QUESTION

IFM Plc is a multinational company based in France and was founded in 1947 after the second world war. The multinational corporation has a market capitalisation of 2.5 billion euros and has a gearing level of approximately 88%. IFM Plc currently turns over 60 million euros per annum in worldwide sales and profits have stabilised over the last 5 years, averaging a trading profit of approximately 1.8 million euros per annum.

The company specialises in financial services to private equity companies operating in the industrial and commercial property construction and development industry. Although IFM’s head office I s currently based in France, they have subsidiaries in Germany, UK, Austria, Monaco and Poland.  The parent company is home to the treasury management team and Board of Directors of the company. The corporation currently operates a centralised treasury management system, operating from France.

The subsidiaries have operations within their home country, offering financial services locally and throughout the Eurozone region.  The company is currently undertaking 5 year strategic review for the period 2013 – 2018 and is looking closely at its operations to identify how it can achieve its expansion and growth objective which is a 5% increase over the next 5 years. The company is considering expansion in Asia – namely China and India as there is much growth in these regions over the last few years.  It has been estimated that 250 million euros will be needed to fund the proposed expansion over the next 5 years.

However, the financial services industry has experienced a range of global macro-environmental forces impacting on the industry, particularly in Eurozone which has led to both increased competition and increased regulation.  IMF Plc have been winding down their German subsidiary (which has been making a trading loss for the last 5 years) with a view to divesting their investment operations which are run here and specialising in other services which they offer.

They have been approached by a new entrant into the market, EMF Plc who has offered 2 million euros in a 50:50 joint venture deal over 4 years.  Hence the total cost of the joint venture will be 4 million euros.  EMF Plc is an investment fund management company based in Germany.

The company is also considering restructuring so that the parent company in France is re-domiciled to Monaco, as a large proportion of their Eurozone sales are generated there.

IFM Plc 2011 (German Subsidiary) – Book values

IFM Plc 2011 (German Subsidiary)

Note 1

The shareholders of IFM plc can invest their money in an alternative investment that yields a return of 12%. Interest of 7% was paid on debt.

Note 2

Cost of capital projected is based on the current weighted average cost of capital (WACC).  It is this rate which should be used to evaluate the joint venture (to the nearest %)

The company is currently faced with TWO strategic issues;

Strategic option 1

Whether to enter into the Joint Venture with EMF Plc. (There is insufficient information to make a comparison between divestment and JV, so just evaluate the JV).

FDI (Joint Venture) Information

The Finance Directors of both companies have come together and listed the following assumptions.  IFM Finance Director, Mrs Diana Worth has asked you as the capital projects accountant to put together a report evaluating the proposed joint venture based on the following information which relates to IFM Plc only.

1. The Joint venture agreement is initially set for 4 years, with the option of a company buy-out in year 4 or continuation of joint venture beyond year 4
2. IFM Plc will pay 60% of investment in year 0 and the remaining 40% of investment in year 1 relating to their share of the investment.
3. Projected annual gross cash flows from the joint venture are expected to be 0.900 million Euros and £0.450 million in year 1 and are expected to increase by 15% per annum.
4. All sales will be generated from Eurozone and UK market
5. The spot rate is £0.8410/€
6. Operational costs of the subsidiary are expected to be 0.235 million euros per annum which includes 0.0258 million euros for depreciation
7. The annual rate of inflation in Germany is expected to be 2.5% (this should be applied to operational costs only)
8. The interest rate for UK is expected to be 2% and the rest of the Eurozone is 1%.
9. The tax rate in Germany is currently 29%
10. Tax will be paid on profits generated in Germany by subsidiary company
11. A double taxation treaty exists between UK and Germany

Strategic option 2

Whether to restructure and transfer the parent company from France to Monaco.

This involves moving the Parent company from France and re-domiciling to Monaco. The Finance Director has estimated that this will require net funding of (equivalent to) 5 million euros.

The board have already decided on expansion across Asia but require some information on the options of sources of finance for them to review at their next board meeting.

Required:

Diana has asked you to write a 3,000 word consultancy report to senior management team (SMT) on the THREE strategic issues below.

1)    Evaluate the proposed joint venture using financial and non-financial analysis.  Clearly state which capital investment appraisal method you have used and it appropriateness.

Clearly state any assumptions and show all workings and calculations in the appendices of your report.

                                                                                (50 marks)

2)    Advise IFM Plc SMT on the key operational and strategic challenges that they face when considering re-domiciling the France parent company to Monaco

                                                                                (20 marks)

3)    Clearly state what options of sources of finance the multinational

corporation has to fund the proposed expansion across Asia. 

What factors should the company consider when deciding what sources of finance to access to fund the restructuring of the company?

SOLUTION

Contents

Evaluation of the proposed joint venture. 1

Key operational and strategic challenges for re-domiciling the France parent company to Monaco. 4

Source of funds in Asia and the consideration. 6

References. 9

Evaluation of the proposed joint venture

To evaluate proposed joint venture the cash flow analysis has been done. The cash flow for the company is calculated based on the given information. The capital investment appraisal method that has been used in the Net Present Value that is calculated by preparing the net cash flows that

To estimate the cash flows the cost of capital has been estimated.  This has been estimated as shown below:

Cost of debt as mentioned in the case is taken as 7% and the Cost of equity is taken as 12%. This is because the shareholders have another option for taking up the investment which will give them a return of 12%. Thus this return is taken as the cost of equity. The debt to equity ratio is taken to be 88:12. This is to say that the 88% of the funds are raised by taking debt from the market. This ratio has been taken as it is mentioned that the gearing ratio for IFM Plc is 88%. Thus the weighted average cost of capital is calculated. The formula used for calculating the weighted average cost of capital is as below

Cost of Debt X Debt percentage + Cost of Equity X Equity percentage

Thus Weighted Average Cost of Capital is 7% X 0.88 + 12% X 0.12

By the above calculations we get the Weighted Average Cost of Capital as 7.6%. After calculating the cost of capital the cash flow statement is prepared. The outflow for the year 0 and year 1 is taken as -€ 1,200,000.00 and -€ 800,000.00 respectively as it is mentioned that the outflow in the form of investment will be 60% in year 0 and 40% in year 1. The cash inflow will start from the year 1 which has been taken as € 900,000.00 and £ 450,000.00. These cash flow have been increased by 15% annually. The operational cost is deducted from the cash inflow and no adjustment is required to be made for depreciation as it has already been adjusted. The operational costs have been increased by 2.5% as inflation of 2.5% is taken into account.

The net cash flow is thus calculated by adjusting the tax rate of 29% which is applicable on the cash flow not including that have been realized in UK.

Another important point is that the UK pound has been converted to euros for the purpose of calculating the net cash flow for the year. The spot rate which is given as £0.8410/€ has been considered for conversion. It has been assumed that the conversion rate for euro to pound will remain same over the period of four years.

The cash flow statement prepared to get the cash flow over the period of four years during which the Joint Venture is in place are shown below

The cash flow statement clearly shows that the cash inflow for the company will be positive or the Net Present Value will be positive for the four year period. This is a positive sign for the company to go in with the joint venture. However there is further analysis that may be done with respect to the given information.

The company has a huge market capitalisation of over 2.5 billion euros and turnover of 60 million euros per annum in worldwide sales and profits over the last 5 years, averaging 1.8 million euros per annum. Also the company is expecting the growth of over 5% in the next five years.

The gearing ratio for the subsidiary is around 35% as the debt is of about 7 million euros and the equity is 13 million euros.  and when compared to the gearing ratio of the parent company is very less. Thus it can be said that the company can increase the debt as the cost of debt is much less than the considered cost of equity. Another important point to consider is that the total sales for the company are 60 million euros and profit of 1.8 million euros. Thus the two points to consider are firstly the profit to sales ratio is just 0.03. Thus the profit after tax is just 3% of the total sales. Secondly the company will have to invest 1.2 million euros at the start of the year itself thereby the profits of the company will be eaten up in raising the funds for the joint venture. With such low margins which have been because of the increasing competition in the eurozone and reduced margins as a result of regulatory framework for the financial companies it has become difficult for the companies to raise funds for the additional projects (Madura 2002). Also the company is already facing issues with this subsidiary making losses, investing another 2 million euros in the joint venture will have to be considered only after in depth market analysis that the margins and the growth rate that has been considered will be achieved.

Thus in short or to summarize the above discussion it can be said that as per the forecasts and the margins highlighted and after taking into consideration the factors such as the inflation rate and making suitable assumptions like the spot rate has assumed to be constant over the period of four years. However such assumptions and predictions might result in deviated results but this has to be done only after suitable consideration and analysis and advice and consultation of the experts.

Another advantage that can be seen in this joint venture and the decision of continuing with the operations in Germany is that there is double taxation treaty in place between UK and Germany. This has resulted in tax being applied on the profits made in Germany. Thus the profit earned in pounds will not be taxed although there has been loss due to currency conversion.

Another important point is that the cash flow has been estimated based on weighted average cost of capital. The better estimates could have been made if other methods such as APV were used to make such calculations (Shapiro, 2009). This is for two reasons as it provides the basis for making such calculations as the business is risky and the estimations have to be made for the cost of equity and thus to estimate the return to shareholders. Secondly since the cost to equity that has been considered is on the higher side as compared to the cost of debt, it will reflect more competitive scenario for the company.

Key operational and strategic challenges for re-domiciling the France parent company to Monaco

The company might faces a lot of operational and strategic challenges. For re-domiciling the France parent company to Monaco. This might impact the company in the long run as a result of inability of closing down the operations and in the short run to meet the working capital requirements. Also there might be issues with the company in deciding upon the strategy to work out on the market share that the company is targeting. These issues have been discussed below.

As mentioned the company will have to part away with around 5 million euros for re domiciling the parent company to Monaco. This is a huge amount for a company like IFM Plc as the company only has a profit of 1.8 million per annum. The only strategic advantage that can be seen from the re domiciling is that the company is having huge client base in Monaco. This might not benefit the company as much as for taking the benefits from this they will have to outlay a huge amount which is around 4.5% of the annual profit. This will result in additional burden on the company. Another important point to consider is that company might lose in on the benefits that could have been taken had the base country for the company been France. Thus in order to gain from the option of re domiciling the company might not be able to gain that much than what is expected

Re domiciling the operations to Monaco the company might end up forgoing the additional tax benefits that it might be gaining from the base country been France. This is to say that Monaco might not be having the double tax treaties and such other treaties with the other countries and France may be there for which advantage can be taken only in case the parent company is registered in France. Thus such are also required to be analysed.

Since the company will be opening up new office in Monaco as a result a lot of activities will have to be performed to complete the re domiciling. This might prove to be disadvantageous at the first point as it will require non productive activities which might be related to the operations. Secondly it will require a lot of money as there will be the costs of re domiciling. Thirdly the operational costs at the start itself might be increased due to a fresh start with the company being the parent company instead of subsidiary. Thus considering all these factor it can be said that there will be other costs involved apart from the cost of 5 million euros that has been mentioned in the case. Such costs will act as the overhead for the company and may result in reduced figures on the balance sheet that might prove costly for the company as it might effect the market capitalization.

These are all very important factors that are also required to be considered and thus the complete analysis of the re domiciling can be done.

With the fresh re domiciling and the position of the company in Monaco can make the competitors of the company realize the threats and thus make the market competitive. It has been stated that the market is already very competitive and thus such acts of increasing the competition can further lead to reduced margins. Secondly Monaco being the region from where the company is earning most of the profits and revenue thus an increased competition may lead to the reduced profit of the company and thus put pressure on the company to perform in other areas. Thus such a decision may lead to the stage where company is deviating from the steps and decisions that have been planned to be taken.

Company has huge plans as far as its investment in Asia and other countries is concerned. Such plans are backed by the current position of the company. With re domiciling decision which has to be taken has to be considered in two ways. Firstly it supports the investment that is planned for other countries, Secondly it does not become the bottleneck for the company and impact the output in the Asian countries. Thus before going for re domiciling this factor has to be considered.

Other factors which are also very important are the changes in regulation and the political stability of the country of registration. Nothing can be said with certainty over such issues. Thus the re domiciling decision can lead to a situation wherein a change in regulations of the country result in reduced profit and the advantage that the company is expecting because of re domiciling may not be there with such changes. The company will have to study the market in Monaco with this effect also as it will effect the current operations of the company in Europe and the  future investment decisions of the company.

Thus the re domiciling decision will first of all impact the profits and reserves of the company and at the same time may lead to increased efforts and impact the other investment decisions. Thus the company should not only look at the benefit that will arise as a result of domiciling but at the same time study the effect on the other subsidiaries of the company and the investments decisions that the company has already planned and has decided to work on them.

Source of funds in Asia and the consideration

There may be a lot of financing sourcing options that are there in Asia a lot of points can be considered before going in with a particular source. However the management at time does not go in with only one financing option for the reason that it is simple and less costly. There are other factors that are considered and that include the payment terms like how the payments will be made and when will the payment of interest be done and what will be the payback period. Considering all such factors the companies go in with the various sourcing decisions and thus diversifying the risks associated and working out the weighted average cost of capital.

The financing options have been categorized as internal source and external source. The companies prefer to go in with internal sources of funding before looking at other external source of financing.

Broadly classifying the external sourcing is done either in the form of equity or debt. The Asian market has seen a boost over the last decade or so. This market is having huge potential growth and has witnessed such growth owing to the investment in the form of equity by the investors as the effective and efficient debt options are rarely available because of the huge requirement of the region. However if the foreign investors are investing then sources of investment other than equity are made available by the country itself to encourage the investor.

There are three general types of options that are there to raise debt from the market in Asian countries (Kahal, 2001). Firstly the parent country makes arrangement on their own and ties up with the banks and other financial institutions for raising the funds for investing in the host country. However such companies that look for investments in the Asian region that are being looked up as future markets gets a lot of support from the local banks and the international bodies that are promoting trade in this region.

There have been a lot of trade treaties that are being signed between the asian countries and the other parts of the world including North America, Europe etc. Thus it makes possible for the foreign investors to take advantage of benefits that are arising out of these treaties.

For example the ASEAN free trade area that has been developed is not constraint to only one country but a group of countries facilitating availability of funds and huge market in the form of the integrated area that has been developed by ten member countries. Thus this arise as huge opportunity for the investors looking for source of finance as this free trade area highlights such opportunities.

Another way by which the companies can have efficient flow of funds is by hedging, in the form of foreign exchange. The Asian markets are highly fluctuating thereby resulting in high volatility in the market with regards to the foreign exchange. The investors can hedge the risk associated in the Asian markets and thus can take advantage which can be another source of funds for these companies (Backman, 2007).

The emerging markets in Asia, especially India and China have huge potentials. But the political environment and continuously changing environment in these countries owing to safeguard the interest of the public lead to the increased risk of the investors. Thus in such cases it is very beneficial for the foreign companies to go in with joint venture with the local companies. In this way the foreign investors can not only use the experience of the local companies but can also assist in sharing the raising of funds with the local company. Thus the risk is reduced and at the same time the companies can raise sufficient funds for the business.

Lastly the foreign investors can seek the support of local governments that are looking for boosting the economy and thus promote the efficiency and stability in the market. It has been very well understood by the governments in the asian markets that allowances and special funds have to be allocated for the foreign investors at first at least for the time being. Thus these are the options for the sources of funds in the asian markets. These may be direct sources like borrowing from local banks or seeking assistance of international bodies and others being indirect source like, assistance provided by the government, special policies for the investors, advantages of free trade area and the joint venture.

A company planning to invest in Asian markets may seek all these possibilities and thus can arrive at making suitable decisions as per the market requirement and the market in which they are operating.

The concept of financial management system wherein they can take advantage of financial arbitrage by transferring financing among units and taking advantage of the foreign exchange fluctuations. However the companies might go in for more than one option in order to take advantage of all and reduce disadvantage associated with others.

However the Asian markets are associated with high political risk and thus at times it becomes very risky to rely heavily on the options available in the Asian markets as the political risk may result in volatility of returns as a result of funding.

Thus it becomes very important to access the situation of the markets in the Asian countries and the situation of political scenario in the country

References

Cheol Eun, Bruce Resnick (2011). International Financial Management . United Kingdom: Tata Mcgrawhill. All.

Jeff Madura (2002). International Financial Management . 7th ed. United Kingdom: South-Western, Division of Thomson Learning

Alan C. Shapiro (2009). Multinational Financial Management. 9th ed. International: John Wiley & Sons

Sonia El Kahal (2001). Business in Asia-Pacific . Asia and Pacific

Michael Backman (2007). Big in Asia: 30 Strategies for Business Success. Asia and Pacific

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