Warner plc manufacturing division relocation proposal to Turkey

Investestment Proposal

I feel honoured and highly placed to be allowed to review the proposal of the manufacturing division of the company, Warner plc. And I give kudos to my boss, MS Weetman for this privilege. This company was established on the crucible of hard work and the propensity to make profit while making the products of the company available to the teaming populace. The portfolio of the company was never lack luster but the trend for some years now has really challenged the continued propensity of this company to make tangible profit. From the current trends in the financial stability of the company, the most recent balance sheet of the company shows the Warner plc has a debt of 10 million pounds which in its own has different composites. A three-year bond is one of the composites of the debt the company acquired by borrowing.

It is also noted that the company has thirty million ordinary shares of which all the post tax earnings are paid out as dividend to the shareholders. Not done with the list of happenings in the company, the company had already spent a whooping £2 million in developing the new technology-driven vacuum cleaner. In addition to that expense, £1 million was disbursed on market survey for this product but the report from the market was that of low market performance for the selected goods despite the forecast of good market situation. However, one of the surveys conducted by the company has allayed the fear of further declining company fortune. The manufacturing division of the company has decided to relocate to Turkey from the UK in search for a greener pasture. In view of the financial posture of the company and the performance of the company, is the proposal of the manufacturing division of the company a viable one?

In determining whether a company has the wherewithal to pursue the goal and plans of a company, the company's balance sheet must be strong enough so as to prove to would-be investors that the company has the financial strength to cushion the effect of any downturn in the market (Adekola et al. 2008; Balkyte, Tvaronaviciene 2010; Tvaronaviciene et al. 2009). The manufacturing division made it know that on relocating to Turkey, the government grant will take care of any tax liability on the investments. In the Opinions of Modigliani and Miller (1958, 1963), in a tax-free environment emphasis should not be placed on market value as regards capital structures. If however there are no tax waivers, a positive relationship thus exists between the value of the company and the level of debt.

There are different approaches to be assumed in determining the viability of the proposal of the manufacturing division of the company. It is divided into four sections: calculating the weighted average cost of capital for Wanna plc; advice the company on the based on the initial estimate of WACC; proffering recommendation to the company and sources of log-term finances for the company.

i. Estimating the "Weighted Average Cost of Capital" (WACC)

Weighted Average Cost of Capital is one of the very important parameters used in deciphering the financial strength of a company. It is used in assessing the internal monetary issues of the company as well as evaluating the true worth of the company in the stock market. In financial and monetary decision making such as that presented by the manufacturing division of this company, WACC is used as a scale of reference in checking the financial outlay of a company. It is used in estimating the possibility of expenditure in view of the current financial state of the company. It is therefore a rate of return of on an organization's or company's capital needs, weighted in proportion to the amount each item requires from the total company's capital.

WCCC = E x Re

D x Rd x (1 - tax rate)

VV

It is assumed that:

E

= % of finance that is equity

V

Re

= Cost of the company's equity

D

= % of finance that is debt

V

Rd

= Cost of company's debt

D

= this is the current market value of the company's debt

E

= this is the current market value of the company's equity

In calculating WCCC appropriately, the cost of equity and that of the debt must be calculated separately. Two major approaches can be used in calculating this. One is dividend growth approach while the second one is capital asset pricing model (CAPM). The first to make use of is the dividend growth approach.

P1 = D2

Re -- g

It is assumed that the parameters above are as follows:

P1 = prevailing market stock in the specified period 1

De = Dividend in period 2.

Re = cost of equity g

= the rate at which dividend is growing

However, when calculating dividend paying shares, we make use of the formula below:

Rc = D2

Po + g

The second approach which is capital asset pricing model (CAPM) can, as well be used as represented below:

Rc = Rf + ?ex (Rm -- Rf) where Rf and Rm are risk free rate and market return.

Cost of debt = company's bond before tax ( 1 -- tax rate)

= 7% ( 1 -- 0.04)

= 6.72%

cost of Equity = risk free rate + beta (market rate of return -- risk free rate)

it is assumed that risk free rate is 6%, market rate of return is 7%

cost of debt

= 6% + 1.3 ( 7% - 6%)

= 7.3%

WACC

= 20% (6.72) + 20% (7.3)

= 1.344 + 1.46

= 2.804%

ii. Advice Given to the Company Based on the Initial estimate of WACC

Making use of weighted Cost of Capital as a basis in estimating the feasibility of a company's project is very important. WCC has as its bases the company's capital structure. The company's financial structure is composed of financing both debts and the company's equity. The company's equity can be in the form of preferred equity and common equity while the debt can be in the form of bonds which of course, the company has. It is a common knowledge that companies raise money from debt and equity (Carland, Jim, and JoAnn Carland 1998). WCC is the cost associated with the either increasing the company's debt and/or equity. The value of WCC is important because it is used in evaluating the net present value of a project. It is as well used in knowing the value of an asset. Above any other consideration, in order for a project to be considered, the value obtained from WCC must be higher that the cost of financing debts or the cost of financing equity. In this regard, the company must be able to make profits from any of its ventures.

Two approaches are mostly adopted in using WCC. It is mostly preferable to first issue debts which may be in the form of bonds before attempting to raise the company's equity. The effect of this is to lower the value of WCC. As it is know that ever business has some level of risks ascribed to it, certain percentage of risk factor should be introduced as a risk management strategy. Considering the value of WCC for the company, it stands at 2.804% which means that the company's debt portfolio is high. Before the company can embark on any capital-intensive venture, additional source of funding is needed.

iv. Sources of finances

There are actually different reasons to consider sources of finances. Certain parameters serve as guidelines: (i) the amount required comes first, followed by (ii) the timeframe the finance is needed. Subsequently, (iii) the security in the disposal of the company and (iv) the preparedness of the business owners to relinquish some level of ownership in return for investment. This could be in order to kick start a business or to finance company's projects. Universally, finances are made available by finance institutions. This comes in the form of borrowing from the bank which is paid back with interests. This source of financing is available to any company that has the required collateral and/or good credit rating. Considering this source of finance for Warner plc may not be feasible. It has been continuously hard for the company to get loans from these finance institution. This is due to the company's lack luster financial stand and credit rating. Bank overdraft would have also been considered but the financing needed by the company is for longer period of time. This is still an area can be explored in addition to other areas. Nonetheless, there are still other sources of financing available. It should not be forgotten that the shares of the company is £3.

Business angels: Just as the name implies, these are 'angels'. They are very wealthy individuals that are ready to dish out cash in exchange for some of the company's equity. These angels take a lot of risk with the hope to owning a part of the company's equity. If the company eventually fails, they lose all their money and investments. Approaching the business tycoons comes to play when companies need huge amount of money to finance heavy projects. Approaching these angels is dependent upon some conditions:

The company must relinquish some of the company's equities

Good communication is required with these business angels. They will also request that they have a hand in the running of the company. This is necessary so as to safeguard their investments

The company must have a good track record of business operation. These angels will not give their monies to those who are not sure of what they are doing. Warner plc must set the record straight if considering this these business angels as an option.

The company must have good and experienced management team

Debentures: These are also another long-term source of financing open to business outfits. Debentures is like a bond or long-term loan issued to the public by the company. It has the uniqueness of fixed interest rates through out the period of this long-term loan. Members of the public whom the debentures are issued to invested in the company. They receive interest irrespective of whether the company makes profit or not. They are however not a co-owner of the company. The amount invested in the company is repaid to them over a period of years. There are no security or collateral requirements in order to access debentures.

Venture capital: This is also another source of long-term financing. It is money invested into a business venture with the aim of making profits from such. This kind of money is risk-laden. The reason for that is that there are no guarantee that profits could be made. The lender of such money will, over the period of the loan receives interest and subsequent repayment of the loaned capital. This is irrespective of the success or failure of the business. When such loan is granted, it is done in exchange for some of the company's equity. In order to access this kind of financing, the lenders look at certain parameters which are summarized below:

There must be high potential of making profits and that the returns can meet the criteria of the investment.

The lender would like to know if the profit accruable is really worth risking their huge sums of money.

They may also want to know if the products of the company are marketable.

They will also want to know if the company has the required management team that can propel the company to profit heights. They know that good business managers prolongs the lifespan of a business and profits are made (Manning 1993)

Although other requirements may be added but the once mentioned are the cogent ones. If these requirements are met, the loan can be secured.

Issuance of new shares: Financing can also be sources by the issuance of new shares. There are different approaches to this. The profit earned so far can be retained instead of being paid to shareholder (Black, 1976). The more dividends are paid, the lesser funds are available to the company (Easterbrook, 1984; Jensen, 1986). By so doing, funds are made available for the company. New shares can also be sold to shareholders which is know as right issues. Another approach is to offer shares to the public. Mush cash can be gotten from this. Owing to the £ 3 per share the company's shares are sold, it can attract the public to buy them with the hope of reselling to make profit (Modigliani-Miller (1958).

Although there are other sources of financing available to Warner plc but the listed ones are better suited to meet the condition of Warner plc. If however the company intends embarking on financing the two projects, the financial position does not allow that but considering the avenues listed, this can be possible. Owing to the current credit rating of the company, it is advisable to first consider debentures. With debentures, there is no bottleneck of security and collateral. Enough financing can be sourced from this channel to carry on with the two projects. A second or additional approach is to issue new shares. The current £3 per share is enough to attract buyers to the company's shares