Introduction
Business financing is a major challenge for companies that seek to implement new projects. Therefore, it is important to review all sources of finance that are available to the company. The sources of funding are broadly classified into internal and external financing. The main sources of internal finance are retained earnings and share capital. The company has been in operation over a period of time. Therefore, the profits that have been accumulated since its operation can be invested in the proposed project. Shareholders are the owners of the business. Therefore, they can be requested to provide additional capital to finance the proposed capital projects. Other sources are sale of fixed assets and debt collection (McLaney & Atrill 2008). One major advantage of the internal sources of finance is that the control of the company will not be diluted. Secondly, there will be no growth of interest expense when internal sources of finance are used. Finally, the use of internal sources of finance improves the value of the company. A major drawback of this mode of financing is that limited capital can be raised. Therefore, it lowers the ability of the company to pursue all the viable projects. Also, if the company decides to use sources such as retained earnings, then they may be depleted. This may not be favorable for the operations of the business (McLaney & Atrill 2008).
External sources of funding are those that are obtained from outside the business. The most common types are debt capital in the form of bank overdraft, bank loan, and bonds. The company can also engage other external investors. An example is the use of preferred stock. A major advantage of the external sources of finance is that large sums of money can be raised with ease. This will enable the company to pursue all viable projects. Further, the use of external financing allows the entity to keep cash to support the operating activities. Also, use of external financing such as debt allows the company to safeguard vital assets by pronouncing bankruptcy. A major drawback of this method of financing is that the company will have to make periodic payments in the form of interest and principal for debt and dividends for preferred stock. Some of these periodic payments have to be made by the company, whether the results are favorable or unfavorable (McLaney & Atrill 2008).
How the company can manage
The management needs to use a blend of equity and debt to finance the proposed new ventures. First, it is important to acknowledge that there are costs that are associated with each mode of financing. For instance, the use of equity financing attracts costs such as a share of profits, dividends, and other expenses such as flotation costs and legal fees. On the other hand, the use of debt attracts periodic interest payments, legal fees, and valuation of securities among others. It is worth mentioning that equity financing improves the capital structure and leverages the company while debt financing cushions the company against the swings in the economy and the business environment. Thus, a company can use debt finance to solve temporary cash flow problems. Finally, retained earnings are the most readily available sources of finance (Steven 2007).
Working capital management
Working capital is important in an organization. Basically, it is the difference between current assets and current liabilities. The main components of working capital are inventory, accounts receivables, and accounts payable. Maintaining optimal levels of the components of working capital ensure that an entity has adequate cash flow that can enable meet immediate obligations and operating expenses. Thus, efficient working capital management can free up cash that can be used to invest in activities (such as merger and acquisitions) that will create value for shareholders. It also reduces the dependency on debt and other external financing and at the same time it improves the operational performance of the entity. In order to have a healthy cash flow, it is important for an entity invest money in processes that can enable them find concealed cash (Steven 2007).
Working capital can be managed and monitored effectively through ratio analysis. Ratio analysis will enable the company to pinpoint the areas of emphasis. Examples of ratios that can be used are working capital and collection ratio. In order for the management working capital to work effectively, the management needs to put in place infrastructure that can support this process. The infrastructure needs to look at the cash inflows and outflows. For instance, a company have can tighten the processes of cost cutting so as to boost working capital. This can be achieved through a number of ways, such as netting of cash flow. This strategy is often successful if its long-term strategic view is taken into account to improve cash flow. Some of the recommendations for the efficient management of working capital are reduction of excess inventory, elimination of early payment of creditors, and efficiency in the collection of accounts receivables.
Investment appraisal
Since inflation and taxation is included in the question, then money method will be used to calculate the net present value and the internal rate of return. In this case, the cash flows and the discount rate will be adjusted with the effect of inflation. Calculating money cost of capital using fisher method is shown below.
Madison Supper
(1 + i) = (1+ cost of capital) * (1 + inflation)
= (1 + 0.14) * (1 + 0.04)
= 1.14 * 1.04
= 1.1856
=18.56%
Second rate
= (1 + 0.10) * (1 + 0.04)
= 1.10 * 1.04
= 1.144
=14.4%
Tax savings on writing-down allowances.
Net present value and internal rate of return.
Madison Platform
1 + i) = (1+ cost of capital) * (1 + inflation)
= (1 + 0.13) * (1 + 0.04)
= 1.13 * 1.04
= 1.1752
=17.52%
Second rate
= (1 + 0.11) * (1 + 0.04)
= 1.11 * 1.04
= 1.1544
=15.44%
Tax savings on writing-down allowances.
Net present value and internal rate of return.
Based on the net present value technique used above, investing in Madison Supper is viable because it generates a higher value of net present value and internal rate of return than Madison Platform. Therefore, the management should invest the ÂŁ5,500,000 in Madison Supper. Besides, it requires a low capital outlay.
Another method that can be used to compare the projects is profitability index. It compares initial costs with the return of the project. A major disadvantage of this approach is that it does not take into account the time value of money. The second approach is the payback period. It shows the period of time it will take a project to recoup the initial investment. A major drawback of this approach is that it does not take into account the time value of money and it ignores cash flows after the payback period. The final approach is the accounting rate of return. It compares the net income of the project and investment. A major drawback of this approach it ignores the use of cash flows and time value of money (Ross, Westerfield, & Jordan 2008).
Break-even analysis
Analysis of break-even tries to establish the number of units that a company must produce and sale in order to cover both fixed and variable costs. This tool can be used by the management to evaluate the viability of the project. Break-even point in units is computed by dividing fixed costs with contribution per unit. For instance, the capacity of a proposed production facility is 50,000 units. The total fixed cost amounts to ÂŁ450,000 while the contribution per unit is ÂŁ15. The break-even point of the project is calculated below.
= 450,000 / 15
= 30,000 units.
Thus, the company must produce and sell 30,000 units for the project to be viable. This is lower than the capacity of the plant (50,000). This implies that the project is viable. The graph presented below shows the values of sales, revenue and break-even point.
Other factors
There are a number of qualitative factors that should be taken into account when making investment decisions. The first factor is ethical considerations. Some of these ethical concerns are employee safety, pollution, and employment. Therefore, it is important to evaluate the effects of the project on some of these factors irrespective of its financial benefits. Secondly, a manager needs to evaluate the impact of the proposed project on the environment. Capital investments have different degrees of impact on the environment. This creates the need for carrying out analysis of environmental effects of capital investment. The third factor is the effect on quality of products and services after the implementation of the project (Shapiro 2005). Capital investments can seek to increase the quantity produced, but it does not take into account the effect it will have on the quality of the product. Therefore, it is important to evaluate if the quality of the product will be compromised after the implementation of the new project. Finally, it is important to analyze if the capital investment will affect the company culture. For instance, constructing an office space in another city might affect information flow and mode of communication. Therefore, it is important to evaluate the cultural consideration of the project with an aim of assessing whether the project will have a significant negative impact on the things the people value, teamwork, and overall morale of employees (Powell & Baker 2005).
Ratio analysis
Puteaux France
Melia Spain
The liquidity ratios for Puteaux France higher than those of Melia Spain. Besides, the ratios for Puteaux France were growing while those of Melia Spain were dropping. Also, the ratios for Melia Spain were less than 1. It implies that the company cannot meet the immediate obligations using current assets. This shows that the company is facing liquidity problems. Therefore, in terms of liquidity, Puteaux France has a better liquidity position than Melia Spain. Further review shows that the Melia Spain had negative profit and it deteriorated during the three years while that Puteaux France were positive and the values improved during the period of analysis. Therefore, Puteaux France had a better profitability position than Melia Spain. In terms of efficiency, the accounts receivable turnover for Melia Spain is higher than that of Puteaux France. This implies that the company is more efficient in handling accounts receivable than Puteaux France. The analysis of ratios for the two companies shows that Puteaux France has a better financial standing than Melia Spain. Therefore, Medison PLC should select Puteaux France for investment (Brigham & Ehrhardt 2010).
Apart from the financial information that is provided, the management should also analyze the additional information for the two companies. This will reveal more information about the figures that are reported in the financial statements. Also, the management needs to compare the results of the two companies with the performance of the industry.
In conclusion, Madison PLC should invest in the Madison Supper because it yields higher returns as shows by the results of NPV and IRR. Also, the results of the ratio analysis show that the company should enter Europe by acquiring Puteaux France
Yours Faithfully,
Consultant.
References
Brigham, F & Ehrhardt, M 2010, Financial management theory and practice, Cengage Learning, Boston.
McLaney, E & Atrill, P 2008, Financial accounting for decision makers, Prentice Hall, New York.
Powell, G & Baker, H 2005, Understanding financial management: A practical guide, Blackwell Publishing, Australia.
Ross, S, Westerfield, R & Jordan, B 2008. Fundamentals of corporate finance, McGraw-Hill Publishing Company Limited, New York.
Shapiro, A 2005, Capital budgeting and investment analysis, Pearson Education India, New Delhi.
Steven, B 2007, Financial analysis a controllers guide: Financial analysis, John Wiley & Sons, New York.