Abstract

• Understand at a deeper level the economic analysis of strategic and tactical investments, the effect financial leverage has on firm value, and the integration of investment and financial corporate strategies

• Analyze issues that face modern corporate managers when making capital budgeting and capital structure decisions

• Apply finance valuation techniques for purposes of business decision making

• Integrate, synthesize, and present finance concepts and analyses

• Be able to use the corporate finance tools necessary to develop the skills, knowledge, and wisdom (SKW) in current demand by employers

• Understand the qualities needed for careers such as corporate managers, financial analysts, investment analysts, brokers, and business practitioners.

Felicia & Fred is a public company of US which deals with manufacturing of jewelry. The company has previously expanded its capacity and included Czech crystal bracelet in its product line. This year the company has included women’s accessories, specially the handbags in its product line. These products are outsourced by the company to a manufacturer in Asia through a licensing agreement.  The manufacturer has exclusive rights to Felicia & Fred’s women logo handbags so that the company can preserve the intellectual property and branding rights in the United States. The company has also increased its investments in the inventory. With the increase in product line the company anticipates that the demand of the product will increase and it will require additional storage space to meet the demand of its customers.

The difference between strategic and tactical decision making

Strategic decision making and tactical decision making are two different ways used in a business to take decisions. The major difference between the two is time oriented. The difference between strategic and tactical decision making is that strategic decision making deals with the planning and taking educated decisions regarding the future problems of the company whereas the tactical decision making deals with the problem faced by the company at present and taking steps to overcome that problem.

The strategic decision making allows the company’s decision makers to forecast the future direction of the company and identify emerging trends and markets for the company. They can plan the future problems and based on the forecasted results of the projects decide whether to go ahead with the projects or close a project.

The tactical decision making deals with the current problems and uses the current market conditions to analyze the situation and competition and then decide the actions to be taken to achieve its goals. It focuses on the resources at hand and focuses on ways to achieve the strategic goals. The planning and decision making involves the challenges and risks in carrying out the strategic goals.

Difference between Strategic and Tactical Decision Making

The decision by the company Felicia & Fred to expand the business and enter the handbag distribution business is strategic in nature. The company has previously expanded its capacity and included Czech crystal bracelet in its product line and inclusion of the other women’s accessories, specially the handbags makes perfect sense and allows the company to provide more variety of products to the same customer base and increase its sells and profits in the long run. It also provides a new direction to the company which is moving from a jewelry manufacturing company to manufacturer of accessories for women and can be a one stop solution to all the requirements of the customers. Thus without having to increase the expenditure in marketing and advertisement the company can sell various products and is a perfect strategic product line extension. Thus the decision of entering the handbag distribution business is strategic. (Owang, 2013)

The indicators of financial performance used in evaluating whether an investment has successfully increased shareholder wealth of company are

Profitability ratios: Profitability of a company is the capacity of the company to make profits. In a business, if the investments by the company are able to generate profits then the investment is considered successful. The various Profitability ratios like gross margin ratio, return on equity, return on investments etc. gives a good idea whether the company has been performing better than the competitors in the industry.

Liquidity ratios: The Liquidity ratio helps the investor find if the company can cover its debt: long term and short term and helps to boost confidence among investors and suppliers. The various Liquidity ratios like current ratio, quick ratio and cash ratio helps in determining whether the company has been able to cover its liabilities and helps in gaining the trust of the investors and other stakeholders.

Efficiency ratios: The efficiency ratio helps investor to find if the company can use its resources and make profits efficiently. The various Efficiency ratios like total assets turnover ratio, fixed assets turnover ratio helps the investors understand how efficiently the assets have been utilized by the company. (Chand, 2015)

The cash flow statement, inventory turnover ratio and accounts receivable turnover ratio are other indicators of financial performance used in evaluating if the investment has been successful in increasing shareholder wealth of company.

Liquidity Ratios of the firm: The Liquidity ratio helps the investor find if the company can cover its debt: long term and short term.

Current ratio: Current ratio is the ability of a company to pay its current liabilities using the current assets. It is given by Current Assets/ Current Liabilities. (Current Ratio)

Indicators of Financial Performance Used in Evaluating Investments

In the prior year,

Current Assets = 29 M

Current Liabilities = 22.4 M

Thus current ratio = 29/ 22.4 = 1.29

In the current year,

Current Assets = 40.9 M

Current Liabilities = 36.2 M

Thus current ratio = 40.9/ 36.2 = 1.13

The current ratio has decreased from the previous year. Hence the company will not be able to clear its current liabilities as efficiently as it did last year. The investment in handbags has reduced the current assets.

Inventory Turnover ratio: Inventory Turnover ratio shows number of times a company’s inventory is sold and replaced in a time period. It is given by Inventory Turnover = Sales/ Inventory

In the prior year,

Sales Revenue = 950 M

Inventory = 13 M

Thus Inventory Turnover ratio = 950/ 13 = 73.08

In the current year,

Sales Revenue = 975 M

Inventory = 24.2 M

Thus Inventory Turnover ratio = 975/ 24.2 = 40.29

The inventory turnover ratio has decreased from the previous year. Hence the company has increased its inventory and is unable to rotate its inventory as quickly as it did last year. The investment in handbags has reduced the inventory turnover ratio and increased inventory.

Accounts receivable turnover shows the number of times the company collects its receivables from its credit customers. It is given by Accounts receivable turnover = Net Credit Sales/ Average Accounts receivable

In the prior year,

Sales Revenue = 950 M

Average Accounts Receivable = 4.6 M

Thus Accounts receivable turnover ratio = 950/ 4.6 = 206.52

In the current year,

Sales Revenue = 975 M

Average Accounts Receivable = (4.7 +4.6) /2 M = 4.65 M

Thus Accounts receivable turnover ratio = 975/ 4.65 = 209.68

The accounts receivable turnover ratio has increased from the previous year. Hence the company has improved its collection method and is able to quickly collect the receivables compared to the last year.

Solvency Ratios of the firm: The Solvency Ratios of a firm is used to measure its ability to meet its long term debt.

Debt to Equity ratio: Debt to Equity ratio of a firm is used to measure the ratio of financing of the company using debt from creditors and investments from the investors. It is given by Debt to Equity ratio = Total liabilities/ Total Equity

In the prior year,

Total liabilities = 109 + 36.2 M = 145.2 M

Total Equity = 169.1 M

Financial Trend Analysis

Thus Debt to Equity ratio = 145.2/ 169.1 = 0.86

n the current year,

Total liabilities = 200 + 22.4 M = 222.4 M

Total Equity = 126.6 M

Thus Debt to Equity ratio = 222.4/ 126.6 = 1.75

The Debt to Equity ratio has decreased from the previous year. Hence the company has reduced the debt and raised more investment from the investors. Thus the company was able to generate investment from the investors for the new product line of handbags.

C Profitability Ratios of the firm: Profitability of a company is the capacity of the company to make profits.

Gross profit margin: Gross Profit Margin is defined as Gross Profit/ Sales. It is used to calculate the profit earned by the company after removing the cost of goods sold per unit of sales. (Chand, 2015)

In the prior year,

Gross Profit = (950 – 801) M = 149 M

Sales = 950 M

Thus Gross Profit Margin = 149/ 950 = 0.15

In the current year,

Gross Profit = (975 – 779.3) M = 195.7 M

Sales = 975 M

Thus Gross Profit Margin = 195.7/ 975 = 0.20

The Gross Profit Margin has increased from the previous year. Hence with the introduction of handbags the company’s gross profit margin has increased. Thus the company is able to generate more profits from the investment in the new product line of handbags.

Net Profit Margin: Net Profit Margin is defined as Net Profit/ Sales. It is used to calculate the profit earned by the company per unit of sales. A higher profit margin ratio is preferred as the company will have more revenues to pay its expenses. (Chand, 2015)

In the prior year,

Net Profit = 13 M

Sales = 950 M

Thus Net Profit Margin = 13/ 950 = 0.014

In the current year,

Net Profit = 52.5 M

Sales = 975 M

Thus Net Profit Margin = 52.5/ 975 = 0.054

The Net Profit Margin has increased from the previous year. Hence with the introduction of handbags the company’s net profit margin has increased. Thus the company is able to generate more profits from the investment in the new product line of handbags.

Return on Equity: Return on Equity is given by Net Profit/ Shareholders equity. It calculates the profit earned per unit of investment by the shareholders.

In the prior year,

Net Profit = 13 M

Shareholder’s Equity = 126.6 M

Thus Return on Equity = 13/ 126.6 = 0.103

In the current year,

Net Profit = 52.5 M

Shareholder’s Equity = 169.1 M

Thus Return on Equity = 52.5/ 169.1= 0.31

The Return on Equity has increased from the previous year with the introduction of the handbags.

With the inclusion of the Czech crystal bracelet in the product line in the prior year the net profit of the company was 13 Million.

Gross Profit Margin = 149/ 950 = 0.15

Net Profit Margin = 13/ 950 = 0.014

The gross profit margin of the company was 15% and the net profit margin was 1.4%. Thus it can be seen that the inclusion of the Czech crystal bracelet in the product line made the business profitable.

Assuming that in the current year the only change affecting the company’s product line sales was the inclusion of the handbag product line.

The profits have increased from 13 Million to 52.5 Million.

In the current year,

Gross Profit Margin = 195.7/ 975 = 0.20

Net Profit Margin = 52.5/ 975 = 0.054

The profits margins have improved compared to the prior year. Thus the inclusion of this product line enhance gross margin for the company.

The company’s sales are projected to grow by 10% next year.

Assuming that the increase in sales, will result in increases of all the income and expenses at the proportionate level. Thus the forecasted income statement will be

Felicia & Fred Income Statement
For the Next Period Ended	000s
	next
Revenue:	1,072,500
Less: Cost of Goods Sold	(795,960)
Less: Depreciation Expense	(61,270)
Gross Margin	215,270
Selling, General & Administrative Expenses	(64,020)
Income Before Interest & Taxes	151,250
Interest Expense	(16,500)
Income Before Taxes	167,750
Income Taxes	(77,000)
Net Income	90,750

Similarly, the balance sheet of the next year

Felicia & Fred Balance Sheet
For the Next Period Ended
	000s
Assets	next
Cash	13,200
Accounts Receivable	5,200
Inventory	26,600
Total  Current Assets	45,000
Land	55,000
Building & Equipment	660,000
Less:  Accumulated Depreciation – Building & Equipment	(413,200)
Total Long Term Assets	301,800
Total Assets	346,800
Liabilities and Stockholders’ Equity
Accounts Payable	10,100
Salaries Payable	0
Interest Payable	1,550
Short Term Notes Payable	3,500
Taxes Payable	11,000
Total Current Liabilities	26,150
Bonds Payable	109,900
Total Long Term Liabilities	109,900
Common Stock	120,000
Retained Earnings	90,750
Total Stockholders’ Equity	210,750
Total Liabilities and Stockholders’ Equity	346,800

Thus the net profit of the company will increase to 90.75 Million by the end of next year if the sales increase by 10 %.

The external financing required by Felicia & Fred next year will be the total liabilities of the company next year and investment from the shareholders.

Total liabilities = Total current liabilities + total long term liabilities = 26.15 + 109.90 Million = 136.05 M.

Additional investment from the shareholders = 210.75 – 169.1 M = 41.65 M

The company already has an external financing of 146.1 M.

Additional Total external financing required for next year = 31.6 M

The qualitative factors that should be considered by a company seeking to raise capital are:

Company Culture: The managers must consider the working culture of the company and the impact of the capital investment on the method the work is executed in the organization. With the investment in technology the flow of goods and information can be improved and changes the method of working the employees are used to. Due to Financial leverage the risk is higher and the business environment can be stressful than before. Thus it is an important factor and managers must take necessary steps to increase efficiency of the company with the capital investment.

Quality of product and service: The capital investment can help company be able to have increase in capacity to produce deliver goods and services to larger target audience. The company should take proper care that with the capital investment, the quality of the goods and services should not be decreased with the additional pressure on employees to have a farther reach and increased risk in business can cause the quality to reduce.

Working Environment Issues: The manager should consider the effect of capital investment on the environment which includes safety of the employees, effect on the working environment of the company and control the pollution which it causes taking it consideration all the stakeholders of the company.

With the increase in debt, the financial leverage of the company will increase. If the financial leverage of the company is high the cost of capital will increase as the lenders will be concerned about the future growth of the company as investment of the equity of the company is low which increases the risk of the firm. Thus the company will be more careful in choosing projects and will avoid projects which are risker and can increase the risk of the business further. (The Agency Problem)

If the cost of capital increases the shareholders are less likely to accept projects as the net profits are reduced whereas if the cost of capital decreases the shareholders are more likely to accept projects as the net profits are increased with reduced interest.

The shareholders must be concerned about the ethics of managers’ selection processes because if the managers are ethical they will not choose projects for personal benefit and will take into consideration the benefits of all the shareholders.

The qualitative considerations that are important for the mitigation of agency conflicts are

Greater Compensation: If the managers are paid highly for their work they are less likely to work for personal benefits and will reduce agency problems.

Intervention by shareholders: The shareholders should have a look at the projects and analysis the reports by managers before acceptance of capital projects.

Threat of firing: The shareholders should have strict policies in place and should remove the managers if they find him working for personal benefits instead of benefits for the form.

The different types of monitoring costs are: Cost of Board of directors, cost of issuing financial statements, and employee stock options. The monitoring activities should have meetings of the shareholders with the management and discussing the availability of funds for projects and various benefits of the projects to the shareholders. The firm should also publish financial statements so that shareholders can check the financial health of the company regularly. (The Agency Problem)

The company must have transparent decision making process so that the managers cannot have projects for their personal benefits and the company should provide them better compensation, and regularly monitor the decisions to ensure ethical project investment decisions

References

Owang, J. (2013). Major Differences Between Tactical and Strategic Intelligence. Retrieved 30 July, 2016, from https://www.web-strategist.com/blog/2013/01/14/the-difference-between-strategy-and-tactics/

Leadcapitalng. (2012). The financial characteristics of a successful company. Retrieved 30 July, 2016, from https://leadcapitalng.wordpress.com/2012/02/08/the-financial-characteristics-of-a-successful-company/

Limbacher, M. (2015). Seven qualitative factors for evaluating investments. Retrieved 30 July, 2016, from https://www.fi360.com/blog/post/seven-factors-for-qualitative-due-diligence

Investopedia. The Agency Problem. (n.d.). Retrieved 30 July, 2016, from https://www.investopedia.com/walkthrough/corporate-finance/1/agency-problem.aspx

Chand, S. (2015). Ratio Analysis: Meaning, Classification and Limitation of Ratio Analysis. Retrieved 30 July, 2016, from https://www.yourarticlelibrary.com/financial-management/ratio-analysis-meaning-classification-and-limitation-of-ratio-analysis/29418/