International Business Finance - IFM Plc - Essay Example

\ Executive Summary The report explores the three strategic issues that IFM Plc needs to address based on financial and non-financial analysis of the strategic options. The financial analysis of the company demonstrates that the joint venture necessitates a €2 million investment that can be funded by shareholders offering a yield return of about 12%. The paper utilizes financial data and computes the WACC, as well as the Net Present Value. The analysis gives a WACC of 10% and an NPV of € 1.359 million, which is indicative of the value of the investment into a joint venture. The report also explores re-domiciling of IFM Plc from France to Monaco, in which the report establishes that there is a logical point of view based on a business perspective. In addition, the report addresses the plans set put by the company in expanding into Asia (India and China) that will require about €250 million. Although, the expansion will deliver growth of about 5% in the next five years and is worth undertaking, it carries high risks connected to the massive investment required. The high gearing level of 88% indicates that IFM Plc is significantly exposed to financial risk. The report outlines options that the company can implement to lower its gearing level and attract funding; however, this remains uncertain owing to the interplay of factors involved. In this section, the reports explore the diverse sources of finance that IFM Plc can utilize in its expansion into Asia and the factors that impact on the sources of finance. Table of Contents Executive Summary…………………….…………………………………………………………2 Section I: Introduction……………………………………………….……………………………4 A. Analysis of the Joint venture………….………………….. …...…..………………….4 B. Core risks and Rewards associated with Joint Ventures..…………………..…………5 C. Financial Analysis of a Proposed Joint Venture….…………………..……………….6 Section II: The operational and strategic challenges presented by re-domiciling.………………..7 Section III: Section III: Sources of Finance for Expansion…………………………….…..……9 A. Internal Sources of Funding…….……………………………………………………...9 B. External Sources of Finance..……………..………………………………………......10 C. Tapping into Global Debt Markets….………………………………………..…….....11 Recommendations………………………………………………………………………………11 Conclusion……………………………………………………………………………………….12 References List …………………………………………………………………………….…….13 Appendix……………………………………..………………………………………………….15 Section I: Introduction The report analyzes and appraises prospective venture between IFM Plc and a German subsidiary (EMF Plc), re-domiciling from France to Monaco and pursuing with its expansion efforts into Asia. Indeed, such a move will make sense since the bulk of the business operations are run in Monaco; nevertheless, such a move could hurt the company’s image since it will be purely for profit and the shareholders may not welcome the idea. In the analysis, the report illuminates the operational and strategic challenges that can create costs and benefits in re-domiciling the business into Monaco. The expansion into Asia will help the company to gain access to fresh markets into India and China, especially given that India and China are high-growth countries. Analysis of the Joint venture The joint venture represents a legal entity that takes the nature of the partnership involved in the joint undertaking of a certain transaction for mutual benefit. As such, the two enterprises jointly undertake a certain transaction for mutual profit, contribute assets and share risks. The motivations for establishing a joint venture vary based on individual cases. In most cases, joint ventures are established between entities that do not have the resources necessary to develop and undertake a new business, which help both entities to leverage resources, share expertise, capabilities, and liabilities, gain market access, and provide an opportunity for flexible business diversification (Das 2010, p.45). The formation of the joint venture will help to strengthen the position of IFM Plc in the market since IFM Plc will be able to gain access Germany market. The formation of an effective working relationship with a competitor can aid the company to develop itself further and gain capabilities and resources (Fey and Beamish 2000, p.139). Joint ventures are considered to deliver enhanced shareholder value relative to mergers and acquisition; however, getting joint ventures off the ground can trip up in unpredictable ways. The joint venture will prove critical in providing competitive advantage for both entities. Joint ventures offer entities the opportunity to speedily gain access to new markets. Indeed, the joint venture can be regarded as strategic and sound since it reduces the risk of entry into the new market of establishing an existing market (Park and Russo 1996, p.875). Furthermore, the joint venture allows the two entities to pursue complementary interests and objectives and help in the attainment of minimum size for operating in the market. Most importantly, the joint venture arrangement will enable IFM Plc to overcome constraints associated in operating in Germany. Core risks and Rewards associated with Joint Ventures Joint ventures are difficult to manage, especially owing to the challenges linked to managing legal entities. Some of the challenges emanate from the culture clash that may arise between the participating entities. Furthermore, there may be an absence of clarity on the desired contribution of the alliance towards each other. The joint venture risks generating unproductive cost and may produce a significant shift in basic competitiveness of the joint venture. Some of the rewards of the joint venture include minimization of unproductive competition. Moreover, the joint venture may also avail tax benefits provided that it is structured carefully. Entry into the market might be too costly if IFM Plc were to enter solo and may also provide an opportunity for risk reduction. Joint ventures can be regarded as on the most suitable test for the establishment of an inter-corporate synergy effect. The approach will inform entrance into new markets, minimizing production costs, while simultaneously spreading the risk (and return). It is not sufficient to enter into joint ventures based on market fundamentals alone, given that a lack of synergy between the two firms may yield to a disaster occasioned by incompatibility in the company cultures (Julian, Wachter, and Mueller 2009, p.107). Trust between the two entities is pertinent and the partners ought to be transparent regarding the value of contributions so as to create a setting from which all parties can benefit. IFM Plc may have to deal with regulations meant to limit anti-competitive risks emanating from collusion, loss of potential competition, and price discrimination and market access. For instance, the European Union merger law ensure that firms do not gain such a level of market power on the free market to the extent of harming the interests of consumers, the economy, and the society at large. The choice of equal (50:50) equity presents a number of advantages such as universal recognition, which gives an independent identity. The vehicle also helps the company to institute effective management and employee structure, derive the benefit of limited liability and flexibility when raising finance. It is essential to avoid the rush to completion since this can lead to marginalization of best practices or temptation to skip steps, which remains one of the reasons for the fall of joint ventures. In cases where the leadership is disjointed, decision made early within the process may possess a disproportionate impact on the effectiveness of the joint venture. Joint venture should be allowed to proceed organically accompanied by executive input throughout the whole process (Insead 2005, p.332). Financial Analysis of a Proposed Joint Venture Net Present Value (NPV) mirrors the present value of the company in light of present and future cash flows. The report utilizes NPV to inform the appropriateness of the joint venture. The positive NPV (€ 1.359 million) highlights that; IFM Plc will enjoy surplus cash as a result of entering into a joint venture (See Appendix 2). The investment appraisal approach taken draws from the notion of discounting, whereby projects that generate cash flows earlier are preferred to those that generate cash flows, later. In order to establish the NPV of a project, one will need to list all the cash flows connected to the project, which are then discounted at the cost of capital. The decision rule details that, a positive NPV paves way for the project, but a negative NPV indicates that the project must be discarded. Such a decision is informed by the fact positive NPV offers a return that surpass the cost of capital and the embracement of such a project will enhance the wealth of the company. The value of an entity will increase by the NPV of a project provided that the WACC of the project remains rigid. Companies possess diverse sources of finance including common stock, preferred stock, retained earnings, and debt. WACC represents the average after tax cost of various sources of finance. The increase in wealth will be mirrored within the share price increase. The NPV approach assumes that that all cash flows generated by the investment in the joint venture will be reinvested in the company’s cost of capital. Overall, the joint venture is likely to lead to accelerated growth (gained via broadening existing markets and/or entering new markets); exchange of expertise (sharing both tangible and intangible assets); and, diversification of risk (generating a balanced portfolio of risk). The organizational arrangement is largely dynamic and present enormous opportunities and challenges. It is pertinent that the organization seeks a strong organizational culture that supports adaptation employee performance by motivating the employees towards a shared goal (Chapman, Hopwood, and Shields 2007, p.708). Section II: The Operational and Strategic Challenges presented by Re-domiciling The practice of re-domiciling is gathering pace since it benefits countries considered having more competitive tax regimes. Re-domiciling of the companies’ abroad aid companies to escape unfavourable tax laws, which enables companies to reincorporate and shift management and control of the company into another country. Monaco avails opportunities for the company with more investment opportunities since the size and structure of the market continue to expand and evolve, which translates to increased returns, since France is a low-yield environment. As such, the net funding of the re-domiciling of the patent company (5 million euros) will be worth the effort. Re-domiciling is necessary for the company to compete effectively. The transfer of operations to foreign entities, the company will be able to lower its tax rate. However, such a move may attract negative publicity and is often denounced as unpatriotic. The re-domiciling of IFM Plc is logical from a business perspective since the bulk of the business operations are run in Monaco. Monaco’s credibility of tax regime remains a key selling point in attracting investment. Most importantly, the tax environment has remained responsive to changes within the financial services industry. Monaco’s streamlined and efficient tax administration system is likely favour IFM Plc in keeping its business overheads low. Re-domiciling of entities registered within foreign jurisdictions to Monaco is made possible by the company law, which outlines that a company seeking to transfer operations in the country need not liquidate. The impacts of such provisions details that the entity does not need to create new legal entity, but rather retain its rights, assets, obligation, and liabilities that it enjoyed in the original registration. Re-domiciling will require massive restructuring largely shaped by the desire to maximize profits emanating from tax advantages and operational efficiencies; nevertheless, re-domiciling possesses minimal effect on the actual management of the company. IFM Plc will have to restructure and reorganize so as to improve capital efficiency; generate cost efficiency via economies of scale; benefit from tax reliefs by structuring in a tax efficient way, and attain administrative benefits. The restructuring will encompass shifting of profit-making activities from one jurisdiction to the next. Business restructuring aligns with IFM Plc’s efforts to derive cheaper distribution, production, tax costs, production, and administration; however, restructuring can also trigger issues relating to transfer pricing and treaty issues. Despite the advantages offered by re-domiciling, political risk remains in the case of the regulation change; however, such a risk remains low (Wai, Liang, Priem, and Shaffer 2013, p.99). In some jurisdictions, restructuring can give rise to possible capital gains tax challenges. The political risk represents the risk that the host country will institute come up with political decisions that prove to have adverse effects on the multinational’s profits and/or goals. However, in the case of IFM Plc, both the macro and micro political risk are low. Although, the company may encounter criticisms, the restricting is legitimate, mirror both the spirit and letter of the law, and will allow the company to maximize its economies of scale by enchaining the operational efficiencies and establishing better specialization and optimization of resources and capabilities. Section III: Sources of Finance for Expansion Businesses possess numerous ways of raising finance informed by aspects such as the firm characteristics, the economic environment, and the nature of the intended investment. Companies can raise new funds from several sources including loan stock, retained earnings, franchising, venture capital, business expansion scheme funds, government sources, and bank borrowing. A company can opt for equity financing by selling part of itself within the form of shares to investors. The main focus in the financing, the expansion, should rest on striking a balance between debt and equity (Jones and Danbolt 2004, p.1325). For instance, too much debt may place the company in a precarious situation since it will worsen its debt sustainability rating while the failure to capitalize on debt funding may limit growth prospects. Internal Sources of Funding Internal sources of funds may take the form of equity capital, loans, inter-firm receivables and payables and dividends. However, inter-firm borrowing remains a far-fetched idea for IFM Plc since the subsidiary is not yet in place. IFM Plc can also opt for trade credit to improve its short-term financial position; nevertheless, this approach is unlikely to provide the financed needed for expansion (Guariglia, Liu, and Song 2011, p.79). Companies can increase finances for expansion by retaining profits and not distributing the earnings as dividends. IFM Plc can retain 50% of its profits to fund the proposed expansion into Asia. Maintaining a healthy cash reserve can be regarded as critical for growing businesses since it does not add to the debt profile of the company. The advantages of reinvested profits include the fact that, there are not interest charges; however, the capital obtained in this form of financing may be limited, which limits the growth rate of the company (Atik 2012, p.146). The company can also opt to sell some of its assets to raise capital, which makes sense since the company can dispose of underused assets. External Sources of Finance IFM Plc global presence is an advantage since the company can effectively respond to the deficiency of affordable financing on the domestic front by coming up with strategies to raise money abroad. The sources of financing can range from equity issuance and sales of debt products, as well as capitalizing on government subsidies and financing agreements via private channels. A company can raise capital by raising capital by selling stock in the business, in which the issue price ought to be equal to or over the nominal value of the shares (Fernhaber, Covin, and Shepherd 2009, p.297). A rights issue can also avail a means of raising capital by offering new shares to the existing shareholders. If IFM opts for rights issue, IFM Plc has to set price low enough to secure the acceptance of shareholders expected to provide extra cash; however, the price should not be too low to avert excessive dilution of the earnings per share. IFM Plc can also float preference shareholders provided that there is less volatility of the market price. Preference shares are advantageous since they do not carry voting rights, which means that they do not dilute control of existing shareholders. Issuing preference shares will most likely lower the company’s gearing ratio unless they are redeemable. Tapping into Global Debt Markets Leverage can be regarded as the most cost-effective means to capitalization given that the interests that the company pay on debt is a tax-deductible expense, while the dividend settled on equity (shares or stocks) are not. Nevertheless, disproportionate dependence on long-term debt heightens financial risk, which further leads to a higher rate of return for investors (Fleming 2004, p.63). The global debt markets may take the form of Eurocurrencies (offshore currencies) and international bonds (Euro, foreign, global). IFM Plc can also negotiate loans with a financial institution; however, the company should be keen to ensure that the rate of interest, repayment dates, and security for the capital are favourable. Since IFM Plc is a global entity, the company enjoys the opportunity to raise cash via hedge funds, asset management companies, and private equity funds (Chang 2004, p.721). Offshore financial centres avail flexible and cheap sources of funding for multinational. China and India offer massive opportunities for the company owing to market size and growth prospects, as well as availability of infrastructure, overall stability of the tax regime reasonable degree of taxation, and stable political climate. Recommendations Some of the issues that IFM Plc will have to explore in deciding what sources of finance to access to funding the expansion include the sources available based on the size of the company; the amount of money required; the risks involved; and, the costs of the finance (Inkpen and Beamish 1997, p.177). IFM Plc will have to explore ways to increase efficiency by minimizing the cost and maximizing economies of scale (Lavastre, Gunasekaran, and Spalanzani 2012, p.828). Overall, internal sources of finance may be too constrained to avail opportunities for growth. Hence, gaining access to external finance may increase the money available, but this form carries the risk of diluting ownership. The gearing ratio of 88% is high and demonstrates a disproportionate long-term finance in the form of loans relative to shareholder funds, which makes the company vulnerable to downturns within the business cycle (Krishnamurthy 2010, p.3). As such, the firm is vulnerable to interest rate movement and is likely to pay higher interest charges and may encounter difficulties in paying interest charges if profits drop too low (Almeida and Campello 2010, p.589). Although, the ideal gearing does not exist, the project cash flows indicate that the company is still in a position to service its debt provided that the return on utilized funds is higher relative to the interests and related charges on debt funds. Conclusion Then joint venture arrangement will allow IFM Plc to gain synergy and competitive advantage since it decreases the risk of market entry and research and development. The arrangement will also avail the company with operation synergy through economies of scale, better pricing power, combination of diverse functional strengths, and increased growth in the new or existing market. The move to France is strategic since Monaco regulatory environment can be considered internationally consistent and responsive. The re-domiciling of the company mirrors market strengths and business opportunities for the company to grow. Lastly, the business risk faced by the company is low; it is advisable that the company lowers its optimal debt ratio to make investors more comfortable. References List Almeida, H. & Campello, M. (2010). Financing frictions and the substitution between internal and external funds, Journal of Financial and Qualitative Analysis, 45 (3), pp.589-622. Atik, A. (2012). A strategic investment decision: “Internationalization of SMEs”: A multiple appraisal approach and illustration with a case study, iBussiness, 4, pp.146-156. Chang, S. J. (2004). Venture capital financing, strategic alliances, and the initial public offerings of Internet start-ups, Journal of Business Venturing, 19 (5), pp.721–741. Chapman, C. S., Hopwood, A. G., & Shields, M. D. (2007). Handbook of management accounting research vol.2, Amsterdam, Elsevier, pp.708. Chui, A. C. W., Lloyd, A. E., & Kwok, C. C. Y. (2002). The determination of capital structure: Is national culture a missing piece to the puzzle, Journal of International Business Studies, 33 (1), pp.99-127 Das, D. (2010). Contours of deepening financial globalization in the emerging market economies, Global Journal of Emerging Market Economies, 2 (1), pp.45-67. Fernhaber, S. A., Covin, P. P., & Shepherd, D. A. (2009). International entrepreneurship: Leveraging internal and external knowledge sources, Strategic Entrepreneurship Journal, 3, pp.297-320. Fey, C. F., & Beamish, P. W. (2000). Joint venture conflict: The case of Russian joint ventures, International Business Review, 9, pp.139-162. Fleming, L. (2004). Excel HSC business studies, Glebe, Pascal Press. Pp.63. Guariglia, A., Liu, X., & Song, L. (2011). Internal finance and growth: Microeconometric evidence on Chinese firms, Journal of Development Economics, 96 (1), pp.79-94. Inkpen, A. C., & Beamish, P. W. (1997). Knowledge, bargaining power, and the instability of international joint ventures, Academy of Management Review, 22, pp.177-202. Insead, H. H. (2005). The effect of general and partner-specific alliance experience on joint R & D project performance. Academy of Management Journal, 48(2), 332-345. Jones, E. & Danbolt, J. (2004). Joint venture investments and the market value of the firm, Applied Financial Economics, 14 (18), pp.1325-1331. Julian, C. C., Wachter, R. M. & Mueller, C. B. (2009). International joint venture (IJV) top management teams: does heterogeneity make a difference?, Journal of Asia-Pacific Business, 10 (2), pp. 107-129. Krishnamurthy, A. (2010). How debt markets have malfunctioned in the crisis, Journal of Economic Perspectives, 24 (1), pp.3-28. Lavastre, O., Gunasekaran, A., & Spalanzani, A. (2012). Supply chain risk management in French companies, Decision Support Systems, 52 (4), pp.828-838. Pansiri, J. (2005). The influence of managers’ characteristics and perceptions in strategic alliance practice, Management Decision, 43 (9), pp.1097-1113. Park, S. H. & Russo, M. V. (1996). When competition eclipses cooperation: An event history analysis of joint venture failure, Management Science, 42 (6), pp.875-890. Wai, L. O., Liang, X., Priem, R., & Shaffer, M. (2013). Top management team trust, behavioral integration and the performance of international joint ventures, Journal of Asia Business Studies, 7 (2), pp.99-122. Appendix 1: Email letter DF Consulting 234 Main St. Paris. Mrs Diana Worth, IFM Finance Director Dear Mrs Diana Worth, Enclosed is the report requested on the strategic options that the company intends to implement including an evaluation of the proposed joint venture. Please inform me of any questions, or further information that you may require. Yours Truly, James, capital projects accountant. Appendix 2 Strategic Option One Enter into a joint venture with EMF NB: all figures are given in million Euros Initial investment = 2 million Investment at year 0 = 60% of 2m (= 1.2 million) Investment at year 1 = 40% of 2m = 0.8 million PV of total investment = 1.2m + (0.8m * 1.1^-1) = € 1.927m Operating costs Costs at year 1 = 0.235 less depreciation = (0.235 – 0.0258 = 0.292) Factoring in inflation rate of 2.5% Year 2 = 0.292 * 1.025 = 0.299 Year 3 = 0.299 * 1.025 = 0.306 Year 4 = 0.306 * 1.025 = 0.314 Annual sales Sales in year 1 = 0.900 + (0.450/0.8410) = 1.435 Factoring in sales growth rate of 15% Year 2 = 1.435 * 1.15 = 1.650 Year 3 = 1.650 * 1.15 = 1.898 Year 4= 1.898 * 1.15 = 2.182 Profit after tax Year 1 = 1.4 35 – 0.292 = 1.143 Less 29% tax (0.331) = 0.812 Year two = 1.650 – 0.299 = 1.351 Less 29% tax (0.392) = 0.959 Year three = 1.898 – 0.306 = 1.592 Less 29% tax (0.462) = 1.13 Year four = 2.182- 0.314 = 1.868 Less 29% tax (0.542) = 1.326 Discounted profit after tax Year one = 0.812 * 1.1 ^-1 = 0.738 Year 2 = 0.959 * 1.1 ^ -2 = 0.793 Year 3 =1.13 * 1.1^-3 = 0.849 Year 4 = 0.849 * (1.1) ^ -4 = 0.906 Total discounted profit after tax = 0.738 + 0.793 + 0.849 + 0.906 = 3.286M NPV = Present value of cash inflows – present value of cash out flows = 3.286M - 1.927m = 1.359 million NPV = € 1.359 Million Read More