Table of Contents
In finance, this is a field that deals with decisions of finance and how these decisions are made using different available tools. Corporate finance aims at maximizing corporate value and still manages the financial risks of the firm. All financial problems can be solved in this study of corporate finance in all firms regardless of the kind. The decisions made by corporate finance can be either long term or short term. Long term decisions are made on the capital investments where decisions are made on the project that should receive investment and decisions are made on whether equity or debt should be used to finance it.
Decisions on whether or not to pay shareholders dividends are also made here. Short term decisions are made on current assets and the current reliability’s short term balances and focuses on cash, inventory, lending and short term borrowing management. Corporate finance thus increases the firm’s value to its shareholders by observing responsibilities and laws which are applicable. Issues geared towards achieving this goal are therefore dealt with in corporate finance. There is a need to look at firms differences in value of equity at different periods so as to find out how effective the decision will be. Equity value is gotten by looking at the balance sheet and then subtracting the liabilities from the assets. This however does not show the real value of the company thus making it not to be accurate though simple. The value of the company can also be gotten by considering the cash future flow and this really shows a clear picture of the decisions impacts. Ideally every company aims at having more cash at the end than in the beginning. The cash cycle is supposed to be known so that financing can be well done. The length of cash cycle needs to be reduced as considerations are made on the impacts that this will have. By subtracting the firm’s expenses from its revenue, the income of the firm is known. Financial ratios are used by a firm to evaluate its performance. These ratios measure margins, leverage, turnover rates, return on equity, return on assets, and the firm’s liquidity. The firm value is the value of its assets and the equity value is equal to this value.
Qatar telecom (Qtel) is a public company based in Qatar. It is a large company that has employed over 200 employees. It has launched other companies like wi-Tribe. It is in its plan to launch some other services through wi-Tribe such as the broadband internet services which will be across Africa and Asia. Existing share holders of this corporation are expected to buy stock to raise enough money to finance its growth and also pay debts. This company provides different telecommunication services and products internationally and naturally. These include the mobiles and wirelines, data services and internet, cable TV services, Wi-Fi and ADSL. They have been known for their great efforts to improve and the way they keep good track of their records.
For any company to successfully manage their finances, they should first start with the statement of income and the balance sheet. Ratio analysis is then applied to these financial statements so as to analyze how successful the business is and see if the business is failing. This analysis is used to see how the company is going to progress. Ratio analysis is used by business owners to compare their business performances with other similar companies of their type. It can also be used to see the performance of a particular business when these ratios are compared for successive years as one looks for the trend. One can locate a problem while doing this analysis thus allowing them to solve it before it is too late. The balance sheet is used to evaluate the ability of a business to clear bills as they occur by measuring the business liquidity, and leverage. Different ratio shows the profitability of a company. These ratios include the price ratios, the profit margin ratios, the growth rates and the investment returns ratios.
The price ratios include the price – earnings ratio and the beta (volatility ratios.). The price earning ratio is gotten by dividing the market value per share with the earnings per share (EPS). A high price earning ratio shows future expectations of higher earnings. However, this measure can not solely used to evaluate a company since the denominator is subject to alterations and manipulations. The beta ratio is used to measure the volatility of a stock price in relation to the rest in the market. It shows the movement of a stock price in comparison to others in the market. This tells whether a stock is performing well or not. Calculations are done using computer soft ware. The stock price is classified as risky, less risky or price fluctuating as the market level if the values are more than one, less than one and equal to one respectively. If the price is less risky then it is safer but lower levels of reward are expected.
The growth rates are used to measure the company’s profitability and solvency. Here one has to look at the sales and the net income. For the Qatar telecom, the sales in the three years 2006, 2007 and 2008 were 4,420.4, 10,543.3, and 20,318.9 respectively. As the years progress there is an increase in the sale that the company is making. On average the company makes sales of (4,420.4 +10,543.3+20,318.9)/3 = 11,760.9 in the three years. The net income of the company for the three years is 1,692.1, 1,674.3 and 2,306.4 respectively for the years 2006, 2007, and 2008. The average net income is (1,692.1+ 1,674.3+2,306.4)/3 = 1890.9. The net profit is gotten when all revenues and gains are added and then all expenses and losses are subtracted from it for a certain reporting period of time. This can be distributed to shareholders as dividends or retained in the company. Dividends are those payments that a corporation makes to its member of shareholder. When a corporation makes profit it can share this among the shareholders or it can retain some amount that they use to reinvest and then divide the remainder among the shareholders as dividends.
The profit margin ratio also measures the profitability of a company. The net profit is found as a percentage of the company’s revenue. For Qatar telecom, the net profit margin is found to be the percentage of net profit gotten after deducting all the taxes divided by the revenue of the company.
Net profit margin = (net profit/revenue) x 100%.
This is going to be (1,692.1/4,420.4) 100%
=38.3% for the year 2006.
=15.9% for the year 2007
= 11.4% for the year 2008.
The average net profit margin for the three years is the percentage of the average net profit dividend by the average revenue for the three years.
Internal comparisons are done using the profit margins. If the margin has a lower value then there is little safety and the business is thus at a higher risk of getting a net loss due to the reduction in sales thus low profits. This margin shows the strategy used by a business to price and how well this business is able to control costs. The gross profit margin is what the business is able to get after it has paid the direct variable and the direct fixed unit cost that cover the overheads and buffers items which are unknown. It is gotten by subtracting the production cost from the sales. This production cost does not include the payments on the payroll, the overhead, interest and taxation. It relates the revenues and the gross profit by showing how well a company’s revenue dollar covers the cost of the sold goods. The gross profit margin is calculated by subtracting the cost of goods sold from the net sales.
Gross profit margin = net sales - cost of goods sold
Gross margin for the year 2006 = 4,420.4-720.2
Gross margin for the year 2007 = 10,543.2-934.0
Gross margin for the year 2008=20,318.9-1521.0
If the value of gross margin is high then this means that the company is very efficient in converting the raw materials into income.
Investment return ratios are other measures of business profitability. It shows the percentage value change of an investment in a period of time. Any investment has got a goal that the business owner wants to be met. It thus shows the amount of money an investment is able to earn over a given period of time. It is thus gotten by subtracting the cost of the investment from the income received. The income received is the sum of the current income and the capital gains.
Return on assets shows the profitability of a company relative to the company’s total assets. It shows how the assets are well managed to give out the earnings at a certain period of time. It is calculated by dividing the company’s net income with the total assets of the company.
Return on assets = net income/ total assets
Return on assets in the year 2006 = 1,692.1/ 7,802.0
= 0.27 and its percentage is 27%
Return on assets in the year 2007 = (1,674.3/47274.6)100
Return on assets in the year 2008 = (2306.4/73149.9)100
This ratio tells the amount of earnings a particular investment generated. It shows how the company is able to convert the assets into net income. The higher the value the better for the company since it is able to generate more income of little assets. Thus here in the year 2006 the company performed better based on this ratio since it had the greatest return on the assets.
Return on equity shows the amount of net income gained from the share holder investments. It is always expressed as a percentage of net income divided by the shareholders equity. The higher the value, the more the company is efficiently able to convert the little shareholders equity into more income and the better the performance of the company.
Return on equity = (net income/ shareholders equity) 100%
For the year 2006 the ROE = 1,692.1/ 4,983.7
=0.33 = 33%
For the year 2007 the ROE = 1,674.3/6,899.9
=0.24 = 24%
For the year 2008 the ROE = 2306.4/12056
= 0.19 = 19%
To measure the liquidity of a company, the financial condition of the company is looked at by finding the quick ratios the current ratios interest coverage and the debt/ equity ratio as well as analyzing the management efficiency of the company by looking at the revenue employee ratio, the income employee ratio, receivable turnover and the inventory turnover.
Quick and current liquidity ratios = ((Cash + short-term investments + receivables) / current liabilities).
The interest coverage ratio determines how a company can pay interests on the outstanding debts easily. It is gotten by dividing the earnings before interest and taxes of a company by the interest expenses of the same company over the same period of time. The lower the ratio the more the debt expenses burden the company and if this value is lower than 1.5 then it poorly meets the interest expenses. If the value is less than one then this company does not generate enough revenue to meet these expenses.
Interest coverage ratio = earnings before interest and taxes/ interest expenses
For the year 2006 the interest coverage = 4,420.4/19.7
For the year 2007 the interest coverage =10,543.2/992.6
For the year 2008 the interest coverage = 20,318.9/1595
This shows that during the year 2006 that company was more able to meet the interest expenses.
Looking at the management efficiency, the year 2008 had the highest revenue employee ratio as well as the income employee ratios. Receivable turn over shows how much a company is able to collect debts and extend credit. It measures the effectiveness of a company in using its assets. It is thus calculated by dividing the net credit sales with the average accoounts receivable. If the value is high then such a company is performing well and it indicates that it its dealings are in cash basis or that it is efficient in the extension and collection of account receivables. In the year 2006 the company still has the highest receivable turn over that in 2007 and 2008.Inventory turnover shows the number of times a company sells its inventory and replaces it over a given period of time. It is calculated by dividing the sales by the inventory. If the value is low, the company had made poor sales thus having excess inventory. High ratios show that the company had made strong sales or buying that is ineffective. It is unhealthy to have inventory levels since this indicate zero return.
Inventory turnover = sales/ inventory.
For the year 2006 the inventory turnover = 4,4420.4/27.2,
In 2007 it is = 10,543.2/127.6
While in 2008 it was = 20,318.9/272.3
This show that in the year 2006 the company made strong sales. The overall ratio analysis shows that in the year 2006 the company’s finances were well managed and the company had great value then. This is the year when the company performed very well.
Cost of capital evaluation
This is the cost of the equity and debt funds of a company. From all the existing securities of a company, it is the return that is required for the shareholders. It is a requirement that has to be met by a new project after the investors provide the required capital. Thus it is used to evaluate new company’s projects. It shows the worthy of having a new project as per the return it offers. It is thus a rate of return received by a company if instead it invested in a different project with the same risks. When investment is done, the investor expects that they will get more than what they used in the investment. The capital components are the common stock, the preferred stock, the bonds and the retained earnings which are the profit that the company makes and do not share with the shareholders as their dividends but instead keep it and reinvests in back. The Qatar telecom has the retained earning as a form of capital and also the common stock. To calculate the total cost of capital different calculations of the retained earning and the common stock has to be done for the Qatar telecom. The formula for the calculation of the common stock cost is the summation of the risk free return and the product of the beta with average stock return after the risk free return has been subtracted from the average stock return. (Bernstein, L and Wild, J., 2000).
Risk-free return + [Beta x (Average stock return - Risk-free return)]. The cost of the retained earnings is then calculated and the two results combined together so as to come up with the total capital cost.
Capital structure optimization.
These are long term debts, common equity, specific short term debts and preferred equity together. Capital structure is thus how the different funds sources are used by the company it its operations and its overall growth. The forms which debts comes in are long term notes and bond issues which are payable. Equity is in the form of preferred stock, common stock and retained earnings. This is the ratio of company’s debt to equity ratio and it is used to show how risky the business is. A company is at a greater risk if it is financed by debt because this shows that the company is levered highly. By using the Qatar financial statement, this capital structure can be calculated so as to find out the source of its financing. It is good that one understands the capital structure of the company so as to determine the cost of the company and how able it is in minimizing this cost. For the Qatar telecom Company, addition are made on all debts of the company which include the preferred and the common share, the retained earnings and the capital contribution. When all of the total debt are added to the equity it equals the assets of the company which for the year 2006 was 7, 802.0, for 2007 it was 47, 274.6 and for 2008 it was 73, 149.9. The percentage that each of the funding source represent on the total funding of the company is what is the capital structure.
Capital Structure = (funding source/ total funding) 100%
As an example, for Qatar telecom, the percentage of retained earnings for the year 2006 is given by =3,656.4/7, 802.0) x 100 = 46.7%
For the year 2007 it was =4,555.5/47, 274.6 x 100
For the year 2008 = 12,056.0/ 73, 149.9 x 100
This is the capital structure of this company. The degree at which it used borrowed money in 2006 was a bit higher but on the other years the leverage went down as the usage of borrowed money for financing went down.
Earnings before interest and taxes (EBIT) measure the profitability of a company and the higher the value the profitable is the company. The EBIT of this company was high in 2006 but slightly went down in the proceeding years. Lowest EBIT was in the year 2008, normal EBIT was in the year 2-007 and the highest EBIT was in the year 2006.
Return on equity shows the amount of net income gained from the share holder investments. It is always expressed as a percentage of net income divided by the shareholders equity. The higher the value, the more the company is efficiently able to convert the little shareholders equity into more income and the better the performance of the company. For the year 2006 the ROE = 1,692.1/ 4,983.7
For the year 2007 the ROE = 1,674.3/6,899.9
For the year 2008 the ROE = 2306.4/12056
The earning per share (EPS) shows the profitability of a company. It is calculated by first subtracting dividends on preferred stock from the net income and then dividing the results by the average outstanding share. In the year 2006 the share holders gained the highest wealth created by the company since this is the year that the company performed very well than the other years. This is seen from the overall analysis that has been conducted on the ratios above.