Corporate Finance of FXZ Samples for Students †MyAssignmenthelp.com

Question: Discuss about the Corporate Finance of FXZ Capital Structure. Answer: Introduction In relation to the financial calculation done, we hereby elaborate WACC in details and discuss the effect of FXZ capital structure and recommended changes in it. FXZ is a un-geared company with its capital structure highly dependent on equity share capital. It is an attempt to find out the efficiencies and deficiencies in the capital structure of the company. The capital structure basically comprises of four elements- Equity, Preference, Debt and Retained earnings. There can be various combinations of above depending upon the needs of the company. It may be different from company to company suiting to their needs and requirements. Calculation of Weighted Average Cost of capital In the given Company, the Weighted Average Cost shall be calculated for Equity and Debt. There are no preference shares in the company portfolio. The retained earnings are in negative i.e there are retained losses. Hence, we shall take the total equity mentioned in the Balance Sheet for calculation of the cost of equity. WACC: W(Ke) + W(Kd) (1-T) where W= Weight Ke Cost of equity Kd Cost of debt T Corporate Tax Rate To find out WACC, first we need to find its component : figures in `000 $ Total equity: 10,34,092 Total debt: 1,79,312 Total Finance Cost: 18,257 here Rf= 2.12% Beta: 0.77 Rm: 12.8% Cost of Equity= 2.12% + 0.77 (12.8% - 2.12%) = 10.34% Cost of Debt = Interest payment/ Interest bearing liabilities (debt) figures in `000 $ Interest Payment = 11,100 Interest Bearing Liabilities = 1,79,312 Cost of Debt = 11,100/ 1,79,312 (1-0.30) = 4.33% Weighted Average Cost of Capital (Amount in '000 $) Year 2016 Amount Proportion Cost of Weighted (%) Capital Cost Total Equity Capital 10,34,092 85.22 10.34 1,06,925.11 Debt 1,79,312 14.78 4.33 7,764.21 Total 12,13,404 100.00 1,14,689.32 figures in `000 $ WACC = Weighted Cost / Total of Equity and Debt = 1,14,689.32/ 12,13,404*100= 9.45 % The cost of Equity = Risk-Free Rate of Return + Beta * (Market Rate of Return - Risk-Free Rate of Return). Judgment on the WACC of the company (FXJ) The company is well placed in terms of its capital portfolio as it is not dependent upon outside debts. The company comprises of 85.22% of total capital as equity which suggests that the company is not liable to pay fixed interest and hence it helps them to retain their profits for any other purposes like capital investment, asset purchase or payment of other liabilities (Fairfax Media, 2016). The company pays a dividend as a return on investment to its shareholder which is $ 4,59,90,000 against a total equity of $ 1,03,40,92,000 which is 4.44 % which is quite low compared to the average cost of capital which is 9.45%. In this way, the company has played a very smart move by not indulging them in any fixed interest payments. The company has not issued any preference shares as well which also suggests that there is no requirement to pay any preference dividend to its shareholders (Bloomberg, 2016). The company has not either issued any debentures as well. So it has also allowed them f rom paying debentures interest. However, there are two reasons to worry for FXZ, which are briefly explained below: The amount of retained losses is huge and ever-increasing which suggests that the company has not been run properly by the management. There are retained losses of $ (37, 20,198,000) which is a dent on companys reputation (Fairfax Media, 2016). The same was the case in the year 2015 as well where retained earnings were in negative to an extent of $ (2, 72, 55,44,000). As the company has not included any outside debt in its capital structure, the company is sure to lose tax benefits on payment of committed interest on outside liabilities and debentures (Fairfax Media, 2016). Also, the financiers do not have any say in companys decision making, unlike equity shareholders which is one of the reasons that the companys management is always under the influence of equity shareholders which shows its adverse effect in companys decision making also (Henderson et. al, 2015). Computation of gearing ratios Gearing ratio refers to an analysis of the ratio of a company's long-term debt compared to its equity share capital. It is a comparison of total debt utilized in the company against the total capital of the company. It reflects the ratio of debt to total capital or total debt against total equity capital. A high gearing ratio reflects that the company is highly dependent on debt as its capital which also says that company shall be required to pay high-interest payments to its financiers (Brealey et al, 2014). On the other hand, A low gearing ratio reflects that company is using more of equity as its source of capital. Both the situations are different and have different effects on the company workings. We shall explain this by an example: Situation no. 1 Total Debt: 100 million $ Total Equity: 500 million $ Total Capital: 600 million $ Gearing Ratio: Debt/ Equity 100/ 500 m $ = 1:5 ratio or 0.2:1 In this situation, we see that company has 20% exposure in debts in its total capital which suggests that company has not entered into any high fixed intrest payments annually. Dividend payment is not necessary hence the dividend payment potion can be retained in the company for various decisions. Situation No. 2 Total Debt : 400 million $ Total Equity: 100 million $ Total Capital: 500 million $ Gearing Ratio: Debt/ Equity = 400/ 100 = 4:1 In this situation we see that the company is highly dependent upon debt as its capital sources, it is evident that company shall be required to pay off annual interest payment to its debt holders may be its bank, debenture holders or other borrowings (Brigs, 2013). The company shall not have the option to save or retain that part of payment. The company shall have the option to pay or not pay dividends to its shareholders. Findings with reference to Capital structure As shown above, the two situations show two different capital structure mixes. Both the situations have its advantages or disadvantages respectively. It is the company strategy or company vision to use the type of the funds it wants to utilize in the company that is dividend or interest (Davies Crawford, 2010). In our recommendation, the company in its earlier years of existence should depend on equity as its mode of capital because the company initially should not want to indulge in fixed payments. On the contrary, the established companies should use debts in its capital portfolio 9 Healy et. al, 2012). The reason behind is that the established companies do not want to share their company voting rights with issuing more equity share capital. The company strategy should decide whether it should use more of debt or equity in its capital structure. An optimal capital structure is one which has a best debt-to-equity ratio for a corporate house that maximizes its market capitalization. The optimal capital structure which offers a balance between debt-to-equity and minimizes the firm's cost of capital is considered as the best capital mix (Correia et. al, 2005). The company aim should be to reduce its total cost of capital i.e. cost of utilization of capital debt, preference shares, equity should be minimum. This shall ensure that the company shall be well placed in terms of optimum capital structure. FXZ is highly un-geared and equity capital oriented company meaning that it has low debt compared to equity share capital, this is not an optimal capital structure as this does not ensure the minimum cost of capital or maximized share value. Market share price is dependent upon company financial performance (Albrecht et. al, 2011). FXZ uses high equity as its source of capital. Its gearing ratio is saved by negative retained earnings which have further reduced shareholders funds. Hence gearing ratios of FXZ are not optimal. The year 2016 has not been good for FXZ because its financial position is not so rosy for its investors . There has been huge impairment and amortization cost in this year 2016 which has an effect on its profits and accumulated losses (Deegan, 2011). Recommendation We recommend changes in company capital structure due to the high dominance of equity capital because the company is able to please its shareholders with negative retained earnings and low dividend payout. The company should borrow some long-term funds with low-interest rates also and it should try to break even or try to reduce its losses (retained losses). The company should try to issue corporate bonds with late maturity or fewer interest rates or it may issue debentures to public to raise funds. Fundraising by the company shall reduce its burden on existing capital structure and shall fuse new energy in the company. The company should also try to explore more earning avenues. The company should various optimal capital structure to find out which suits them better for their company (Brealey et. al, 2016). The company should calculate the cost of capital at different capital mixtures. Conclusion The company FXZ is in cash crunch and is running into losses, the management should seriously think about ways to pull back the company from this awful situation. The company is eating up its resources with every day like high retained losses shall finish shareholders funds and the company shall not have anything to pay back its shareholders. The company can approach its debtors and receivables to pay them fast and soon so that they may invest them and reduce their losses. The company should try to identify areas where cost cutting can be done to reduce its expenses. Budgeting is an excellent tool which can be used by the company to standardize its expenses and spend accordingly. These are some of the ways we would like to recommend to the company to improve company financial position. The company FXZ has to try to include some leverage effect to its financial statements at minimum interest rates. The company board has to bring a radical change in its capital structure by managing it s long-term capital commitments. The company should decrease its cost of capital by using an optimal capital mix. The basic aim of optimizing capital structure is to select that proportion of various forms of debts and equities mixes that maximizes the firms value while minimizing the average cost of capital. References Brealey, R. A., Myers, S. A., and Marcus, A. J. (2015). Fundamentals of Corporate Finance, 8th ed. Australia: McGraw-Hill Irwin. Correia, C, Mayall, P, O'Grady, B Pang, J. 2005. Corporate Financial Management, 2nd ed. Perth: Skystone Investments Pty Ltd. Henderson, S, Peirson, G, Herbohn, K, Howieson, B. (2015). Issues in financial accounting. Pearson Higher Education AU. Healy, P. M, Palepu, K. G. (2012). Business Analysis Valuation: Using Financial Statements. Cengage Learning. Albrecht, W, Stice, E Stice, J. (2011). Financial accounting. Mason, OH: Thomson/South-Western. Brealey, R, Myers, S. Allen, F. (2014). Principles of corporate finance. New York: McGraw-Hill/Irwin Brigs, A. (2013).Financial reporting analysis. Mason, Ohio: South-Western. Davies, T. Crawford, I. (2012). Financial accounting. Harlow, England: Pearson. Deegan, C. M., (2011). In Financial accounting theory. North Ryde, N.S.W: McGraw-Hill Fairfax Media. (2016). Fairfax media 2016 annual report accounts. Retrieved May 22, 2017 from https://www.fairfaxmedia.com.au/ArticleDocuments/193/FAIRFAX%20Annual%20Report%202016.pdf.aspx?Embed=Y Bloomberg. (2016). Australian rates and bonds. Retrieved May 22, 2017 from https://www.bloomberg.com/markets/rates-bonds/government-bonds/australia