Question:
Discuss about the Capital Structure of Aveo.
The most important decision that is made within a company in the quest to maximize its value is usually the decision on which products to manufacture and / or which services to offer, however, the decision on how to finance the investments in those assets that allow offering such products and / or services (eg in machines and equipment), is often seen as a minor or secondary decision (Miglo, n.d.). This paper intends to emphasize the importance that financing decisions can have on the value of a company, without forgetting that the expected results will depend considerably on the assumptions that are made about the capital markets and the agents that operate in these markets.
The capital structure of a business is the combination of debt and capital that an organization uses to
It is time to review how the capital structure of a firm behaves in the presence of taxes. To that end, we will continue to use the theoretical framework that Modigliani and Miller developed in his article: The Cost of Capital, Corporation Finance and the Theory of Investment published in 1958 (Bena and Hanousek, 2006).
With a very strong balance sheet, the investors look at various things in the balance sheet to invest in the company. There are two measurements for evaluating a company’s strength. The first one is the capital structure and the second is the working capital of the company. Aveo has had a very good performance in terms of asset performance of the company and therefore has had good running’s with the investors. For purposes of the report, we shall analyze the company structure of Aveo Ltd for the last five consecutive years (Agarwal, 2013).
For capitalization, the company has a record of long-term and short term structures of capital which are permanent in the long term and are a combination of debt and of equity. Aveo has most likely concentrated on keeping a healthy record of equity as opposed to capital debt of the company. This is a clear indication that the company is financially healthy as the yardstick for debt to equity ratio of any company according to IFRS and IAS is 1:1.
Aveo ltd equity comprises of preferred stocks and retained earnings which are the inputs of shareholders equity on the balance sheet account. Aveo equates its debt with its liabilities; however, there is a major difference between operational liabilities and the debt liabilities. The difference is that debt liability forms the capitalization component of a company capital structure. Short term and long term debt form the debt component of a company (Martin and Baker, 2013). Short term debts mostly comprise notes payable. The golden rule is that long term debt should take up two third of the total debt figure according to the prudent principle in accounting. Short term will take the remainder.
|
2012 |
2013 |
2014 |
2015 |
2016 |
|
|
Total debt/Shareholder equity |
2574/701.8=3.7:1 |
2183/669.6=3.16:1 |
1840/853.2=2.16:1 |
1887.2/918.4=2.0:1 |
2428.5/1072=2.2 |
The analysis in the figures above indicate that the debt to equity ratio in the five years have been very high. While the recommended yardstick of debt to equity ratio is 1:1, Aveo ltd remains to have a high ratio in terms of debt to equity ratio. In the year 2012, the debt to equity ratio was 3.7:1 which was 3 times higher than the recommended threshold. This is not optimal at all. In 2013, the ratio dropped albeit marginally to 3.2: 1 as well as in the year 2014. This was an improvement in terms of financial management despite being high for the accounting standards. In the financial year ended 2015, it dropped to 2.0:1, although not optimal, it seems the company had put in place measures to tame the high debt to equity ratio. This shows that the liquidity of a company is improving (Brown, Liang and Weisbenner, 2006). This is also the case in 2016 where the debt to equity ratio was 2.2: 1. This shows that in all the 5 financial years the debt to equity ratio exceed the yardstick and this is not good for the investors in Aveo ltd.
The assumption in prudence use of leverage or debt is that the management can earn more on borrowed money to the amount of interest and fees expense paid on these funds.If a company in a highly competitive environment, is hobbled by high debt , the company may find its competitors taking advantage of the problems facing the company to grab more market share. But if there are taxes, is the irrelevance of the capital structure maintained? To answer this question, let us imagine that the cash flow (FC) of a company is similar to a pie. That cash flow, brought to present value with the appropriate discount rate, will give us the value of the firm. In a taxed world, a company without debt would have a CF like this: (Brown, Liang and Weisbenner, 2006)
The financial value of the company, that is, the value of the shares, can be expressed as the current equivalent of the expected dividend stream, valued at the required return (ke):
The model is based on the reasonable assumption that the dividend is the principal source of shareholder remuneration but, please note, it does not pre-empt that it should be immediately recognized: all dividends expected over the investment horizon are included, as well as the price which is expected to be able to sell the T share; retained earnings will revert to future dividends and also to terminal value because reinvestment will cause the company to grow at a rate g = ROE (1 – pay out).
|
2012 |
2013 |
2014 |
2015 |
2016 |
|
|
Dividend paid (in millions) |
21.1 |
17.7 |
– |
– |
– |
Arguments in favor of investing in companies that do not distribute dividends (Chen, 2005)
In Aveo Ltd, the company cannot afford to be capitalized by distributing their dividends to the shareholders because of their investment need. Reinvestment is done in bid not to fall behind their competitors and to give the shareholders maximum value in terms of shareholders value for the future. In many cases, the company like Aveo will sell its shares in order to have a tax advantage where dividends are subject to the IRPF.
This is the other side of the coin, where shareholders can sketch a smile every three months. The perspective from this position is totally different from the previous one, where it is preferred that the money earned with the contributions made by the shareholders be returned to them, since in a certain way these benefits belong to them. In this way the shareholder has the freedom to choose what to do with the liquidity obtained.
Another fact that we usually take into account when we intend to invest in a company that distributes dividend is the Pay-out. This is the part of profits that the company destines to dividends, so it will always be advisable to take it into account since, depending on the situation in which the company is, more or less dividends will be distributed.
Where are the profits of companies that do not distribute dividends invested?
The profits that the company obtains and are not destined to the distribution of dividends do not have a specific destiny, each company makes the most appropriate decision as to where it has to invest this money, although usually this destination is usually the same for all the companies7. For example: to ensure greater liquidity, to have a working fund to help us in a difficult situation, etc. But we must also take into account that there are shareholders who have deposited their trust and money in the company so that it can carry out its activities, so the reward to these shareholders has to come from a part of the profits (Graham, n.d.)
The quality of dividends distributed is directly proportional to the quality of financial reports produced. The dividend structure is commensurate to the profits received for the company. Aveo ltd has not paid out dividends for the last three years. In fact the last dividend paid was in the year 2013, the debt to equity ratio has also reduced in those years.
Aveo ltd has not paid out dividends for the last three years, and its debt equity ratio has reduced in those three years (Vandekerckhove, 2012).
This report discusses the impact of dividend payments on company value, whose maximization, remember, is the financial objective. Modigliani and Miller demonstrated that, under certain conditions, shareholders should be indifferent between the payment of dividends and the capitalization of results; however, some companies have turned this pay into an essential element of their relationship with investors. Others, on the other hand, maintain a systematic policy of reinvestment, without their actions being penalized by investors.
Know the complete process that must be followed to make successful decisions in Financial Investments.
Dividend distribution
Problems in individual decision-making are mainly due to two causes of fear of decision making and thoughtless decision-making (Vandekerckhove, 2012).
Aveo is a very attractive company to invest in. it has had its fair share of troubles especially in dividend payout but remains a very attractive company for investors nonetheless. The dividend policy, and its broader expression as a self-financing policy, is closely related to both the financial structure and the investment decisions. Retained earnings are a source of financing that, depending on the preferences of the company and its owners, can make growth possible by supplementing or supplementing debt or other sources of self-financing, such as capital increases. Self-financing is, in fact, the preferred source for many R & D-intensive companies, and / or latent opportunities (Graham, n.d.).
Regarding how dividends are canceled Brealey and Myers point out: The dividend is fixed by the company’s board of directors. The announcement states that payment will be made to all shareholders who are registered on a certain closing date. Later, about two weeks later, dividend checks are sent to shareholders. Dividends can only be declared by the board of directors, which then has the authority to order the payment of a dividend. If the directors or board of directors decide to declare a dividend, they must take appropriate measures to pay the members at a certain date (Vandekerckhove, 2012).
Aveo ltd profitability levels are high showing that investors can be attracted by the levels of profit that the company is having. Although attractiveness of a company can be measured using different yardsticks, profitability, liquidity and the company’s general stability remains the key areas of focus for the investors outlook (Graham, n.d.).
According to this approach, the shareholder’s profitability in any period t is the sum of the dividend yield and the profitability accrued by the change in the value of the shares:
so that the model does not establish any express priority between dividends and retention. This result has some logic, because the value of the company’s asset is the current equivalent of free cash flow, discounted to the weighted average cost of capital, and neither of these two variables depends on the distribution policy (maintaining the presumption that the decision involves a trade-off between paid dividends and new capital)
Nor does it pre-judge that both profits (dividends and capital gains) are strictly equivalent: in fact they are not, because the latter are subject to risk, hence a financial valuation and a discount rate with risk. Accordingly, in a first approximation the effect of the dividend policy on the value of the enterprise will depend on the future impact of the retained earnings: to the extent that the incremental result provided by the domestic reinvestment offsets the risk and the time (preference for liquidity), shareholders will be willing to waive their current dividends in exchange for future (incremental) dividends.
Conclusion
Aveo is a good company to invest in. It is clear, that the cash flow of the business, will be shared by the shareholders and the State. Then, the present value of what is left to the shareholder, would be the value of the company, or otherwise seen, Vu = E, where Vu is the value of a deleveraged company and E is the equity (Vandekerckhove, 2012).
References
Agarwal, Y. (2013). Capital Structure Decisions. Hoboken: Wiley.
Bena, J. and Hanousek, J. (2006). Rent extraction by large shareholders: evidence using dividend policy in the Czech Republic. Prague: CERGE-EI.
Brown, J., Liang, J. and Weisbenner, S. (2006). Executive financial incentives and payout policy. Washington, D.C.: Divisions of Research & Statistics and Monetary Affairs, Federal Reserve Board.
Brown, J., Liang, J. and Weisbenner, S. (2006). Executive financial incentives and payout policy. Washington, D.C.: Divisions of Research & Statistics and Monetary Affairs, Federal Reserve Board.
Chen, A. (2005). Research in finance. Amsterdam: Elsevier JAI, .
Graham, B. (n.d.). The intelligent investor. New York: Collins.
Martin, G. and Baker, H. (2013). Capital structure and corporate financing decisions. Hoboken, N.J.: Wiley.
Miglo, A. (n.d.). Capital structure in the modern world.
Vandekerckhove, W. (2012). Responsible investment in times of turmoil. Dordrecht [u.a.]: Springer.
Essay Writing Service Features
Our Experience
No matter how complex your assignment is, we can find the right professional for your specific task. Contact Essay is an essay writing company that hires only the smartest minds to help you with your projects. Our expertise allows us to provide students with high-quality academic writing, editing & proofreading services.
Free Features
Free revision policy
$10Free bibliography & reference
$8Free title page
$8Free formatting
$8How Our Essay Writing Service Works
First, you will need to complete an order form. It's not difficult but, in case there is anything you find not to be clear, you may always call us so that we can guide you through it. On the order form, you will need to include some basic information concerning your order: subject, topic, number of pages, etc. We also encourage our clients to upload any relevant information or sources that will help.
Complete the order form
Once we have all the information and instructions that we need, we select the most suitable writer for your assignment. While everything seems to be clear, the writer, who has complete knowledge of the subject, may need clarification from you. It is at that point that you would receive a call or email from us.
Writer’s assignment
As soon as the writer has finished, it will be delivered both to the website and to your email address so that you will not miss it. If your deadline is close at hand, we will place a call to you to make sure that you receive the paper on time.
Completing the order and download