Campion Plc Financial Management - Case Study Example

Word Count: 3,500

Executive Summary

Campion plc is an old company (established in 1950’s) that sells and manufactures chocolate of high quality. For the company’s objective to be met, the taking of decisions should be based on three aspects and include: investment decisions, financial decisions and dividend decisions. Based on the company’s position and objectives, financial management is very critical in its operations and this is based on efficient deployment and acquisition of both long and short term financial resources. Decisions related to the equity mixture and debt capital is referred to as financing decision. The return is seen to be more than the capital weighted average cost of 11.0%. A bondholder who is convertible is able to trade the bond for equity and hence there will be a high dividends attained based on condition that at the time of trade the company is required to be performing well. It is clearly evidence that the price went up and the yield is seen to have a greater effect when compared to tax rate change. The company is much interested in expanding to overseas and hence various nations have been identified and they have been considered to be having the capacity of organic growth. It is evident that the proposed project’s net present value is negative at 10% discount. Therefore, this means that Campion plc should not invest in the project.

• Introduction

Campion PLC being a very old company (established in 1950’s) as well as selling chocolate of high quality, it considered to have a strong brand that is reputable in the market. In this case, it sells its products across UK and Europe and it is considering expanding further to other avenues. Campion PLC considers coming up with new projects and this will entail the purchasing of assets that are non-current as the beginning of the process. Secondly, For Campion PLC to be successful as well as implementing and identifying appropriate projects, it has to be sustained or survive in the given economical environment. In this case, working capital management majorly focuses on liquidity management and hence ensuring payables are paid on time, appropriate cash balance investment, minimal inventory levels and debt collection.

• Campion Group

Based on the company’s position and objectives, financial management is very critical in its operations and this is based on efficient deployment and acquisition of both long and short term financial resources. For the company’s objective to be met, the taking of decisions should be based on three aspects and include:

Investment: This entails both short-term and long term investments associated with working capital and non-current assets respectively.

Finance: The entails the type of funding sources

Dividends: This involves the way of allocating cash funds to shareholders as well as the way this will be influenced by the business value. Based on the company’s objective of maximising the shareholders wealth (considerable period of growth and expansion has been projected), there is need for investment decision, financial decision, and dividend decision and the objective of the current report is based on this. For efficient operation in relation to these three decisions there is need to ensure that the finance is utilised effectively and efficiently so that the objective of the company is met. This is suggested to be based on two components: Firstly, consideration of company’s long-term plans by investment appraisal also appropriate projects should be identified so that the financial objective is achieved.

Based upon the financial decision, before Campion deciding to invest in any project, it is very critical for them to have finance and in this case, appropriate sources (short or long term) of finance identification is a major decision of financial management. In this respect, the company’s requirements should be taken into consideration, perhaps the investors demand as well as the amount expected to be made.

Based upon dividend decisions, the company is expected to generate cash as well as being profitable after investing wisely. The financial manager’s final decision is based on the deciding if the cash is to be returned to the business owner (in dividend form).Optionally, the cash can be retained for investment to earn further returns. This therefore is associated with the financing decision. The dividend level to be paid decision is considered to have a significant effect on the company’s value as well as the business capacity to raise finances in future.

2.1. The main different between Campion Plc and Abacus Ltd

Both companies are different in terms of products where Campion plc sells chocolate products while Abacus Ltd is a pharmaceutical company. The Abacus Company is seen to be a small pharmaceutical company (unlisted) with approximately 20 million pounds of annual sale and it has about 200 employees’ shares owned by the majority of employees. It is as well seen to have paid a consistent dividend over the years and its operation is with lower debt level than the industry that historically operates at levels that are high such as Campion plc. In this respect, it is pertinent to compare Campion plc with this company due to its better financial position in terms of divided decisions and financial decisions. As such the main aim to understand the relationship between the investment decisions, dividend and financing decisions (the effect the investment projects will have on dividend and financing decisions). In this case, it is pertinent to show how this varies between Abacus and Campion.

2.2 Optimal capital structure

This part determines if there is any possibility of increasing shareholder’s wealth by capital structure change. In this respect, convertible debt application is to be considered by the Campion directors and it is one of the areas that am interested in. As such I believe it is realistic to give a bond with 3% coupon with 7% discount as well as providing an option of converting it to ordinary shares at 23 ordinary shares per 100pound bond rate. The company’s Capital structure refers to the debt and equity finance mixture and it is employed in financing its assets. It is known that certain companies could be debt free but they are equity financed while others high debt level and have low equity levels (Stiglitz 1998).

Decisions related to the equity mixture and debt capital is referred to as financing decision. In this case, financing decision is seen to have direct influence on the weighted average cost of capital (WACC). This is the simple weighted average of equity cost as well as the debt cost. The weightings are directly related to the equity market values as well as debt and hence as debt and equity proportions vary, so is the WACC. In this case, when there is change in capital structure of a company, it will lead to a change in its WACC. Before exploring capital structure of Campion in details, it is important to find out how the finance decisions such changing capital structure is related to the company’s aim of shareholder wealth maximising. Based on the fact that wealth is considered to be future cash flows’ present value that is discounted at the desired return of the investor, the company’s market value is equal to future cash flows’ present value that is seen to be discounted by WACC (Zhou 2001).

It is pertinent to note that lower WACC will lead to a higher company’s market value ,vice versa as seen in the calculations below. At 15 percent WACC , the company’s market value is 666, and at the point WACC drops to 10 percent, the company’s market value increase to 1000.

The company’s market value =

Therefore, if the capital structure is altered so that the WACC is lowered, the company’s market value will have to increase and hence this will lead to increase in shareholder wealth. In this case, optimal capital structure searching will be very critical in searching for WAAC that is lower and this is due to the fact that there is minimization of company’s value or shareholder wealth. This implies that finance managers have the responsibility of finding optimal capital structure that is associated with lower WACC. It can therefore be noted that the debt cost is seen to be cheaper when compared to equity cost. Since equity is seen to be more risky than the debt the return needed for debt investors’ compensation is less when compared to the return needed for equity investors’ compensation. The interest payment is seen to be fixed as well as compulsory and hence equity is more risky than the debt. In this case, the interest payment is considered as a priority to dividend payment and thus considered to be discretionary. Also liquidation is one of the contributing factors where the debt holder can get the repayment of capital prior to shareholders as they are considered to be higher in the hierarchy of creditors. In this case, there is payment of shareholders is done last.

Debt is as well considered to be cheaper than equity based on the perspective of the company and this is due to variations in the treatment of corporate tax of dividends and interests. In the accounts of profits and loss, there is subtraction of the interest prior to calculations and hence, the tax relief is awarded to the company. Dividends are however subtracted following the tax calculation: Thus there is no tax relief awarded to the company in relation to dividends. In this respect, in case the payment of interest is 10 million pounds as well as rate of tax is 30 percent; it will cost the company 7 million pounds. A big advantage here is that interest is considered to be tax-deductable. Based on the type of debt and equity mixture that is associated with lowest WACC, the probable response is to act by considering to replace expensive equity with debt that are cheaper and this is aimed at reducing the WACC. When more debts are however issued such increase in gearing, it will imply that there is payment of more interest based on the profits prior to getting of dividends by the shareholders. The dividend payment volatility increases as a result of increased interest rates payment due to the fact that they had a poor year as such the payment of interest rates will still be a must and hence influencing the capacity of the company to pay dividends (as seen below). Dividend payment volatility increase to shareholders is as well referred to as financial risk associated with share holders. In case there is increase in the financial risk there will be a greater return to be compensated due to risk increase and hence the equity cost will have to increase where it will lead to increase in WACC.S

Weighted

Cost

Weights

  Cost  

Debt

6%

50%

3%

Common equity

18%

50%

9%

capital Weighted average cost

12%

As observed above the return is seen to be more than the capital weighted average cost of 11.0%.

2.3 The benefits and limitations of convertible bond

Before the convertible bond is evaluated, it is critical to understand the investment type considered. A loan is made to an indebted financial entity when the bond is bought and it is referred to as issuer. A bond is considered to be a written promise repaid by the issuer on the date of maturity as well as a given amount of interest is received and it is referred to as coupon where it is received at a constant interval up to the maturity level. Interest rate is usually paid semi-annually. The interest rates of bonds are basically determined by credit duration as well as quality. The corporation do issue convertible bonds and this is due to the fact that they are able to be converted to the number of stock shares that are pre-determined a t a given time of the life of the bond. Convertible bonds are considered to be bonds that have stock options. Lower rates of returns are exhibited, but this is associated with trading of the bond for stock instead of the bond cost (Hull 2000).

A bondholder who is convertible is able to trade the bond for equity and hence there will be a high dividends attained based on condition that at the time of trade the company is required to be performing well. In case the company is not doing well as expected, the bondholder is seen to have a bond security as well as cashing option at the date of maturity. The convertible bond value may not drop lower than the price associated with the yield being higher relative to the bond that is non-convertible within the same duration. In a bear market there is safety as a result of convertible bonds and hence this will enable investors to be able to convert equity the time there is increase in value of the stock (Pereira et al. 2003).

Calculation of the post tax cost of debt for the convertible bond based on its yield over the next four years.

Kd= Yield (1 – T)

= 13% (1 – .36)

= 13% (.64)

= 8.32%

Based on this the director is advised on using convertible debt over equity and the major focus is on both the limitations and benefits. It is clearly evidence that the price went up and the yield is seen to have a greater effect when compared to tax rate change.

• Overseas expansion

The company is much interested in expanding to overseas and hence various nations have been identified and they have been considered to be having the capacity of organic growth. In country A 10 million dollars associated with the conducted research is considered to have a strong economy. The Campion directors are more interested in coming up with decision related to this for a period of three years. Similarly, country A is seen to have dollars as the currency. There has been identification of the retail outlets as well as recruiting of staff to manage these outlets. Based on this, the CEO believes that this will lead to a certain risk for the company and on the other hand he is optimistic that further upsides will be exhibited and it will not be shown by NPV. The main aim is to determine if there is any chance of having other real options. This was achieved by putting together financial appraisal of the country A based on the provided information.

3.1. Evaluate the GBP net Present Value

The main aim is to determine if there is any chance of having other real options. This was achieved by putting together financial appraisal of the country A based on the provided information.

The working capital is 150 million dollars for a period of one year and the increase is by 10 percent per annum as well as recoverable in full at the end of three years. Net present value is an approach for capital proposals evaluation, the cash flow as a single factor is used in judging the given proposal. Campion plc has a plan of expanding to overseas and hence various nations have been identified and they have been considered to be having the capacity of organic growth. There is identification of the retail outlets as well as recruiting of staff to manage these outlets. In this case, positive cash flow yield is expected for the next four years. The discount rate is at 10 percent and it was used in the calculation of the net present value of the proposed project. Based on the above results, it is evident that the proposed project’s net present value is negative at 10% discount. Therefore, this means that Campion plc should not invest in the project.

3.2. Project evaluation

When a company with high managerial ability invests abroad, both the citizens of the host country and the shareholders do benefit. But despite how this suits what the host nation requires as well as what the company offers, success is not guaranteed. There are several factors such as economic crises, political events and societal attitude changes can significantly disrupt or influence the already well structured plan in both the advanced and emerging economies. This factors are very critical since they are associated with additional risks involved in foreign investment, thus should be included during the evaluation of the company.

3.3. Structure of proposed

The proposed swap structure arrangement is presented and it shows cash flows for a forthcoming period of four years. In this case rise and fall in the interest rates will affect Campion in different ways. Swaps refer to cross currency swap as well as interest rate swap. In this respect, company’s asset structure is considered to be liability sensitive which means that there is re-pricing of liabilities faster than assets

Net operating cash flow (m)

2016

2017

2018

Arising in A dollars

200

250

350

Arising in UK pounds

-25

-25

-25

The interest payment is seen to be fixed as well as compulsory and hence equity is more risky than the debt. In this case, the interest payment is considered as a priority to dividend payment and thus considered to be discretionary.

• Potential acquisition of DC Limited

Net realization value is considered to be a method of asset’s value evaluation.

P/E basis calculation

This is the ratio used in company’s valuation where the current share price to the per share earnings is measured.

The calculation:

For our case, the company has share capital worth 0.1dollars a share and it earning is 10.5 per share. Based upon this, the P/E is: 0.1/10.5 =0.02

Dividend basis

This refers to the total amount invested together with any commission considered in the purchase. It can be defined based on the amount of investment dollar. Commission is included for the calculations as below:

Investment amount + commission amount= dividend basis

4.1. Describe the suitability of each method

Asset basis (realisation value)

Asset basis refers to asset cost and it includes purchase price as well as other associated services. It is very important to know the asset basis of an asset since capital gain depends on the asset price gain from the purchase original cost. In this case higher basis are associated with lower capital gains in tax. Also depreciation as an asset spread cost can be business expenses and higher basis the less the expenses

P/E ratio

The P/E ratio can typically show the amount of dollar expected to be invested by an investor in a give company so that to get a earnings of the company. This is the reason P/E is also known as multiple since it indicates the level an investor wishes to pay per earning dollar.

Dividend basis

This refers to the total amount invested together with any commission considered in the purchase. It can be defined based on the amount of investment dollar. The dividend basis calculation is seen to be complicated and this is as a result of many changes exhibited such as takeover and split.

4.2. Share exchange

Share exchange ratio refers to the new shares amount to be given to the current company’s shareholders and this is after the company has been merged or acquired by other entity. The merged entity new shares value is expected to be the same as the original one. The approach for financing is considered to be appropriate since the exchange ratio is seen to be higher than 1 as well as being positive

4.3. Integration issues

Acquisition for the purposes of reshaping and redirecting the strategy of corporate is usually seen to be quite appealing. It has been indicated that these deals faces a lot of problems and they don’t meet there objectives as expected. In terms of fragment perspective, there is technical complexity associated to it as it is not easy for the managers to maintain generalist’s transaction grasp. This can be resolved by matching demographics characteristics, corporate culture and administrative systems and hence the organization fit that is expected between the merging companies will be achieved.

4.4. The role of the IMF

The IMF role in global crisis has been considered to be a powerful force in solving the financial crisis effect. The IMF helped in shaping the response of global policy through its policy spot-on and advice analysis of global financial and economic situations, and hence this contributed to financial architecture modernization process (Acharya and Schnabl 2009). After crisis onset, there was provision of recommended valuable policy for regulators and policymakers based on the global financial crisis consequences (Bernanke 2010; Ghosh et al. 2009). In both countries (country C and UK), the funds helped in shaping the response to policy by supply and demand factors analysis and hence the credit growth sluggish pace was explained and bank write downs were estimated as well as extraordinary support from the government were assessed through recapitalization and guarantees (Cooper 2009).

5.0: Conclusion

For the company’s objective to be met, the taking of decisions should be based on three aspects and include: investment decisions, financial decisions and dividend decisions. Based on the company’s position and objectives, financial management is very critical in its operations and this is based on efficient deployment and acquisition of both long and short term financial resources. There are several factors such as economic crises, political events and societal attitude changes can significantly disrupt or influence the already well structured plan in both the advanced and emerging economies. This factors are very critical since they are associated with additional risks involved in foreign investment, thus should be included during the evaluation of the company. It is evident that the proposed project’s net present value is negative at 10% discount. Therefore, this means that Campion plc should not invest in the project.