Essay: What is corporate finance

“Discounted cash flow is the purest way; I would prefer to adopt it if the information is there”.

To get a more realistic and acceptable price | value of the company i.e. Record Master four franchises income earning method is been used as following:

Using WACC:

Formula:

Cash flow (CF 1)

WACC

For calculating I have divided my calculations in two parts;

i) Cash Flow

ii) Calculating WACC

i)Calculation of Cash Flow:

1. Increase in Working Capital

Accounts Receivables

Receivable x 365 1278267 x 365

Sale 6957758

= 67days

Assuming revenue will increase in lieu with compound growth rate i.e. 49%.

Account Receivable (1994)

Revenue (1993) x 1.49

= 6957758 x 1.49 = 10367059

Assuming 90% of sales are on credit basis.

Increase in Account receivable:

= Revenue (1994) x 90%

= 9330353

= 9330353 x 67

365

= 1712695

= 1712695 – 1278567

= 434428

Accounts Payable

= Creditors x 365

CGS

= 126502 x 365

4529758

= 10

Assuming cost of sale will increase in lieu with compound growth rate i.e. 49% of revenues.

= cost of sale x 1.49

= 4529758 x 1.49 = 6749339

60749339 x 90%

= 6074405

Increase in Accounts Payable:

= 6074405 x 10

365

= 166422

= 166422 – 126502

= 39920

Increase in Fixed Assets:

= Turnover

Fixed Assets

= 6957758

959421

= 7.25 times

= 6957758 x 1.49

= 10367059

= 10367059

7.25

= 1429939

= 1429939 – 959421

= 470518

Tax:

= EBITA (93) X 1.49

= 1535016 X 1.49

= 2287174 @ 3.2%

= 73190

Depreciation;

Year (93) = 146800 + 221304

= 368104

Accumulated Depreciation = Dep (Previous Year) + Dep (current year)

Fixed Assets at the start of (93) = Net F/A + Dep of current year

= 959421 + 368104

= 1327525

Depreciation rate = 368104 x 100

1327525

= 28%

Depreciation (1994) = 959421 + 470518

= 1429939 x 28%

= 400383

Interest Payment:

EBITA (93) X 1.49 = 1535016 X 1.49

= 2287174 (EBITA 94)

= 2287174 X 8%

= 182974

Cash Flow (CF 1):

ii) Calculation of WACC:

194794

= 8%

(ref: KPMG’s Corporate Tax Rate Survey from 1993 to 2006)

Cost of Equity:

= 11% ( ref: Canada Bank research)

(Ref: Bank Canada Review, Autumn 2007. Lorie Zorn, Financial Markets Departments)

Cost of Debt:

= Interest rate (1 – Tax%)

0.08 (1- 40%)

= 4.80% or 5%

Value of the company

= Cash Flow 1

WACC

= 1453696

10.70

=

$13,585,943

Or

Value of the Company (Franchises)=

$ 13.586m

Cross check comparison:

Owners Earning Method:

= Cash flow @ growth rate

Ke – g

= 1,142,390 @ 3% growth rate*

= 1176662

= 1176662

11% – 3%

Value of Record Masters (Franchises) = $14708275 or $14.708m

Investment appraisal Projected cash flow statement

1. Net Present Value:

NPV= PV – I

NPV=13.587 – 13.586

NPV= 0.001

Investment opportunity should be accepted.

2. BENEFIT COST RATIO:

=

Present value of cash inflow

Net investment

=

13.587

12.906

= 1

.053

EACH DOLLAR INVESTSD WILL EARN Rs 1.053

3. Project payback period

4. Internal Rate of Return (IRR)

A = 18892362 (cumulative cash flow) = 3778472

5

PVIFi, 5 = 12,906,000 (equity part to be invested i.e. 60%) = 3.41

3778472

27% 34/28%

3.30 2.266/3.43

As inflow is increasing so we move backward direction.

NPV1 =

16,466,517- 13,587,000

= 2879517

NPV2 =

16,953,978- 13,587,000

= 3366978

IRR = R1 + (R2 – R1) NPV1

NPV1 – NPV2

= 27% + (38%- 27%) 2879517

2879517- 3366978

= 27% + 2879517

487461

= 27%+ 5.907

=

32.90%

OR

= 33%

RECORD MASTERS

Requirement # 2.

How should the acquisition be financed? Recommend the amount and type of financing required, and provide a full justification for recommendation.

The Need of Finance:

Firms need funds to:

1. provide working capital
2. invest in no-current assets

The main source of funds available is retained earnings, but as per consolidated balance sheet position amount of retained earning is unlikely to be sufficient to fiancé all business needs.

Choosing between sources of equity:

When choosing between sources of finance, consideration must be taken of factors such as:

• The accessibility of finance
• The amount of finance
• Costs of the issue procedure
• Pricing of the issue
• Control

Financial Structure:

The ratio explains that creditors have provided 5% of the business (franchises) financing for its assets and the stockholders have provided 95%. This gearing ratio is on a lower side that does not expose business to market risk on the same time have increased variability of returns to shareholders.

Franchises financial structure is appended below:

Before selecting any source of finance consideration of following factors is crucial:

A vast range of funding alternatives is open, before examining various sources of finance available, following factors needs consideration before reaching to some decision.

Note:

As per acquisition criteria, Dauten wants to invest | sponsor buyout in which he would provide the majority of equity capital and would play a more active management role (ref: pg. # 1) and on the same time keep the same financial structure (ref: pg. # 4). Further as cost of debt of 5% after taking tax rate adjustment is less than cost of equity i.e. 11%. This makes raising debt option more viable to increase earnings resulting in greater EPS.

Sources of Finance:

The suitable sources of finance for the acquisition price are as under:

DISTRIBUTION OF LOAN AND EQUITY ON CAPITAL AND WORKING CAPITAL

*Note:

As balance sheet position of more then one year is not given, comparison of increase in working capital requirement is assume on the basis of increase in account receivable ($434428) and account payables ($39920) making total woring capital requirement for 1994 $474348.

PROJECT FINANCING

Modus operandi for acquisition transaction:

For acquisition transaction $12.906m will be injucted in form of equity by way of taking over equity from original stakeholders | owners. Out of total equity amount $0.450m (95%) will be used in working capital to meet day to day requirement rest will be used in equity in shape of capital investment.

Advantages of Equity Investment:

• As owner of the four franchises, have the right to exercise control over the acquired franchises.
• Right of vote to determine crucial matters.
• Right to approve | disapprove of major strategic
• Right to receive dividend.

Amount of $12.208m will be put in by debt (long term & short term) as under:

Debt Options:

Taking over a company (franchises) that is private ltd. in structure. For raising debt Dauten has following options:

Advantages of Debt Investment:

1. Interest is tax deductible
2. Tax relief reduces finance cost.
3. Is low risk.
4. Cheap compare to equity
5. Has predictable flows
6. Does not dilute control
7. As compare to cost of equity i.e. 11%, cost of debt is low i.e. 5%

Considering the growth rate in sales volume and EBITA raising debt will not have a significant effect on the financial position. Furthermore debt (short | long) has a definite maturity and the amount of obligation is fixed so the lender gets the same interest whatever the earnings of the company is.

This induction of debt will raise capital structure of the company at the same time the WACC rate will also surged down that will increase the value of the business. Furthermore the by adding debt proportion in financial structure of the business consequently result in high return to shareholder’s on their investment, that is what Dauten expects i.e. internal rate of return on investment i.e. 35%.

RECORD MASTERS

Requirement # 3.

What strategies could Dauten adopt to increase the value of the business?

Strategy # 1:Improving the company’s Financial Performance

One of the statutory that Dauten can focus on for increasing the value of the business is for improving the business financial position that the business is good and profitable. There are some red flags in the financial especially in the current assets containing account receivable amount that is on a higher side with collection days near to 35 days. Dauten have to introduce new strategies regarding sales collection to reduce this collection period, sales are not very good if we compare the figures with other company in the industry i.e. Bell + Howell Records Management amounting $95m. EBIT of the company is lower than the total assets, equity is very low as compare to debt. Ploughing back the profit into equity as retained earning can help to strengthen the equity poison.

To improve the business financial position, Dauten should maintain the current assets of the business to a certain level and reduced the current liabilities of the business because the current liabilities carry charge on current assets. Looking to the capital strucurte with debt weightage of 83% maintainance of assets (quick assets) is crucial to carry on lenders / creditors trust going on, this can also help to improve current ratio and Quick Ratio. Sales figures are high compare to fixed assets and total assets, as per Record Masters management planning i.e. technology innovation. Dauten should invest more in fixed assets. Dauten also need to improve EBIT to enhance profit ratio and to improve Time interest earned ratio and also improve EBITDA ratio.

The assets of the company is not very large and the profit of the company is good as compared to assets and equity of the business. If we improve Return on assets, return on equity and basic earning power ratio. Dauten must improve profit to meet the level of the business and also achieve the benchmark of the company.

Strategy # 2: Raising debt portion in capital structure

Dauten can further improve the market value of the business by raising more debt portion in capital structure to offer more benefit to the share holder of the business. By increasing debt portion in capital structure that surge-down the WACC of the business the value will increase ultimately benefiting the shareholder due to the characteristics debt financing brings with it (already discussed above in detail).

This is further explained below:

Equity : 80% Debt : 20%

than WACC:

Value of the company = cash flow

WACC

= 1.454

9.20

= $15.804m

Strategy # 3:

Marketing Plan

To increase the value of the business adoption of solid, well structured and goal oriented marketing gameplan is essential.

Following are the Marketing plans that can be applied in business to further increase its value (ultimate goal).

1. Focussed marketing to high-potential prior relationships.
2. Broader screening of referral sources to cultivate new relationships.
3. High degree of service = personal selling, super responsiveness, periodic communications, unique gifts and memorable / fun dialogue.
4. Origination efforts through direct company contracts and trade shows.
5. Development of five (5) target industries.
6. Developing more distribution channels providing an opportunity to market additional products and services to the institutions i.e. hospitals.
7. Enriching staff with necessary job training as under:
1. Training Program
2. Evaluate Training
3. Job Rotation
4. Talent Identification and Management
5. Job Enrichment Techniques
8. Introduction of new technology and atomisation (Record Masters vision) to en-cash the available opportunity in record management industry and to increase clientele volume.

RECORD MASTERS

Requirement # 4

Suggest how the local owners incentives can be aligned with the goals of Dauten.

Dauten’s Goals:

1. Achieve unique levels of profitability (01% of 15+%) through high degree of acquisition selectivity, aggressive profit improvement programs, and meaningful management incentives.
2. Achieve $25 – $50 million in revenues within five years by closing one core acquisition in the next year.
3. Control own destiny by growing at a deliberate pace, maintaining voting control, employing conservative financial structure, and having dependable operating management in place.
4. Have fun working with a more concentrated group of referral sources, managers, suppliers, and customers.
5. Build wealth over a long-term time frame through price discipline, reinvestments, growth, debt, paydown, pre-tax compounding of value and QSBS tax treatment.

In present structure of the business the management are the local owners of the frenchises performing as CEO | Directors enjoying the voting right, control and decision making.

Share options give the executive the incentive to manage the firm in such a way that share prices increase, therefore share options are believed to aligned the managers’ goal with those of shareholders (Dauten).

Considering the fact, each management local owner has a distinct advantage based on his / her past experience. After acquisition Dauten should retain the management on the senior positions to attract and motivate them to successfully retain them.

This may be determined in number of ways, Basic Pay the wages and salary that forms the base of pay should be emphasized and incentives to be provided by way of increasing pay scale in order to motivate the local owners.

Furthermore, A short term or per annum bonus may be paid to the directors | local owners each accounting year. This can be based on number of accounting measures whichever suit the most to the company nature and environment.

Economic value added (EVA), this is the surplus calculated above a charge on all assets used using the WACC as a threshold percentage minimum return before a bonuses is achieved.

Pension funds / policy in addition to increase in basic pay can be a good tool to attract and motivate the local owners.

In lieu of Dauten’s goal to provide a professional and friendly environment, job training and evaluation is necessary part of strategy for the contribution to the company future growth.

Recommendation / Conclusion:

DECISION OF THE INVESTMENT

After making this feasibility analysis now we make decision either this investment should be undertaken or not. So we make decision on the following basis:

PAYBACK ANALYSIS:

The payback period calculated is 3.14 years , shows that the investment of $13,586,000made in the project will be returned to the owner in 3.14 years. So on these bases we decide that the project should be undertaken.

NPV ANALYSIS:

The NPV of Cash Inflow calculated at an annual rate of 35% for 1st five years is positive i.e. $13.587M. So the investment made in the Project will be feasible.

BENEFIT COST RATIO:

The benefit cost ratio calculated is $1.053 . It shows that each dollar invested in the business (RML) will return $1.053.

IRR ANALYSIS:

The IRR calculated on the annual rates of 29% and 30% is 29.86%.
The IRR is Greater than the cost of Capital. So it is recommended that the investment should be made in the project.

SO IN THE LIGHT OF ABOVE ANALYSIS IT IS RECOMMENDED THAT THE PROJECT IS FEASIBLE AND SHOULD BE UNDERTAKEN BY DAUTEN AS AN INVESTMENT OPPURTUNITY.