Introduction
The company needs additional capital to finance its business expansion project and in particular, the capacity expansion projects. The planned capacity addition under the next five years is setting up a new production plant and adopting the most sophisticated production technology. The company plans to spend approximately £ 500 million over the coming years to fund the capacity addition, which will enhance the production capacity of the company. The expansion plans will result in the growth of sales of 30% per year and this will enhance the growth capacity of the company. The ability to finance the capital expenditures is subject to some risks, contingencies, and other factors, some of which are beyond the control of the company and which includes tariff regulations, interest rates, borrowing or lending restrictions, and the ability to obtain financing on acceptable terms (Swart & Kinnie, 2004).
Events in the product market that could influence the share price of the Eagles Electronics
Stiff competition from other producers could limit the selling capacity of the company. Poor marketing strategies adopted by the company, which could adversely affect its selling capacity. The decline in production capacity reducing the volume of production of the products limits the amount of revenue to be generated because of sales.
Events in the capital market that could influence the share price of the Eagles Electronics
A general downturn in the capital market undermines the investment capability of investors. Announcements such as dividend cuts, which could make an investment in the company by the investors be slowed down
Sources of capital available to Eagles Electronics
Capital markets-companies wishing to acquire more capital to finance various investments do so by floating shares on stock markets, under initial public offer arrangement, where the public is invited to buy a certain stake in the company (Giroud & Holger, 2010).
Venture capital, which is offered by organizations who engage in financing relatively high-risk investments, which other lenders of capital may be unwilling to provide. These organizations also offer screening of the projects that are undertaken by the companies seeking their funds; as a result, venture organizations are given a share of the profits that these businesses make (Myers, 1984).
Family and friends-Entrepreneurs tend to seek support of friends and family members after exhausting their own initial investment funds. They seek funds for expansion purposes or for settling debts that fall due.
Debt in terms of borrowed capital from banks and other financial institutions
The companies repay the borrowed capital and the accruing interest has to be noted that the lender assess the viability of the company before advancing the loan (Amihud, 2002).
Strategies to enhance share price value of Eagles Electronics
Managers managing the shareholder mix so that there are many people waiting in the wings they have met and impressed with the company’s performance can achieve this. This can ensure stronger stability on the downside, so that the company does not encounter big downdrafts. In addition, because they have reduced available supply of stock and they have attracted many investors to buy it, the share price will increase and enhancing improvement in the quality of the company’s products, placing it strategically located and thus improve its share price value (Goldstein & Alex, 2008).
Computations
- 1. After tax cost of debt=cost of debt*(1-tax rate)
=7*(1-0.4)
=4.2%
Total assets=1800+450
=2,250 million pounds
Total Equity of the firm=750+500=1250 million pounds
In order to balance the balance sheet of eagles’ electronics then retained earnings will have to be 250 million pounds.
- 2.cost of equity=risk free rate of return + beta*(market rate of return-risk free rate of return)
=4+1.4(12-4)
=6.8%
WACC (Weighted Average Cost of Capital)
Where debt is zero (0)
Where debt is £100m
Where debt is £200m
Where debt is £300m
Where debt is 400million pounds
Where debt is 500million pounds
Value of the firm= EBIT (1-T)wacc
Debt being 0
=877.5(1-0.4)6.8=77.43
Debt being 100
=877.5(1-0.4)6.824=77.15
Debt being 200
=877.5(1-0.4)6.842=76.95
Debt being 300
=877.5(1-0.4)6.858=76.77
Debt being 400
=877.5(1-0.4)6.87=76.65
Debt being 500
=877.5(1-0.4)6.88=76.54
Value of equity
Modigliani and miller propositions
- Affirms WACC, weigthed average cost of capital is independent of the debt/equity ratio and equals to the cost of the capital (Modigliani 1978)
- The expected yield of a share of equity is equal to the appropriate capitalization rate plus a premium related to the financial risk(Modigliani 1978)
- Residual dividend policy
Dividend Cut
Dividend cut occurs when the level of the current cash dividend is lower than that in the previous quarter, this definition, includes dividends omissions that is marked by a cut to zero or missing dividends (Lie, 2005).Another definition is proposed by Modigliani and Miller(1961) who define dividends as payments made by businesses to shareholders. Firms are reluctant to opt for dividend cuts and they only do so under extreme circumstances (Roberts, 2008).
Residual theory of dividends
Divicut is a case where the company is forced to retain funds through lack of alternative financing options, with the explicit assumption that the firm is capital-rationed with access only to internal sources of finance. Dividends should be paid only when there are no further worthwhile investment opportunities. Having decided on the optimal set of financing, the firm should distribute to shareholders only those funds not required for investment financing (Modigliani & Miller, 1961)
Reasons why sometimes firms opt for dividend cuts
Dividend omissions are strategically motivated to preserve financial flexibility within the firm and violations of company covenants, as dividend cuts occur frequently even among healthy firms and are not necessarily indicator of financial distress (Bulan, 2009). Brockman & Unlu (2009) point out that countries with weaker creditor rights, firms adopt more restrictive payout policies in order to mitigate the agency cost of debt.
Powell & Veit (2002) emphasize the importance of achieving stable dividend policy. They suggest that managers tend to maintain a stable dividend payment because managers feel that a dividend increase should not occur unless there is confidence that the business could sustain the higher level in near future. Dividends should never be missed and that the market places a higher value on a business that maintains a stable level of dividends paid than on one that pays a constant proportion of its profit as a dividend.
Impact of dividend cut on Eagles Electronics
Firms that cut their dividends report very low earnings in the year of dividend change, in large part due to the recognition of negative special item, these firms report substantial earnings per share increase in subsequent years. Dividend cut trigger negative stock returns, are unrelated to future earnings after controlling for current earning, and are associated with an increase in firm risk, thus dividend cut announcements signal an increase in risk, which in turn triggers a negative market response (Grullon et al., 2002).
Dividend decrease do not convey new information about future earnings but rather increase in firm risk. DeAngeleo et al. (1992),found out that those firms that cut their dividends in the current year report lower next year earnings even after controlling for current year earning. Persistence earnings is positively related to the level of dividends, especially for low levels of dividends, that is low dividend firms have particularly low earnings persistence, this evidence suggests that dividend decrease firms may also have low earnings.
Dividends
Total number of shares as a result of takeover=50+50=100 million share
Internationalization of Firms
Internationalization is a concept that is increasing in the modern world with many companies worldwide embracing the chance to go global. Exchange of goods and services internationally has increased leading to the need for companies to invest in international markets. Participants in the supply chain have increased their networks leading to a higher degree of interdependence. The globalization process has increased the speed of the internationalization process since it is accompanied by advanced technology.
Organizations internationalize due to the need to compete for the limited resources and the need to diversify their market globally. Political factors affect diversifying firms since the firms are expected to adhere to the different regulations existing in different countries they venture. They need also to show the ability to manage the currency fluctuations international policies that conflict (Bell, Crick, 2004).
Analysis of a Takeover
This is the last option should Eagles Electronics fail to raise the required amount to finance its expansion project. Takeover is the acquisition by one company of the share capital of another in exchange for cash, ordinary shares, loan stock or some mixture of these (Shivdasani, 1993). Shivdasani (1993) points out that those managers who seek to maximize the wealth of shareholders seek to exploit value-creating opportunities too. There are two situations when managers feel able to enrich shareholders via takeovers (Breale & Franklin, 2000).
According to Masum & Fernandez (2008), the internationalization process enables firms to avail their new and old products in new markets in different countries. A low market valuation makes a firm a takeover target, investors seem to track firm’s valuation multiples for indication on the potential for acquisition and managers strive to maintain high market valuations to prevent hostile takeover and market price will affect takeover activity if they are related to expect future acquisition prices. Moreover, the takeover premium might include synergy as well as efficiency gains, same industry takeovers where synergies are most likely do not involve a high takeover premium and hostile takeovers which are less likely to be synergy driven do not feature a lower premium( Jensen,1993)
Jensen (1986) points out that takeover may be launched by: a) raiders, they are purely financial investors and they take over the firm at exactly the right level of product demand and they shut the firm down immediately. Thus, the strategy implemented by raiders is that of first-best outcome in which the value of the firm is maximized through abandonment and not the company’s value as viewed by the managers or investors. b) Another firm: the management of another organization is able to undertake a hostile acquisition of a firm. Although their actions are almost similar to raiders, they are usually forced to disclose the bid.
Impact of takeover of the company (Benefits)
Synergy, takeovers bring real benefits to shareholders owing to genuine increase in positive cash flows and reduction in risk. The synergy benefits accrue to the shareholders of the target as well as to those of the bidder, it also results in risk reduction and away of spreading risk (Hackbarth & Erwan, 2008). Access to some aspects of target that the bidder considers underutilized, there is also overall increase in positive cashflows,through stronger management skills being brought to bear on the target’s assets and finally takeovers result in elimination or reduction in competition, where the bidder and the target are in competition for the market price for their output. A takeover could lead to a monopoly or at least a larger market share for the merged unit, this strength in the market place might enable prices to be raised without the loss of turnover (Alexandra, 1997). This could be of greater importance on the share prices of Eagles Electronics.
Cremers & Kose (2009) suggests that acquisitions fail to thrive because, acquires often pay too much for their target, either as a result of a flawed evaluation process that overestimates the likely benefits or as a result of getting caught up in a competitive bidding situation, whether the yield is regarded as a sign of corporate weakness (Fama & French, 2001).
Limitations of takeover
The approach has its various limitations, which are the approach does not allow for risk, any improvement in profitability may simply be due to a restriction of competition, rather than more efficient use of resources are. To assess properly the impact of the takeover requires an extended analysis ranging over five years, measures of profitability may have been distorted due to the application of acquisition accounting procedures and because of different accounting conventions used by different firms (Chava & Michael, 2008). Acquires often fail to plan and execute properly the integration of their targets, frequently neglecting the organizational and internal cultural factors. Inadequate knowledge, about the targets business should be corrected in the process of due diligence (Merton, 1985).
Assessing impact of takeover of produtos compostos by eagles electronics
Weston (1998) suggests that the impact of takeovers is assessed by financial characteristics approach, is based on examining key financial characteristics of both acquiring and acquired firms before the takeover, to study whether they are more or less profitable (Schwert, 1996).
- Total shares to be exchanged=50 million shares
Shares exchanged=505=10 million shares
Net income of produtos compostos=30 million euro
Exchanging the euros to pounds gives us
30*0.85
=£25.5 million
Total net income=135+25.5
=£160.5 million
- Free cash flow=operating cash flow-net fixed asset investment-net current asset investment
Operating cash flow=EBIT (1-T) + DEPRECIATION
=30+7=37 million euros
=37-7-(-190)
=220 million euros
The amount in pounds=220*0.85=£187million
- Acquisition through stock will be cheaper compared to use of cash, it will cost eagles electronics a stock of 450 million pounds as compared to paying cash of value 892.1 million pounds.
- Eagles electronics should grow internally by doing so a net income of 526.5 million pounds will be realized in the first year of expansion as compared to a combined net income of 160.5 million pounds that will be realized upon takeover of produtos compostos.
Long term debt=500 million pounds
Equity=750 million pounds
Weighted average cost of capital increased to 6.88%
Conclusion
Pecking order theory, Myers(1984),suggests that business are reluctant to make new share issues, because, share issues are expensive in terms of issue costs, it is often believed that managers often feel that their businesses’ share undertakes its true value. Issuing new shares at this low value would in these circumstances, disadvantage existing shareholders to the advantage of those taking up the new shares issued. Due to that managers fear that the market may view making a new share issue as a sign that the directors believe that the shares to be overpriced in the stock market (Kaplan, 1992).
Alternatively, it could be viewed as an act of depreciation, only to be undertaken when the business has no option these points are likely to make it difficult to make a new issue and may lead to a low issue price. According to the pecking order theory, businesses will tend to finance their activities in the following sequence, retained profit, debt, which is relatively cheap to raise, particularly if it is in the form of a term loan from a bank or similar institution, equity share issue. Based on these options available to the firm, Eagles Electronics would be in a better position; to implement a dividend cut which in this case would be viewed as a means of internal financing and which would be cheaper in the end as compared to other options available to the company.
References
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