has some kind of limitations. All those limitations can be addressed with the help of MIRR. Internal rate of return considers only future values but MIRR considers both future and present values (Coombs, Hobbs and Jenkins, 2005). MIRR provides significant clearer view about the company than IRR does. IRR provides more optimistic view related with a project but it does not consider various practicalities. On the other hand MIRR provides more realistic view about the company. IRR has a significant disadvantage. It does not consider risk factor and cost associated with project. IRR considers all the cash flow as important. IRR always seeks for maximum profitability for the shareholders. It is a genuine advantage with this technique. IRR is a difficult method to understand. Two mutually exclusive investments cannot be compared with the help of IRR. MIRR cannot provide value maximizing decision in the case of project related with capital rationing. MIRR gives significant importance towards all types of cash flows. Discounted cash flow analysis is commonly used for investment analysis. The method involves predicting future cash flows and then discounting future cash flows to present values using appropriate discount rate. The free cash flow is computed by subtracting capital spending from the working cash flow. After the prediction of future cash flow the next important step of the model is to predict an appropriate discount rate. Discounted cash flow method actually caters to the idea of opportunity cost. Although discounted cash flow seems to be a good tool for investment analysis but it is applicable and useful only in theory. The main problem that arises with discounted cash flow method of investment appraisal is the various assumption and prediction of future values that is required by the model. The predictions that are required as part of the model are 1. Prediction of future cash flows. 2. Prediction of the appropriate discount rate to be used in the model (Begović, Momčilović & Jovin, 2013). The problem that arises is that although prediction of the correct discount rate is very vital for the model to predict accurate result it is very difficult to make the predictions accurate. The present values estimates vary widely for small deviations in the estimate of discount rate. For example for X Company if the estimated future free cash flows are Year FY 15 FY 16 FY 17 FY 18 FY 19 Cash Flows ( in 000s) 16,799 18,033 20,120 6,560 10,100 If discount rate is assumed to be 10% then the figure for the present value comes as 56043451 and if the discount rate is assumed as 12% then the figure comes as 53595933. This means that a change in discount rate by 200 basis points, changes the estimated present value of the cash flows by 2447519. The problem arises because there is no full proof method of prediction of the discount rate. Normally the analysts use Markowitz’s model or weighted average cost of capital approach is used for prediction of discount rate. But the problem lies in the fact none of the models are accurate in their prediction of discount rate (Pratt, 2003). In case of Vodafone for example free cash flow was £4.4 billion which was down by about 21.5% from the previous year due to changes in exchange rate that existed between sterling, African rand and to some extent Euro (Vodafone Group Plc., 2014). Such cash flow changes of future are very difficult to predict and so applying discounted cash flow approaches in such cases becomes very difficult. In addition to the exchange rate risk that affects future cash flows, there are other risks as well. Some of the other risks are strategy, reputational damage, legal and regulatory compliance, operational and malicious events. The problem becomes more aggravated as the company is engaged in operations on a multinational scale. In going for investment Vodafone has to not only access risk associated with future cash flow predictions but also analyze those risk in the context of specific country. Some of the risks likely to be faced by Vodafone and are impossible to predict are Reduction of market share Loss of customer confidence or threat of legal action. Changes in regulatory decisions and environment. Funding Vodafone Plc considers various funding options for the purpose of noncurrent assets. The organization has chosen several committed banking facilities for the purpose of assets funding (Khan and Jain 2006). Bonds and issue of commercial papers is also an important source of funding. The organization has foreign exchange contracts to mitigate the risk of foreign exchange fluctuation. In 2014 the company has taken £ 4,647 m bank loans for the purpose of non-current assets funding. In 2014 the organization has issued bonds worth £ 4,465 m. That means the organization has several sources of funding for the purpose of noncurrent assets. Recently to increase some debt capital the organization has chosen debt as the source of fund for the non-current assets purpose. Net debt of the company is 23% of the organizational market capitalization. In March 2014 the organization had £10,134 million cash or cash equivalent for the purpose of risk settlement policy. The organization has used commercial paper program as the significant source of noncurrent assets funding. Currently the organization has two commercial paper programs one is related with USA and other is related with Europe. Commercial paper program with USA has a value of US$15 billion. On the other hand European commercial paper program has a value of £5 billion. All these funding are for the purposes of both current and noncurrent assets. This source of funding has significantly helped the organization to maintain its liquidity related with the business operations (Debarshi, 2011). Generally this way of funding is being considered for the purpose of backup funding. Commercial paper is an unsecured note and generally this type of funding has maturity time period. This source of funding is a commercial paper for the purpose of money market security. The company has used €30 billion program for the purpose of medium and long term assets program. The organization issued the bonds in against of three kinds of currencies. The raised amounts of funds by issuing bonds are US$14.6 billion, £2.6 billion and €6.2 billion. The organization has credit facilities from the banks for the purpose of fund raising. It enjoys €3.9 billion syndicated credit facilities and it has maturity date on 2019. This source of funding is generally being use full for the purpose of conducting any kind of acquisition. Apart from the previous syndicated credit facilities, the British telecom giant has other two credit facilities worthy of US$4.2 billion and US$4.1 billion will be matured on 2016 and 2017 respectively. All the above factors are indicating that for the purpose of noncurrent assets the company is highly dependent upon the various committed facilities. Currently the organization has sufficient amount of funding for the purpose of its noncurrent assets. The company has enough funds to manage the noncurrent assets situation for upcoming 12 months. It has been observed that under the current situation funding for the noncurrent assets of the organization is significantly dependent upon the future committed facilities. Here is the critical challenge of the organization as far as the balance sheet matching concept is concerned. Most of the committed facilities are going to be matured in future and that is why it will be difficult for the company to manage the assets side of the balance sheet. Conclusion Financial management comprises of three main decisions investment decision, financing decision and dividend decision. The particular report focuses on investment decisions and Financing decisions with respect to Vodafone. In case of investment decisions the report focuses on various ways to appraise a particular investment decisions. That is through various methods it was tries to find out whether a particular investment decision is worthwhile. It was found that none of the methods that are used to appraise investment decisions are accurate and full proof. For example the report analyses a particular investment appraisal method that is discounted cash flow. In case of discounted cash flow method it was found that the method uses the predicted value of future cash flows and discount rate as input for the calculation. So the accuracy of the final result depends to a lot extent on the accuracy of input data. The problem is although analysts use several different models to predict these two input parameters the accuracy of these parameters cannot be granted. All the methods have some associated advantage and disadvantages. Next the sources of funds to fund these long term investment decisions are analyzed. It was founded that Vodafone as a company uses several sources of finance like bonds, commercial papers, bank loans etc. Analysing the sources of finance to finance a particular investment opportunity is very vital. The decision of choosing a particular source of finance depends on its cost of capital and expected return of that particular investment opportunity. If the cost of capital is less than the expected return of the project then the project is a worthwhile investment opportunity. Another factor to be considered in choosing a source of finance is its impact on balance sheet. In this respect the financial structure of the company is also analysed, especially with a view to understand its sources of finance. It has been noticed that Vodafone is mainly funded by equity capital. References Begović, S. V., Momčilović, M. & Jovin, S. 2013. Advantages and limitations of the discounted cash flow to firm valuation. [Pdf] Available at: www.vps.ns.ac.rs/SB/2013/1.4.pdf. [Accessed on 24 November 2014]. Coombs, H., Hobbs, D. and Jenkins, E., 2005. Management accounting: principles and applications. London: SAGE. Debarshi, B., 2011. Management accounting. New Delhi: Pearson Education India. Fridson, M. S., and Alvarez, F., 2011. Financial statement analysis: a practitioners guide. New York: John Wiley & Sons. Khan M. Y. and Jain P. K., 2006. Management accounting. New Delhi: Tata McGraw-Hill Education. Pratt, S. P. 2003. Cost of capital: estimation and applications. NJ: John Wiley and Sons. Robinson, R. T., Henry, E., Pirie, W. L. and Broihahn, M. A., 2012. International financial statement analysis. New York: John Wiley & Sons. Vodafone group Plc., 2014. Annual report. [Pdf] Available at: http://www.vodafone.com/content/annualreport/annual_report14/downloads/full_annual_report_2014.pdf. [Accessed on 24 November 2014.]. Read More