It is important that all business enterprises analyse their financial statements at the end of every trading period (Helfert, 2001, p.78). Once the financial statements have been prepared, they have to be analysed to show the stability, liquidity, solvency and profitability of the organisation among other areas of concern. In financial analysis, a couple of financial statements including the balance sheet, income statement, cash flow statement just to mention but a few are looked at. As a matter of fact, financial analysis is of great essentiality in making of investment decisions (Helfert, 2001, p.78). This paper is therefore an analysis of the financial statements of Competition Bikes so as to decide on whether it can merge with or acquire the Canadian Biking facility.
The Recommended forms of the capital structure that can maximize the shareholders wealth
Each and every company that minds about the welfare of their shareholders has to find ways of maximizing their wealth (Helfert, 2001, p.137).. A common way in which they maximize shareholders wealth is through the capital structure. Despite the fact that there may be an optimal capital structure a company loses its value on taking more debts unlike if it decides to take on risks. Therefore among the ways of maximizing shareholders wealth is through the adoption of the dividend policy, issuance of bonds and funding projects that have a positive Net Present Value such that the shareholders indirectly benefit through the capital gains achieved from the high value of shares. The recommended capital structure for Competition Bikes among the given alternatives is apportioning the 20% of the capital to 9% bonds and the remaining 80% on common stock. This means that the company issues 480,000 common shares to the public and 120,000 bonds of 9%.
A good capital structure is one that benefits the company as well as providing most wealth to the shareholders. The option of 20/80 is the best option because it gives the highest income to the company even in the subsequent years. In addition to the high income, the earning per share is relatively high as compared to the other options. The high income will benefit the company while the earnings on shares will benefit the shareholders hence maximizing their wealth. The recommended capital structure is also depicted to be increasing in the subsequent years. For example the total income on common stock increases from 48,012 in year 9 to 101,810 in year 13. The same case applies to the value of the earnings per share.
Areas of capital budget that raise concern
Capital budgeting generally entails determining which investment decision is preferable compared to the others (Helfert, 2001, p.86). In most cases the, riskiness, discount rate, outflows and inflows of the projects are considered before the selection of a project. Some of the commonly used techniques in the choice of investment projects include; profitability index, NPV (Net Present Value) and discounted cash flows among others. In the case of Competition Bikes, the areas of concern from their capital budget spread sheet are first of all the net present value of the project. This is because the projected capital budget in a situation of low demand is (-39, 281).
The NPV is negative because of the low rate of cash flows generated in the case of low demand which result from less value from the cost of goods sold. As a rule in capital budgeting, a project with a negative NPV is always rejected. This should applied in this case since the project aims at introducing a new product in the market which in most cases will initially have a low demand before the consumers get acquainted to it. At the same time the internal rate of return (IRR) is very low in the low demand having a value of 8.2% compared to the 10.4% in moderate demand situation. Therefore it will only be advisable that the company undertakes the project if it expects high or moderate demand in their new product.
The internal rate of return is low because the simultaneous cash flows generated are lower than the investment value. Therefore the Internal rate of return is an area of concern as its shows the interest that a project or investment brings to the investor while putting into considerations anticipated expenses. In the case of competition Bikes Company, the cost that comes with changing demand is the expense that affects the internal rate of return. When analyzing the IRR, the company has to look at the current rate of return in the capital or securities market as a benchmark. This helps the company determine how much the same investment could return if it decided to invest in the market instead. Therefore, this makes the IRR an important area in capital budgeting since you require adequate knowledge to make the investment decision well.
The Obtainment and Management of working capital
Working capital essentially means the amount of capital that is available in the business enterprise to cater for the short-term operations such as debtors, inventories, salaries just to mention but a few (Lasantha,2010, p.1). From the balance sheet of Competition Bikes the working capital depicts that the company is able to pay its current liabilities without any difficulty. The working capital of a company could be sourced from short-term sources such as; interests earned and account receivables or long-term sources such as capital gains and loans. However in all these, the operating cycle and the cash-conversion cycle should be up to date (Lasantha, 2010, p.1).
The management of Competition Bikes Company should properly manage the working capital to avoid the organisation having insufficient or excessive working capital. If it is in excess, it means that the organisation has idle funds that are not generating profits. On the other hand, if it is insufficient, the organisation will not be able to cater for its short-term liabilities. The management can do this by regulating the amount of cash within the organisation such that they have limited debtors as well as creditors. This can be achieved by making sure that they only purchase the stock that is to be used immediately and by also avoiding purchasing on credit.
They could also make sure other current liabilities are minimal to avoid the company spending a lot by settling them. They could also ensure that the capital gains and interests earned are used efficiently to avoid accumulation of funds in the company. In a nut shell, the mangers should regulate the circulations of funds in the short-run appropriately.
The Decision on merger or acquisition
A merger entails the coming together of two or more companies through share acquisition to form one large company (Helfert, 2001, p.124). To qualify a merger, two tests are performed, that is the assets test and market share test. Mergers if effectively utilized play a great role of redistributing the resources of the state. In the case study, Competition Bikes has the option of either merging with the Canadian Biking company or else acquire it at an offer price 10% above the ending share price of year eight. Several factors will have to be considered before any of the options is adopted (Helfert, 2001, p.254).
For example considering a merger the earnings per share of Competition Bikes will go up from $ 0.056 to $ 0.076 after the merger. This is clearly a good move for the Competition Bikes Company. In addition to this, looking at the Canadian Biking company, it can be found out that it is a successful company. The growth projections show that the earnings of the company will be tremendously increasing given the expected high demand (Helfert, 2001, p.267).
A merger option is preferable because it is affordable as per the company’s financial status. The acquisition option on the other hand is not favourable for the company because of the high selling price. Therefore the fact that Competition Bikes has a high share price, merging with Canadian Bikes which has a high growth rate will make the new company successful in the market.
Helfert, E. (2001). Financial Analysis: Tools and Techniques. McGraw-Hill Professional.
Lasantha, W. (2010). Why Working Capital should be managed efficiently. Web.