Principles Of Corporate Finance: Hospitality Industry Essay

Question:

Write about the Principles of Corporate Finance for Hospitality Industry.

Answer:

Introduction

Background and profile description of acquirer firm and its industry

As our company is in hospitality industry, the name of our hotel is 18x hotel and currently ranking at top 10 five-star hotels in Malaysia. Our hotel boasts 43 eloquently decorated rooms equipped with everything to make your stay a special one. All rooms offer; flat screen TV's, Hair Dryers, Ironing Facilities and were designed with your comfort in mind. We also offer two Superior rooms that simply add that extra touch to your stay. Free Wi-Fi is available throughout the Hotel and free onsite car parking for all guests.

Our main target market is tourist on holiday season because on holiday peak is where most of the people will travel; and thus we provide promotion and discount. Second, we also targeted business man, if they stay our hotel, we provide meeting room and package for business trip, for example, business related trip longer than 1month we provide lower rate compare to normal rate.

Background and profile descriptions for the target firms

In view of the success we achieve in the hospitality industry, our company intends to acquire a firm of different industry in order to venture in new market and risks diversify. So we target two company, they are caring pharmacy and nestle.

Caring Pharmacy SdnBhd is a group of pharmacies under one banner collectively shares the same supply and inventory management similar to that of chain stores; however each outlet is independently owned and operated by pharmacists. Caring pharmacy provide 12 hours a day, 7 days a week full time pharmacist service. It also providing easily accessible pharmacist counseling service, free blood pressure checks and other health checks at a minimum fee. Besides that, Caring pharmacy designing the store with a modern, open concept to maximise interaction with customers and merchandise. As at April 2017, Caring has 97 pharmacies nationwide. In terms of number of outlets, Caring is ranked third after Cosway and Guardian, with an estimated market share of 4%. No single operator controls more than 7% of the market. Within the Klang Valley, Caring has a share of 8% (Annual Report 2017, Caring Pharmacy).

Nestle is the biggest nutrition and foods company in the globe, established his headquarter in Vevey, Switzerland. As Nestle global business portfolio includes a wide range of brands from food and beverages to health care nutrition, skin health and petcare. Their portfolio covers almost every food and beverage category offering products and services for all stages of life, for example, NaturNes, Nesturn, Milo, Nestea and etc. Every moment of the day, helping people care for themselves and their families (Annual Report 2017: Nestle Group).

Comparison of financial performance and position of the two target firms

Financial Strengths and Weakness of the firms from various perspectives

Ratio Analysis

Profitability Analysis

Profitability Ratios

Ratios/Company Name

Caring Pharmacy

Nestle Group

Years

2016

2017

2016

2017

Gross Profit Ratio

17.47%

23.30%

50.60%

49.97%

Net Profit Ratio

1.86%

4.17%

9.54%

8.00%

Return on Assets

3.87%

6.85%

6.47%

5.51%

return on Equity

6.86%

12.39%

13.21%

11.68%

Profitability analysis is carried out for determining the amount of profits generated from both the potential companies to be acquired. The profitability analysis of both the companies sis carried out through the use of the following ratios:

Gross Profit Ratio: It depicts the relation between the gross profit and total net sale revenue and thus provides an analysis into the operational performance of the companies. It is calculated as follows:

Gross Profit Ratio=Gross Profit/Net Sales (Brealey, Myers and Marcus, 2007)

It can be stated from the calculation of gross profit ratio of both the companies that Caring Pharmacy gross profit has increased from the year 2016 to 2017 but has been declined for Nestle Group.

Net Profit Ratio: It depicts the profitability position of a company after meeting all the operational expenses and is calculated as follows:

Net Profit Ratio=Net Profit after tax/Net Sales

The net profit ratio of Caring Pharmacy has increased from 1.86% to 4.17% between the financial years 2016-2017 but for nestle it has shown a decreasing trend from 9.54% to 8% for the same time period (Annual Report 2017: Nestle Group).

Return on assets (ROA): The ratio provides an analysis of the efficiency of the company to realize profits from utilization of its assets and is calculated as follows:

Return on Assets=Net Income/Total Assets

The ROA ratio Caring Pharmacy has shown a positive trend from the financial year 2016 to 2017 from 3.87% to 6.85% and for Nestle has depicted a declining position from 6.47% to 5.51% for the same financial years.

Return on Equity (ROE): It measures the ability of a corporation to generate profit from the money invested by shareholders. It is calculated as follows:

ROE=Net Income/Shareholders Equity

ROE ratio for Caring Pharmacy has depicted a positive growth from 6.86% to 12.39% and for Nestle has depicted a decreasing trend from 13.21% to 11.68% (Annual Report 2017: Nestle Group).

Therefore, it can be said from the profitability analysis of both the companies that the financial strength of Caring Pharmacy is its good profitability position while the financial weakness of Nestle is its declining profits (Annual Report 2017, Caring Pharmacy).

Liquidity Analysis

Liquidity Ratios

Ratios/Company Name

Caring Pharmacy

Nestle Group

Years

2016

2017

2016

2017

Current Ratio

2.08

2.01

0.85

0.89

Quick Ratio or Acid Test Ratio

1.03

1.13

0.63

0.64

Working Capital Ratio

94236.00

102241.00

-5475.00

-3864.00

The liquidity analysis helps in predicting the ability of a company to meet its financial obligations. The following ratios are calculated for assessing the liquidity position of both the companies:

Current Ratio: It provides a measure of the ability of a company to meet its liabilities with its assets and thus provides an estimate of its financial position. The ratio can be calculated through the use of the following formula:

Current Ratio=Current Assets/Current Debts

The current ratio for Caring Pharmacy has decreased somewhat from the year 2016 to 2017 but for Nestle Group has shown a positive growth (Annual Report 2017: Nestle Group).

Quick Ratio: The ratio provides a measure of the ability of a company to meet its short-term liabilities and the formula used for its calculation is as follows:

Quick Ratio= (Current Assets-Inventories)/Current Liabilities (Brigham and Michael, 2013)

The quick ratio of both the companies is showing positive growth from the financial year 2016 to 2017.

Working Capital Ratio: This liquidity ratio assesses the comparison of the current assets of a company in relation to the current liabilities and is calculated through the following formula:

Working Capital ratio=Current Assets-Current Liabilities

The working capital ratio for Caring Pharmacy has increased from the financial year 2016 to 2017 but the working capital position of nestle is not good as it is having negative working capital (Annual Report 2017: Nestle Group).

It can be stated from the liquidity analysis that Nestle financially weakness is its negative working capital and that is it is not able to meet effectively its current assets from current liabilities. However, the financial strength of Caring Pharmacy is its positive working capital that means it is having good liquidity position in comparison to Nestle (Annual Report 2017: Nestle Group).

Asset Management Efficiency Ratios/Turnover Analysis

Asset Management Efficiency Ratios/Turnover Ratios

Ratios/Company Name

Caring Pharmacy

Nestle Group

Years

2016

2017

2016

2017

Inventory Turnover Ratio

5.04

4.52

10.65

9.91

Receivables Turnover Ratio

473.21

557.57

8.93

7.23

Total Asset Turnover Ratio

2.08

1.64

0.68

0.69

The asset management efficiency ratios are used for analyzing whether the companies are using their assets effectively for generating sales. It is analyzed through calculation of the following ratios:

Asset Turnover Ratio: It is an efficiency ratio used for measuring the ability of a company to generate sale from the assets and is calculated through the use of following formula:
Asset Turnover Ratio=Net Sales/Average Total Assets

The asset turnover ratio of Caring Pharmacy has decreased from the financial year 2017 to 2016 but for Nestle group has been increased (Annual Report 2017, Caring Pharmacy).

Inventory Turnover Ratio: It measures the efficiency of a company to replace its inventory and is calculated through the use of following formulae:

Inventory Turnover Ratio=Sales/Average Inventory

The inventory turnover ratio for both the companies has decreased from the financial year 2017 to 2016.

Receivables Turnover Ratio=It is an activity ratio used for measuring the efficiency of a company to use its assets and is calculated through the following formulae:

Receivable Turnover Ratio=Net Value of Credit Sales/Average Accounts Receivable

The receivables turnover ratio for Caring Pharmacy has increased from the financial year 2016 to 2017 but has been decreased for Nestle for the same period.

Thus, it can be said from the analysis of the asset management efficiency ratio’s that the financial strength of Caring Pharmacy is its higher efficiency in collecting the accounts receivables in comparison to Nestle. However, its financial weakness is that it is not able to utilize effectively its assets to generate sales in comparison to nestle. Also, the financial weakness of both the companies is their less capability to replace inventory that can increase their operational cost and decline profitability.

Long Term Financing and investment decisions of target firms

Every company depends upon two main type of financing source, debt and equity. Debt capital refers to those financing capitals that bears fixed charge on the profits of company and have to be paid at regular interval while equity capital refers to owner’s capital which is financed through issues of common equity shares. In order to evaluate the long term financing and investment decision it is important to look after the debt equity ratio, debt to total asset ratio and interest coverage ratio for both the firms for last two years.

Long Term Financing Decisions

Ratios/Company Name

Caring Pharmacy

Nestle Group

Years

2016

2017

2016

2017

Debt equity ratio

0.60

0.65

0.17

0.26

Debt to total asset ratio

0.34

0.36

0.08

0.12

Interest coverage ratio

67.12

176.62

17.53

13.31

(Annual Report 2017: Nestle Group) and (Annual Report 2017, Caring Pharmacy)

Debt-Equity Ratio: The ratio is used for measuring the proportion of debt and equity used by a company for financing its assets. The debt-equity ratio is calculated through the formula as follows:

Debt-Equity Ratio=Debt/Equity

The debt-equity ratio of both the companies is increasing and therefore it can be said that they are using larger proportion of debt in comparison to equity for financing their assets.

Debt to total asset ratio: The ratio is used for assessing the proportion of debt used by the company in comparison to the total assets. The debt to total asset ratio has increased from 2016 to 2017 for both Caring Pharmacy and Nestle. Therefore, it can be said that both the companies are adopting high use of financial leverage in financing their assets.

Interest Coverage Ratio: The interest coverage ratio is used for determining whether a company can easily meet their expenses on outstanding debt. It is calculated through the use of formula:

Interest Coverage Ratio=EBIT/Interest Expenses

The interest coverage ratio of Caring Pharmacy has increased from the financial year 2017 to 2016 whereas for Nestle has decreased significantly. Therefore, it can be said that Nestle is not able to meet its interest expenses on outstanding debt appropriately whereas Caring Pharmacy ability to meet interest obligations is appropriate. This is largely due to larger amount of debt used by the company for funding the opening of its new assets such as KIT KAT Chocolatory. Therefore, the presence of high debt on Nestle has caused a significant increased in its interest expenses to which the company has faced somewhat difficulty in meeting up appropriately at present.

Distribution Decisions made of the target firms

As both the firms belong to different industry and different target market, therefore there can huge differences between the distribution decisions of both firms. In order to evaluate the distribution decision it is important analyse the earning per share, dividend per share, payout ratio and other corporate exercises followed by both the companies. Following is the information of all the required data we need to make analyse:

Distribution Decisions

Ratios/Company Name

Caring Pharmacy

Nestle Group

Years

2016

2017

2016

2017

Earnings Per share

0.03

0.06

2.75

2.32

Dividend Per share

0.02

0.01

2.23

2.29

Payout Ratio

60.60%

28.40%

79.80%

76.40%

(Annual Report 2017: Nestle Group) and (Annual Report 2017, Caring Pharmacy)

Earnings per Share: The EPS ratio ensures the amount of earning generated by a company in relation to the money invested by shareholders and therefore it can be said that Caring Pharmacy is generating more revue for its shareholders in comparison to Nestle.

Dividend per Share: It provides an assessment of dividend paid out to shareholders by a company for it outstanding shares. The dividend per share ratio of Nestle has increased from 2016 to 2017 but for Caring Pharmacy has decreased for the same period. Therefore, it can be said nestle is providing more dividend to shareholders in comparison to Caring Pharmacy.

Payout Ratio: It provides a comparison of the dividend paid out by a company in proportion to the total net income realized. The payout ratio for both the companies has been decreased from 2016 to 0217 which indicates that their ability to payout the dividend in comparison to the net income has decreased significantly (Bromwich and Bhimani, 2005).

Valuation Technique to estimate the fair value of firms

The discounted cash flow method is the best method to value the target firm offer price. The most appropriate free cash flow (FCF) used in this calculation is cash flow after the capital expenditures that is important for ongoing concern. In this method there is required to estimate the free cash flows using the pro forma financial statements.

The main purpose of using DCF method is it allows changes in cash flow in future time period. The cash flow is purely based on future cash flows. So it can be said that DCF is best method to estimate the offer price of target firms.

Recommendations

Based on overall calculations it is advised to the 18x hotel to acquire the Caring Pharmacy as their target company because it has better profitability, highly efficient asset management as compare to Nestle Group and very liquidity performance in both the years (Lumby and Jones, 2007).

Conclusion

Merger and acquisition decision requires complete strategic and financial analysis of the target firm as well as acquirer firm so that best firm can be selected from the selected target companies. On the basis overall results and offer price, Caring Pharmacy has been suggested to 18x Hotel as best target company.

References

Annual Report 2017. Nestle Group. [Online]. Available at: [Accessed on: 9 April, 2018].

Annual Report 2017. Caring Pharmacy. [Online]. Available at: [Accessed on: 9 April, 2018].

Brealey, R., Myers, S.C. and Marcus, A.J., 2007. FundamentalsofCorporate Finance. Mc Graw Hill, New York.

Brigham, F., and Michael C. 2013. Financial management: Theory & practice. Cengage Learning.

Bromwich, M. and Bhimani, A., 2005. Management accounting: Pathways to progress. Cima publishing.

Lumby,S and Jones,C. 2007. Corporate finance theory & practice. Thomson.

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