Financial Management Theory and Practice Limited

Question: Discuss about the Financial Management for Theory and Practice Limited. Answer: Introduction This paper addresses various crucial aspects of financial management which helps in analyzing the financial performance of a firm and preparing estimations and budgets (Brigham and Ehrhardt, 2016). The current paper has been divided into five sub-headings such as financial analysis, operating revenue prediction, interest on loan, choosing investment funds, and bond valuation. The financial analysis has been carried out on the financial statements of Boral Limited, which is engaged in manufacture and supply of building material primarily in Australia and the United States. The company is listed on the Australian stock exchange. Financial Analysis of Boral Limited The financial analysis of Boral Limited carried out here covers financial statements for the year 2016 and 2015. The ratio analysis has been considered to be the most appropriate tool for financial analysis of Boral Limited (Tracy, 2012). The process comprising five steps such as liquidity analysis, asset management analysis, Debt management analysis, profitability analysis, and market value analysis have been followed in conducting the ratio analysis. Liquidity Analysis It refers to the companys ability to pay the short term debt on time. The short term debt here implies the current liabilities which consist of trade payables, expenses payables, and the short term borrowings. The ability of the company to pay short term debt is adjudged based on the sufficiency of the current assets and the sufficiency of the current assets is analyzed by current and quick ratio (Tracy, 2012). The current ratio is computed by dividing the current assets with the current liabilities. The quick ratio is computed in the same manner except that the current assets here do not include inventories (Tracy, 2012). In the case of Boral Limited, the current ratio for the financial year 2015 and 2016 has been found to be 1.89 times and 1.43 times (appendix). It could be observed that the current ratio of the company is falling down in the current year as compared to the previous year. The downfall in the current ratio clearly indicates that the current assets of the company are decreasing relative to its current liabilities. Further, the quick ratio also went down from 1.30 times in 2015 to 0.95 times in the year 2016 depicting that the company is facing problems with liquidity (Appendix). Asset Management Analysis Analyzing the efficiency of management to convert the assets into sales or use the assets effectively to generate sales falls under asset management analysis. The prominent ratios such as asset turnover, inventory holding days, and accounts receivables days are computed to analyze the efficiency of management in regard to asset management (Tracy, 2012). The asset turnover ratio depicts revenues per $ of total assets deployed in the business. The inventory turnover days depicts the time period for which the inventory is usually held in the go-down by the company and accounts receivable days depicts the credit period extended by the company to its customers to pay their dues (Tracy, 2012). In the current case of Boral Limited, asset turnover ratio has been found to be 0.73 times in 2015 and 0.74 times in the year 2016 (Appendix). This indicates that the company was earning revenues of $0.73 by utilizing $1 of total assets in the year 2015 which slightly improved to $0.74 in the current year. Further, the inventory holding days were found to be 65 days in 2015 and 69 days in 2016 (Appendix). Increment by 4 days in the inventory holding period is indicative of inefficiencies of the management in managing inventory. On the other hand, the accounts receivable days were found to be decreasing by 3 days in the current year. The accounts receivable days were 56 days in 2015 which reduced to 53 days in 2015. The decrease in the accounts receivable days indicates improvement in the managements efficiency. Debt Management Analysis The debt management is one of the most important aspects of business. The recklessness in debt management could hamper the companys business severely and endanger its solvency. This is the reason that the investors first look into the debt management of the company before analyzing the profitability (Tracy, 2012). In order to analyze the efficacy and effectiveness of the debt management, two most important ratios such as debt equity ratio and Interest Times ratio have been calculated and analyzed. In the current case of Boral Limited, the debt equity ratio has been found to be 0.66 times in 2015 and 0.65 times in 2016. Thus, it could be observed that there has been slight decrease in the debt equity ratio in the current year as compared to the previous year. The decrease in the debt equity ratio depicts that the company is using less debt as compared to equity in financing its business. However, ideally, it is considered that the company should not use more than $0.33 of debt against the $1 of equity. In the current case of Boral Limited, the debt to equity ratio is much more than the ideal one, thus, the risk of solvency could be higher. Further, the Interest Times ratio was observed to be 4.60 times in 2015 and increasing slightly it reached to 4.91 times in the year 2016. The increment in the Interest Times ratio depicts that the companys ability to repay the debt has improved. Profitability Analysis The analysis of profitability is considered to be the decisive factor for the investor in taking an investment decision. In order to analyze the profitability of the business, two most crucial ratios such as net margin and return on equity are taken for computation and analysis (Tracy, 2012). In the current case of Boral Limited, the net margin ratio has been found to be 5.98% and 5.94% in the year 2015 and 2016 respectively (Appendix). It could be observed that the net margin has dropped slightly in the 2016 as compared to the previous year. The drop in net margin ratio depicts downfall in the profitability of the company. Further, the return on equity was found to be 7.29% and 7.30% for the year 2015 and 2016 respectively (Appendix). This implies that the return on equity has improved a bit in the current year. It could be observed that despite downfall in the net margin ratio, the return on equity has improved in the current year. This implies that the improvement in the return on equity was due to reduction in the shareholders equity in the current year. The shareholders equity reduced from $3,524.10 in 2015 to $3,506.30 in the year 2016 (Appendix). Market Value Analysis The market value analysis covers evaluation of the stocks price of the company. The evaluation in regard to the price of the stock is focused on analyzing that whether the stock of company is over or under valued. The two most crucial ratios such as Price to Earnings (PE) ratio and Market value to Book value ratio are considered essential in this regard (Tracy, 2012). The results of ratio analysis on the financial statements of Boral Limited depict a PE ratio of 17.47 times in 2015 and 17.21 times in 2016 (Appendix). An increase in the PE ratio is considered good for the company and the investors wealth. However, in case of Boral Limited, it could be observed to be slopping slightly downwards, which is indicative of reduction in the wealth of the shareholders. Further, the market value to book value ratio was found to be 1.27 times in 2015 and 1.26 times 2016 (Appendix). There could be observed a slight downfall in the market to book value ratio of the company. The downfall in the market to book value ratio indicates that the company is not performing well in the market. Operating Revenues Prediction Report of Research and Markets has forecasted that the timber and building material supplier industry is to grow at the compounded annual growth rate (CAGR) of 4.63% per year from 2017 to 2021 (Finanznachrichten , 2016). Therefore, it can be expected that the operating revenues of Boral Limited which is a major supplier of timber and building material will rise. The CAGR of 4.63% in the timber and building material industry appears to be sustainable because of innovative products coming into the market. It is expected that the use of decking in construction of buildings will increase which will push the demand of timber and building material industry. Based on the CAGR of 4.63%, the operating revenues for the year 2020-21 have been computed as under: Presently, the company earns operating revenues of $4,311.20 million (Boral Limited, 2016). The current revenues compounded at the rate of 4.63% per annum will rise to $5,406.40 million by the end of 2020-21. Interest on Loan The interest rate computed using the interest expense and the average long term debt of the company is given below: Boral Limited A. Interest Expense ($M) 70.8 B. Average long term debt ($M) 1156.8 C. Interest rate annual (A/B) 6.12% D. Interest rate quarterly 1.53% Thus, the interest rate that would be charged on the loan will be 6.12% per annum or 1.53% quarterly. At this rate of interest, the quarterly installment of loan will be as follows: A Loan amount $300,000 B Tenure (years) 30 C Quarterly periods 120 D Quarterly rate 1.53% E PAVF 54.7898 F Installment quarterly (A/E) $5,475.47 Using the above amount of installment, the loan schedule for first ten years has been presented below: Period Opening outstanding Installment Interest Closing 1 300,000.00 5,475.47 4,590.25 299,114.78 2 299,114.78 5,475.47 4,576.70 298,216.01 3 298,216.01 5,475.47 4,562.95 297,303.49 4 297,303.49 5,475.47 4,548.99 296,377.01 5 296,377.01 5,475.47 4,534.81 295,436.35 6 295,436.35 5,475.47 4,520.42 294,481.30 7 294,481.30 5,475.47 4,505.81 293,511.64 8 293,511.64 5,475.47 4,490.97 292,527.14 9 292,527.14 5,475.47 4,475.91 291,527.57 10 291,527.57 5,475.47 4,460.61 290,512.72 11 290,512.72 5,475.47 4,445.09 289,482.33 12 289,482.33 5,475.47 4,429.32 288,436.18 13 288,436.18 5,475.47 4,413.31 287,374.02 14 287,374.02 5,475.47 4,397.06 286,295.61 15 286,295.61 5,475.47 4,380.56 285,200.70 16 285,200.70 5,475.47 4,363.81 284,089.03 17 284,089.03 5,475.47 4,346.80 282,960.36 18 282,960.36 5,475.47 4,329.53 281,814.41 19 281,814.41 5,475.47 4,311.99 280,650.94 20 280,650.94 5,475.47 4,294.19 279,469.66 21 279,469.66 5,475.47 4,276.12 278,270.30 22 278,270.30 5,475.47 4,257.77 277,052.60 23 277,052.60 5,475.47 4,239.13 275,816.26 24 275,816.26 5,475.47 4,220.22 274,561.01 25 274,561.01 5,475.47 4,201.01 273,286.55 26 273,286.55 5,475.47 4,181.51 271,992.59 27 271,992.59 5,475.47 4,161.71 270,678.83 28 270,678.83 5,475.47 4,141.61 269,344.96 29 269,344.96 5,475.47 4,121.20 267,990.69 30 267,990.69 5,475.47 4,100.48 266,615.70 31 266,615.70 5,475.47 4,079.44 265,219.67 32 265,219.67 5,475.47 4,058.08 263,802.28 33 263,802.28 5,475.47 4,036.39 262,363.20 34 262,363.20 5,475.47 4,014.37 260,902.11 35 260,902.11 5,475.47 3,992.02 259,418.65 36 259,418.65 5,475.47 3,969.32 257,912.50 37 257,912.50 5,475.47 3,946.28 256,383.31 38 256,383.31 5,475.47 3,922.88 254,830.71 39 254,830.71 5,475.47 3,899.12 253,254.36 40 253,254.36 5,475.47 3,875.00 251,653.89 It could be observed from the table shown above that the interest for the first year is $18,278.90 ($4,590.25+4,576.70+4,562.95+4,548.99). Thus, the company can claim a sum of $18,278.90 as interest in its profit and loss statement in the first year. The interest amount of the tenth year would amount to $15,643.28 ($3,946.28, 3,922.88, 3,899.12, 3,875.00). Choosing Investment Funds An evaluation of all the three options is given as below: A fund with a quoted fixed rate of 4.25% compounded semi-annually: A. Amount required to pay loan back 2,000,000.00 B. Rate annual 4.25% C. Compounded Semi annual D. Semi annual rate (B/2) 2.13% E. Terms (years) 3 F. Semi periods (E*2) 6 G. Cash required to invest $1,762,940.19 A fund with a quoted fixed rate of 4.2% compounded monthly A. Amount required to pay loan back 2,000,000.00 B. Rate annual 4.20% C. Compounded monthly D. Monthly rate (B/12) 0.35% E. Terms (years) 3 F. Monthly periods (E*12) 36 G. Cash required to invest $1,763,617.62 Zero coupon bonds maturing in three years and currently trading at $88 per $100 face value: A. Amount required 2,000,000.00 B. Face value of bond 100.00 C. No of bonds required (A/B) 20,000.00 D. Current price of bond 88.00 E. Cash required to invest (C*D) 1,760,000.00 Decision: It could be observed that the cash required for investment at present to get a sum of $2,000,000 after 3 years is lowest in the case of first option. In the case of first option, the company can arrange loan repayment of $2,000,000 by investing $1,762,940.19 today. Thus, it is advisable that the company chooses option one to make investment for arranging money in regard to loan repayment. The yield on the Australian government bond outstanding for 10 years is 2.73% (Blomberg, 2016) and the company has a spread of 570 basis points on this yield. Thus, the yield for companys bond will be 8.43% (2.73%+5.70%). In the case if the bond had been issued for shorter term than 10 years, the yield to maturity would have been lower than the current level. This is because the interest rate (coupon rate) remains higher for the short time period and as the period is enhanced, the interest rates fall downside. For example, the coupon rate on Australian government bond having term to maturity of 10 years is 4.75%, but it goes high to 5.75% if the terms to maturity of the same bond are reduced to 5 years (Blomberg, 2016). Further, there exists an inverse relationship between the coupon rate and the yield to maturity (Gitman, Juchau, and Flanagan, 2015). Thus, if the coupon rate of the bond goes up, the yield to maturity will go down. For example, the Australian government bond having 10 years to maturity has yield to maturity of 2.73%, but it goes down to 2.27% of the term to maturity are decreased to 5 years (Blomberg, 2016). The primary components that play crucial role in determination of the market interest rates are risk free rate, inflation, default risk premium, liquidity premium, and maturity premium. If it is expected that the Australian economy will do well in the upcoming years, there would be less risk of default, rising inflation, liquidity crunch, and instabilities in the market (Brigham and Ehrhardt, 2016). Thus, due to less risk, the premium for risk which is added to the risk free rate in computation of market interest rate will be also be less. Therefore, it could be inferred that the spread on the companys bond would be lower if it is expected that the Australian economy will perform with stability in future (Brigham and Ehrhardt, 2016). If the predictions in regard to the Australian economy go correct, the spread of the companys bond will be decrease. Due to decrease in the spread, the yield to maturity of the bond will go down. The decrease in the yield to maturity of the bond will increase the price of the bond. Thus, the price of the companys bond will increase. This has been illustrated below: When coupon rate and Yield to maturity is same at 8.43% annual Face value 100 Terms (Semi years) 20 Coupon rate 8.43% Yield to maturity 8.43% Half yearly interest 4.22 Yield to maturity (Half yearly) 4.22% Price of bond $100.00 When coupon rate remains at 8.43% but Yield to maturity goes down by 2% Face value 100 Terms (Semi years) 20 Coupon rate 8.43% Yield to maturity 6.43% Half yearly interest 4.22 Yield to maturity (Half yearly) 3.22% Price of bond $114.59 References Blomberg. 2016. Australian Rates and Bonds. [Online]. Available at: https://www.bloomberg.com/markets/rates-bonds/government-bonds/australia [Accessed on: 11 January 2017]. Boral Limited. 2016. Annual report of Boral Limited. [Online]. Available at: https://www.boral.com.au/Images/common/pdfs/annual-reports/Boral-Annual-Report-2016.pdf [Accessed on: 11 January 2017]. Brigham, E.F. and Ehrhardt, M.C. 2016. Financial Management: Theory Practice. Cengage Learning. Finanznachrichten . 2016. Research and Markets- Global Timber Decking Market CAGR of 4.63%. [Online]. Available at: https://www.finanznachrichten.de/nachrichten-2016-09/38476394-research-and-markets-global-timber-decking-market-cagr-growth-of-4-63-by-2020-trends-technologies-opportunities-report-2016-2020-key-vendors-008.htm [Accessed on: 11 January 2017]. Gitman, L.J., Juchau, R., and Flanagan, J. 2015. Principles of Managerial Finance. Pearson Higher Education AU. Tracy. A. 2012. Ratio Analysis Fundamentals: How 17 Financial Ratios Can Allow You to Analyse Any Business on the Planet. RatioAnalysis.net.