Strict Capital Requirements Raise Cost Of Capital, Essay.

Capital Budgeting for Bathurst and Wodonga Site

Discuss about the Strict Capital Requirements Raise Cost Of Capital.

In order to have an understanding of the effectiveness of the site that would be undertaken by “Saturn Pet Care”, the process of capital budgeting has been undertaken. The results that have been attained has been able to express the fact that the site in Wodonga is suitable for “Saturn Pet Care”. In order to have an understanding of which is site is more suitable, it is seen that profitability index, net present value and payback period has been calculated. The comparison and the computation of the figures that are associated to two sites have disclosed that profitability index of Wodonga has been “1.349”, which is higher than the index for Bathurst and their value has been “1.117”. The net present value and the payback period of Wodonga has been better than Bathurst as well as it is seen that the NPV value for Bathurst has been $58,44, 567 and Wodonga has a higher value of $95,94,827. Therefore, by looking at the results obtained for the two manufacturing sites, it can be concluded that Wodonga site should be used by “Saturn Pet Care” in order to start their new line of product and accordingly expand their business.

Product Cannibalization is an effective process that relates to lowering the original sales of an existing product of an organization in order to enhance and highlight the new product line that has been brought into the market. In case of “Saturn Pet Care”, it can be suggested that the company can undertake the same in order to brand the product that has been newly introduced in the market in order to attract the customers (Brusov et al., 2018).

The case study has stated that a director of the company maned Nathan has identified the fact that anticipated sales of the firm is more and the extent of sales requires cut down in order to make management planning decisions even more effective. Net present value analysis has been exploited so that with the help of this analysis the anticipated errors can be discovered and the issue that arises due to the rise in the outflow of cash can be mitigated (Moore et al., 2014).

Mr Nathan has the point of view that the actual expense that is related to the site of the factory needs to be included in the primary investments and accordingly relevant estimations can be made. It is seen that the perspective of the direction is not fitting because of the net present value looks to recently built factory shed and not the one that was already available.

Product Cannibalization

This part of the paper is related to the operational activities that have been undertaken by ARB Ltd and in order to have an understanding of the current capital structure that is being undertaken by the company with the help of which the effectiveness of the operational activities of the company can be understood. The faults that are associated to the operations of the capital structure can be understood and thereby proper recommendations can be given with the help of which the capital structure of the company can be enhanced.

The table explains the existing capital structure of ARB Ltd.

An evaluation of the current ARB Ltd.’s capital structure has indicated the fact that the organization only has equity capital within their capital structure. The capital mix of the company is not equally distributed among the equity and debt and thereby increases the risk for the company. Debt capital is even essential for ARB Ltd in order to make their operational activities flawless and maintain a balance in the capital mix.

“Weighted Average Cost of Capital” for ARB Ltd has been framed and the value that has been generated explains the fact that the WACC for ARB Ltd is “18.05%”. It is known that weighted average cost of capital is known to the collection of the expenses that is seen with the capital and this is found with the help of the financial sources that have been exploited by the concerned organizations (Baker, & Wurgler 2015). The entire cost of capital for ARB Ltd has observed a fall with respect to the forecasts, which were constructed in the preceding year and in this manner it is seen that the costs related to finance has even fallen and the fall has been taken in an optimistic manner. The weighted average cost of capital for ARB Ltd in the last year has been “19.01%” and accordingly one can say that the company is not performing in an effective manner with respect to last year

The equity expense for ARB Ltd with respect to CAPM is discovered to be “7.906%” and this result is very significant and effective for the company when comparing with the rate of return from the market and this percentage has been found to be “8.54%”. The figures that have been discovered in this paper has been able to address the aims and objectives of the company as well as satisfy the wealth accumulation desire for the stakeholders.       

Solving the excess sales that are recorded

This section of the report has been constructed in order to undertake a comparison with a similar company operating in the manufacturing sector like ARB Ltd. Therefore, Modine Ltd is the company that has been chosen in order to compare their operational activities and the capital structure with the structure that is followed by ARB Ltd. By assessing the operations that are undertaken by Modine Ltd, it is seen that the company makes use of a balanced capital structure and therefore the capital mix of the structure comprises of the debt as well as equity capital. The maintenance of this kind of structure is helpful to the organization because of the fact that the risks that are associated to the enterprise can be recognised and can be mitigated accordingly (Öztekin, 2015).

Now by examining the capital structure that is undertaken by ARB Ltd, the values and the figures have indicated that unlike Modine Ltd, ARB has a capital structure that does not have any debt capital but the entire capital is generated from equity. This reduces the efficiency level of the capital structure of ARB Ltd as the capital not being distributed among equity and debt leads to the development of risk as downfall in the equity would not provide any contingency for company in order to recover their capital. It is seen that the equity capital of Modine Ltd has been “$421.20” million and the debt capital has been “$519.90” million. The explanation that has been provided highlights the fact that the capital structure of Modine Ltd is a much better one than the one that is seen for ARB ltd.

The financial ratios that have been taken into consideration for ARB Ltd has been solvency ratio, profitability ratio and the efficiency ratio. The ratios have been constructed by taking help of the financial statements that have been disclosed by the company. In this manner, it is found that the current ratio for the company has amplified in accordance to the predictions that were made in the preceding year (Graham et al., 2015). In this manner, there has been an observation that position of liquidity has increased and the accordingly the debt to equity ratio has enhanced and this explains that debt of the company has been developing. ARB Ltd has an inventory ratio that has increased exceedingly all the ratios explain the fact that ARB Ltd has been functioning properly in the economy.

The following table looks to explain the changes that have been taken place in the capital structure of ARB Ltd in accordance to the last few years.

The results that have been attained explains the fact that with the advent of time there has been a massive changes in the capital framework for the company and outcome addresses the fact that capital that is available in the company is all from equity.

The table has able to explain the fact that ARB has been ineffective in making developments with respect to the predictions the management of the company undertook in the previous year. The table suggests net profit after tax for the firm increased a little bit but the rise is in not accordance to the expectations of the management.

Recommendations and Conclusion

The recommendations with regards to the case study has been explained as follows:

• The company has to construct strategies with the help of which the company would be able to introduce the wealth optimisation concept with regards to the functional operations of the company (DeAngelo, & Stulz 2015).
• ARB Ltd in order to improve their capital structure has to take steps with the help of which the company would be able to bring debt capitals so that a balanced structure can be maintained which would be effective in reducing the level of risk.

The report that has been constructed by taking assistance of the financial analysis addresses the fact that debt capital formation can minimise the extent of risk and in this manner ARB Ltd would be able to payback the dividend that is desirable from the aspect of the shareholders.

Reference List

Baker, M., & Wurgler, J. (2015). Do strict capital requirements raise the cost of capital? Bank regulation, capital structure, and the low-risk anomaly. American Economic Review, 105(5), 315-20.

Brusov, P., Filatova, T., Orekhova, N., Kulik, V., & Weil, I. (2018). New Meaningful Effects in Modern Capital Structure Theory. Journal of Reviews on Global Economics, 7, 104-122.

DeAngelo, H., & Stulz, R. M. (2015). Liquid-claim production, risk management, and bank capital structure: Why high leverage is optimal for banks. Journal of Financial Economics, 116(2), 219-236.

Graham, J. R., Leary, M. T., & Roberts, M. R. (2015). A century of capital structure: The leveraging of corporate America. Journal of Financial Economics, 118(3), 658-683.

Moore, A., Straub, S., & Dethier, J. J. (2014). Regulation, renegotiation and capital structure: theory and evidence from Latin American transport concessions. Journal of regulatory economics, 45(2), 209-232.

Öztekin, Ö. (2015). Capital structure decisions around the world: which factors are reliably important?. Journal of Financial and Quantitative Analysis, 50(3), 301-323.