Executive
Summary
The report looks at the
different options that Ethical Trading Group can use to raise capital. It takes
into account the options available and not only analyses them theoretically but
also through the use of mathematical, financial and statistical methods. The
end result is that bonds are a more favorable options since the dividends and
share market price of ETG are not attractive. In addition to that it can afford
to pay the interests on bonds.
Contents
Introduction
The
Ethical Trading group is looking into getting into small-scale manufacturing
and thus need to raise an additional $20,000,000. To do this, they need to know
the current economic trends and also to know which option of raising capital is
most appropriate for them. The objective of the report is too look at the above
mentions facts and make a recommendation on the best option for Ethical Trading
Group. The report looks at all the options available, analyses the impact on
Ethical Trading Group finances and the demerits and merits of each option. The
report aims at recommending the best option after analyzing all this.
Economic Theories
Macroeconomics
Principles
The
macroeconomics looks at general/large scale economics factors that might affect
Ethical Trading Group in this new venture. The basis of this is the
macroeconomic theories that relate to the decision that is being made by
Ethical Trading Group. One of those is the Keynesian theory which looks at how
spending in the economy affects output and inflation (Cliffs Notes, n.d.). The
Keynesian theory advocates for increased government spending and lower tax
rates to stimulate the economy. The downside of the theory is that it focuses
on the short run while the Australian government not only focuses on the short
run but also the long run. The other theory is the classical theory. The main
idea behind the classical theory is that the economy is self-regulating as
self-adjustment mechanisms exist within the economy and thus requires little to
no government intervention. The Australian government takes a more Keynesian
approach by intervening directly or through the Australian Reserve Bank when it
comes to monetary policies. Australia is experiencing its 26th consecutive year
of economic growth (The Australian Government, 2017). The general wage growth
has been slow. The government plans to stimulate the economy by increasing it’s
spending on Infrastructure and also funding in housing, healthcare, disability
support, education, and employment. The 2017-2018 budget seeks to ease the
burden on the people, especially in the household sector. The inflation could
also grow more rapidly than previously forecasted which could lead to tighter
monetary policies such higher interest rates and price and wage control
(Reserve Bank of Australia, 2017).
If
any of this happens, Ethical Trading Group will be affected either negatively
or positively. In case of inflation, the ethical group will be affected by the
interest rates going up making it more expensive to borrow. In addition to
that, tighter monetary policies will mean that there will be less money to be
spent on its products by consumers. The situation, however, looks bright as the
government is planning to stimulate the economy as it is in the current budget
and plans. With the stimulation, taxes will be lowered, and subsidies offered
to companies especially in the manufacturing sector as they create a lot of
employment. This means people will have more money to spend on goods in
general, extras to invest and the interests rates will go down which will
benefit Ethical Trading Group with its aim of raising capital especially when
it comes to loans. The upper current lending rates of banks is 8.65% which can
even go lower if the government intervenes (Trading Economics, 2018). The
Australian Reserve Bank has also maintained cash rate at the all-time low of
1.5% where it has been since 2016.
Microeconomics
Principles
Microeconomics
principles look at single economic factors that affect individuals and their
effects on individual decisions especially their economic choices. One of this
factors is the consumer behavior whereby many Australians are more inclined to
go for products which are eco-friendly and Ethical Trading Group has to adhere
to this. In addition to that, the company should consider the opportunity cost
from the point of view of the consumer as the products must be worth the price
to consumers. Others factor include the competition, externalities and supply,
and demand. The most important of this is the supply and demand.
Sources of Information And Their Relevance To Report
The
Reserve Bank of Australia
The
reserve bank is a vital source of information due to its functions, duties, and
responsibilities. It is in charge of the monetary policies in Australia. Apart
from that, it is the official government bank and also the bank of other
commercial banks. In addition to the monetary policies, it has additional
functions which include; holding and managing Australia’s foreign currency
reserves, design, produce and issue Australia’s banknotes, operating
Australia’s main high-value payment system and promoting the overall stability
of the financial system (The Reserve Bank of Australia, 2012). It usually
releases reports on the general macroeconomic situation of Australia and the world
in general which are very helpful for this report.
Australian
Securities and Investments Commission
This
is the independent body that is charged with regulating corporates. The main
aim of AISC is to protect consumers, creditors, and investors by enforcing laws
that regulate companies and financial services. It reports directly to the
treasurer and is responsible for the administration of the Corporation Act
2001, Insurance Contracts Act 1984 and the National Consumer Credit Protection
Act of 2001. In addition to that, it contains and maintains Australia’s
business and company register (ASIC, 2018). The Ethical Trading Group has to
adhere to rules and regulations set by the commission. Apart from that, the
commission produces reports on the overall performance of industries including
the manufacturing industry and also aggregate financial data.
Options for Capital Raising
Share
Equity
Ordinary shares
Ordinary
shares are a type of equity which entitled the holder dividends and certain
rights such as voting rights in the company. They also have a right to sit at
the annual general meeting and get a portion of the profits after the
preference shareholders have been paid. The company can decide to issue out
ordinary shares in addition to the 201,480,000 that it has already issued. Currently, the total value of ordinary shares
is 196,228,000. Based on the information, each share has a book value of $0.97.
However, due to its profitability and dividend policy, the price has gone up as
it can be seen in the closing stock price of $1.34 per share. With a daily
volume of 198,076, Ethical Trading group can issue additional shares at a
premium or at the market rates. Assuming it issues at the market price, it will
need to issue additional 14,925,374 shares to raise $20,000,000. It can add up
a premium to cater for the cost of issuing this shares.
The
advantages of this are that the ordinary shares do not incur any interests. In
addition to that, it will increase the value and the size of the company. A
disadvantage of this is that the company will have to share the dividends and
capital gains with the investors who will take up this shares. In addition to
that, the ownership of the company will also be split based on the shares that
one owns thus some shareholders will increase their hold on the company while
others will lose this. The shares might also not all be taken up which is a
risk as the company will be forced to seek an alternative/ additional source.
This is a long-term source of financing.
Preference shares
Preference
shares are a special type of shares which may have a combination of features
which are not possessed by ordinary shareholders. The terms of the preferences
shares will be found in the company’s articles of association. The dividend for
preference shareholders is fixed and has to be paid.
The
main advantage is that the dividends are fixed and thus the company and
ordinary shareholders can keep the rest of the income in case they make a
substantial profit. They also help in differentiating between control and the
economic interest in the company. In addition to that, the company can easily
convert them to ordinary shares as per the articles of association. Just to add
to that, the preference shares improve borrowing capacity as they reduce the
debt to equity ratio. The main disadvantage as stated earlier is dividends
whereby they have to be paid and if not they are carried forward. Their rate is
higher than that of ordinary stock. In addition to that, they have a claim on
the company’s asset in case it is being liquidated.
These
preference shares are not ideal for Ethical Trading Group as they will take
cash flows away from the company. In
addition to that, the payments are not tax deductible.
Other Types of shares.
This include shares
such as redeemable shares which the company has an option of buying back.
Debts
Types
Loans
Ethical
Trading Group can a get a loan which it can pay later. The most appropriate
lender will be the banks. Most banks offer corporate loans that are payable in
5 years at an average rate of 5.79% (Commonwealth Bank of Australia, n.d.). At
a compounded rate it means that ETG will pay up to $6,500,439.8 in interests over the period.
Also, the loan will have to be secured by an asset. An advantage of this is
that the ownership of the firm is not affected.
Bonds and Debentures
Bonds
are another option of financing. This is a debt security that Ethical Trading
Group can issue to investors. The bond can have a face value of $1,000 thus
Ethical Trading group will have to issue 20,000 of them to raise the
$20,000,000. The bondholders will get interest until the maturity day when they
can claim the face value of the bond, In Australia, the face value of most
corporate bonds is $100.A debenture is a corporate bond that is secured by property
and has a fixed rate. The average interest rate on corporate bonds based on
S&P BBB investment Grade Corporate bond index is 5.32% (S&P Dow Jones
Indexes, 2018).Assuming that Ethical Trading Group issues a bond to be paid in
the next five years since it has a stable cash flow.
Interest = (20,000,000
* 1.05325) – $20,000,000
= $ 5,916,971.6
The
advantage of this is that the period is not fixed as the company can decide on
the maturity date. The interests’ rates are also lower compared to bank loans
and other lenders and can be fixed or floating. In addition to that, it can be
both a long term and short-term financing option. A disadvantage is the
interests paid which takes income away from the company and shareholders.
Conclusion
on Debt Options
Regarding loans, the
cheapest option is the bonds based on their interest rates and the facts that they
do not necessarily require security. When it comes to shares, the cheaper
option is the ordinary share capital which does not incur interest rates. The
rest of the analysis will focus on the two.
Payback Period
The
payback period looks at the time it will take to recover the money that is
invested in the business. The formula is as stated below. The current tax rate
is 30%.
PayBack Period =
Initial outlay/After tax Cash flows
Equity
Payback period / Current payback period
Payback period =
20,000,000/ 5,000,000
= 4 years
Bonds Payback Period
Payback period without
taking into account investment costs = 20,000,000/ 5,000,000
= 4 years
Payback period after
taking into account investment costs = 20,000,000 + $ 5,916,971.6 (interest on
bonds)/ 5,000,000
= 6 years
Based on the payback
period on the payback period, the best option is equity since it has a short
payback period if the financing cost is taken into account. However, the accounting
cost of equity is actually permanent since the dividends will be paid for life.
Based on that fact, 6 years for bonds is not a bad a bargain for ethical
trading group.
Weighted Average Cost of Capital
WACC =( cost of debt
capital* Total value of debts divided by the total value of debts plus the
total value of equity) + (Cost of equity capital * Total value of equity
divided by Total debts plus total equity)
Current
WACC
Cost of debt = interest
expense/total value of debt
=4850 / 106151
=0.046 or 4.6%
Total value of debts =
106151
Total value of equity
= contributed equity – ordinary shares
=198228
Cost of equity =
dividends paid / value of equity
= 24,047/198228
=0.121 or 12.1%
WACC = (0.046 *
(106151/ (106151+ 198228)) + (0.121 * (198228/ (106151+ 198228))
= 0.016 + 0.0788
=0.0948 or 9.48%
WACC
if equity is issued
Cost of debt = interest
expense/total value of debt
=4850 / 106151
=0.046 or 4.6%
Total value of debts =
106151
Total value of equity
= contributed equity + – ordinary shares
+ issued equity
=198228 + 20,000
= 218228
Cost of equity =
dividends paid / value of equity
= 24,047/218228
=0.11 or 11%
WACC = (0.046 *
(106151/ (106151+ 218228)) + (0.11 * (218228/ (106151+ 218228))
= 0.0151 + 0.074
=0.0891 or 8.91%
WACC
if bonds are issued
Annual interest on
bonds = 5,916,971.6 / 5
=
$1,183,394.32
Cost of debt =(
interest expense + interest on bond)/total value of debt
=4850 + 1,183.39432/
106151 + 20,000
=0.0478 0r 4.78%
Total value of debts =
106151 + 20,000
= 126151
The total value of
equity = contributed equity – ordinary shares
=198228
Cost of equity =
dividends paid / value of equity
= 24,047/198228
=0.121 or 12.1%
WACC = (0.0478 *
(126151/ (126151+ 198228)) + (0.121 * (198228/ (126151+ 198228))
= 0.0186 + 0.0739
=0.0925 or 9.25%
Leverage Ratio
The leverage ratios
look at the ability of ETG to meet its debts obligations.
Current
Debt to Equity Ratio
Debt to Equity Ratio =
Total debt less cash/market value of equity (share price * equity)
=
(106151-7192) / $1.34 * 201.48m
= 98959 /
269983.2
= 0.3665
Debt
to Equity Ratio In case Equity is Issued
Debt to Equity Ratio =
Total debt less cash/market value of equity (share price * equity)
=
(106151-7192) / $1.34 * 201.48m + 20,000
= 98959 /
269983.2
= 0.3413
Debt
to Equity Ratio if Bonds are issued
Debt to Equity Ratio =
Total debt less cash/market value of equity (share price * equity)
=
(106151-7192) + 20m / $1.34 * 201.48m
= 118959 /
289983.2
= 0.4102
As expected, the bonds
will increase the debt to equity ratio but not to dangerous levels as
manufacturing companies are capital and debt intensive. Investing in equity
will improve on the debt to equity ratio but on a very small margin.
Line of Graph of ethical Trading vs. ASX all ordinary index
2011-2015
INSERT
FROM EXCEL
The
ASX all ordinary share index has been trading way higher as compared to ETG. In
addition to that, ETG share price has been unstable and fluctuating from time
to time while the ASX index has been fairly stable. This is not the ideal
situation for an investor looking to invest in shares.
Correlation coefficient
R = Summation of ( ETG
P – average ETG) * Summation of (ASX all ordinary – average ASX)/
Root ((summation (ETG P – Average ETG
P) squared) ) ((summation ASX – average ASX))squared
= -8.43769E-15 *1.18234E-11)/( root (27.28*12807653.23))
=--5.33675E-30
= --5.33675E-30 the
figure is close to zero. It shows that the ETG share price and the ASX have
almost no linear relationship. This can confirm the results of the graph and
can be as a result of the fluctuating prices of ETG group.
The negative
correlation shows that the share price of the Ethical trading group is unstable.
I have done the work on an excel sheet, and I have also used a calculator to
confirm. I have also counter checked my ASX all ordinary share from different
sources to confirm the accuracy.
Dividend
Yield
=Dividend
amount of ETG / average share price of ETG
Using
closing balance
2011
= 0.08/ (20.3/12)
0.047
2012
= 0.08 / (17.705/12)
= 0.0542
2013
= 0.1/ (28.06/12)
= 0.04
2014
= 0.09/ (35.58/12)
0.03
2015
= 0.03/( 7.44/5)
0.02
Average
dividend yield graph 6(months difference)
The
dividend yield of Ethical Trading group has been dropping which means the
shareholder's return has been reducing.
This way lower than the average manufacturing industry yield in Australia which is at 5.19%.This makes equity
an even more complex option has investors want to invest in a company that will
give them returns.
Recommendation
Based
on financial measurements and statistics evaluation such as the dividend yield,
correlation, comparisons to the market etc.- Ethical Trading Group shares are
more riskier due to their instability. In addition to that, they have been
inconsistent over the years. This will make selling them very hard to sale
equity. On the other hand, it has a good cash flow and can afford to pay interest
on investments. In addition to that, its weighted average cost of capital is
still low and the same is also true for its leverage ratio. Due to this factors
and many more, bonds are a more appropriate method of financing for this new
venture. In addition to that, the bonds will ensure that the status quo is
maintained within the company. The expected cash flow alone can cover a large
junk of the interests’ expenses and thus it is sustainable.
The legislation, statutory and Industry Code of Practice
Legislation
and Statutory
Corporation Act
The
Corporation Act or CA 2001 as it is popularly known sets out the laws that deal
with business entities in Australia. It mainly deals with companies and is thus
the basis for the corporation laws of Australia. It regulates matters which
will affect Ethical Trading Group such as the operations (in harmony with the
company constitution), duties of officers, takeovers and most importantly
fundraising which ETG is currently undertaking.
Consumer Law
Consumer
laws such as the competition and consumer Act are made to protect the consumers
from unfair business practices, promote competition as well as fair trading.
Other laws include the fair trading acts and other laws adopted by the
different states. This includes the Fair Trading Act of 1989 in southern
Australia, Consumer Affairs and Fair Trading Act in the northern territory
among others. Thus fair trading group needs to understand and adhere to this
laws so as not to break the laws of not only the country but also the different
states. Failure to adhere can lead to legal battles and loss of revenues.
Industry
Codes
The
industry codes relate to the particular field in which a company is operating
in. Ethical Trading Group thus has to adhere to manufacturing codes and
regulations. One of this is the Victorian Occupational Health and Safety Act
2014 which applies to all Victorian manufacturing. Among other things that it
checks and regulates include noise, the hazardous substances. Confined spaces,
certification of plant users/ operators, manually handling among others.
Another vital law is the Dangerous Goods Act (1985) which is very relevant in
the construction workplace. With the new plant coming up, Ethical Trading Group
has to familiarize itself with this. Another vital law is the Environment
Protection Amendment Act of 2007.
Knowledge
and Skills Gained
Use
of Excel and word: Through this assignment, I was able to learn additional
functions that I did not previously know existed or did not know how to use
Microsoft word excel and word. Some the items I learned is the use of financial
formulae in excel and the auto in-text citation in Microsoft word.
Economic
Theories: I was also able to expand my knowledge in economic theories other
than what we had been taught. I also got to appreciate how the Australian
government and reserve bank uses these theories to bring our economy to
equilibrium.
Sources
of Information: In addition to the above I got to appreciate how we are leaving
in a digital world and our easy information is readily available nowadays. I
found a lot of sources on economic data such as interest rates, dividends,
bonds, share price, etc. I will definitely use these for my future investment
decisions.
Financial
Workouts: The task was challenging and made not only work a variety of
financial workouts but also understand them. I now have a better understanding
of financial statements, financial ratios, weighted average cost of capital
among others.
Australian Laws and
Regulatory Bodies : I got to have a deeper understanding of the different laws
and regulations that we have in the country that govern the activities of
companies, consumers, financial institutions among others.
References
ASIC. (2018, march 8). ASIC. Retrieved march
8, 2018, from ASIC website: asic.gov.au
Cliffs Notes. (n.d.). Cliff
Notes. Retrieved march 5, 2018, from Cliff Notes Website:
www.cliffsnotes.com/study-guides/economics/classical-and-keynesian-theories-output-employment/the-keynesian-theory
CommoWealth Bank of Australia.
(n.d.). Retrieved march 10, 2018, from
https://www.commbank.com.au/business/rates-fees.html
Guide star. (n.d.). Guide
star. Retrieved March 4, 2018, from Guide Star Website:
https://www.guidestar.org/Profile/ViewPdf?ein=13-1562242
Henry Street Settlement. (n.d.). Henry
Street Settlement. Retrieved march 4, 2018, from Henry Street Settlement
Website: https://www.henrystreet.org/
Reserve Bank of Australia. (2017,
May). Statement on Monetary Policies. Sydney: Reserve Bank of
Australia. Retrieved march 6, 2018, from
www.rba.gov.au/publications/smp/2017/may/economic-outlook.html
S&P Dow Jones Indexes. (2018,
march 12). Retrieved march 12, 2018, from
us.indeces.com/indeces/fixed-income/sp-australia-bbb-investment-grade-corporate-bond-index#
The Australian Government. (2017,
December 2018). budget.gov.au. Retrieved March 5, 2018, from
budget.gov.au 8 Website: budget.gov.au/#
The Reserve Bank of Australia.
(2012). Reserve Bank of Australia. Retrieved march 11, 2018, from
Reserve Bank of Australia:
www.rba.gov.au/publications/annual-reports/rba/2012/functions.htm
Trading Economics. (2018, march).
Trading Economics. Retrieved March 7, 2018, from Trading Economics
Website: tradingeconomics.com/australian/bank-lending-rate
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