SBU716 Corporate Financial Management Coursework Sample

SBU716 Corporate Financial Management

Task 1

Scenario Continued from AE1:

After deliberations you are informed that a company XYZ has decided on two possible approaches. First being to diversify their operations into aerospace & defence industry. The company has asked you to evaluate the proposed investment project:

• The project is expected to create a cashflow of £12.6 million over 4 years, this cashflow will be spread equally across all years. The investment requires an investment of £7.2 million in the first year of operations; this is for necessary machinery with no residual value at the end of the project. The depreciation of the machinery is tax deductible. 40% of the depreciation will be charged in the first year, the remaining balance will be charged equally across the next years.

• It was agreed that the cost of the machinery will be financed with 40% a bank loan carrying a 1.5% issue cost. The remaining 60% will be financed by ordinary share issue costing 2% of the total value of the gathered equity. The finance gathered will have to cover the issue costs.

• The loan will be paid off over the 4 years in equal instalments at the regular company XYZ’s interest rate. You are informed that the corporate tax rate is 25%.

• The aerospace & defence industry has an average debt to equity ratio of 2 : 5 and an equity beta of 1.24. Company XYZ currently has a equity beta of 1.1 and a debt financing represents 25% of its overall long term capital structure. Company’s XYZ’s debt is regarded as risk free.

• You are also informed that the average return on a market portfolio is 10.2% and the risk-free rate is 5% per annum.

a) You are required to calculate the adjusted present value to help the company XYZ judge if the project is worth investing in.

b) Provide commentary on your results for the APV, the data provided, and the validity of the above project considering relevant research. (1500 words)

Task 2

In addition to task 1, an alternative to the above project would be to acquire a company within your chosen industry (AE1). To diversify further XYZ desires to acquire a company within a different country to their base operations (UK). Critically evaluate the process of an acquisition, possible issues, risks, as well as possible effect on the value of the company X.

Solution

Task 1- Feasibility of Investment into the project
(Refer to Excel)

An approach to capital budgeting known as the Adjusted Present Value (APV) method weighs the value of the unlevered project in addition to its financial implications like financing costs and tax shields. This helps to assess investment opportunities. The fundamental idea of APV is to calculate the present value of the projects cash flows from operations and its financing from costs or benefits related to the use of debt separately and then combining the two to get the total value. As per Kulwizira Lukanima (2023) adjusted present value is determined by combining two of the most important factors: net present value (NPV) and present value of the financing side (PV). When the projected cash flows of the project are discounted at the unleveraged cost of equity the present value of those cash flows is represented by NPV. It evaluates the projects profitability solely based on its operational aspects ignoring the effects of debt (Dvorsky et al. 2021). The effects of financial leverage notably the tax-shielding advantages of debt interest payments are taken into account by the latter component. Other financing side effects such as guarantees subsidies or any additional expenses related to debt financing might also be included. Compared to the NPV method the APV method has a few advantages (Tibiletti, 2022). The analyst can explicitly model the financing effects and their impact on the project value making it more transparent and flexible in the first place. Furthermore it aligns more closely with the value-additively principle which posits that a company’s worth is determined by the total value of its undertakings. Thirdly it works better on projects with intricate or dynamic capital structures like recapitalizations business acquisitions and leveraged buyouts. Furthermore it is imperative that businesses understand the implications and importance of business taxes (Dvorsky et al. 2021). This is especially true for companies operating in the dynamic economic environment of the United Kingdom. the tiny levies that governments impose on a company’s profits revenues or even cash reserves.

As per Alexander et al. (2021) APV with positive balance of returns is expected to improve the company position and also create business profitability. Therefore, tax related compensation helps in increasing this prospect of business opportunity. The interesting part in terms of these taxes aren’t one-size-fits-all rather they’re like a custom suit differing from one nation or state to the next and based on the type of business one operates. In order for a business to function on a daily basis taxes are essential. It functions similarly to fuel enabling the government to maintain vital services and build infrastructure like roads and schools. Businesses that operate in the UK must pay corporation tax. This implies that all profits must be reported and corporation tax must be paid in proportion to the profit margin of the business (Arjunan, 2022). The amount that businesses must pay is determined by their annual profit margin.

Every year all businesses are expected to file a company tax return that details their profits and losses for the specified period. HMRC will then determine how much corporation tax companies have to pay. Its crucial to remember that some business rate reliefs can lower the amount of corporation tax that companies must pay. Capital allowances against investments in plant and machinery for instance or relief from research and development (R&D) costs. Declaring dividends in the company tax return throughout the year is also crucial (Conrad et al. 2023). Though businesses must pay tax on dividends at the individual rate instead of the company rate they are a profit that shareholders can keep. Taxes have a wide range and complex economic impact. Businesses profitability is directly impacted by these taxes even though they are in place to bring in money for the government (Karas and Režňáková,, 2020). Income taxes imposed on a businesss profits have an impact on hiring decisions expansion plans and the enterprises financial stability. Sales and use taxes can also have an impact on consumer behavior and purchase decisions which can then have an impact on a businesss sales and total revenue. Because of this the composition and rate of taxes greatly impact the business environment of an economy affecting everything from consumer spending and job creation to startup activity. When in doubt about the particulars of a given situation it is advisable to seek the advice of an experienced tax professional. Ultra Electronics can maximize profits while still satisfying its tax obligations by learning about the applicable tax laws and keeping up to date on any changes.

From the provided data on investment and depreciation due to tax indicates that the project is likely to gain from the tax gain. It is because any companies that have made expenses for company related work is likely to access the funds in the form of tax benefit. These benefits are provided from government in the form of rebate so that the corresponding business of Ultra Electronics holding can be able to acquire maximum savings in the form of profitable revenue.

The company’s revenue growth for MBA assignment expert is also likely to increase from investment in project which also has a set a target of generating a cash flow annually by 3.15 million Euros. This was calculated by utilising the total investment cost and using the depreciating percentage with a span of time will be taken to cover the debt pay off process. The following profit will be acquired from tax benefits because expenses covered in the form of expenses to resources and materials will be counted as rebates as mentioned previously. Therefore, the investment in this project can be able to promote the brand image which also has a positive marketing value for future growth. As per the views of Thanos et al. (2020) brand image helps an organisation to not only have a continuous cash flow from business but also attends to potential consumers. The market of defence will also attract government agencies to have long term project with Ultra Electronics because of financial viability and authority gained from investing in this project.

Use of both forms of financing which is debt and equity is appreciable in context of reducing the leverage of company. It cannot be denied that company leverage often results in bankruptcy when stakes are higher for the company incurring the investment losses and profit after achieving the benchmark point. Moreover, the availability of industry beta with 1.1 and risk percent 10% has promoted the value of project as it points toward risk premium from investment. The company would not have to introduce measures to counter expenses because they will be stress free in dealing with the debt related insecurity. Financial feasibility is also seemed to be more because of involvement of higher equity and lesser debt percentage with a ratio of 40:60. Higher dividends for shareholder is also likely possibility resulting in retaining their trust and faith on the project.

The risk adjusted returns also sides with the need to establish a better expansion of Ultra electronics’ reach in defence sector. It will also be helpful to cover the initial investment in a period of 4 years thereby meeting the benchmark point of investment. As per Birollo et al. (2023) benchmark points signifies the amount after which the acquired revenue showcase profit post tax and post deduction of variable costs.

Ultra electronics can be able to cover the depreciation cost from tax benefit and also attract other source of revenue to meet the financial expenses. However, the equity cost at 10% also showcase the intended project is capable of covering the expenses despite the volatility in market. However, the positive NPV and also APV shows that in a span of 4 years the profitable revenue will start coming in thereby resulting in accomplishment of the reason for investing in the project.

Moreover, the positive APV indicates the ability for ultra electronics to expand their operations in aerospace sector as well. The ability to coordinate both sectors will help the company to dominate their presence in the industry creating a market shift in their favour. The profitable cash flow from the initial stages of fifth year would help the company to finance innovation and research department. This will lead the company to a more dominated presence where suppliers would be curious to open business channels with Ultra electronics as the continuous exchange of business meet supplier’s needs of iterated cash flow.

The total capital cost from Ultra Electronics will be majorly covered by the use of debts in the form of investment, receiving the tax relief and utilising equity. This enable the company position to be able to not only pay off the lender money from market while also establish a good credit score which amounts to future need of monetary resources in the form of debt. Since the project is involved on the use of capital cost and equity, it also has a significant impact for the total values held by shareholders. Since the NPV value and APV is on a positive trajectory, it would not be time consuming to pay off the interest based returns to shareholders. This can further enhance the position of Ultra electronics in the market as shareholder satisfaction leads to feasible budget for future projects.

Task 2

Process of Acquisition

The goal of the business acquisitions process will be specified by Ultra Electronics or Company X. The kind of deal that the buyer or seller wants to undertake and the amount of money that they are willing to invest or aim to get for this deal are important factors that they consider when developing their strategy. Having a clear idea of the acquirers objectives and business goal for acquiring the target company is essential to developing a strong acquisition strategy. Generally speaking bigger companies in the market look to acquire smaller businesses. Still the inverse is also accurate (Hosseini-Motlagh, et al. 2022). For instance during Teslas worst moment ever Musk was searching for possible Ultra electronics for his business and Apple was one of his goals. Businesses have various policies in place regarding business acquisitions including those pertaining to current business growth research and development and so forth. Before launching a merger and acquisitions strategy both companies should take into account these policies put forth by the target companies.

It is needed that Ultra electronics have a complete grasp over the potential opportunities of growth that can result in financial benefit post purchase deal. In order to ensure the acquisition process needs to avoid insufficient planning which can result in risk of improper company with a volatile consumer base. Additionally it will give a sense of the advantages and disadvantages of the acquisition. Additionally in order to minimize negotiation points during the purchase agreement stage the investment entity must make sure that the LOI is comprehensive enough. Therefore it is best practice to include the basis for the indemnities the basis for the employment and/or non-competition agreement with the sellers the basis for the representations and warranties and their duration and the various closing conditions (working capital adjustments representations and warranties performance clause). Please take note that the LOI (Letter of Intent) is subject to the findings of due diligence (Conrads et al. 2023). Ultra electronics acting in good faith may choose not to move forward with the transaction if its analysis reveals material issues. The letter of intent should be reviewed by Ultra Electronics legal counsel prior to its issuance as it will be utilized in the eventual purchase agreement drafting. In order to further assess the target as a stand-alone enterprise and as a potential acquisition candidate the acquirer Ultra Electronics will also ask the target company to provide specific information such as their most recent financial statements.

The seller on the other hand will make an effort to determine what a fair price would be in order to generate profits for the shareholders who in the case of a startup or small business would be the founder and his or her team. A reasonable offer for the target will also be ascertained by the seller. In contrast Ultra Electronics will also make an effort to determine the potential synergy and risks the transaction may pose for the buyers company. An M&A deal may actually involve a number of risks and difficulties including problems getting regulatory approval accusations of antitrust and a long list of legal disputes. However once both parties have completed their evaluation and appraisal either party may make an offer to the target company (Effiong and Ejabu, 2020). This offer may take the shape of stock exchange or cash. The other party will haggle for a better deal if they dont think the offer is reasonable. Because neither party wants to give the other the upper hand by showing a rush to finish the agreement this step could take a while to complete.

When the target is a particularly attractive company there might be a large number of potential bidders which is a common source of difficulty for the buying side. As a result competitors may arise to offer the target better terms and conditions. Because of this rivalry Ultra Electronics may even file a lawsuit against Company X in an effort to gain the upper hand. After the LOI is executed due diligence will start right away. Working in close collaboration with the companys advisors (legal accounting tax) the investment banker will oversee the due diligence process.) to guarantee that everything is covered and that the Ultra electronics is delivered within the timeframe specified in the Letter of Intent (usually 30 to 60 days).

All relevant information including that related to accounting taxes law the environment human relations and operations will normally be reviewed as part of the due diligence. Keep in mind that if funding is needed access to the results and materials from the due diligence may be required by the lender or investor. Customer due diligence is a crucial component that is frequently disregarded in business acquisitions. One of a targets most valuable assets is its customer base. Kindly refer to our newsletter on Customer Due Diligence. Our experience has taught us the value of putting together a team of M&A-savvy professionals for due diligence even though it is sometimes normal for Ultra electronics to turn to their seasoned professionals. Experienced teams dedicated to these exercises are found in many mid-size to large accounting and legal firms. On the prearranged date both parties will get ready for the transaction to close if the due diligence reveals no significant problems that might imperil the deal. The purchase agreement will be prepared by legal counsel ideally from Ultra Electronics using the commercial terms specified in the LOI. New information that comes to light during the due diligence process could cause the terms to alter.

Risks Involved in Acquisition

Planning for acquisition transactions requires careful consideration of due diligence. Preparing for such big transactions can involve a lot of pressure from many sources. The buyer or Ultra Electronics may also be encouraged by teams within their own organization and any intermediaries involved in the agreement in addition to the seller (Dvorsky et al. 2021). When purchasing established property, the individual offering them typically possesses a large amount of data. Prior to completing a purchase, the organisation ought to attempt to learn as much as possible concerning the Company X finances, binding agreements, clients, coverage, and any additional relevant details to ensure that they have a complete grasp of the offer (Kang et al. 2020). Overpaying is an exceedingly common type of risk which is attended when acquiring a business. This could force the business to pay excessively rather than reach a cost-saving, win-win compromise with the objective to seal the contract.
If Ultra Electronics closes a deal believing it will create synergies areas in which the two businesses work together to create value greater than it would have separately number of issues could occur. Businesses frequently go into deals with an unrealistic expectation of the quick payoff and underestimate how long it takes for synergies to materialize (Fahlevi, 2021). Workers and operational procedures must be consolidated gradually. Inaccurate expectations regarding the completion date of the integration may also result in excess expenses.

Overpayment can also result from synergy miscalculations because of the other relevant expenses which are not needed to be included into agreement is also surfaced as a part of acquisition contract. Ultra Electronics can faces the possibility of suffering a large loss due to an ongoing or prospective legal dispute. Due to the unpredictable nature of such events sellers may find it challenging to draw in a buyer who is unwilling to take on an open-ended exposure to loss when litigation is a possibility in the transaction. Businesses may suffer greatly as a result of cyberattacks (Conrads et al. 2021).

Theft of priceless intellectual property disclosure of private information pertaining to the M&A deal financial loss harm to a brands reputation and legal ramifications are all possible outcomes of a successful cyberattack. For businesses these outcomes can be disastrous particularly when they occur during an M&A deal (Kang et al. 2020). A cyberattack during the merger or acquisition process has the potential to completely collapse the deal resulting in large losses in terms of money and harm to the reputations of all parties. With the use of numerous bog-data tools businesses can conduct forensic analysis of the cyber risk associated with an M&A transaction.

This kind of analysis concentrates on reputation and dependability and aids in identifying risks that are generally missed in routine due diligence. The regulatory approval process which can be costly and time-consuming is a prerequisite for business acquisitions. Regulatory obstacles may occasionally impede the completion of a merger or acquisition which may lead to missed opportunities and resource waste (Birollo et al. 2023). It can be difficult and complex to integrate two businesses particularly if their cultures systems and operating procedures differ. If not handled correctly the integration process can cause disruption and lost productivity and take months or even years to complete.

Potential effect on Company X

The success of a deal involving the acquisition of another company in the same industry is largely dependent on the target companys valuation. Evaluation of the target companys value is done through a variety of criteria including market share assets liabilities and financial performance (Fahlevi, 2021). On the other hand the acquisition premium is an additional crucial element that has the potential to greatly affect the deals total value. Receiving a premium price for its shares which represents the value that the acquirer anticipates creating from the deal is one of the primary advantages of an acquisition for target company X (Kang et al. 2020). Shareholders managers and staff of the target may be rewarded for their work and output in this way. Access to the acquirers networks resources and skills allows the target business to expand innovate and compete more successfully. For instance the target business X may benefit from the acquirers clientele technology distribution networks and reputation.

A third advantage is that the target company particularly if it is facing obstacles like regulatory changes market volatility or competitive pressures can lower its risks and uncertainties by merging with a bigger and more stable organization. But depending on the specifics of the situation an acquisition may also have certain disadvantages for the target company X that could outweigh the advantages. When a target company has to adhere to the policies practices and values of an acquirer one of the main disadvantages is that it may lose its independence identity and culture (Thanos et al. 2020). As a result the targets suppliers customers and employees may feel betrayed or alienated by the change leading to disputes uncertainty and animosity. There is also the potential for integration problems like incompatible systems procedures or standards to hinder the target company’s performance quality or efficiency. The target company might have to deal with various IT platforms accounting systems or organizational structures for example (Kang et al. 2020). A potential third disadvantage is that the target company may become vulnerable to the risks liabilities or issues of the acquirer potentially impacting its viability profitability or reputation.

For instance the target business might inherit the debt legal disputes and operational problems of the acquirer. As a result of a variety of factors the advantages and disadvantages of a merger for the target company are not fixed or predetermined. Opportunities for value creation and synergies may depend on how well the target and the acquirer align strategically. While a lower cultural fit can obstruct communication a higher fit between the two businesses can promote integration and cooperation (Arjunan, 2022). The incentives risks and expectations of each party as well as their control and bargaining power can also be impacted by the transactions terms and structure. For example the target company might prefer a cash offer to lock in a premium price and eliminate any doubt about the acquirers performance going forward.

References

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Arjunan, K., (2022). A new method to estimate NPV and IRR from the capital amortization schedule and the advantages of the new method. Australasian Accounting, Business and Finance Journal, 16(6), pp.23-44. https://ro.uow.edu.au/aabfj/vol16/iss6/3/

Birollo, G., Rouleau, L. and Teerikangas, S., (2023). In the “Crossfire” of the acquisition process: Exploring middle managers’ unfolding mediation dynamics. European Management Journal. https://www.sciencedirect.com/science/article/pii/S0263237323000798

Conrads, J., Heinzen, M. and Baum, M., (2023). Reconfiguring resources for strategic posture: Changes of entrepreneurial orientation through acquisition. Journal of Open Innovation: Technology, Market, and Complexity, 9(3), p.100135. https://www.sciencedirect.com/science/article/pii/S2199853123002378

Dvorsky, J., Belas, J., Gavurova, B. and Brabenec, T., (2021). Business risk management in the context of small and medium-sized enterprises. Economic Research-Ekonomska Istraživanja, 34(1), pp.1690-1708. https://hrcak.srce.hr/file/434655

Effiong, S.A. and Ejabu, F.E., (2020). Liquidity risk management and financial performance: are consumer goods companies involved. International Journal of Recent Technology and Engineering, 9(1), pp.580-589. https://www.researchgate.net/profile/Sunday-
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Hosseini-Motlagh, S.M., Nematollahi, M. and Ebrahimi, S., (2022). Tri-party reverse supply chain coordination with competitive product acquisition process. Journal of the Operational Research Society, 73(2), pp.382-393. https://www.tandfonline.com/doi/abs/10.1080/01605682.(2020).1824550

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Kulwizira Lukanima, B., (2023). Free Cash Flow Discount Models: The Adjusted Present Value Approach. In Corporate Valuation: A Practical Approach with Case Studies (pp. 541-557). Cham: Springer International Publishing. https://link.springer.com/chapter/10.1007/978-3-031-28267-6_16

Thanos, I.C., Papadakis, V.M. and Angwin, D., (2020). Does changing contexts affect linkages throughout the mergers and acquisition process? A multiphasic investigation of motives, pre‐and post‐acquisition and performance. Strategic Change, 29(2), pp.149-164. https://onlinelibrary.wiley.com/doi/abs/10.1002/jsc.2318

Tibiletti, L., (2022). One-size risk-adjusted discount rate does not fit all risky projects. The Journal of Risk Finance, 23(3), pp.289-302. https://www.emerald.com/insight/content/doi/10.1108/JRF-03-(2021)-0035/full/html

Kang, E., NANTHARATH, P. and Hwang, H.J., (2020). The strategic process of merger and acquisition (M&A) market using integrating change management. Journal of Distribution Science, 18(6), pp.57-62. https://www.academia.edu/download/87059935/JAKO202018853212719.pdf

Fahlevi, M., (2021). Corporate branding in banking environment: evidence from acquisition process. In IOP Conference Series: Earth and Environmental Science (Vol. 729, No. 1, p. 012130). IOP Publishing. https://iopscience.iop.org/article/10.1088/1755-1315/729/1/012130/meta