7 pages/≈1925 words
Mathematics & Economics
Financial Analysis Task 3 (Essay Sample)
Financial Analysis Task 3
Financial analysis is an important exercise for Competition Bikes, Inc, to carry out as an assessment for an acquisition or merger with Canadian Biking, Inc. According to McDonald, Courtyard and De-Lange1 (2005), mergers and acquisitions are common growth strategies for companies especially those that want to carryout cross-border expansion. This summary report will practically apply financial analysis and give the best advice to Competition Bikes, Inc, on merging with or acquiring Canadian Biking, Inc. The recommendation will take into consideration the interests of the shareholders and the company.
Capital Structure Approach that Maximizes Shareholder Return:
Capital structure is a firm’s most suitable blend of debt, equity and other financial sources that it applies to fund its long term long-term financing. In most cases the capital structure always safeguards the interest of the shareholders and the company concurrently. However, in this task the chosen maximizes shareholder return. This task will be based on the earnings before interest and taxes from the Canadian Biking, Inc, sales forecast spreadsheet. After analyzing the data of each capital structure given for this task, the most favorable capital structure is: issuing 5 year, 9% bonds for 20% and common stock for 80%.
The shareholders return will be maximized when the company has minimum or no debt on the finance on the capital structure (Hall, 2008). As such, the company should be highly financed from equity, common stock, and debt finance when turmoil market conditions emerge. However, since the company is not in a position to use more of debt, it may end up facing larger operating costs in terms of expenses incurred. As such, the company should have alternative sources of debt financing that will boost its performance in all of its operations. These alternatives for debt financing are generated by the debt capacity of the company. Therefore, the company should focus on debt capacity increment in order to give it power to access debt capital when circumstances demand that the company accesses debt capital. This is because current markets have a characteristic of being turmoil. Therefore, the inability of the company to have sources for debt capital may impact its performance extremely. In addition, generated debt for the company will have an impact of increasing the current debt capital and the organization cash flow will be sustainable.
This option of using both debt and equity financing is crucial since the financial performance of the company has not had any sustainable trend. Considering income statement, for the company, the three years depicted dynamics in the operation expenses for the company. In 2006, the operation expenses were 1,066,895, in 2007, 1,322,075, and in 2008, were 1,273,867. On the other hand, total liabilities and equity, in 2006, was 4,199,303, in 2007, 4,319,217, and, in 2008, 4,316,817. These results depict possibilities of unexpected market dynamics that the company will face. As such, relying on one source of capital is not adequate for the company performance to improve.
Capital Budget Areas of Concern:
The analysis of the capital budgeting spreadsheet, that is PV and IRR analysis give the capital budget areas of concern. The general concern areas that might rise are: first, the business rules and regulations of Canada as a country could render sections of the budget unworkable. The labor cost as is done by others also poses a challenge since it is impossible to preempt such confidential information in this budget.
The second concern is that the budget activity is not divided by quarter. The sport of bicycling is practiced outdoors. It is likely to be weather dependent. Therefore, an assumption is made that there are seasonal trends to competitions and events involving professional bicycle teams. Without the separation of production activity by quarter, we cannot see and respond to peak seasons and low seasons. An optimal example of this is that materials are purchased without regard to seasonal activity so that if the peak is summer the company should be building up inventory in the spring, and lowering inventory in the falls. This way the company avoids having higher inventory levels than it needs. This also helps the company make use of its reserve inventory for its right purpose, to cover unforeseen increases in sales, not to cover budgeting concerns.
The sales budget is based on projections that take into account trend information as well as competition, market, and other econometric information to provide an accurate forecast of future sales. The projected sales figure of 3,510 units for year 9 is not supported by past sales performance. For year 8, there was a 15% decrease in sales compared to year 7 levels. According to information provided by the company, this is due to the economic situation, which affects professional rider’s sponsorships. The company also states that this trend is expected to continue for year 9 through 11 while at the same time expecting an increase in sales volume.
The capital budget takes into consideration demand for the company’s products. This demand is based on two projections, which are low demand and moderate demand. At low demand, sales growth is expected to be at 1% for 2010 and 2011 Fiscal Years, and 2% for 2012 and 2013 Fiscal Years. This will have an impact of increment in cost of goods. On the other hand, moderate demand projects as sales growth of 3% in 2010 and 2011 Fiscal Years, and 5% in 2012 and 2013 Fiscal Years. This will be accompanied by increment in cost of goods sold, as well as growth of production costs at 2% in each fiscal year. As such, demand characteristics determine the budget projection expected. This will aid in allocating funds to measures that aid in revenue generation during demand dynamics. Since the project will have a sales growth, even at low-demand times, there is a need for the project to progress. The project should be accepted since the projections for sales growth for the company are viable. In addition, the projected budget for the company is sufficient to service the project.
Obtaining and Management of Working Capital for the Expansion Operation:
Working capital is money that will be accessible to the company for day-to-day processes. Working capital is computed using the formula: current assets minus current liabilities (Hall, 2008). Obtaining an already built building on a lease basis, would give this company the most working capital. We arrived at this option following the evaluation of the working capital in all the options.
A positive value of working capital generally implies that a company is able to pay off its short-term liabilities virtually immediately. A negative value working capital will imply that the company is unable meet these short-term liabilities. Obtaining an already built building on a lease basis gave a more positive value; thus, the best option for working capital. It is also important to mention the fact that there are several other ways for evaluating the working capital, they include: computing the inventory-turnover ratio, the current rations, the receivables ratio, the quick ration and the days payable. The company must utilize these tools to evaluate the working capital as a management action. These ratios show that this is not the best point for asset purchase for this company. Considering cash flows for both lease and purchase, leasing has minimal cash flows (321,660) in comparison to purchasing (333,999). However, leasing has been opted as the most beneficial scheme for the company as illustrated.
The company should manage its capital effectively since working capital in an organization exists as a cycle. The management team of the company should; therefore, ensure that capital flow into the company is in a continuous process rather than a discontinuous process. The capital sees to it that the organization generates revenues, as well as surpluses. This is a necessity since if there is no cash; the company’s business terminates immediately. Competition Bikes, Inc should access capital through leasing. However, the accessed capital needs careful management through adoption of the concept that TIME IS MONEY. This means that the higher the rate of money movement (collection of debtors due), or reduction in the tied money (inventory levels reduction) in the working capital cycle, the more the company generates additional cash. In addition, this results in minimal borrowing of money as a means of working capital increment.
Moreover, the company may enter into contracts, with suppliers, which aid the company in attaining increased limits in credit. This results in the availability of free funds that the company may use for future sales. However, in order for the company to manage its working capital effectively, the company shoul...
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