Assessing The Viability Of FBA’s Ice Cream Project

Requirement a

Requirement a

As per the case, FBA is a food processing firm which is looking to establish its own ice cream business for which the management anticipates that positive cash flows would be generated. The project would be requiring an initial investment of $500,000 and the management intends to finance the project entirely by using equity capital. In addition to this, the discounting rate which is considered for the project is around 12% and relevant calculations for assessing the viability of the project is presented below:

The table which is presented above shows that the project being considered will be able to generate positive cash flows and further the NPV calculated for the project is shown to be positive. This is a clear indicator that the business would be able to make profits from the project and consistent cash inflows can be generated from the operations (Marchioni and Magni 2018). Therefore, it is advisable to the management to accept the project considering the NPV computed and the positive cash flows which is estimated.

Requirement b

As per the case, the in-house business analysts for the business suggests that the business utilizes Gelateria’s discount rate as a benchmark for estimating the viability of the Ice Cream. As per the financing option which Gelateria follows, the management utilizes only equity capital. In order to assess the viability of the project considering the benchmarks, NPV is computed for the project as shown below:

The table which is provided above appropriately shows that the cost of capital is computed which would be the discounting factor considered for computing the NPV for the project (López-Marín et al. 2020). The cost of equity which is also the cost of capital is computed utilizing the Capital Asset Pricing Model and the estimate comes around 15%. On the basis of the same, the NPV for the project is computed to be $ 42,533 which signifies that the business would be able to generate appropriate cash flows from the project in future and the cash inflows which the project generates is also quite consistent. In an overall basis, it can be said that the project can be accepted.

As per this scenario, the in-house analysts is confident regarding the 3% growth in cash flows in the first three years and then he estimates that the project would not be able to generate any further growth. On the basis of such a scenario, analysis needs to be undertaken regarding the viability of the project and thereby NPV needs to be computed accordingly. The computation undertaken to assess the viability of the project is listed below:

The above table shows that the NPV computed for the project is positive and expected cash flows which can be generated from the project is appropriate (Benamraoui et al. 2016). The results of NPV signifies that the project is that much profitable that it would generate proper returns even if there is no growth after the first three years of implementation. In an overall basis, it can be suggested that the management should accept the project and achieve a higher rate of growth from its operations.

Requirement b

Requirement a

As per the case, the business of DublinTech is an all-equity firm which has a cost of capital of 10%. The business is looking to appropriately value it stocks so that appropriate decisions can be taken regarding the business operations. In order to estimate the value of shares of the company, Dividend Discount Model is applied which can effectively estimate the value of shares of the company. The computation for the same is shown below:

The dividend discount model operates with the principle that the value of the shares can be computed by considering the sum of future value dividends estimated in present value terms. The table above shows that the business has an earnings per share of $ 2 and it has a dividend payout ratio of 100%. The value of stock is computed considering the cost of capital of 10% and the expected dividend per share $ 2. On the basis of the calculation, the value of stock for the company is estimated to be $ 20. The estimated price for the share can be considered as an appropriate indicator for investors to take decisions as to whether they should make investment in the company or not. One aspect which needs to be considered by investor is that DDM approach does not provide accurate results regarding the value of shares for the company (Ivanovski, Ivanovska and Narasanov 2015). Further, DDM approach is more useful for companies which are looking to offer higher rate of dividends to the investors and then only accurate estimation can be made regarding the value of company. Further DDM model can also be used by business for ascertaining their own valuation and take major decisions for the company in terms of merger or acquisition. In an overall basis, the business of DublinTech should consider its own share value at $ 20.

Requirement b

As per the case, the business of DublinTech is looking to make changes to its dividend payment policies so that proper control can be maintained over the profits. The management of the company intends to change the dividend payout ratio to 60% and it is to be considered that the same would also affect the share valuation under the DDM approach (Sim and Wright 2017). Further, the management anticipates that the business would be generating a return on investment of 15%. The relevant computation under DDM approach is appropriately shown below:

The above table shows that dividend payout ratio has altered to 60% which means that the business is looking to retain a portion of the earnings per share as retained earnings and rest is offered to the investors in the form of dividends. The value of stock which is computed under this approach is shown to be $ 8. The analysis makes it clear that change in return on investment and dividend payout ratio for the business has significant impact on the valuation of stock for the business. The management of the company needs to consider the change in the dividend payout ratio and estimate whether the same would remain consistent in future as well or not. The approach in this scenario for the business is keep aside some portion of earnings so that a level of liquidity is maintained in the business operations (Lazzati and Menichini 2015). One of the reasons due to which the accuracy of the DDM approach is questioned is due to the fact that fluctuations in dividends can affect the valuation of the shares of the company. Therefore, in an overall basis, it can be said that DublinTech can anticipate the actual value of the share price to be $ 8. The management can take appropriate decisions on the basis of share price of the business regarding the approach which the company would be following in future.

Requirement c

Requirement a

The trade-off theory of capital structure states that the management makes an attempt to balance the benefits of interest tax shields against the present value of possible costs of financial distress. The theory states that the management should make an effort to formulate their capital structure in such mix of equity and debt capital so that costs and benefits can be balanced properly. The trade-off theory says the cost of debt is always lower than the cost of equity because tax can be deducted from the interest on debt (Adair and Adaskou 2015). The proportion of debt which is used by the management would be depending on the distress costs as well and this would be affecting the tax shield (Nicodano and Regis 2019). In the same manner, the signaling theory of capital structure states that all parties do not have access to all information at the same time and therefore the capital structure which the firm uses provides a signal to the market (Shahar et al. 2015). The theory appropriately measures the behavior of the managers in the scenario where the stocks are overvalued or undervalued. For instance, if a stock is overvalued, the management would issue new stock to finance new projects and if the stock is undervalued than the management would be using debt to finance new projects. Therefore, it is clear that capital structure decisions are influenced by the market valuation of the stocks and accordingly future of the business is decided.

Requirement b

In the scenario, where a business takes excessive debts that agency costs of the leverage might arise in the form of excessive risk taking by the firm and engaging in over-investment. The equity holders in such a scenario are basically playing with the money of the debt holders and this becomes especially risky when the business is facing a financial distress situation. The equity holders in such a situation can benefit by taking negative NPV projects and taking on risky investments while the debt holders might suffer in such scenario. The management of the company would also undertake investments to increase the value of the investors while not considering the need of the debt holders. In the same manner, underinvestment situation arises when equity holders do not want to invest in the project of the business even if the NPV for the same is positive as they do not want to accrue the benefits if the investments debt holders. In such a scenario, the company is usually in a financial distress situation and efforts are being made to reformulate the capital structure so that the overall financial situation of the business improves. In order to avoid both the situations mentioned above, it is imperative that the business formulates an optimum capital structure which is a mixture of both equity and debt capital in the right proportion. An optimum capital structure appropriately balances the risks and return relationship and allows the management every opportunity to thrive.

Requirement a

The share repurchase program is an alternative way to pay cash to investors and the management of the company utilizes its own cash accumulated to purchase its own outstanding stocks. As per the case of KSA, the management has accumulated significant amount of cash and is looking to make a repurchase of its stock. The rational which can be identified for the management of KSA is to pay cash to the shareholders and this is a more effective as the overall shareholdings gets reduced and further this does not affect the stocks prices.  The management might also be looking to regain a portion of the ownership back so that control can be reinstated to some extent. The signal which the repurchase program would sent is that it would provide an opportunity for the investors who are looking to get cash immediately, have an option out (Cain et al. 2017). Further it would also give an idea to the investors that the management of the company is looking to consolidate its shares and further distributed the excessive cash among the remaining investors. Further the stock price of the business would not be affected due to the repurchase program and thereby the business can operate in a transparent manner. The most important point for the repurchase program is that it would return the control of the business and ensure that efficiency is achieved. The cash which is paid to the investors are called homemade dividend and this earnings would keep the investors happy.

Estimating the Value of DublinTech’s Shares

Requirement b

Hostile takeovers are serious concerns for small companies and therefore certain strategies are available to the management which can be used as defenses against hostile takeover. The three defenses which can be suggested for ensuring a hostile takeover is avoided are appropriately listed below in details:

• Poison Pills: This is a major defense against hostile takeover and the method allows the investors to acquire shares in the acquirer or Target Company at a deep discounted price. This is a strategy which dilutes the shareholdings of the acquirer or the hostile company. This strategy makes the takeover assessment quite unattractive as the major shareholdings of the company is diluted(Kay 2018).
• Golden Parachute: As per this strategy, the senior management of the target company is given an attractive severance package so that the senior management get attractive offers in the scenario that they are being laid off. This is a strategy which protects the interests of the senior management of the target company and in many situations the golden parachute has such offers which can have an effect on the merger agreement which is being considered(Puchniak and Nakahigashi 2018).
• Recapitalization: One other effective strategy which is considered against hostile takeover is recapitalization where the capital structure of the business is altered so that the operations of the target company looks less attractive. For instance, the management of the target company might choose to issues debts and engage in repurchase agreements in order to ensure that the attractiveness of the company is reduced. With more issuance of debts, the overall leverage position of the firm would enhance and the financial distress for the company would also increase.

Requirement a

Dividend policies in the real world are considered to be important as it is a means of providing returns to the investors and further can be used as a device to attract more investors. As per the research survey undertaken by Lintner (1956), dividend policies are sticky and are tied to the long term sustainability of the business. Further, the research showed that dividend decisions send a positive message to the investors and demonstrates the overall financial strength of the business (Guirguis 2021). The survey results shows that dividend policies not only attracts the investors of the business but also the institution itself. Many respondents who were executives of the survey stated that dividend payout policies demonstrates the overall accountability of the firm and provides message regarding the overall performance of the business during the period. The survey undertaken which considers 28 companies and executives responses show that 85% of such executives believe that reducing the dividends of the business have a negative impact on the operation and future growth of the company. It is therefore preferred by most of the executives to follow a conservative approach so that efficiency and transparency can be maintained. The analysis of the case shows that majority of the executives also believe that regular flow of dividend can keep the investors satisfied and also help the management to estimate the future earnings of the business. Therefore, it can be said that dividend payout proportion is very important in the modern business environment as they help to placate the expectations of the investors.

Requirement b

The use of repurchase option of shares is another viable option for the management to ensure that surplus cash which is accumulated is paid to the investors and some proportion of the shares are repurchased. The option is considered to be appropriate as this is also a return to the investors and is often termed s homemade dividends. The research which is undertaken by Lintner (1956), appropriately shows that majority of the executives believes that accumulated cash for the business is utilized firstly for reducing the debt of the business and then the same can be utilized for repurchase arrangements (Andriosopoulos and Lasfer 2015). Further, it is the belief of several executives that repurchase arrangements are not a conservative strategy as dividends and therefore most of the managers are willing to reduce their repurchase but not their dividend payouts. Further one of the main reasons why management utilizes repurchase agreements is to defend the company against any form of hostile takeover. One of the main advantage which can be identified for repurchase arrangements is that the management can regain the control by buying off the shares and this would improve the decision making process and achieve transparency in their operations. The management of the company can still demonstrate to the investors that the company is looking after their needs as and provide an option to the investors to sell off their shares. Therefore, it can be said that repurchase decisions can be taken for ensuring that proper control is regained in the business operations and a level of stability is achieved.

Requirement c

One of the main reasons why shareholders engage in investment activities is to get an appropriate share of profit which the company earns. The share of profits which the business generates is provided to the company in the form of dividends. The dividend policies are expected to have an effect on the investment decisions of an investors. It is has been seen in different studies that dividend payout ratio and history are considered by investors to assess whether the business would be able to meet their expectations. In addition to this, a business which regularly pays its dividends often attract more investors and positive notion is signaled to the market. Companies which can regularly provide dividends can be viewed as profit making concerns and it is natural that investors would be more attracted to such businesses. From an investors point of view regular return on the investment is a sign that the company is performing well and is looking after the needs of the investors and thereby is following wealth management practices. In the case of repurchase policies, the investors have the options to sell their shareholdings but most of the investors might not be inclined to sell of their shareholdings as they are owners of the business. Repurchase of shares option dilute current holdings and some investors might want to hold the shares for a longer period and therefore such an option is much preferred. Therefore, it can be said that dividend policies are more preferred by investors in comparison to repurchase policies.

Requirement d

As per the case, a company which pays its dividends on a regular basis is recognized as a profit making concern and investors are attracted to such a company. In case of two company which has the same assets and debt position, the dividend payout ratio would definitely be one of the criteria which the investors would consider for taking important investment decisions. The investors could be considering the approach of the management in terms of dividend payments and consistency of the same so that future decisions can be taken. Further, the dividend payments can also be used by investors for applying forecasting models for estimating the growth which the company can achieve in long run. Therefore, it can be said that dividend payment history and ratio has a significant effect on the stock valuation of the business in the market. For instance, a company which has positive history of paying dividends would be recognized by the investors as a profitable investment choice and this would also improve the reputation of the business in the market. Therefore, it can be said that dividend payment history and ratio which the business maintains can be a differentiating factor affecting the decision of potential investors in the market.

The analysis which is presented below appropriately shows the performance for the business of Apple Inc. over the years and measures the appropriate value of stocks so that investors can take appropriate decisions. The analysis presented below utilizes Dividend Discount Model approach and Relative valuation model for estimating the stock value of the business. It is on the basis of the value computed that comparisons can be made for taking viable decisions for the future. The analysis recommends that the investors should undertake investment in the operations of the business as the future of the company is bright.

The main purpose of the assessment is to analyze the capital structure of Apple Inc. and assessment whether the stocks of the company is appropriately valued. In order to undertake the analysis, different valuation methods are used to assess whether the stocks of the company are valued properly or not. The analysis would be reviewing the capital structure of the business as well so as ascertain the policies which the business follows in terms of capital structure management.

Apple Inc. originated in the year 1946 and was founded by Ronald Wayne, Steve Jobs and Steve Wozniak (Forbes 2022). The company started off its operations by selling personal computers and since then the business has diversified its product line offering products like smartphones, laptops, personal computers, tablets, wearable’s, accessories and a wide variety of related services (Finance.yahoo.com 2022). The company is regarded as the largest information technology organization on the basis of revenue generated as per data of 2021. The company is publically listed on the Nasdaq Stock Exchange also forming a constituent of Nasdaq-100, DJIA, S&P 100 and S&P 500 component (Investor.apple.com 2022).

One of the current issues which the management of Apple Inc. faced was the trade restrictions which was placed across the globe for COVID 19 pandemic. The business was able to stabilize its operations but the overall growth rate of the company declined. In addition to this, the business further has faced criticism from government of different countries that the management of Apple has used its dominant position in the market to choke out the competition. It is for such a reason that anti-competitive regulations have been mostly applied to the business. In addition to this, the issues are expected to continue in the future period as the level of competition in the market is also a concern (Forex.com 2022). In an overall basis it can be said that proper strategies needs to be formulated so that overall stability can be maintained in the organization.

In order to ensure that investment decisions are appropriately taken by the investors, it is imperative that stock valuation of the company is also assessed along with the financial performance of the business. For the purpose of estimating the stock values of the business dividend discount model and relative valuation models are applied and the results of both the valuation method would be compared so that proper recommendation can be given to the investors regarding their investment decisions. In order to apply stock valuation models, cost of equity and dividend payout ratio for the company is to be estimated. The calculation for the same is projected below:

The table which is presented above appropriately shows the cost of equity of the business which is 9.98% which is computed considering the CAPM model which considers Beta, risks free rate of return and market premium. In addition to this, the table further considers dividend which the company has paid over the last five years to estimate the average payout ratio and growth rate for the company. This is done so that proper estimation can be made regarding the value of the stocks and investment decisions can be taken by the investors. 

Application of Relative Valuation Model

The first table which is projected above shows the application of Dividend discount model which is effectively used for ascertaining value of stock for the company. The dividend discount model considers the dividend paid by the company over the last few years in order to estimate the future earnings of the business. It is on the basis of the dividend paid in 2021 that the computation forecasts the dividend which the business can pay in future up to 5 years. This is computed considering the current dividend paid in 2021 and estimated dividend growth over the last five years. Therefore the value per share is estimated to be 29.44 while the actual market price per share is $ 146.92 per share. On an overall basis, it can be estimated that the stock of Apple Inc is overvalued immensely as per DDM model.

In the same manner, the relative model of valuation appropriately considers the earnings per share of competitors of Apple Inc. like IBM, Microsoft and Samsung. The analysis considers the earnings of the competitors to estimate the value of the stock of Apple Inc. which is computed to be $ 719.61 while actual market value of the stocks are $ 146.92 per share. The method appropriately shows that the stocks of the business are considerably overvalued. The investors of the business needs to consider such a fact before undertaking any investment decisions in relation of the same.

In comparison between the two methods which are considered, DDM approach is expected to provide a more accurate result as it is based on the dividend payout ratio of the company itself. In addition to this, the DDM approach can be considered to be more systematic in nature which ensures that a level of accuracy is maintained in the calculation process. The comparison shows that the market value of the stock is quite higher than actual value of stock as per DDM approach which means that the investors in the market are willing to invest in the company for generating appropriate returns. In addition to this, the investors can rely on the stock market value the company considering the past performance and dividend history of the company. Therefore, it can be said that the investors can rely on the results of valuation and compare with the market price of the business to take appropriate investment decisions. 

The capital structure of the business covers the proportion of debts and equity the business utilizes and this provides an indication regarding the risks and returns which the business is able to generate. It is to be noted that for a business it is imperative that a proper capital structure is maintained for ensuring solvency and also maintaining the risks which is associated with excessive use of debts.  In order to assess the capital structure for the business of Apple Inc., the financial reports for the company is assessed for 2021 specifically, the balance sheet. The equity which is used by the business amounts to $ 63,090 million and this has decreased from 2020 estimate of $ 65,339 million. In terms of debts, the business currently possess as debt of $ 109,106 million which is more than previous period figure of $ 98,667 million. This shows that there is an increase in the usage of debts by the business in 2021 which can be due to the pandemic situation or for undertaking a new project. On the basis of the capital structure which the company has in 2021 and past year, it can be said that the management of Apple Inc. relies more debt capital than equity capital and thereby maintains a higher proportion of debts in the business.

Conclusion and Recommendation

The above analysis appropriately shows the valuation of stocks for the business of Apple Inc. under two different valuation techniques. The business of Apple Inc. has consistently maintained its financial performance over the years and this makes the stocks of the business quite attractive for investment purposes. The results of the valuation methods shows different results. As per DDM approach, the stocks of the business is undervalued and as per relative valuation method, the stock of apple is undervalued. In addition to this, the analysis above shows assessment of the capital structure of the company which shows high percentage of debts are used by the management. However, considering the effects of pandemic and numerous investments which the business undertakes, debt might be an appropriate choice to fund its activities. Therefore, it can be recommended to the investors that stocks of Apple Inc. should be purchased as the value for the same can be expected to grow further in the market.

Requirement a

Part i

The table which is presented above appropriately shows the bifurcation of costs of head office on the basis of sales figures achieved by the stores. The operating profit which is computed shows considerable difference in the profits of Store A in comparison with Store B and Store C. This is mainly due to the allocation of the indirect head office costs to individual store’s costs. The allocation techniques which the management has applied is not appropriate considering the fact that indirect costs has affected store B &C more in terms of profits. This is the main reason that the managers of the stores are dissatisfied with the allocation of costs. It is to be noted that Store A produces maximum revenue and therefore it is quite possible that the resource allocation for Store A is much more than other stores and therefore the costs allocation technique needs to consider this aspect as well.

Part ii

The above table appropriately shows allocation of costs of head office on the basis cost drivers which are the key activities of the business. In the above table, the management of the company utilizes ABC method and accordingly it is clear that the operating profits are different than original method which was used. Therefore, it can be said that the table provides an accurate picture of costs allocations and estimation of net profits.

Part iii

As per the case of Tayles Co, the management has three stores and a head office which controls the entire operations. Earlier in order to determine the profitability of each stores, indirect costs of operations were allocated on the basis of total sales achieved by the stores. However, due to the dissatisfaction of the store managers, the management decided to allocate the costs on the basis of ABC system. The computation under the two system shows that ABC method can provide an accurate picture of the costs of each stores and accordingly the management can estimate the profitability from each of the stores. The analysis further shows that the management can take decisions on the bass of actual results which ABC method of costing provides and make subtle improvements in the business so that long run operations can be optimized. The costs structure also gets improved under the ABC framework and therefore the business can maintain accountability under such a costing approach.

Requirement b

Strategic management accounting process allows the management to engage in planning actives as well controlling the performance so that a level of efficiency is achieved in the business operations. For a retail sector as well, strategic management accounting can be used for planning the capacity of inventory which needs to be maintained, ensuring that the costs of the business are properly controlled and further implementing performance management systems. For instance, a retail store can use ABC approach for ensuring that the costs are bifurcated in terms of appropriate cost drivers which would improve the cost management system of the business. In addition to this, the stores can use tools like benchmarking and budgeting approaches to develop competitive advantage and at the same time control the costs and flow of cash from the business. Benchmarking tools can allow the stores to assess the pricing strategies of its competitors and implement the same so that competition can be negated (Turner et al. 2017). Further there are certain performance management tools available in the market such as lean systems which not only improves the operational structure of a business but also helps the management develop a competitive edge in the market. In an overall basis, it can be said that Strategic management accounting tools have widespread implications on retail businesses as well and can benefit such businesses.

Requirement a

Part i

Part ii

The above analysis appropriately shows the financial viability of the three divisions which are considered in terms of return on investment, residual income and EVA for the divisions. The return on investment is considered to be one of the main indicators depicting financial success and the same is closely considered by management as well as investors for taking vital future decisions. As per the, X division shows the highest return on investment in comparison to other two which signifies that in terms of profit generation X division would be most appropriate. Residual income appropriately considers the economic profit which is generated from the divisions and this profit is estimated after considering the opportunity costs of the business. In terms of residual income, Division Z has the highest figure which clearly shows that opportunity costs in such a division is lower than the other two divisions. Another important parameter which is considered for the analysis is EVA which shows how profitable the business or division is and how effectively the management utilizes such a segment. The table which is presented above appropriately shows that X division has a positive EVA while Y division and Z division has negative EVA. In terms of EVA, X division is more superior to the other two divisions and this is an indication that the management should focus more on X division as it has higher return on investment and also a positive EVA. It is thereby recommended that proper resource allocation is required to be made to ensure efficiency is achieved in the operations.

Requirement b

The transfer pricing policies for a business reflect cross border intra group transactions which can be for products, services, finances and technology. One of the main principle of transfer pricing is that the transactions operate at arm’s length price and this is predefined by the senior management of the companies engaged in trade. It is imperative for the MNC to ensure that the arm’s length price is appropriately formulated considering the current market conditions. In addition to this, the price needs to be dynamic in nature so that any changes can be incorporated and efficiency can be achieved in the operations. The arms lengths prices are determined by the parties who are involved with the agreement and this significantly helps in maintaining transparency in the operations.

In most cases, businesses tend to maintain a complex transfer pricing system as they are of the belief that it would be more accurate and effective and the management estimates that they will be able to instill level of flexibility so that changes in international markets can be accommodated.

Requirement c

Balance scorecard is an effective tool which is used in management accounting for planning and controlling the activities of the business. Balanced scorecard as a tool is considered to be dynamic as it covers four perspectives which are key areas of business performance. Balance scorecard allows the management to set KPIs on the basis of the perspective and on the basis of the same actual performance of the business can be measured (Madsen and Stenheim 2015). The first perspective is the financial perspective and it deals with the overall financial performance of the business. The management can set KPIs such as increase in sales, higher profit margins and appropriately follow them to optimize the overall performance of the business. The second perspective is customer perspective which deals with the overall needs and opinions of the customers and also provides insights regarding whether the product or services offered by the business is creating value for the customers or not. In such a perspective, customer retention and satisfaction can be important parameters (Hasan and Chyi 2017). The third perspective which is considered is internal processes perspective wherein the management needs to consider the efficiency of the internal processes and how well policies are implemented in the business. In such a perspective, the parameters which are considered are employee’s efficiency and loyalty. The fourth perspective which is covered in a balanced scorecard is learning and growth perspective which allows the management to oversee the technology advancements and training programs which is undertaken by the workforce so s to enhance the overall efficiency of the business. The four perspectives which are stated are so much effective that it can create competitive advantage for the business in long run while improving day to day operations of the company. 

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