Discuss about the Fundamentals of Corporate Finance Theory and Practice.
The company selected for this task is Nick Scali Furniture which is listed on the stock exchange under the symbol of NCK. The company tends to import premium furniture and engage in the retailing of the same. Currently, the company has limited presence only at selected locations across Australia but the company in the near future aims to expand its operations and presence across more locations (NCK, 2015). In the wake of the future growth that the company expects, the role of CFO is of particular importance and cannot be overemphasised. The three main responsibilities that the CFO of NCK is expected to discharged are briefly discussed below.
In relation to the existing business model of the company, two factors are pivotal for the sustained success of the company. One is to select reliable vendors globally which can supply high quality furniture to the company and second is retailing of the same to the customers through a host of distribution channels. Currently the company sources furniture from Asia and as the business grows, it would be imperative for the company to scout for new opportunities from where the furniture could be bought from (NCK, 2015). Typically, this would require significant investment in the backend furniture value chain particularly at the end of the Asian vendor so as to assure that the company is able to get access to quality products. In this regard, there are a plethora of cost considerations as multiple factors are at play. For instance, the raw material availability and cost, availability of skilled labour, labour norms along with exchange rate fluctuations, underlying transport cost need to be considered by the company in order to choose vendors for the future. In this decision making, CFO plays a key role as he is aware of the various cost centres that contribute to the overall cost and ensures that these are built into the decision making process (Bhimani et. al..,2008).
An additional requirement for the company’s success is retailing. Although, the company does engage in e-retailing but considering the target segment that the company is targeting, it is imperative for the company to enhance its present in terms of retail stores. This is a strategic decision for the company which involves significant inputs from the CFO. The opening of new stores is a sizable capital investment for a company of the size of NCK (NCK, 2015). Hence, intense deliberations need to be carried put before narrowing down on a prospective location. Further, the estimated costs and revenue flow expected from the store would also be estimated based on the given information and empirical understanding of the business. Further, it is quite possible that the company may narrow down on multiple locations for setting up a retail store with all expected to create value for the company (Drury, 2008). However, the financial resources available with the company may be typically constrained and hence under the aegis of the CFO capital rationing would be required so as to select on the most viable investment alternatives. Considering the high elasticity of the business, a sensitivity analysis of the prospective locations is also done in order to narrow down the choices and ensure a prudent choice be made (Petty et. al., 2015).
Besides, it is also possible that the company may scout for some small acquisitions in the future in order to either gain presence in a new market or for backward integration. With regards to the due diligence of these acquisitions and the actual financing of these acquisitions, the role of CFO is integral and the success of these endeavours would depend on the business acumen, experience and knowledge of the CFO (Parrino & Kidwell, 2011).
As a listed company, in case of NCK, segregation of owners and managers tend to exist which gives rise to the formation of an agency relationship. In order to safeguard the interest of the principal, the agent or the managers should continuously report the financial and operational performance to the owners so as to ensure that they prudent investment choice with regards to continuing their investment (Drury, 2008). Also, it needs to be considered that the company is a listed entity and hence needs to comply with regular reporting requirements as highlighted in the respective listing agreements of the stock exchanges. Further, this needs to be reported in a timely manner and at the same time should be compliant with the relevant accounting norms which is the responsibility of the CFO (Bhimani et. al., 2008).
The CFO tends to be in regular touch with the audit committee of the company so as to understand the various loopholes that exist in the internal controls put in place by the company and ensures that requisite corrective measures are taken so as to ensure that the underlying risk of misreporting is minimised. Additionally, the tax liabilities of the company need to be prudently recorded considering the mode of sales and the value of imported furniture from abroad (Brigham & Ehrhardt, 2013). Also, the impact of exchange rate is particularly significant for the shareholders of the company as the furniture is imported from Asia and hence currency fluctuations tends to have a direct impact on the underlying profitability of the business operations. The CFO ensures that these are reported correctly and also ensures that requisite hedging mechanism be put in place so as to deal with current risk (Brealey, Myers & Allen, 2008).
Additionally, the CFO acts as a chief coordinator to the external auditor and ensures that all the requisite information and support is made available to the external auditor so that the audit process is conducted smoothly and in a timely fashion. Besides, general overview of the company’s operations, risk factors and the performance enables the auditor in making robust audit plans and resulting strategies (Seal, Garrison & Noreen, 2012).
The corporate strategy is the basic framework on which the companies operations are based so as to achieve the goals and objectives. In the process of corporate strategy formulation in wake of the competitive and dynamic business environment, the CFO plays a key pivotal role as he exploits his experience and superior financial skills so as to realistically present the likely financial implications of pursuing various options. This is particularly of significance for a company like NCK which operates in a highly elastic product segment and hence the business fortunes would be highly susceptible to the underlying economic trends (Brealey, Myers & Allen, 2008). The CFO also tenders advice to the board with regards to any strategic alliances of acquisitions that may be value accretive for the shareholders. Additionally, since CFO is responsible for management of financial resources, hence his support his critical so as to ensure that the requisite resource allocation is done for a given project (Brigham & Ehrhardt, 2013).
The CFO also plays a crucial role with regards to erection of various benchmarks that act as milestones for ascertaining the performance of the various key executives. He/She also plays a critical role in the budget exercise which tends to spell out the key priorities of the company and acts as a potent tool to establish control over operations by limiting the availability of capital only for those projects that are considered value accretive by the management. Also, the CFO needs to meet the financing needs of the company so that the company has funds both for meeting working capital liabilities and also for setting new retail outlets (Bhimani et. al., 2008).
The role of CFO is a crucial one for the overall success of the company which is apparent from the responsibilities undertaken by him/her. The first step in this regard is to set a corporate strategy which is capable of achieving the company’s vision and the objectives set by the management. Based on the corporate strategy, the various benchmarks are put in place which the key executive are expected to meet in a time bound manner. These benchmarks tend to be variable in nature and driven by a plethora of factors. The resource allocation is carried out under the aegis of CFO keeping in mind the budgetary allocations (Brigham & Ehrhardt, 2013). Further, to achieve sustainable growth, it is imperative that the company enhances its presence which typically would require capital rationing and would to an extent be driven by the underlying preferences in whose determination, CFO would play and active role (Bhimani et. al., 2008). Also, it is the duty of CFO to ensure that the operational and financial performance of the company is disseminated to relevant internal and external stakeholders in a timely manner (Drury, 2008).
To critically examine the given statement, the preliminary step is to discuss the efficient markets concept which is aptly represented in the form of Efficient Market Hypothesis (EMH). In accordance with the EMH concept, market efficiency exists primarily in three forms. The weak form of market efficiency hypothesises that the stock price movement is essentially random in nature and has no linkage with the past prices. Further, it is driven only by the information entering the market and technical analysis as an investment technique would fail (Petty et. al., 2015). The semi-strong form of market efficiency hypothesises that there is no utility of tracking stock specific information as any new information tends to get captured by the prices almost in an instantaneous matter and thereby does not provide opportunities to the market participants to derive gains based on this (Damodaran, 2008). The strong form of market efficiency hypothesises that the market price of the stock equals the intrinsic price which is indicative of the all stock specific information and therefore there is no role for fundamental analysis as the stocks do not deviate from their intrinsic prices and any minor deviations are corrected automatically (Brealey, Myers & Allen, 2008).
If the capital markets become efficient and display features shown above, it seems that the statement that the pension fund manager could select the stock with a pin may be true. This is because the empirical prices of the stock are not significant for initiating any trades as the future prices are not linked with past prices. Also, the information about individual stocks is also equally futile because by the time the pension fund manager is in a situation to react to the news, the entire impact of the news has already been reflected in the price of the security. Thus, it makes sense for the pension fund manager to act as a passive investor in such scenario (Parrino & Kidwell, 2011).
The investors in stock market are exposed to two risks i.e. systematic risk and unsystematic risk. The systematic risk cannot be eliminated through diversification of portfolio but the unsystematic risk can be minimised and even eliminated through portfolio diversification. As a result, it is imperative for the pension fund manager to choose a portfolio which is well diversified so as to atleast minimise the unsystematic risk associated with the investment. Clearly, this cannot be ensured through random selection of stocks and needs active choice of stocks designed towards a specific aim (Brealey, Myers & Allen, 2008).
Besides, considering that pension fund is directed towards providing a secured income to investors after retirement, hence the stock choices tend to be biased in the favour of large blue chip stocks that may offer limited capital gains but offer sizable dividend income. Hence, the portfolio that the pension fund manager must select should be representative of this objective and hence the stocks would not be chosen with a pin as the portfolio may include high risk growth oriented stocks (Damodaran, 2008).
Based on the above reasoning, it may be concluded that the given statement is indeed false.
References
Bhimani, A, Horngren, CT, Datar, SM & Foster, G 2008, Management and Cost Accounting 4th eds., Prentice Hall/Financial Times, Harlow
Brealey, R, Myers, S & Allen, F 2008, Principles of Corporate Finance, 9th eds., McGraw Hill Publications, New York
Brigham, EF & Ehrhardt, MC 2013. Financial Management: Theory & Practice, 14th eds., South-Western College Publications, New York
Damodaran, A 2008, Corporate Finance, 2nd edn, Wiley Publications, London
Drury, C 2008, Management and Cost Accounting, 7th eds., Thomson Learning, London
NCK 2015, Annual Report 2015, Available online from https://www.nickscali.com.au/media/wysiwyg/pdfs/NS_AnnualReport_2015_Final_LR_1.pdf (Accessed on September 13, 2016)
Parrino, R & Kidwell, D 2011, Fundamentals of Corporate Finance, 3rd eds., Wiley Publications, London
Petty, JW, Titman, S, Keown, AJ, Martin, P, Martin JD & Burrow, M 2015, Financial Management: Principles and Applications, 6th eds., Pearson Australia, Sydney
Seal, WB, Garrison, RH and Noreen, EW 2012, Management Accounting, 4th eds., McGraw -Hill Higher Education, Maidenhead
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