Financial management analysis plays a key role for every modern business organizations. There are various roles and aspects of the criteria of financial business management that can be utilized by all the modern business organizations. With the help of financial management analysis, the organizations can manage its financial resources.This assignment will discuss about the one of the food producing companies of United Kingdom, Premier Food Plc. The organization is listed on London stock exchange and was found in the year 1975. The organization is a geared company as its total amount of debt is higher than its total number of equity. This is mainly because, the total amount of debt of the organization is much higher than the total amount of equity.
The organization Premier Foods Plc is a geared organization. Due to this reason, it is important for the given organization to find effective sources of finance to manage their working capital requirements effectively.
Various sources of finance are available to the modern business organizations. It can be classified as equity and debt. Equity can be considered as a long term of source of finance and on the other hand, debt can be considered as short-term sources of financing. In case of equity source of finance, there are various forms of classifications. These classifications are in the form of venture capitalists, home loans, reserves and surplus, existing capital, funds from public and personal sources of income (Labbi, 2005)
Venture capitalists/Merchant bankers- The organization Premier Food Plc can raise capital through the help of venture capitalists and merchant banks to raise capital. Generally, these types of financial institutions provide capital to those institutions that have a degree of competitive advantage associated with them. Therefore, the organization Premier Food Plc can opt for venture capitalists or merchant bankers to raise financial funds (Marsh, 2012).
Reserves and surplus- The organization can opt for raising capital from their own financial sources. The organization Premier Food Plc has a certain amount of reserves and surplus with them. They can utilize the amount of that money for their future cash generations. The organization can also opt for right issue of shares to their respective shareholders. In addition to this, the organization can also opt for dividend yield polices to their shareholders.
Investments from public via new issue of shares- Since, the organization are listed on London Stock Exchange, it can be deduced that they can sell some portion of their shares and can subsequently get money from them. This is the biggest advantage of an organization listed on secondary exchange. The organization can also opt for further public offerings (FPO) from secondary market (Vogel, 2011)
Personal sources of income- The organization Premier Foods Plc can also take sources of funds from their personal sources like drawings and others. This given sources of income can be of both short term and long term sources of income.
The organization Premier Foods Plc can also opt for debt sources of financing for their respective sources of income. There are various types of debt sources of financing. These are in the form of:-
Loan from financial institutions- The organization can opt long term and short-term loans from financial institutions like banks. Such form of loans can be of both short term and long-term sources. Such form of loans from financial institutions will help the organization to carry out their working capital activities efficiently. However, the organization has to pay a certain rate of interest to the respective banks. The level of interest will vary in accordance to the period of loan (Cvijanovi, 2014).
Treasury bills- Premier Food Plc can also opt for government treasury bills for their respective source of funds. In addition to this, any form of treasury bills is less risky and it would be highly beneficial for the respective organization.
Commercial bills- The organization can also select short-term money market instruments like commercial bills to investigate source of funds for short-term purpose. This will be of great essence for the organization to meet their short term and long term sources of funds.
Lease and mortgages- Financial lease and asset-backed mortgages can be another option for the respective organization to evaluate the different sources of their funds. The organization can take financial leases or they can also opt for mortgages for their respective assets.
Government Bonds- Government bonds can be also another option Premier Food Plc for the respective sources of funds. This can be considered as effective source of funds for the food manufacturing organization (Haslem, 2010).
These are the different sources of finance that is available for the given business organization Premier Foods Plc.
There are more than a few considerations that can be taken into account by the management of Premier Foods Plc for choosing different sources of finance. One of the major factors that can be taken into account by the management of Premier Foods Plc is regarding the structure of their capital. The ratio of debt and equity for the respective organization is the most important factor that will decide whether the management will opt for equity form of sources of finance and debt form of sources of finance. From the financial reports of the organization, it has been seen that the organization has a higher amount of equity and lower of debt. Due to this reason, the management of Premiers Food Plc can easily opt for different forms of debt sources of financing. However, such debt of source of financing may be only short term in nature. It may be inferred that the management of the organization may evaluate the pros and cons for the different types of sources of funds effectively. The respective management of the organization Premier Foods Plc can evaluate multiple numbers of implications of the given sources of finance. The overall impact of the sources of finance on the business structure can also be taken into consideration by the respective management of Premier Foods Plc. Another important factor that the management considers is regarding the forms of business risks associated with the sources of funds. The different forms of debt source of finance have a higher amount of risks associated with it. Due to this reason, the organization evaluated the different types of interest and loan structure associated with the debt sources of finance. In addition to this, a geared organization like Premier Foods Plc requires a minimal level of cost of capital structure. With effect to this, the management of the organization will incur of sources of capital in an equal amount of debt or equity. The organization may also choose multiple money market instruments like treasury bills, corporate bonds and others in order to improve or lower down their cost of capital. This is mainly because, debt source of finance is far cheaper than equity source of funds. The organization Premier Foods Plc requires source of funds to expand their business activities and to meet their working capital requirements (Ardalan, 2000).
Another type of consideration implemented by the management of Premier Food Plc is regarding the total amount of capital required by the organization. The organization is a growing organization; therefore, it will need lot of sources of funds for their respective operational activities. If it is seen that the organization requires short-term sources of finance to meet up with their short-term debts, then the organization can opt for short-term loans, corporate bonds to raise finance effectively. In addition to this, the organization may also consider the rate of interest regarding short-term loans of finance from different financial institution. The rate of interest can affect the structure of the organization. The total amount of reserves and surplus of Premier Foods is on the lower side; therefore, the management cannot raise capital from their respective reserve and surplus account. In addition to this, the organization can consider the repayment terms of equity like venture capitalists or merchant bankers. Due to this reason, the management of Premiers Food Plc issue shares in the secondary exchange to raise funds from public. In addition to this, they also opt for treasury bills as short-term sources of finance. The management of Premier Foods Plc also selects asset backed loan mortgages to raise capital. However, the organization is having a lower amount of equity. Therefore, it is important for the organization to balance their capital structure by finding appropriate sources of equity capital( Baker and Wurgler, 2013).
Since the organization is a geared organization, therefore, the management of the organization may implement an optimal level of capital structure to minimize their weighted cost of capital for their potential investors. This can only be done with effective allocation of sources of funds to minimize their total amount and rate of cost of equity and cost of debt effectively.
For every modern business organizations, it is of great essence to calculate the cost of capital to evaluate the appropriate structure of the organization. The capital structure of any business organization forms the core for every business organizations to give the operational activities an effective direction. All of forms long-term sources of equity, that is, equity share, preference share, government bills, bonds, long and short-term debt are included in the calculation of Weighted Average Cost of Capital. The formula is as follows:-
In case of the given organization, Premier Foods Plc, the given cost of debt is as follows,
Further, cost of equity can be calculated as-
The current risk free rate of the organization Premier Foods Plc is 2.3 in accordance to the average Treasury bill rate.
As per the London Stock Exchange, the market premium of the organization is 7.5percent.
Therefore, cost of equity of the organization is 2.3+10*7.5 = 9.7 percent.
The total amount of cost of debt can be calculated as total amount of interest expenses/ Total book value of debt = 81/1622 = 5.04 percent.
Therefore, the expected Weighted cost of capital of the organization is =0.2*9.7%+2.762*5.04(1-0.3) = 9.72 percent.
The Weighted cost of capital of the organization Premier Foods Plc cannot be considered as optimal level for their respective investors. The practical implication and calculation of weighted cost of capital is of extreme difficult in nature.
The given elements and variables of calculation of weighted average cost of capital are equity and debt. It is a challenging task to calculate and interpret the total value of cost of equity and cost of debt for the respective business organization Premier Foods Plc. In most cases, several number of proxy values are used to calculate the respective cost of equity and cost of debt for any business organization. Apart from this, to measure cost of equity, different managements use different approaches. Some may use capital asset pricing method (CAPM), some may use dividend growth model and other may use both of them. All the given models are based on several interpretations of the secondary markets. Therefore, both the given models can give different forms of results. There can be a contradictory nature between the calculation of risk premium and expected return from the market. In addition to this, there is a great difficulty in the assumption of market premium in the calculation of cost of debt for any organization like Premier Foods Plc. In addition to this, a business organization calculates weighted cost of capital based on expected market returns of the market rather than historical returns of the market. In addition to this, the total rate of risk premium reflects the current rate of treasury bills in the secondary market. Due to this reason, many financial analysts predict the rate of risk free rate that is prevailing in the current market scenario. On the other hand, in case of the organization Premier Foods Plc, it has been seen that, the capital structure of the organization is of extreme complex in nature. In case of calculation of weighted cost of capital of Premier Foods Plc, there were potential problems to find the required rates of risk free rate and expected market return of the organization. Apart from this, the calculation of beta is also assumed of the given organization. The management of the organization also assumed the existing rate of market premium of the given organization. Due to the complex capital structure of the organization Premier Foods Plc, the calculation of weighted average cost method is not that much effective for the respective organization. Another difficulty that the organization Premier Foods Plc faced is regarding allocation of cost of equity and cost of debt effectively. This is the major reason why, the structure of capital is not that much simple. However, the rate of weighted cost of capital is not optimum in comparison with its current competitors in the present business scenario( Correia, 2011)
The capital structure of the organization Premier Foods Plc has a higher amount of debt in comparison with its respective equity. This is mainly because; the management of the organization depend upon debt source of funds rather than equity source of funds. In addition to this, the total amount of equity and capital reserve of the firm is extremely low; therefore, the firm may require incurring more amount of equity source of finance effectively. The capital structure of the organization is exposed to higher amount of financial risk. The total amount of debt is almost 2-3 times higher than the required equity of the organization. Due to this reason, the organization needs to incorporate an effective structure of equity and debt within their capital structure. In addition to this, the organization incurs sources of funds mainly from debt sources of finance. For this reason, the debt portion of the organization consists of both short-term debts and long-term debts effectively. In addition to this, the share premium amount of the organization is also on the higher side and this is the reason why, the financial risk of Premier Foods Plc is higher. Apart from this, total assets to capital ratio are on the higher side. For this, it infers that the organization is not utilizing their total assets in their respective capital structure. In addition to this, the cost of interest is on the lower side, which further infers that the organization is utilizing its debt in cheapest manner.
Due to this reason, different forms of recommendations are required to be given to the given organization Premier Foods Plc in order to improve their weighted average cost of capital.
There are several recommendations that can be given to the respective organization Premier Foods Plc m order to improve their capital structure. This can also be done with the help of minimization of weighted average cost of capital. The organization needs to minimize their total amount of debt or improve their total amount of debt-equity ratio. This can only be done through effective analysis and evaluation of selected sources of finance. The organization needs to incur more amounts of equity sources of finance to make their capital structure more appropriate. In addition to this, the organization may minimize their systematic risk effectively. This will further minimize the required beta for the organization and can have a considerable effect on the cost of equity of the respected organization. In addition to this, the organization can also lower total cost of equity and total cost of debt to improve their capital structure. However, since debt is the cheapest source of finance, the weighted average cost of capital of the organization is lower. Although, it is observed that the organization can also opt for effective for more short-term sources of finance to meet up with their working capital requirements. Another recommendation that can be given to the organization is that the organization needs to incur debt-equity ratio in the form of 70-30 rule. Due to this reason, it is important for the respective organization to incur more form of equity from selling shares to public. With the help of this, the organization can improve their capital structure in an optimum manner. In addition to this, the organization Premier Foods Plc can also opt for government bonds and treasury bills to incur different sources of finance in an effective manner. These are the different recommendations that can be given to the organization Premier Foods Plc about their capital structure.
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