Introduction
ABC Healthcare Corporation is a company involved in healthcare services. Its activities include owning hospitals, urgent care centers, ambulatory surgical centers, and outpatient clinics. Maria Gomez is the company’s chief finance officer (CFO). In the years 2017, 2018, and 2019, the company’s stock price was 83.62 for the three years. Its Earnings Per Share (EPS) were 9.15, 7.87, and 6.9 for the three years, respectively (Appendix 1). On the other hand, its price/earnings ratios for the same period were 9.14, 10.63, and 12.10, respectively (Appendix 2). Financial analysis is required to be performed and recommendations are offered based on the analysis.
The second situation is that the company intends to increase shareholder value by investing in a new project. However, there are three options in which they can invest, namely, investing in new equipment, expanding into three additional states, or a new marketing campaign. To select the best project, capital budgeting techniques are used.
Overall Financial Health of the Company
Among the metrics that have been analyzed include market price, Earnings per share (EPS), Price/Earnings ratio, book value per share (BVPS), and price-to-book ratio. Since financial ratios are little sense in isolation, it was necessary to compare the values over time, which was chosen to be the financial years 2017, 2018, and 2019. Upon analyzing the values over the three years, it was discovered that the company has not been performing exceptionally well over the years, evidenced by the stagnation of its stock price. Since financial ratios vary from industry to industry, it was essential to select an industry peer to juxtapose ABC results against for which HCA Healthcare Inc. was chosen which showed marginally better ratios than ABC. However, the values were not radically better than ABCs, and one firm is not sufficient to conclude a bleak situation for ABC.
In a bid to increase shareholder value, the company has three proposed investment projects and can only choose one. The first proposal is the purchase of new major equipment projected to reduce the cost of sales by 5 percent over an 8-year period. The second project involves expansion into three additional states that are projected to increase revenues and cost of sales by 10 percent over 5 years. The third project is a marketing/advertising campaign that is estimated to cost 2 million dollars every year over six years. This paper aims to apply capital budgeting techniques and appraise the three projects to determine the best one for ABC to invest in. The capital budgeting tools that will be employed include NPV, profitability index, payback period, and internal rate of return.
Analysis
ABC Corporation seeks to enter a partnership. For this reason, a financial analysis needs to be carried out to determine if this is a viable option. Financial results from three years, 2017, 2018 and 2019, are chosen. The parameters analyzed were market price, earnings per share, price to earnings ratio, book value per share and price to book. Ratio analysis was carried out on these financial parameters. Apart from ratio analysis, trend analysis was carried out since the values do not make sense in isolation but are analyzed in comparison with other years. The ratios also depend on the industry, which is why they were compared with those of HCA Healthcare (30-year financials, n.d.). Trend analysis showed declining financial attractiveness, while comparative analysis showed that HCA was doing better but not very radically so. Despite the average results, they were not desperately bad, so a partnership was recommended.
Analysis: Discounted Cashflow
ABC Corporation aims to increase shareholder value since the stock market has remained constant for three years. They have proposed three proposed investment options but can only choose 1. Discounted cash flow analysis was selected to analyze which project is the best. This method involves calculating the present value of future cash flows because of the time value of money concept. NPV, IRR and PI utilize the DCF method, while payback period analysis utilizes the undiscounted cash flow analysis. The three projects had impressive NPV, IRR, PI and payback periods in isolation. All three would have been viable projects for the company to invest in since the investments had different project lives, and the metrics needed to be standardized using the equivalent annuity cash flow, showing that Project A was the most impressive.
Evidence-Based Analysis
From the above chart, in the financial years 2017, 2018, and 2019, the market price remained constant; automatically, the percentage change would also remain constant. This indicates that demand for the stock had not increased over the period; interestingly, the stock price had not slumped either, which could indicate loyal investors. ABC Healthcare Corporation’s EPS was 9.15, 7.87, and 6.91. The percentage changes for the same period were a 14% and 12% drop for the years 2018 and 2019, respectively. EPS is calculated by dividing the company’s earnings by the common shares. The trend from the period shows that EPS was falling over the three years. This is not a good sign since declining earnings could scare away investors. Over the three-year period of 2017, 2018, and 2019, BVPS values for ABC Healthcare Corporation were 226, 209.05, and 199.1, respectively. Automatically, the percentage changes were an 8% and 5% drop for the years 2018 and 2019. Trend-wise, ABC Corporation shows a declining BVPS value which is not a good sign since it indicates declining shareholder equity. ABC Corporation were 0.37, 0.4, and 0.42, respectively. Automatically, the percentage changes were an 8% and 5% increase in the years 2018 and 2019, respectively. PB ratio indicates a company’s market capitalization against its book value. A lower PB value could indicate that the stock is undervalued.
ABC Corporation needed to increase shareholder value and has proposed three projects. The NPVs for the projects are way above their initial costs, evidenced by the PIs that are also way above the threshold of 1 for accepting a project. For this reason, the projects are viable in terms of NPV. In terms of the internal rates of return, the IRR is supposed to be above the project’s discount rate for a project to be considered viable. The three projects had discount rates below 20%, while their IRR were all at least 79%. This shows that the projects were all viable. In terms of payback period, the projects had lives of at least 5 years, but all three had payback periods slightly above 1 year, meaning they were all viable. Since the projects had viable results for all the capital budgeting tools proposed and they had different lives, equivalent annuity cashflow was used to choose project A which proposed the purchase of new equipment that would improve efficiency. It also happens to be the project with the least risk.
Recommendations
The first project involves the purchase of new equipment that will cost an initial investment of 10 million USD. The investment is expected to reduce the cost of sales by 55 over the next 8 years. The equipment is projected to be sold at the end of the 8th year at 500000 USD salvage value. Because the equipment is safe in relative terms, it has a required rate of return of 8% and will be depreciated with a 7-year MACRS schedule. There are projected annual sales of 20 million USD for year 1 that are expected to remain constant for the 8-year period. The cost of sales was 60 percent before this project; the marginal rate of corporate tax is presumed to be 25 percent.
Tactical Objectives
It has been established that the best project for the company to invest in will be the purchase of new equipment. This project is attractive since it will help improve efficiency in service delivery which is a win-win situation for the ABC ecosystem comprising staff, the management, shareholders and clients. Typically, new equipment requires that staff members are trained on new procedures to handle the equipment otherwise, the investment would be counter-productive (Truitt, 2011). The management would need to ask the HR department to weigh in on any human resource needs, such as technicians. There will also be a necessity to train the existing staff on how to use the equipment. The Engineering department will be tasked with maintenance and training. It is not just about training the HR department would also need to carry out a training evaluation to establish whether it was worthwhile.
After the preferred investment has been selected for investing in new equipment, it is necessary to keep track of performance. The project was chosen based on assumptions; it is mandatory to stick to those assumptions. It has been observed that the new equipment is supposed to provide improved cash flows. These cashflows are mere projections and are prone to inaccuracies. They are also predicated on proper utilization of the equipment, which is why all departments need to be hands on deck to facilitate the delivery(Ra et al., 2019). Financial tools that can be used to keep track of future cashflows are financial analysis tools based on financial results, such as cash flow analysis (Ross, 2018). These would help in juxtaposing reality against projections and adjusting the system accordingly.
Conclusion
A financial analysis of ABC Corporation revealed that the company needed to do a better job of improving shareholder value and building investor confidence. As a result, three investment projects were proposed from which we were supposed to choose. Future cashflows for the three projects were projected; Discounted cash flow techniques were used to select project A involving the purchase of new equipment. Since the project’s selection was based on projections, it is vital that the company’s management acknowledge the difference between reality and projections. For this reason, the company needs to implement the proper use of the new equipment. Besides this, the company needs to keep conducting financial statements such as balance sheets, income statements and cash flow statements. After the preparation of these statements, the company will need to conduct financial analyses such as ratio analysis, trend analysis and comparative analysis. The company needs to calculate overheads from the equipment and create dashboards to illustrate the performance.
References
30 year financial data of HCA Healthcare Inc (HCA) (n.d.). Gurufocus. Com. Web.
Ra, S., Shrestha, U., Khatiwada, S., Yoon, S. W., & Kwon, K. (2019). The rise of technology and impact on skills. International Journal of Training Research, 17(sup1), 26–40. Web.
Ross, S. A. (2018). Corporate finance: Core principles & applications (Fifth edition). McGraw-Hill Education.
Truitt, D. L. (2011). The effect of training and development on employee attitude as it relates to training and work proficiency. SAGE Open, 1(3), 215824401143333. Web.