Abstract
Going international has stood to be the primary means by which corporations have gained access to the global markets. Beyond their home markets, companies have been able to increase their sales and growth rate following the large customer base created and greater access to capital in existence in the larger market. The emerging markets such as China have been the primary focus for the companies seeking to globalize their operations. Companies have used different financial strategies, such as bonds and stocks that finance expansion and growth in the international markets. However, an ultimate understanding of the internationalization plays a vital role in ensuring a successful expansion. Galaxy Skis considers expanding into the international markets through the issuance of the IPO as either debt or equity. Through the assessment of the financing options available, the paper evaluates the linked pros and cons by recommending the best possible course of action to expand successfully into the global market. The use of debt IPO stands preferred in financing the expansion with the paper providing an outline of the expected returns, cost of capital and the preferred course of action needed to expand successfully into the China.
Introduction
Failures and success cases of internationalization have widely been pegged on the potential and financing means by which the companies go international. By this, firms have considered going international through bonds and stocks as the source of funds to enable the companies to expand their operations. This paper aims at examining Galaxy skis, a high-tech company that seeks to expand its operations into China by evaluating its proposed means of financing expansion, leasing decisions and the prospective encounters of expanding into the Chinese market.
Galaxy Skis recommends issuance of an IPO to finance its internationalization which its underwriter, Morgan Stanley projects raising 60Million in equity and 50M from bonds. The publication of an IPO presents both pros and cons that would either support Galaxy's success or failure on expanding its lines to China. An Initial Public Offer (IPO) is the financial market launch that features the sale of company shares for the first time to the public. Depending on the company’s preference, the IPO may be sold as equity or debt to the prospective investors investing their money with the expectations of making returns.
Expanding into the international market requires immense finances to operationalizing the expansion and growth. Using the IPO, Jeremy Riven, the owner of Galaxy Skis, shall be publicizing the company making him one of the owners of the firm but not the sole proprietor. This transition shall mean that the corporation shall have multiple sources of capital an advantage to the company being able to easily access more than the required capital for expansion. With the vast availability of capital, Galaxy Skis shall be able to meet its set objectives of development as well as develop and improve the efficiency of its operations. This is a growth opportunity of Galaxy in the international market with its management after expansion projected to grow with expansion. Also, on using the IPO, the company shall stand to report increased sales and profits following its publication. In this case, transforming into a public company shall enable the company brands to be known in the greater market, hence creating public awareness that shall support increased sales and growth of the market share.
On the other hand, Galaxy Skis faces great challenges on considering IPO to finance its expansion into the international markets. Complying with the SEC and Sarbanes-Oxley Act mandates, using the IPO shall force Galaxy Skis to adopt and abide by the accounting jurisdictions after publication. This compliance includes restructuring its management structure, publication of its financial statement, auditing practices and establishing financial accounting oversight boards. This poses a great disadvantage to the company with its expansion and use of IPO attracting costs on auditing and complying with the SEC mandates that may adversely affect the budgetary allocations of the company. Also, with the publication of the company, the public’s expectations of the company increases, hence posing immense pressure that may become a hurdle for the company to achieve its long-term goals due to short-termism.
Weighing the pros and cons of the IPO, Galaxy Skis primarily focuses on increasing its market share, sales, profits and growing rate. It is, therefore, important and appropriate for the company to consider using the IPO to finance its expansions. By this, Galaxy shall be able to access greater capital and the benefits attached to increase access to capital such as growth. IPO usage is in line with the core company objectives and through its sale; the company shall meet its growth objectives. Increased capital and public awareness shall enable the company to increase its profits, sales, market share and successful establishment into the Chinese market.
Other than the use of the IPOs in raising capital there are different financing alternatives available for Galaxy such as bank loans and plowing back of profits to finance its business operations. Through the bank loans, Galaxy Skis can attain the required capital to finance its expansion, which is to be repaid with interest. This capital shall be provided using the company assets as the collateral for the funds issued hence may stand as a challenge on usage for the unknown market the company is yet to venture. On the other hand, the company may consider using its retained earnings as the capital for expansion, a cheaper means of attaining capital, but a constrained one as the company shall have limited access to capital threshold following the limited earnings. The company is thus only left with the IPO capital access option as it allows the company access, unlimited capital with great potential for growth attached.
Using the IPO provides debt and equity options that are issued shares or bonds that would allow Galaxy Skis attain the capital needed for expansion. Both debt and equity shall help the company attain sufficient capital as projected to be $60M as equity and $50M as debt capital to be attained. Equity capital is raised whereby investors buy shares of the company making them own a unit of the company and liable to profit and loss sharing. On the other hand debt, capital exists whereby the investors lend money to the company with expectations of receiving interests after a defined period that whether with the loss of profit.
However, debt financing strategy stands more advantageous compared to equity financing as Jeremy stands to enjoy all the benefits of expansion without interference from any stakeholders as the earnings shall pay up the debts while maintaining the growth benefits to Jeremy. Also, through debt financing, the company stands to benefit from the uninterrupted management flow with prompt decision making that is free from the stakeholder's interference as in the case of equity-based financing where each owner influences business operations. Besides, the bond shall have a tax shield that shall make it cheaper compared to the equity stocks. The bonds shall thereby cost;
8% of50M=4M of which 28%*4m = 1120000/0.08 = 14000000 is shielded from tax. Hence, 28%*36000000= 10080000 and the cost after tax = 40000000. On the other hand, equity shall cost 60M – (28*60M) = 43200000.
WACC=[43200000/(43200000+40000000)*0.08] +[40000000/(43200000+40000000)*0.08* (1-0.28)]= 14.9%
Today, the market presents immense volatility than ever. Corporations and investors have been left with no option but to embrace risk management measures to cushion investments from the implications of price fluctuations. These fluctuations are caused by either inflation of the global economy and the currency volatilities for the home country. For example, Galaxy Skis uses oil for its manufacturing practices an input that has showcased a significant shock in their prices in 2015. The company cannot thereby predict the future prices, and supply of oil, hence may affect its planning and overall production process.
Using the derivative instruments such as the futures and the future forwards, Galaxy Skis can engage in agreement with the sellers to purchase the oil at a specific date in the future, which shall enable them to have a stable supply of oil with no interference from the market volatilities. To hedge their purchases from currency fluctuations, Galaxy Skis may consider using the currency options as the hedging strategy. A currency option is an agreement between two parties (a buyer and a seller) whereby the buying party holds the right, but not the mandatory obligation to purchase or sell the stated currency at the defined exchange rate on or before the agreed time from the seller of the currency as agreed to the contract. Under this alternative, the buyer is mandated to pay up a premium to the buyer as compensation for giving the buyer a right to purchase at a specified price and date. By this, the Company shall be able to hedge from currency volatilities and be able to plan for the future.
It is critical for Galaxy Skis to assess and determine whether to buy or lease the plant in China as this greatly influences the success of the company in China. Galaxy Skis is going international expansion that is set to set its roots in China for the long term, therefore, buying the plant shall be appropriate for the expansion. China poses numerous restrictions on leasing of properties following the massive improvement of Chinese infrastructure with huge taxes being laid on the leased property. From Galaxy's projection, it shall cost $50M to build a 50000 square ft facility and $10M on leasing a facility. Being a long term project it shall mean after five years, Galaxy Skis shall have spent enough money to build own facility. Leasing is always preferred for short-term and expansions that are working on constrained budgets, which are against the Galaxy's case. Galaxy shall use the raised capital to finance the development of plant hence saving while establishing a stable entrance into China.
Besides the Company benefiting from the issue of the IPOs, the portfolio managers also stand to benefit from the sale. As a portfolio manager, I would consider engaging in the IPO as being the manager the company shall vest stock opportunity to me that shall help guarantee long-term gains attached to the capital. These shares shall be acquired at relatively lower prices that would equip me as the portfolio manager to have full control over the company's interests as well as personal interests. Markowitz in his research realized that most investors dislike risks of their investments, thus prefer investments that have minimal risks attached. He thereby developed the Capital Asset Pricing Model (CAPM) that would enable the investors estimate their expected return from the investments. By this, the investors are able to determine the relationship between the investment portfolio and risks involved in the investment. Using CAPM, a portfolio valuation tool, the expected return on stock for Galaxy Skis using CAPM shall be;
Solution
E(r) = Rf-β ( Rm -Rf)
Where Rf=Risk free rate
β= portfolio beta
Rm=market risk
=0.02- 0.018(0.14-0.02) =0.01784 /1.784%
Using the WACC and the expected return of the company the performance of the portfolio can be evaluated to understand its profitability. Galaxy’s rate of return stands at 1.784%, whereas its WACC stands at 14.9%. The cost of capital exceeds the company's rate of return making the venture unattractive for investment with the company’s liquidity being compromised that may result in bankruptcy. This exceeds shows that Galaxy may end up losing value while continuing to raise capital through IPO equity, thus may not be able to meet the dividend requirements tied to stock capital.
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