Discussion FIN317
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Week10Assignment4FIN317.docxRunning Head: FINANCING AN EXPANSION
FINANCING AN EXPANSION 8
Financing an Expansion
Crystal Messer
FIN317
8/31/2019
Introduction
Financing an expansion requires extensive examination of an organizations present financial state. This is one of the most important steps of determining whether the expansion will be successful. Once this has been done the next step is to access the feasibility of acquiring a huge competitor. This requires performance of valuation techniques and financial options that the organization has (Bellavitis et al., 2017). This paper will use the primary venture capital valuation technique which helps to estimate the value of the enterprise by projecting terminal flows at the time of exit of a business. One of the key factors that should be considered when purchasing a competitor is competitor analysis (Fraser, Bhaumik & Wright, 2015).
One of the techniques that can help the organization to gain more knowledge about the competition is by using the Porter’s Five Forces. This method could help the company to learn about the strategy, capability, assumption and goals of the competitors. Using all the important information collected and analyzing it effectively will help the organization to predict the competitor’s next move (Fraser, Bhaumik & Wright, 2015). The competitor that has been chosen in this paper is Mc Donald’s. This is a publicly traded organization and has been considered to be the largest restaurant company in the world. The main challenge the organization has faced over the past few years is the perception matter.
Valuation Techniques
Mc Donald’s will be evaluated using the market valuation and the income valuation approach. The income approach estimates the assets of an organization based on the profit it can generate. One of the most important methods in this approach is the discretionary earnings. In the State of Georgia, the average annual profit generated by a restaurant is estimated to be $50,000.00. In the past few years were Café grill has been in business it has achieved significantly higher profit margin compared to this estimate and therefore acquiring Mc Donald would only increase its income.
The discretionally earning for Mc Donald’s is calculated as follows. Mc Donald’s cash flows were $65, 000.00, $72,000.00 and $86,000.00 in the first year, second year and third year respectively. The simple average is calculated as follows:
The next step is to calculate the weighted average.
Discounted cash flow method on the other hand is used to determine the value of the business by considering the terminal value, the net cash flows and the discount rate. This is very vital for the company to determine the feasibility of the expansion. The following table shows the projected DCF for Café grill.
|
Café grill |
|||||
|
|
2021 |
2022 |
2023 |
2024 |
2025 |
|
Revenues |
$145,000 |
$160,000 |
$175,000 |
$187,000 |
$195,000 |
|
- Wages |
$15,000 |
$15,000 |
$15,000 |
$15,000 |
$15,000 |
|
- Other expenses |
$13,000 |
$13,000 |
$13,000 |
$13,000 |
$13,000 |
|
- Materials |
$24,000 |
$24,000 |
$24,000 |
$24,000 |
$24,000 |
|
Operating Income |
$100,000 |
$110,000 |
$120,000 |
$134,000 |
$140,000 |
|
- Taxes |
$20,000 |
$34,000 |
$36,200 |
$40,000 |
$42,000 |
|
Net Income |
$73,000 |
$74,000 |
$86,800 |
$95,000 |
$101,000 |
The discount rate based on these calculations is 37%. So long as all business relationships are maintained and customers remain dedicated the terminal gain will be around $640,000. These parameters are very important and losing one could have adverse effects on the business. Since Mc Donald’s is well established organization with presence in many parts of the world it would cost approximately $ 354,000.00 to acquire it.
Financial Tools
There are various tools that can be used to determine whether Café grill will be successful after acquiring Mc Donald’s.
Financial ratios
It is always important to contact an extensive analysis to determine the financial status of a company before you purchase it. These ratios are used to determine the performance of different areas of the organization. They also help internal management, investors and creditors to determine how the business is doing and identify areas that need improvement. These ratios can be computed from three statements including cash flows, income statement and balance sheet. The most common categories of financial ratios include coverage, leverage, market prospects, profitability, efficiency, solvency, and liquidity (Penman, 2015). Results can be analyzed from the ratio computations to provide important insights about the business question.
Accounting Reports
These are statements that provide the financial status of an organization over a certain period of time. It details the company’s operations and transactions. Successful entrepreneurs and business owners ensure that their companies conduct proper accounting practices. These accounting reports can be compiled from three statements including cash flows, income statement and balance sheet. The balance sheet helps to shows the support needed to enhance the business profitability. Cash flows on the other hand help the company to determine its cash
outflows and inflows (Penman, 2015). Finally, the income statement shows the ability of the organization to generate profits.
Debt Market
Debt financing refers to the borrowing money to purchase an asset. This is very beneficial to the existing stakeholders as it allows them to maintain their percentage of ownership. There are various ways in which companies can raise capital to expand their businesses. This includes equity market and debt market financing. In equity market, companies raise capital by selling some stock to new investors. However, in debt market organizations obtain capital from external financiers who grant the company a loan and the purchasing company would in return provide collateral. In case the company that has secured the loan is unable to repay back then the financier will take ownership of the collateral. External sources can provide both short and long term loans.
Loans
Companies can obtain different types of loan to help them expand their business. These loans can be obtained from small business associations, standard banks, personal loans, family and friends. Despite where the loan is obtained from, it has to serve the purpose it was borrowed for. The loan must also have collateral just in case the company is unable to pay back. The loan will also require to be paid back with a certain agreed interest. Companies consider taking loans from financiers who have lower interest rates. In case the company that has secured the loan is unable to repay back then the financier will take ownership of the collateral (Cole & Sokolyk, 2018).
Line of Credit
Obtaining line of credit is one of the best options that a company can use to raise capital. It provides improved flexibility that is not provided by the other options. There is no exact limit on how the amount borrowed will be used as long as it will be used for business purposes. Most lenders require the borrowing company to have a few years of history and strong revenue to qualify for the line of credit. However, collateral is required for larger lines of credit that will be paid for a longer period of time. Some factors to be considered while choosing the best debt financing options include ability to qualify, affordability of financing, nature of business, use of funds and amount needed.
Equity Market
In equity market, companies raise capital by selling some stock to new investors. Most organizations will restrict potential buyers to be its employees. In this market, sellers ask for specific prices while the investors place their bids (Belo, Lin & Yang, 2018). A sale occurs when the two prices match. If an organization sells its shares then it gives away a portion of its ownership to the purchasing party. This method is best utilized when an organization need to raise considerable funds. In this type of financing, while the company being funded does not provide collateral it gives away part of its shares.
Cross comparison- equity vs. Debt
An analysis of the equity and debt financing shows that if Café grill needed small amount of money the best financing option would be debt. However, in our case we need to obtain $100 million. This is a large amount of money. Using debt financing would most likely strain the company. For this reason the best option for the company would be equity financing. This would involve selling shares to investors to raise the capital needed for expansion. This would yield mutual benefits for both Café grill and the investors as the company will raise the required funds for expansion and the investors will become shareholders.
References
Fraser, S., Bhaumik, S. K., & Wright, M. (2015). What do we know about entrepreneurial finance and its relationship with growth? International Small Business Journal, 33(1), 70-88.
Bellavitis, C., Filatotchev, I., Kamuriwo, D. S., & Vanacker, T. (2017). Entrepreneurial finance: new frontiers of research and practice: Editorial for the special issue Embracing entrepreneurial funding innovations.
Penman, S. H. (2015). Financial Ratios and Equity Valuation. Wiley Encyclopedia of Management, 1-7.
Cole, R. A., & Sokolyk, T. (2018). Debt financing, survival, and growth of start-up firms. Journal of Corporate Finance, 50, 609-625.
