Overview of Facebook

1.The company which is chosen for this assignment is Facebook. Facebook is a social networking site and a social media service based company which has its headquarter in Menlo Park, California in United States. The company is engaged in providing popular social networking services to the people and the company was founded in 2004 and was founded by Mark Zuckerberg (Investor.fb.com, 2018). Thus the company is engaged in social network services industry.

2.Operating risk are those risks which affect the business and the profitability of the business due to market changes, technological obsolescence, increased level of prices and other such factors (Domokos, 2012). The operating risk factors which affect the business of Facebook are given below in brief:

1. The size of the user base of facebook is very large and in order to keep such user base satisfied the business needs to add continuously new features or introduce a new product or there is a risk of losing such customer base. In any social network providing business the number of the users of the company is very crucial for the business. In such a service industry the level of satisfaction of the users is very crucial.
2. A major part of the revenue of the company is generated through advertisements and there is a risk of losing such revenues due to advancement of digital market which provides advertisers with a range of options.
3. Another risk which the business constantly faces is the threat of competitors which are also providing more or less same services to the users. Some of the major competitors of the company are Orkut, Snapchat and others as well.
4. Facebook faces governmental regulations and even restriction in certain countries which hamper the financial status of facebook in such countries.
5. Introduction of new products in the market by facebook may be not be preferred by the users due to lack of quality standards as compared to previous products of the company. This is a risk as the user’s preferences are of main concern for the company.
6. In recent times facebook has faced security breaches where hackers have hacked the websites of the company and made away with information of the users. The company is responsible for such breaches and will have to compensate for any losses of the company.
7. The cost of the business is increasing continuously which is a risk as the company will lose its growth and profitability if such a situation continues.

3.Financial risks refers to the risks which are associated with financial condition of the business which can be risks related to loan taken by the company. Facebook faces risks of information loss (Turner, 2014). In recent times the facebook has been hacked which results in loss of information of the users as well as the company. In such a case the company sometimes need to compensate for such losses. The financial risks of the company relate to the various lawsuits, contingencies and claims for damage.  The company has terminated the long term debt services of the unsecured credit facility in 2016. 

4.A preferred stock is a class of stock which is much different from common stock and may be possess both the qualities of shares and debentures. In other words a preferred stock has more claim over the assets of the company in comparison to the common stock of the company (Kallberg, Liu & Villupuram, 2013). As per the annual report of 2016 the company has only common stocks which are distributed among shareholders.

5.As per the balance sheet of the Facebook for the year 2016 the company does not have debts and the company has terminated the unsecured credit facility and whatever the remaining debt which was used will be paid off in 2021. Thus the capital structure of the company does not have any debt capital and solely comprises of equity capital of the company (Robb & Robinson, 2014). The company also does not have any preferred stocks as per the annual reports of Facebook in 2016. The share capital of the company comprises stocks of Class A stocks and Class B stocks and the stock of the company. The company has also given shares to the employees of the company as awards during the year. The stock figure shows that the company has an additional paid up capital of $38277 million which is much more than previous year figure. Out the Class A shares 2354 million shares are issued and 2293 million shares are outstanding which includes 4 million and 5 million shares subjected to repurchase in 2016 and 2015 respectively (Brigham & Ehrhardt,  2013).

Operating Risks Faced by Facebook

6.Beta refers to the level of risks which is there in the business. It is used in the Capital Assets Pricing Method (CAPM) in order to calculate cost of equity of the business. The current Beta of Facebook incorporation is 0.57 (Finance.yahoo.com, 2018).

7.The company’s effective tax rate is 18.4% in the year 2016 and the company had an effective tax rate of 40.4% in 2015. The corporate tax rate of the company is 35% and is followed accordingly.

8.Cost of Debt refers to the cost which is incurred to maintain debt capital of the company which is useful in calculation of overall cost of capital or weighted average cost of capital. Cost of debt is calculated on the basis of interest which is to be paid on the debt after considering the prevailing tax rates followed by the business (Valta, 2012). The analysis of balance sheet of Facebook shows that the company does not have any debt as on 31^st December 2016. The company in May 2016 terminated its long term credit facility from where the company could have withdrawn 6.5 million as per the requirement and the company entered a new credit from where the company can withdraw 2 million. However the company does not have any debts for 2016. Hence the company does not have a cost of debt in its analysis.

Cost of Debt(Kd) = Interest(100-Tax rate)

9.As per the balance sheet of the company the company does not have any preferred stocks in the year 2016. The total stock of the company consists of common stocks, Class A stocks and Class B stock. These makes up the capital structure of the company as the company does not have any debt capital.

10.The cost of equity of the company shows that the company the cost of maintenance of the equity shares and also the level of return which the shareholders expects from the business. Cost of equity is calculated on the basis of capital assets pricing model which considers the market return rate and risk free rate return. This method also consider beta which refers to the risk factor of the business (Da, Guo & Jagannathan, 2012). These risks are related to the securities of the business which always have certain risk factors. The company’s market return is taken on an average and the beta is 0.57 as mentioned above.

ITEMS
Risk free Interest rate (Krf)		0.08
Beta (B)		0.57
Expected rate of market return (Km)		0.165

Ke = Krf+ B(Km-Krf)

Ke

13%

11.Weighted Average Cost of Capital measures the overall cost of capital of the company. This refers to the average rate of return which the shareholders expect from the business (Hou, Van Dijk & Zhang, 2012). In this case as the company does not have any debt capital the overall cost of capital will be made up cost of equity and cost of retained earnings. The cost of retained earnings will be calculated in the same way as Cost of Equity or in certain cases the cost of equity is taken as cost of retained earnings of the business. The cost of equity comes at 13% which will also be taken as cost of retained earnings of the business and then the combined result will be averaged to get the overall cost of capital or Weighted Average cost of capital.

Financial Risks Faced by Facebook

12.As per the analysis of the company’s stock prices in the last five years it can be said that the company is performing very well in the market (Brealey et al., 2012). The analysis show that there is a constant growth in the stock prices of the company which is an indicator that the company is focus is wealth maximisation of the shareholders and the company is achieving the same. The 2016 financial reports show that the company has market funds of $5409 million which was just $2409 million in 2015. This alone show the tremendous growth which the company has achieved. Facebook’s US government securities have also drastically increased from the previous year figures.

13.The computation of dividends of the company is done on the basis of the net income which is earned by the company which is distributed among the shareholders of the company after keeping aside a part of the profits for retained earnings (Fan, Titman & Twite, 2012). The net income which is attributable to common stockholders under class A and B are $8246 million and $1942 million respectively. On the basis of which the EPS which is calculated shows a figure of $ 3.56 which is much more than the figure years EPS.

14.The operating risks which the company faces are more as compared to the financial risks of the company. The prices or costs of the company are continuously rising which is a serious threat to the business (Osamwonyi & Asein, 2012). Moreover the level of competition in the market has increased over the years and in addition to this the company faces several law suits, damages claims and governmental regulations and restrictions in some of the countries which affects the business of Facebook. These though are not immediately pressing problems for the company at present but these if not countered can cause serious problem down the line for the company. The financial situation of the company however is looking good. The company is maximising the wealth of the shareholders as well as providing with a growing EPS for the shareholders of the company. The company does not have any debts which show that the company is under no interest burden (Aloini, Dulmin & Mininno, 2012). All the above stated facts are positive indicators which show the financial risks in the company currently is minimum. The overall analysis show that there does not exists any significant risks either operational or financial in nature.

14.Any investor will be interested in investing in the company as the company is showing growth trends with adequate dividends and more or less controlled risks. Therefore the investors should definitely invest in the company
 

References

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Brigham, E. F., & Ehrhardt, M. C. (2013). Financial management: Theory & practice. Cengage Learning.

Da, Z., Guo, R. J., & Jagannathan, R. (2012). CAPM for estimating the cost of equity capital: Interpreting the empirical evidence. Journal of Financial Economics, 103(1), 204-220.

Domokos, L. (2012). Operating Risks and the Increasing Indebtedness of Hungarian Local Governments. Audit Experiences of the State Audit Office of Hungary. Public Finance Quarterly, 57(2), 155.

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Hou, K., Van Dijk, M. A., & Zhang, Y. (2012). The implied cost of capital: A new approach. Journal of Accounting and Economics, 53(3), 504-526.

Kallberg, J., Liu, C. H., & Villupuram, S. (2013). Preferred stock: Some insights into capital structure. Journal of Corporate Finance, 21, 77-86.

Osamwonyi, I. O., & Asein, E. I. (2012). Market risk and returns: Evidence from the Nigerian capital market. Asian Journal of Business Management, 4(4), 367-372.

Robb, A. M., & Robinson, D. T. (2014). The capital structure decisions of new firms. The Review of Financial Studies, 27(1), 153-179.

Summary for Facebook, Inc. – Yahoo Finance. (2018). Finance.yahoo.com. Retrieved 19 January 2018, from https://finance.yahoo.com/quote/FB?p=FB

Turner, P. (2014). The global long-term interest rate, financial risks and policy choices in EMEs.

Valta, P. (2012). Competition and the cost of debt. Journal of Financial Economics, 105(3), 661-682