Corporate Reporting and Its Role for the Company

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  1. Option 1: Verakia M.G. Company
  2. Option 2: Matoke Construction Company
  3. Option 3: In-house Arrangement
  4. References

Assessing the present and future performance of this or that company requires studying specific elements, such as market overview, strategy and structure, managing for value, and the actual performance of the company.

The theoretical knowledge is more and more commonly applied to real-world situations thus becoming more sufficient. Considering business and finance knowledge we should say that it can be gained through investigating both the elements related to a particular industry where the company is engaged and the theoretical framework established in the works of various authors.

Corporate reporting as a voluntary public presentation of information about an organization’s non-financial and, partially, financial performance serves as a springboard for those engaged in studying this or that organization’s performance. The information intended primarily for the stakeholders but used in various circles may be considered as an important mechanism for improving an organization’s performance. We will apply the main principles of creating the corporate reports when presenting the case study.

Also, the research will be based on the information sources that follow below.

Givens’s More Wealth without Risk (2002) proposes a system of strategies (insurance credit, tax, and investing ones) one needs to know to succeed in his or her business by making correct and confident financial decisions. Analyzing practical and easily used financial techniques that the author has presented we will find the most effective alternative for the company’s development.

Financial planning, budgeting, and forecasting are the main strategies we will be guided by in the current case study. All of them are required for successful management and these aspects of managerial position are sufficiently outlined in Finance for Managers (2002) by Luecke R. The work is fundamental in acquiring financial literacy.

Another work that deals with the problems of adequate management is Fundamental of Risk and Insurance (2002) by E. J. Vaugan. In fact, this work addresses the principles of risk management and illustrates how insurance can be used to deal with the issues that arise from this risk.

Capital Budgeting and Long-Term Financing Decisions (2004) by Irwin D. is useful in terms of studying the areas of capital budgeting and suggested strategies of long-term financial decisions. Going by them we will make the most appropriate decision concerning the case studied.

Partially, we will act as a shareholder of the company or the one who is at a loss whether it is worth buying shares in it. Namely, we will need to resort to the company’s annual report, evaluating what is and what is not being disclosed by the directors. We can also benefit from the company’s statements that are the company’s report cards for the year. The financial media presents certain interest to us as well, as there we can find announcements by the company we explore; documents on the public record can also reveal the information about the company under analysis.

For objective evaluation of the possible options that the company need to choose we will resort to competitive analysis of each of the option, the company has at its disposal, partially, to industrial analysis, to see how the industry influences the company’s needs and comparative analysis to recommend the most profitable option for the company.

The focus of our investigation is Potino ltd. This is a regional real investment company that specializes in the construction, acquiring and letting out buildings for office purposes. The company currently operates in the North West United States with offices in New York and Rome, Italy. They offer office spaces in various town centers at affordable rent charges. Most of their buildings have been under their renovation teams.

Many of their tenants have been with this company since early 1990s. They appreciate the quality of service and personal attention given to them. Tenants are informed and educated about their rights through the existing Tenants Union functioning in the company. The status and conditions of tenants are constantly improved by the responsible body mentioned above. Also, the Union aims at representing and speaking for the collective interests of tenants in the field of law and policy making. More and more people become the tenants of the company. New tenants are drawn to the company’s ability to rapidly acquire new premises and the responses given when a query is raised.

Potino ltd was started by Paul and his son Timothy as a small family owned construction company. Paul received his degree in Accounting and Finance and spent his life as a government employee in the department public works in charge of housing. He took early retirement to implement a lifelong dream of owning a construction company. His first construction works received a lot of praises. Timothy studied business management and Chartered Financial analyst with major interest in real estate management. Upon completion, he went to London where the Grandmother lived. He joined a respectable real estate management company where he worked for four years before going home. On arrival home he persuaded his father to convert his construction company to real estate management firm. Using his knowledge he insisted on the importance of incorporating the company instead of managing it as a sole proprietor.

The company acquired a building in Hertfort where they did not hire a renovation team. They contracted the services to one of the local companies. For years, the renovation of the city has been performed by Verakia M.G. ltd. Both parties have always been satisfied with the cooperation and the results achieved. But in two months time the contract is coming to an end. Therefore, the management of the Potino ltd is now faced with a problem of either renewing the contract or pre-qualify a new contractee and award the contract to another company or even build renovations department within the company ‘in house’.

Regardless of the option taken it is expected that the annual cash flows from the project will be as follows for the next five years:

Year Amount:

  1. 30,000,000
  2. 76,000,000
  3. 76,000,000
  4. 90,000,000
  5. 50,000,000

The company is financing its operations through a mixture of sources namely equity, bonds and has set some earnings aside. To be more specific these are:

  1. Debt: the company can raise an unlimited amount of debt by selling 1,000 par values, 6.5% coupon interest rate, 10 year bonds on which annual interest payments will be made. To sell the issue, an average discount of 20 per bond needs to be given. Also, there is an associated flotation cost of 2% of par value.
  2. Preferred Stock: the company can raise an unlimited amount of preferred stock under the following terms: (a) the security has a par value of 100/share, (b) the annual dividend rate is 6% of the par value, (c) the flotation cost is expected to be 4 per share. The preferred stock is expected to sell for 102 before cost considerations
  3. Common Stock: the current price of Potino ltd Corporation’s common stock is 35/share. The cash dividend is expected to be 3.25/ share next year. The firm’s dividends have grown at an annual rate of 5% and it is expected that the dividend will continue at this rate for the foreseeable future. The flotation costs are expected to be approximately £2/share. Potino ltd can sell an unlimited amount of new common stock under these terms.
  4. Retained Earnings: the company expects to have available 100,000,000 of retained earnings in the coming year. Once these retained earnings are exhausted, the firm will use new common stock as the form of common stock equity financing.

Currently the company Capital Structure is as follows and it is assumed to be:

  • Market Capital Structure
    • Short-term debt 36,000,000
    • Long–term debt 75,675,000
    • Preference Stock 40,000,000
    • Common Stock 180,000,000
    • Retained earnings 85,000,000

= 416,725,000

Going by the data presented the management should choose the most profitable alternative as far as the contract is concerned. The facts relating to each option are given below:

  • Renewing the contract with the same contractee or awarding the contract to another company?

If it is Verakia M.G. ltd., considered to be a rather safe partner, the amount that will be required to pay at the beginning of this contract is 50 million and 5 million annually at the end of the year for 5 five years long.

If it is Matoke Construction Company, a less famous company functioning in the field under consideration, the total cost will be the same but the payments will be: 20 million at the beginning, 10 million, 15 million, 5 million, 10 million and 15 million.

It means that the management is expected to evaluate the opportunities of their company and decide what contract is more efficient in terms of financial policy. Also, both companies should be evaluated regarding their experience in the operations conducted and their reliability. We believe that the companies are to be analyzed from the perspective of their claims that they make and opportunities they suggest and only then the final decision about either to apply to their services or not should be made.

  • Bringing the activity ‘in house’.

If the company decides to do the service in-house, they will need staff members whose salary is 7 million per annum. They will be entitled with a gratuity of 15 million at the end of each five years. They will need an extra office space at the equivalent of 1 million per annum and equipments for the work to be 20 million. The managers of the company should undertake the following steps to decide whether in-house production will turn profitable.

Estimating Cost of Capital.

We will start with estimating the average cost of capital required by the company. Average cost of capital is equivalent to weighted average cost of capital

WACC = wdrd(1-T) + wprp + wkerke

WACC = Weighted average cost of capital;

wdrd(1-T) = Weight of debt capital X cost of debt capital;

wprp = Weight of preference capital X cost of preference capital;

wkerke = Weight of common stock capital X cost of common capital;

Cost of capital for retaining:

Ke = D1 + g

PO

Po = 35 D1 = 3.25 g = 5%

Ke = 3.25 +5% = 14.3%

35

Cost of capital for common stock:

Ke = D1 + g

PO – f

Po = 35 D1 = 3.25 g = 5% f= 2

Ke = 3.25 +5% = 14.8%

35-2

= 14.8%

Cost of capital for preferred stock:

Kp = D1

PO – f

Po = 102 D1 = 6% of 100 f= 4

Kp = 6 = 6.1%

102-4

= 6.1%

Cost of capital for debt:

Pd =CF+ interest

(1- Kd)n

Pd – CF = interest Pd – 1000

(1- Kd)n CF – ( 1000-20- 20)= 960

1000 – 960 = 6.5% X1000

(1- Kd)10

40 (1- KD) 10 = 65

(1- KD) 10 = 65

40

10 log (1- KD) =log 1.625

log (1- KD) =log 1.625

10

log (1- KD) =0.21085

10

log (1- KD) = log 1.0497

1- KD = 1.0497

Kd =5%

WACC = wdrd(1-T) + wprp + wkerke

Source Market Value Proportions Cost (%) Product
Short Term Debt 36,000,000 0.09 5(1-.4) 0.18
Long Term Debt 75,675,000 0.18 5(1-.4) 0.36
Preference Stock 40,000,000 0.10 6.1 0.61
Common Stock 180,000,000 0.43 14.8 6.364
Retained Earnings 85,000,000 0.20 14.3 2.86
416,675,000 1.00 10.374

The cost of capital is 10.4%

Each option should be analyzed in detail. Below, there is the analysis.

Option 1: Verakia M.G. Company

Table for Cash Flows.

Details Year 0 Year 1 Year 2 Year 3 Year 4 Year 5
Cost
of
new machine		 (50,000,000) (5,000,000) (5,000,000) (5,000,000) (5,000,000) (5,000,000)
REVE
NUE		 30,000,000 76,000,000 76,000,000 90,000,000 50,000,000
Net Cash Flows (50,000,000) 25,000,000 71,000,000 71,000,000 85,000,000 45,000,000
PVIF 10.4% 1 0.9058 0.8205 0.7432 0.6732 0.6098
(50,000,000) 22,645,000 58,255,500 52,767,200 57,222,000 27,438,928

The net present value for this value is 168,328,628

Non- financial associated with this option include:

  1. Ability to focus on core competencies: By handing over non-core activities to a trusted third party, a company can concentrate on activities central to its value proposition and increase its competitive positioning.
  2. Faster and higher-quality service and improved efficiency: Vendors’ economies of scale, combined with service level guarantees, translate into increased operational efficiency for a company.
  3. Access to new skills and technology: Gives a company access to resources not available internally, such as modern, up-to-date technology and skilled human capital.
  4. Greater flexibility. The flexibility gained helps a company react quickly to changing market conditions, fluctuating demand cycles, and increased competition.
  5. Staff reallocation. Personnel whose job responsibilities are reduced or eliminated can be reassigned to other, strategic tasks.
  6. Improved predictability of costs. It provides a company with predictable yearly costs for the management of all.
  7. The management’s understanding of the services.
  8. There will be no new equipment to install, thus the enjoyment of privacy will be continuous.

Option 2: Matoke Construction Company

Table for Cash Flows.

Details Year 0 Year 1 Year 2 Year 3 Year 4 Year 5
Cost of new
machine		 (20,000,000) (10,000,00) (15,000,000) (5,000,000) (10,000,000) (15,000,000)
REVENUE 30,000,000 76,000,000 76,000,000 90,000,000 50,000,000
Net cash flows (20,000,000) 5,000,000 61,000,000 71,000,000 80,000,000 35,000,000
PVIF 10.4% 1 0.9058 0.8205 0.7432 0.6732 0.6098
(20,000,000) 4,529,000 50,050,500 52,767,200 53,856,000 21,343,000

The net present value for this value is 162,545,700.

Non- financial associated with this option include

  1. Ability to focus on core competencies: By handing over non-core activities to a trusted third party, a company can concentrate on activities central to its value proposition and increase its competitive positioning.
  2. Faster and higher-quality service and improved efficiency: Vendors’ economies of scale, combined with service level guarantees, translate into increased operational efficiency for a company.
  3. Access to new skills and technology: Gives a company access to resources not available internally, such as modern, up-to-date technology and skilled human capital.
  4. Greater flexibility. The flexibility gained helps a company react quickly to changing market conditions, fluctuating demand cycles, and increased competition.
  5. Staff reallocation. Personnel whose job responsibilities are reduced or eliminated can be reassigned to other, strategic tasks.
  6. Improved predictability of costs. It provides a company with predictable yearly costs for the management of all.
  7. New methods or techniques of renovation will be introduced.

Option 3: In-house Arrangement

Table for Cash Flows.

Details Year 0 Year 1 Year 2 Year 3 Year 4 Year 5
Initial
cost		 (20,000,000)
salary (7,000,000) (7,000,000) (7,000,000) (7,000,000) (7,000,000)
Rental expense (1000,000) (1,000,000) (1000,000) (1,000,000) (1000,000)
Gratuity (15,000,000)
REVE-NUE 30,000,000 76,000,000 76,000,000 90,000,000 50,000,000
Net cash flows (20,000,000) 22,000,000 68,000,000 68,000,000 82,000,000 27,000,000
PVIF 10.4% 1 0.9058 0.8205 0.7432 0.6732 0.6098
(20,000,000) 19,927,500 55,794,000 50,537,600 55,202,400 16,464,600

The net present value for this value is 177,926,100.

Consequently, the in-house arrangement will create more wealth as compared to the other options. We also believe that bringing the activity in-house will positively influence the company’s own funds, increase its resources and improve the staff performance in terms the new activity introduced. In contrast to the production that is contracted out, in-house activity will be more challenging and arising new opportunities for the company that we discuss. All this empowers us to strongly recommend in-house services as the best option for the Potino ltd.

We foresee that after carrying out the same analysis the company will have to conduct the competitive analysis of the option taken, it will acquire the form of industrial analysis. The management is expected to get the insights on how other firms are doing in order to compare the principles of one’s own work with those adapted by other companies engaged in the same business.

References

Carlson, S 1969, International financial decisions, North Holland Pub.

Choi, F. S. 2003, International finance and accounting handbook, Wiley.

Christofferson, P. 2003, Elements of financial risk management, Elsevier.

Ellet, W. 2007, The case study Handbook: How to Read, Discuss, and Write Persuasively About Cases, Harvard Business School Press.

Gapenski, L. & Brigham E. 1994, Financial management: Theory and practice, Dryden Press.

Givens, C. 2002, More wealth without risk, Mc GrawHill.

Irwin, R.D. 2004, Capital budgeting and long-term financing decisions, Thomson Learning.

Luecke, R. 2002, Finance for managers, Harvard Business School Press.

Poitras, G. 2002, Risk management, Elsevier.

Sanzo, R. 2005, Ratio analysis for small business, Yale University Publishers, USA.

Seitz, N. 2004, Capital budgeting and long-term financing decisions, Thomson Learning.

Unidas, N. 1993, Transnational corporations & management division; International financial management, Routledge.

Vandyck, C. 2006, Financial ratio analysis, Wiley books, USA.

Vaugan J. E. 2002, Fundamentals of risk and insurance, Wiley.

Weaver, S. & Weston J. 2001, Finance and accounting for non-financial managers, Mc Graw-Hill.

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