Financial Analysis & IPO Essay
It is the offer of company’s securities to the public which were previously not traded in the stock exchange. These shares are offered to the public the stock exchange. The shares to be listed could have been previously held by private investors and or promoters of the company. Promoters are those investors who support the business during its initial formation. Initial public offering is a complex process that involves many institutions and it is therefore prudent that before considering an IPO, Superior Living Inc. should consider its cost. A cost benefit analysis could be undertaken to determine this cost.
The step undertaken during an IPO includes; The hiring of a manager usually investment bank that will ensure effective running and management of the IPO to ensure it is successful. What follows after the investment bankers hiring is the performance of the due diligence on the company. This is where the IPO manager examines the company’s books and its operations to ascertain its value. The IPO manager performs this together with a team of accountants, lawyers, and marketers. This also where the prospectus is produced and presented to the Securities Exchange Commission.
After the approval of the prospectus by the SEC, the IPO
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Despite all these complex and costly processes, an IPO has several advantages to the company key among them; IPO enables superior living Inc. to have a wide access of capital in the stock market through the company issuing more stocks and even debts. Shares traded in the stock market are liquid and therefore the company can dispose more shares e. g. through a rights issue. The other benefits of listing are that companies listed in the stock market have the publicity through electronic and print media which enhances their image. The investing public and customers usually have high regard on listed companies.
It is even possible for companies listed to merge or acquire other companies because of their enhanced image. Companies listed in the stock exchange are perceived by the investors as stable and strong. This enables the company easily get capital from the public or financial institutions. Any future capital requirement by Superior Living Inc. will be facilitated by its listing in the stock market. This is done through issue of debt certificates and issue of more stocks e. g. through a rights issue or the remaining authorized stocks. The drawbacks of listing include;
Where the company lists, many investors buy into the shareholding of the company and thus any profits made and to be distributed will have to be shared among many investors. The stringent requirements concerning the presentation of books and financial reporting by the SEC is another drawback of going public. Companies listed are required to follow the listed regulations and present their books in a certain format which may be expensive. The IPO itself is an expensive undertaking and only those companies with huge resources are able to conduct successful IPOs.
Companies listed are always subject to public scrutiny and therefore their policies and operations no longer remain a secret. This provides competition with vital information which they can use against the company. Other disadvantages include the management being subject to liabilities in case of misstatements, loss of the company’s control to outsiders and the long wait of the IPO cash which usually takes months before it can be accessed for use by the company The advantages of using debt by the company rather than using non debt can be summarized below. Debt capital has tax savings to the company.
This is because interest on debt is tax allowable thus the company pays less corporate tax if it uses debt. However the use of debt by the company only brings in tax savings up to a certain optimum point where the use of debt outweighs the tax benefits. Too much debt in the capital structure may portray a negative image to the investors on the financial position of the company. Favorable financial average is where the company uses the debt capital to improve the E. P. S of the company. Interest payments also affect the profitability of the company. Too much debt leads to high interest payments and hence it lowers profitability.
The hurdle rate is the least required rate of return that an investment must produce so an investor may invest in that investment. Superior Living Inc should invest in projects that exceed or equal the returns of the existing projects. Key financial metrics There are the key parameters that the performance of the company is gauged and measured on. Some of the metrics to be used in Superior Living Inc are profitability, return on investment, return on assets payback period, net present value, internal rate of return and modified internal rate of return. The profitability of the company has been increasing in line with the increasing revenues.
This indicates that the company has been utilizing its assets efficiently to generate profits. The new project should be able to increase profitability above the current rates. Return on assets shows the level of profitability of the company compared to its total assets. It indicates the amount of profits generated by the assets. ROA= net income Total assets For Superior Inc (2003 figures) ROA =29414 184900 =16% The planned expansion should generate a ROA equal to or greater than 16% in order to be accepted. Return on investments measures the returns realized relative to the money invested.
In Superior Living Inc case, the ROI of each product line can be calculated. The proposed investment on each product line should be able to provide higher ROI than existing ROI to be accepted. ROT= return Cost of investment Payback period is the period when the company when the company is able to recover the initial cost of the project. The new project should have a short payback period. The rule in payback period is to accept a project with a short payback period. Net present value is the future cash flows discounted to present terms minus the initial out of investment. The future cash flows are discounted using the company’s cost capital.
Normally those projects with positive NPVs accepted. Internal rate return is that point where the NPV is equal to zero. It is a superior method of project evaluation than NPV. Projects with greater IRR than cost of capital should be accepted. Modified internal rate of return works on the assumption than the cash flows are ploughed back to the project at the firms discounting rate (cost of capital) in determining the projects accept the IRR and MIRR should be compared Recommendation Using the profitability metric, the company should undertake the project if it increases the company’s profit.
The same applies to ROA which should be more than 16% for the new project. If the proposed expansion costs can be recovered within a short duration then together with other projects appraisal techniques, the project should be accepted MIRR comparison with IRR provides a superior evaluation and thus if the project’s IRR is greater than the cost of capital accept the project. Reference: PCMC (2007) Going public advantages and disadvantages Retrieved on 13/11/2007 from http://www. gopublictoday. com/goingpublic/goingpublic-disadvantages. php