Evaluation Of Financial Strategy For TNS Limited
Evaluation of Capital Structure
The company TNS Limited should evaluate various financial strategy and decide upon the best funding strategy for the company. The different source of funding for the company depends on the capital structure of the company and the financing structure for the company. The distribution of the ownership structure and the preferred finance structure for the companies were evaluated depending on the profile of the investors (Abushammala and Sulaiman 2014). Existing and old shareholders preferred a safe and a different capital structure for the financing of the project while the new generation was more aggressive in deciding upon the capital structure of the company. The funding source for the company could be aggressive if the company goes for the primary issue of equity shares i.e., Initial Public Offering (Asquith and Weiss 2016).
Present Recommendations
The growth project of the company is evaluated with the different capital structures of the company and the incremental funding requirement for the same will be evaluated depending on the capital structure of the company. The funding of the growth project has been evaluated based on the three key options of the project (Atanasov and Black 2016). The capital structure of the company currently is based on the debt to equity structure of the company, which is around 10:90 ratio for debt to equity ratio of the company. The WACC was determined keeping the debt to equity ratio of 10:90 and the following interest rate for the discount rate was taken into consideration for the evaluation of the WACC (Bancel and Mittoo 2014). Tax rate was taken into consideration for the evaluation of cost of debt. The company has been presented with the three possible options for financing the growth project. The capital structure for each of the option will be changed depending upon the type of funding structure preferred and as per the risk and return criteria of the investors. The three recommended options are evaluated based on the applicable WACC for the company. The company should select the best funding strategy by changing the capital structure of the company, which will cost less for the company in the terms of reduced WACC (Clark, Feiner and Viehs 2015).
Option 1: The first option “Increasing Gearing” will be evaluated on the basis of the Weighted Average Cost of Capital for the company. The younger generation of the family are preferring the debt financing for the new project of the company as the current debt level of the company is around 10% of the total capital structure. The increase of the debt structure as the financing source will result in a reduced WACC, as the companies will get a tax advantage from the same. The second option will be result in a reduced WACC, which will eventually lower the cost of borrowing for the company (Ehrhardt and Brigham 2016).
|
Increasing Gearing Scenario |
|
|
Risk Free Rate |
3.00% |
|
MRP |
7.50% |
|
Tax Rate |
30% |
|
Beta Assets |
0.61 |
|
D/V |
9.00% |
|
D/E |
50% |
|
Beta Equity |
0.6 |
|
Interest Rate |
7.50% |
|
Beta Debt |
0.6 |
|
Cost of Equity |
7.50% |
|
WACC |
6.38% |
Evaluation of Funding Sources for Growth Projects
The increase in debt financing and by changing the capital structure of the company the same will result in a reduced WACC from 7.30% to 6.38% and the same applies when the debt to equity ratio was considered at 50:50 ratio. Thus, the preferred method can be selected, as the same will lower the cost of borrowing for the company (Eiteman, Stonehill and Moffett 2016).
Option 2: The other capital structure, which can be preferred, is raising the fund from the primary source of equity that is going for an Initial Public Offering (I.P.O). The same will result in an additional exposure towards equity and the same will increase the WACC of the company costing the company’s total cost of borrowing at 7.5%. The equity capital structure for the company will not much affect the beta value of the capital structure of the company (Foley and Manova 2015).
However, the Investment bankers suggested that for going for a primary source of funding for the equity capital the company’s total amount of shares that should be in a free float stage should be around 50% of the total share capital of the company.
|
Equity Capital Raising |
|
|
Risk Free Rate |
3.00% |
|
MRP |
7.50% |
|
Tax Rate |
30% |
|
Beta Assets |
0.61 |
|
D/V |
9.00% |
|
D/E |
100% |
|
Beta Equity |
0.6 |
|
Interest Rate |
7.50% |
|
Beta Debt |
0.6 |
|
Cost of Equity |
7.50% |
|
WACC |
7.50% |
Option 3: The third option for the consideration shows that the funding strategy for the company will remain intact for the company and the total debt to equity ratio for the company will be at the existing capital structure of the company. The third capital method is discouraged as it does not considers the importance of the debt financing in the capital structure of the company and the benefit flowing out from the same.
|
Base Case Scenario |
|
|
Risk Free Rate |
3.00% |
|
MRP |
7.50% |
|
Tax Rate |
30% |
|
Beta Assets |
0.61 |
|
D/V |
9.00% |
|
D/E |
10% |
|
Beta Equity |
0.6 |
|
Interest Rate |
7.50% |
|
Beta Debt |
0.6 |
|
Cost of Equity |
7.50% |
|
WACC |
7.30% |
The exit of 15% equity shareholder which is primarily held by 15% ownership by Barney can be done wither in the way of primary or secondary source of equity financing. The 15% stake of Barney will be sold to the public at the current valuation of the company or the same could be done weither offering the shares to the existing shareholders of the company that is the secondary source of financing for the equity capital. In both the ways, the tax implications and the price factor are some of the actors which will play an important role and that needs to be considered for the evaluation of the same. The tax would be paid by the Barney in the form of long-term capital gain tax depending on the Australian Tax structure and the final net capital gain arrived from selling the stake.
Impact of Changing Business Conditions
If TNS retain the same amount of long term amount of dividend payable to the shareholders for the company it is important for the company for the long term growth perspective that the same needs to be growing in nature. The incremental funding requirement and the selection of the capital structure for financing of the new project will depend on the cost of each source of financing which will in-turn affect the dividend payout ratio for the company. If the company goes for additional debt financing then it would be difficult for the company to raise dividends and maintain the same dividend as the interest payment on the debt borrowed will significantly influence the net profit and simultaneously the dividend of the company. If the company goes for equity sources of financing then the risk for the company will increase in terms of additional risk and equity share capital of the company. The required return on equity in this case will increase in the form of rise in expected dividend of the company. Hence, it is optimal for the company to maintain an stable capital structure for funding requirement of the company and the same would not affect the dividend structure of the company much.
The given scenario shows that the economy under which the TNS Company operates and the possible economic scenario available for the company is unfavorable which can affect the long-term success of the organization. The two macro-economic factors identified such as the fall in expected inflation rate and the fall in the volume growth of the business would significantly affect the growth of the company and would have different consequence depending on the factor evaluated. The fall in expected rate of inflation could be a positive scenario for the company as the level of goods, services sold to the consumers would become cheap, and thus the sale of the company would therefore in contrast will rise. The other factor evaluated was the fall in the Australian economy where the level of output or the volume of the company will fall significantly and this would be dangerous for the operations of the company. The company in this case would suffer additional from financial risk as well as the company due to its prior business operation might not be able to pay off with the financial interest due which would hence the financial risk of the company. The changing business condition and the business operations of the company would in turn also affect the dividend payout structure of the company where the dividend of the company would no further would remain at the sustainable level. The same will affect the valuation of the company and the risk of the company and thus thereby hurting the future long-term prospects of the company.
Valuation of TNS Limited
The comparable company selected for the valuation of the company was Reece where the company does not uses the application of debt in the capital structure of the company. Debt to equity multiples was the common source of multiple, which was identified in the analysis section and the same, which can be evaluated for the purpose of comparison (Damodaran 2016). The beta of the both equity and debt also implies the level of change in the capital structure and the level of interest rate of an company if the risk of the company changes by 1%.
The valuation of the IPO offered to the public will be dependent on the value generated after incorporating the growth assumption and the future growth prospect of the company. Discounted Cash flow analysis and the residual income model are the two common source of evaluation for valuation of the company. Enterprise Value and Equity value for calculating and determining the total value of the company. The Enterprise Value was calculated to be around 427,484 and the Equity value for the company was determined to be around 457,255. The differences in the value was primarily due to the different factors involved in each of the valuation multiple undertaken for the analysis of the same (Kariuki, Namusonge and Orwa 2015).
The IPO structure and the evaluation of the issue of the IPO should be done from the company’s perspective and the same should be done while considering several economic factors. The gearing and the issue of the IPO structure also depends on the risk profile and the willingness of the existing shareholders of the company. The IPO should be evaluated based on the business conditions and the operations of the company and the correlation of the some with the macroeconomic environment of the country (Kothari, Mizik and Roychowdhury 2015).
The mix towards the primary and the secondary issue of the equity shares should be carefully analyzed and dependent on the risk profile of the investors. The primary source of investing or raising equity capital should be given the least amount of preference as the same would increase the risk of the company and lower the profitability of the company in terms of dividend per share. The secondary source of investment will be the ideal source of raising the fund for the project as it would be timely and valuable option for the company. The secondary source of financing would also ensure that the issue of funds are issued to the existing shareholders of the company and the evolution of the same would be done by the existing shareholders.
Evaluation of IPO structure
The dividend policy following the IPO of the company should be stable and the same should reflect economic reality via payment of dividend as per the business activity of the company.
If the company goes for primary source of investment in the equity finance that is IPO it would have to incur several amount of floatation charges and the same would increase the cost of acquisition or investment for the shareholders of the company (Lerner and Seru 2017).
The funding of the new project could be evaluated based on the equity source of financing for the company. The company should go for an secondary offering and the same would affect the funding strategy of the company as the company would not have additional risk of failed IPO for the company and the equity beta for the company will remain well within the standard levels (Orwa, Nduati Kariuki and Namusonge 2017).
Conclusion
The TNS Company operates and the possible economic scenario available for the company is unfavorable which can affect the long-term success of the organization. The company TNS Limited should evaluate various financial strategy and decide upon the best funding strategy for the company. The different source of funding for the company depends on the capital structure of the company and the financing structure for the company. The funding source for the company could be aggressive if the company goes for the primary issue of equity shares i.e., Initial Public Offering. The valuation of the TNS Limited was evaluated considering the DCF valuation to determine the actual valuation of the company and the way in which the same differs from the original value in the market was compared. Thus after careful analysis and evaluation we recommend that the TNS Company should remain private and the company should not go for the IPO as the same would increase the risk of the company. There are several other conditions even that should be taken into consideration while evaluating the issuance of the IPO like the pre effect and the post effect of the same on the financials of the company. Consistency and sustainability of profit are some of the key factors that should be undertaken or evaluated while going for the issuance of the Initial Public Offering
References
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