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Finance for Managers

Contents

Introduction.

Capital Structure of Harvey Norman Holding Limited.

Capital Structure Policy of Harvey Norman Holdings.

Practical Considerations.

Observation 1: Capital structure varies across countries.

Observation 2: Capital structure varies across industries with some distinct patterns.

Dividend Payout Structure of Harvey Norman Holding Limited.

Payout Policy of Harvey Norman Holdings.

Memo Writing.

Reference.

Task 1: Capital Structure and Payout Policy Analysis

Introduction to Finance for Managers

In this task, the capital structure policy and the dividend payout policies of Harvey Norman Holdings Limited are going to be discussed. The report will describe the capital structure and payout policies of HVN based on historical annual data. It will also evaluate these policiesbased on the company’s current situation and characteristics.

Capital Structure of Harvey Norman Holding Limited

The capital structure of HVN has been shown in the following table

HVN

All amounts in 000’

Sources of Financing

2019

2018

Interest-bearing loans and borrowings

   

Current

494579

422191

Non-Current

346942

503203

     

Total Debt

841521

925394

Total Equity

3197793

2937932

Total

4039314

3863326

     

Weights

2019

2018

Debt

20.83%

22.91%

Equity

79.17%

72.73%

Table 1: Capital structure of HVN

As per the above capital structure, it can be clearly observed that HVN has largely employed equity financing as compared to debt financing. The equity capital comes out to be $ 3197 million while debt including both current and noncurrent remains just $ 841 million(Mota and Moreira 2017).

As per such capital employment, the capital structure of HVN becomes approx. 80 per cent and 20 per cent for equity and debt respectively(Grosse-Rueschkamp, Steffen and Streitz, D 2019).

It is also interesting to note that the company has further reduced its reliance on debt financing in the financial year 2019 as compared to previous financial year 2018. The funding has been increased in a similar proportion.

Capital Structure Policy of Harvey Norman Holdings

Capital structure determines the proportion in which the funds of a company have been distributed in equity and debt. In other words, an optimal capital structure is an appropriateallocation of equity and debt financing that aims at maximization of the value of the company(Gadtaula 2016).

As per the annual report, the primary objective of the consolidated capital management policy of the company is:

  • To generate longterm justifiable value for the shareholders of the company;
  • To maintain ideal returns to the shareholders of the company while benefit other stakeholders at the same time;
  • To accumulateavailable capital from sources with the lowest cost; and
  • To take appropriate decisions in the benefit of the company and prevent anyopposing outcomes in the short-term.

The Capital Structure Policy of Harvey Norman Holdings lay down a net debttoequity ratio target for the overall (consolidated)organization to be less than 50%. That means the debt financing must not outcome equity and remain less. As per the Annual Report of HVN for the financial year 2019, the capital structure of the company remains approx. 80% and 20% for equity and debt respectively(Balachandran et al. 2019).

Practical Considerations

Observation 1: Capital Structure Varies Across Countries

Harvey Norman is an Australian based multinational company and in Australia full dividend imputation tax systems is applicable and there are lower tax benefit on debt financing (the gearing factor), which is duly reflected in the capital structure of the company.

Observation 2: Capital structure varies across industries with somedistinct patterns

  • The industry in which the company Harvey Norman Holdings conducts its operations is retailing and whole selling. HVN is a multinationalcompany that is engaged in the business of retailing of furniture, electronics, consumer goods, etc. As per empirical observations, debt financing is largely used in industries including utilities, transportation and manufacturing but low debt funding is preferred in retailing industries.
  • The other factor behind lower debt funding by HVN is that it has higher levels of current asset (especially inventories) as compared to fixed long term assets which can be put on collateral to avail debt funding(Arjunan and Kannapiran 2017).

Dividend Payout Structure of Harvey Norman Holding Limited

HVN

Dividend Payout Structure

2018

2019

Dividend per Share

0.29

0.33

Dividend Yield

9.43%

8.04%

Dividend payout Ratio

71.28%

86.53%

Total Dividend (in $ million)

342.12

267.34

Table 2: Dividend Payment Structure

HVN paid higher dividend during financial year 2019 of $342.12 million as compared to the previous FY 2018, where it made payments of just $267.34 millionin the form of dividends, it is a year on year increase of $74.79 million. The main reason behind this increment in dividend payment is due to a higher final dividend that was paid during December 2018. Also, the directors of HVN announced a fully franked final dividend to be paid on 1 November2019 for 21.0 cents per share (total fully franked dividend distributed was $247,744,684)(Balachandran et al. 2019).

The following fully franked dividends of the Companyhave also been paid, declared or recommended since the end of the preceding financial year:

Payment Date Amount for FY 2019

2018

final fully-franked dividend

2 November 2018

$200,554,004

2019

interim fully-franked dividend

1 May 2019

$141,568,391

The total dividend payments for the financial year ended 30 June 2019 remains 33.0 cents per share and signifies 96.77% of profit after tax and non-controlling interests, it was 89.05% in FY 2018.

Payout Policy of Harvey Norman Holdings

A dividend policy decrees how much cash out of profit is returned to the shareholders of the company(Chan and Lin 2017). When deciding what dividend to pay, if any, a company must look at the profits it has made and weigh up how much should be retained in the business to fund future growth and how much should be returned to investors. If it has had a bad year and it doesn’t have enough profit to cover its investment needs and the dividend, but expects the poor performance to be a one-off, then it may still make a payout to investors by either dipping into any surplus cash it has or using debt. In Australia, the dividends are distributed following an imputation system, which is a corporate taxation system.Underthe dividend imputation taxation system, the taxes paid by a company are imputed, or attributedto the shareholders of the company by way of tax creditsin order to reduce the net income tax payable on a distribution(Pham et al. 2020).

Payout policy determines the level, stability and form of cash distributions (referred as dividends) to the shareholders of the company.As per the annual report of HVN for financial year 2019, the Dividend Policy of the entity is to make paymentsof such dividends that are notgoing to compromise the competence of the entity to execute company’s strategic objectives.

Task 2: Capital Budgeting Task

Given

Income tax rate

30%

Discount rate

10%

Decrement in annual sales from year 4

30%

R&D cost

1,000

   

Plant cost

150,000

salvage value

0

Useful Life years

5

Depreciation

prime cost method

   

Opportunity cost

2000

increment per year

3%

   

COGS % of sales

60%

Annual increment in S, G & A

3%

Working Capital % of sales

20%

 

Net income ($'000s)

1

2

3

4

5

Revenues

$180,000

$180,000

$180,000

$126,000

$88,200

– Cost of goods sold

$108,000

$108,000

$108,000

$75,600

$52,920

– Operating expenses

$12,000

$12,360

$12,731

$13,113

$13,506

– Depreciation expense

$30,000

$30,000

$30,000

$30,000

$30,000

Taxable income

$30,000

$29,640

$29,269

$7,287

-$8,226

– Taxes

$9,000

$8,892

$8,781

$2,186

-$2,468

After-tax income

$21,000

$20,748

$20,488

$5,101

-$5,758

 

Working Capital ($'000s)

0

1

2

3

4

5

Net working capital

$36,000

$36,000

$36,000

$25,200

$17,640

 
   

Opportunity Cost

 

$2,000

$2,060

$2,122

$2,185

$2,251

Calculation of net cash flow after tax

Annual Net Cash Flow Estimates ($'000s)

0

1

2

3

4

5

Investment in fixed assets

-$150,000

$0

$0

$0

$0

$0

CF due to change in net working capital

$0

$0

$10,800

$7,560

$17,640

Opportunity Cost

-$2,000

-$2,060

-$2,122

-$2,185

-$2,251

Net income

$21,000

$20,748

$20,488

$5,101

-$5,758

Add back depreciation (non-cash expense)

$30,000

$30,000

$30,000

$30,000

$30,000

Plant value at end, less dismantling cost

$8,000

Net cash flows during forecast period

-$150,000

$49,000

$48,688

$59,167

$40,476

$47,631

Calculation of five investment decision criteria

NPV

$36,457

   

IRR

19%

NPV @ IRR

$0.00

   

Profitability Index

1.24

   

Pay Back Period (Years)

2.88

Discounted Payback Period (Years)

3.75

Memo Writing

Memorandum

To: The CEO, XYZ Ltd

From: Research Department

Date: July XX, 2020

Subject: Project Analysis and Recommendation

It has come to my attention that the CEO has asked to conduct a financial analysis on a project through which the company is likely to introduce a new medical product in the market. The product is named as Product X. The Board of Directors is highly interested in Product X considering its characteristics that will help the company in meeting the aim to become a better environmentally responsible business, but the CEO also needs to reconsider the riskier nature of the product than the company’s current operations. However the company has already spent a huge amount of $ 1 million on the research and development of Product X, and the company is now close to the final investment decision stage(Malenko 2019).

As per the research conducted by the marketing department, the new product is recommended to be produced and sold for five years from now considering the changes in technology will probably make the product totally obsolete after this prescribedperiod.

On the basis of the market research report which stressed on various required areas including revenues, costs, etc. an analysis for project appraisal has been conducted on the basis of five methods of capital budgeting, which includes NPV, IRR, Profitability Index, Pay-back Period and Discounted Payback Period.

The discount rate has considered being the weighted average cost of capital (WACC) of the company which is 10% and the corporate tax rate of 30% has taken for the determination of estimated net cash flows from the project.Apart from that the company is expected to have taxable income from other projects that could be reduced by any losses on the project, which would reduce the firm’s overall tax in that year. The company is not eligible for any research development tax deductions(Batra and Verma 2017).

On the basis of the information collected, the following results have been found from the capital budgeting analysis:-

  • NPV = $36,457
  • IRR = 19%
  • Profitability Index = 1.24
  • Pay Back Period = 2.88 Years
  • Discounted Payback Period = 3.75Years

Recommendation:

  • As per the above results, it is recommended to carry the project as the valuations as per net present value comes out to be positive. The NPV method says that a project can be accepted if the NPV value results in a positive figure. Now since the NPV value to produce and sell Product X is $ 36457, which is both positive and a high value, hence XYZ should accept the project on the basis of NPV(Kengatharan 2016).
  • The internal rate of return (IRR) method is a highly popular method in capital appraising. The IRR rule says that a project is likely to be accepted if the internal rate of return (IRR) is larger than the required rate of return. In other words, the companies require the IRR figure of any project analysis to be higher than the weighted average cost of capital (WACC) of the company to cover the financing. The IRR of the project of XYZ comes out to be 19%, while the WACC of the company is 10%. Now since the IRR of the project to produce and sell Product X is higher than the overall WACC of the company, hence the company can accept the project on the basis of IRR.
  • Profitability index (or PI) calculates an index that determines the relationship between the benefits and costs of a project. The index is calculated as a ratio between the PV of future expected cash flows and the amount of investment made initially in the project. The PI rules states that a higher PI is preferred and a PI indexlarger than 1.0 is deemed to be a better investment. The PI of the project of XYZ is 1.24, which is greater than 1, hence the company can accept the project on the basis of profitability Index(Arjunan and Kannapiran 2017).

Reference for Finance for Managers

Arjunan, K.C. and Kannapiran, K., 2017. Cost‐benefit Analysis and the Controversial Reinvestment Assumption in IRR and NPV Estimates: Some New Evidence Against Reinvestment Assumption. Economic Papers: A journal of applied economics and policy, 36(3), pp.351-363.

Balachandran, B., Khan, A., Mather, P. and Theobald, M., 2019. Insider ownership and dividend policy in an imputation tax environment. Journal of Corporate Finance, 54, pp.153-167.

Batra, R. and Verma, S., 2017. Capital budgeting practices in Indian companies. IIMB Management Review, 29(1), pp.29-44.

Chan, C.H. and Lin, M.H., 2017. Imputation tax system, dividend payout, and investor behavior: Evidence from the Taiwan stock exchange. Asia Pacific Management Review, 22(3), pp.146-158.

Gadtaula, K.P., 2016. Critical evaluation of capital structure policy on Nepalese manufacturing firms.Journal of Accounting and Finance, 16(2).

Grosse-Rueschkamp, B., Steffen, S. and Streitz, D., 2019.A capital structure channel of monetary policy.Journal of Financial Economics, 133(2), pp.357-378.

Kengatharan, L., 2016. Capital budgeting theory and practice: a review and agenda for future research. Applied Economics and Finance, 3(2), pp.15-38.

Malenko, A., 2019. Optimal dynamic capital budgeting. The Review of Economic Studies, 86(4), pp.1747-1778.

Mota, J.H. and Moreira, A.C., 2017. Determinants of the capital structure of Portuguese firms with investments in Angola. South African Journal of Economic and Management Sciences, 20(1), pp.1-11.

Pham, H.Y., Chung, R., Bao, B.H. and Min, B.S., 2020. Corporate payout policy: does product market competition matter? Evidence from Australia.International Journal of Managerial Finance.

Remember, at the center of any academic work, lies clarity and evidence. Should you need further assistance, do look up to our Accounting and Finance Assignment Help

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