Case Study of Adam Co: Investment in Turkey

Words: 3023

Business

11th Jun, 2023

Adam initially chose the PLC format for his company. His decision is understandable because a PLC is a separate legal entity that generally does not limit the availability of capital. In addition, the corporation itself looks more advantageous for asset accumulation and financing through equity while retaining the company’s partners. Nevertheless, Abdulrahman did the right thing when he accepted the attempt to convince Adam to form a partnership. A partnership is a more established corporate structure with multiple management options (van Veen et al., 2019). The league can be changed because everyone can contribute to the association. In addition, liability and risks are shared equally among all participants. This minimizes the frequency of errors and allows for quicker resolution of conflicts.

In my opinion, the tactic used was to explain the advantages and disadvantages of different types of companies. Abdulrahman likely suggested a general partnership but met Adam’s doubts by mentioning LLP, which combines the elements of a traditional partnership and a corporation. LLP reflects Adam’s requests and is consistent with the view of the unnecessary assistance of investment bankers for issuance and marketing (Jacob & Michaely, 2017). In addition, Adam may have been interested in the possibilities of an LLP as a platform for new business without access to significant capital. Overall, Abdulrahman’s beliefs were probably based on the options of integrating Adam’s ideas into practice with a combined structure format.

In the case of a small Adam Co-type business, the choice to walk away from responsibility to shareholders does not seem right. Shares can help the company grow, and a complete disclaimer policy will lead to a low trust factor for potential partners. As a result, other partners’ interest in Adam’s company may drop considerably because of limited stock market action. Nevertheless, the stock policy should be strictly regulated, achievable in the LLP type.

In my opinion, the company should have a responsibility towards its shareholders. Its product policy should reflect the firm’s focus on its key owners. Since the goods sold by Adam Co. are produced by child labor, there is a question of the ethics of these products. Stocks will be helpful because they will facilitate entry into the stock market and allow the company to get rid of long-term debt (Laws, 2018). Unlike other metrics, this one is primarily controlled by a company’s stock ability. It seems to me that using a mission like Sainsbury could help the partnership grow and discover new ways to turn revenue and income.

The principles of corporate social responsibility (CSR) are related to considering the interests of society and contributing to its development. According to the Business Development Bank of Canada (BDC), responsibility is an important indicator because it solves the issues of the company’s image, which positively impacts sales in many ways (BDC, n.d). The approach to CSR, which is becoming more and more common, is development projects that consider the local community’s interests. A more common approach to CSR is to help local organizations and the poorest in developing countries (van Veen et al., 2019). Some organizations do not like this approach because it does not help improve the skills of local people, whereas community-driven development leads to a more sustainable environment.

In Adam’s case, CSR principles are violated because of the company’s lack of pity or emotion. It chose low-cost products without committing itself to get rid of child labor and low-wage jobs for women. Given the enormous influence of feminism on the modern world, such practices would frown upon significant countries (Jacob & Michaely, 2017). While such large clothing companies abandon child labor and cheap labor, Adam’s company, on the contrary, follows the trend: less cost of production – more net profit. Such an attitude is unacceptable and utterly inconsistent with CSR (Laws, 2018). It violates the principles of equal rights, equal opportunities, and the good economic position of rank-and-file employees. The chosen policy may negatively affect the company’s overall image if the working conditions of their workers become known.

Dividend policy is the policy of a joint-stock company in the distribution of company profits, i.e., the distribution of dividends to shareholders. The board of directors forms the dividend policy (BDC, n.d). Depending on the company’s goals and the current/forecasted situation, the company’s profits may be reinvested, written off to retained earnings, or paid out as dividends. The term “the dividend policy” is in principle related to the distribution of profits in joint-stock companies (Hardin et al., 2017). The dividend policy should be structured to find the optimum levels of profit distribution between payments and the part that constitutes the company’s capital. In the case of the analyzed situation, the partners’ opinions are based on different theories.

Adam’s opinion is based on the theories of clientele and signaling. The signaling theory assumes that dividend per common share outstanding affects its market value. Adam probably believes that issuing dividends to his shareholders will create a good image. Still, he does not consider that family and friends may refuse to pay higher rates on shares as their value rises. Shareholders in the form of loved ones are also an incorrect choice because it limits the company and obliges partners to rely on the opinion of a small group of people. This theory does suggest that stock growth will stimulate company capital, but it is unreliable. The clientele theory assumes that dividend policy is influenced by the preferences of most shareholders. Thus, again, Adam’s view is based on the choice, not of the global stock market but a narrow group related. Adam’s tactic might work if the partnership limited the number of shareholders to relatives.

Mohammed’s view is similar to Adam’s but relies on another similar theory. The Modigliani-Miller theory assumes that the market price of a company is independent of the structure of corporate securities for a given dividend stream. According to the theory, the ratios of equity and debt capital and the terms of the dividend payments issued do not affect the company’s total capital (Jacob & Michaely, 2017). Mohammed believes that equity for the public would facilitate financial investment. It would be feasible if the company complied with certain conditions. Tax payments continue to exist in today’s economic environment, and business costs are not decreasing. In the case of Adam Co., there is an increase in profits, which may fall in the future. It will be helped by Ying Shue’s decision to get more value for the goods they produce. As a result, the company’s stock may, on the contrary, fall and not get demand, mainly because of the characteristics of the shareholders.

Saeed’s opinion is fundamentally different from that of his partners: he adheres to the theory of dividend minimization. This theory assumes that the efficiency of dividend policy is determined by the depreciation of tax payments on the distributed and capitalized part (Hardin et al., 2017). The value of tax payments in the current period exceeds the value of tax payments in the future period because money changes (decreases) its value over time. Therefore, reducing the number of dividends makes sense to reduce the tax payments on them and increase the capitalizable portion of profits. Saeed rightly believes that a negative NPV can negatively affect stock performance and contribute to the deterioration of the company’s financial etiquette. He probably expects a positive NPV to allow for risk assessment using different discount rates. In addition, the indicator considers the value of money over time, which will increase the purity of decision-making and its feasibility.

It seems that it is appropriate to use the Gordon-Lintner theory for a company that does not expect significant growth in the future due to the peculiarities of industrial production and the general purpose of goods. The authors argued that the assumption that dividend payments do not affect the company’s cost of capital is wrong (Berk, 2017). The central premise of the Gordon-Lintner concept proposed was the assertion that low dividend payments increase the company’s cost of capital. Investors would prefer a more certain dividend payout income to a less certain capital gains income if they agreed to a dividend reduction in favor of increased retained earnings. The rationale for this assertion is that as time increases, risks increase, so the uncertainty of capital gains is higher than that of dividend income (Acharya et al., 2017). Their preference for dividend income over capital gains influences investors’ behavior.

The main merits of the Gordon-Lintner theory for Adam Co. will be several points. First, investors will understand the risks of investing in the company and find it worthwhile to work on capital. Second, future earnings could be reallocated at a higher rate and then play into the hands of the small company (Berk, 2017). Third, the stock’s market price will be dynamic so that investors may see potential in this. In addition, I would advise changing course on the company’s shareholders and going public on a small but stable stock exchange without the risk of subjective performance evaluation.

Adam Co believes that the project in question will pay for itself within three years. Therefore, only four values must be used to calculate the NPV: the starting value and the following three cash flows. The following formula is used to calculate NPV:

;

Where:

is the net cash in each period,
t is the period of the cash flow, and
i is the discount rate.

The NPV formula is a general formula that allows substitution of values into the formula. However, to better understand how the NPV works, the values can be calculated per year and finally determine the NPV after the period. For example, the calculation of the NPV for the first year for project A can be determined as follows:

;

= 909.090909

= 909

NPV for second year;

;

= 2479.338842

= 2479

NPV for third year;

;

= 3380.9166

= 3381

NPV for fourth year;

;

= 4439.58745987

= 4440

The NPV is therefore given as sum of present values of cash flows less the initial investment.

Therefore, NPV is ((909 + 2479 + 3381 + 4440) – 10,000)

= 1209

For project B,

;

= 6363.63

= 6364

NPV for second year;

;

= 5785.123

= 5785

The NPV is therefore given as sum of present values of cash flows less the initial investment.

Therefore,

NPV is ((6364 + 5785) – 12,000)

= 149

For project C

;

= 1818.1818

= 1818

NPV for second year;

;

= 2479.338842

= 2479

NPV for third year;

;

= 1153.9444

= 1154

NPV for fourth year;

;

= 1366.02691

= 1366

The NPV is therefore given as sum of present values of cash flows less the initial investment.

Therefore,

NPV is ((1818 + 2479 + 1154 +1366) – 8,000) = -1,183

Using the same process, other values are calculated per year as shown in the appendix. The final value of the NPV is thus reported and explained.

The calculations reveal that the NPV for project A is 1209, project B has an NPV of 149, and project C has an NPV of -1183. Based on the NPV calculations (shown in the appendix), project A has the highest NPV value, hence the most beneficial to the company. The main limitation of using the NPV method is that the technique requires assumptions on the company’s cost of capital. Moreover, NPV is not helpful when there is a need to compare two or more projects that differ in size since the method gives results that depend on the input size.

The payback period refers to the time a company needs to run a project to recover the initial money or other forms of assets invested in each venture, or the number of years a business would take to earn the initial investment made to begin it. As a capital budgeting method, the payback period is used to compare various projects in a portfolio and derive the period for each venture to generate profit equal to the initial capital outlay. The project that has the least period is selected and funded. In this case, the company can determine each project’s payback period and consider one that has the lowest period, which reveals faster profitability. Empirically, the payback period can be determined using the following formula in cases where there is an unequal cash flow:

Payback period = Completed year + (remaining amount/available amount)

In the case of project A,

Payback period = 3 years + ((10,000-8500)/6,500)

= 3 years + (1,500/6,500)

= 3 years + ((10,000-8500)/6,500)

= 3.2 years

For project B,

Payback period = 1 year + ((12,000-7,000))/7,000)

= 1 year + (5,000/7,000)

= 1.7years

For project C,

3 years + (0/2,000)

Payback period = 3 years

The calculation of the payback period of the three projects reveals that project B is the most viable because it has the least period among the three projects. This is so because project B has the least period of 1.7 years compared to project A and C, which have 3.2 and 3 years, respectively. The main limitations of using the payback period include focusing solely on the timeframe the initial investment is recovered and ignoring the time afterward. The payback period method also fails to consider the time value of money as well as the cash flows that arise upon recovering the initial investment.

Based on the calculation of the NPV and the payback periods, the NPV method reveals that project A should be selected because it has the highest value. On the contrary, the payback period determination shows that the company should choose project B because it has the least period for investment return. The limitations of each method can then help in the choice of the project to select. Based on the analysis of the projects, it is wise to select project B because it requires the highest investment, which the business can recover within the shortest time. This shows that project B is likely to generate a faster rate of profit than the other two projects.

The following formulas were used for the calculation:

where:

is the cost of equity
is the current dividend or dividend to be paid shortly
is the expected annual dividend growth rate
is the ex-dividend share price

Number of shares = book value of share capital/ nominal value per share

= 4,000,000/0.5

Number of shares = 8,000

EPS = Earnings/shares

= 10,000,000/ 8,000,000

= 12.5

Now P = EPS * PE of competitor

= 12.5 * 10

= $125

Since the company is not listed while the competitors are listed, it follows that P has to be discounted by 1/3.

Therefore, P = $125 /3

P = 41.57

Now into the calculation of .

= rate of return on reinvested profits * rate of return

Rate of retention = (EPS-DPS)/EPS,

where DPS is the dividends per share

= (12.5 – 0.25)/12.5

= 0.98

The rate of return given is 12%

Now, = 12*1

12%.

= 0.078

= 7.8%

Cost of Preferred Shares

The limitations of WACC include its assumption that the capital structure remains the same way over time when the structure changes because of the introduction of new projects. At the same time, companies can manipulate WACC by increasing their debts. The company should reconsider its policy on common stock and available reserves. It is also worth paying attention to income from retained earnings and changing the debt obligations strategy.

All values are on OMR

Land and building = 800,000

Machinery = 90,000

Others = 100,000

Net current asset = 84,000

(-) 6% loan notes= (200,000)

Therefore,

Adjust Net Asset Value = 874,000

(Total) Non-current assets = 900,000

(-) land and building = 600,000

(-) machinery (200,000)

Others – 100,000.

The payment to the firm is $100,000

The company’s capital structure is such that its debt (total liabilities) is OMR 7,000,000, and its equity is 22,000,000. Therefore, the debt-to-equity (D/E) ratio is 7,000,000/22,000,000, which is 0.32. In this case, the debt-equity ratio is below 1, hence considered a good D/E ratio that is less risky. On the contrary, when the ratio is too low, it can indicate a negative signal showing that the company does not take advantage of debt finance to expand and grow. Based on the above explanation, I concur that the firm should not issue shares to the public; instead, it should rely solely on debt. The net income approach to capital structure theory best fits this argument. If the business takes more debts to leverage its investment, it increases its capital structure while its WACC decreases, resulting in high company value. This approach assumes an optimal capital structure.

Adam Co can face the following risks if the company decides to invest in Turkey. First, it will have challenges accessing different information since most companies outside Turkey do not give investors the same information as those within the country (Gezici et al., 2019). The company is also likely to face the costs associated with international investments, which can be more expensive. Gezici et al. (2019) further reveal that Turkey’s currency has been facing consistent crises, which have led to inflation in the country. Moreover, the firm can face unforeseen risks from brokers or investment advisors; hence it must make sure such experts are registered with appropriate state regulatory authorities. There are also challenges with dynamics of market value, especially various security markets outside Turkey. Furthermore, the company can be affected by multiple political, economic, and social events within Turkey, which may have adverse effects on the market.

References

Acharya, V. V., Le, H. T., & Shin, H. S. (2017). Bank capital and dividend externalities. The review of financial studies, 30(3), 988–1018.

Business Development Bank of Canada, n.d. 4 ways to assess your business performance using financial ratios. BDC, Web.

Berk, A. (2017). Small business social responsibility: More than sze. The Journal of Corporate Citizenship, 67, 12–38.

Gezici, A., Orhangazi, Ö., & Yalçın, C. (2019). Determinants of investment in Turkey: A firm-level investigation. Emerging Markets Finance and Trade, 55(6), 1405-1416.

Hardin, W. G., Nagel, G. L., Roskelley, K. D., & Seagraves, P. A. (2017). Institutional monitoring, motivated investors, and firm performance. The Journal of Real Estate Research, 39(3), 401–440.

Jacob, M., & Michaely, R. (2017). Taxation and dividend policy: The muting effect of agency issues and shareholder conflicts. The Review of Financial Studies, 30(9), 3176–3222.

Laws, J. (2018). The time value of money, the dividend discount model and dividend policy. In Essentials of Financial Management (pp. 51–70). Liverpool University Press.

van Veen, E., Bos, W., & van Beijnum, M. (2019). Conflict context: Factors influencing mission effectiveness (Level 1). In Mission impossible? Police and justice capacity building by international peacekeeping missions (pp. 7–12). Clingendael Institute.