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Assignment Unit VI:

Essay

External Financing and Stock Repurchases

MBA 6081, Corporate Finance

Columbia Southern University

Huynh Dong Ha
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Part 1

Key factors must be considered when determining external financing requirements.

[ CITATION Bur90 \l 1033 ] Financing is always a problem business face after they have acquired

initial financing. Faced with changing customers, competitors, .... the need to finance your

business is important to companies. [ CITATION Ber172 \l 1033 ] To sustain growth and protect

initial investment, businesses know that capital is essential in the economic system because it

allows them to buy and sell products or invest in new projects that are out of their immediate

reach. However, no matter what industry you are in, finance is still the backbone of your

business. An owner has initial financing to start a business that does not help you grow and

develop. When it comes to expanding or scaling your business, you should consider the

financing option: internal financing or external financing. But this article will focus on analyzing

external funding sources.

External financing: venues for obtaining funds that come from outside an organization. External

sources of finance might include taking on new business partners or issuing equity or bonds to

create long term obligation, or commercial paper to take on shorter term debt. Lines of credit or

bank loans are used by start-ups firm to generate initial cash infusion. Another example is the

sale of shares in a firm to urge foreign investors to contribute to the business. External capital

sources include the following major sources of capital: Loans from relatives (for private

enterprises); Borrowing from commercial banks and other financial institutions; Supplier

commercial credit; Rental property; Raising capital by issuing securities (for some types of joint

ventures is allowed by law).

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So, what kind of external financing the corporation can borrow? For start-ups there will be

attractive investment opportunities, but they have little return to investment. Even a large

company has experienced a period of low profitability or loss, but unless the company has strong

and reliable financial capital to be able to continue investing in difficult times. In short, most

companies must look for a source of financial capital other than the profits they got. Borrowing

from banks and bonds which is method get money to contribute their corporation. The company

borrows an amount from the bank and will repay it within a set time, including interest. If the

company does not pay, the bank will sue in court or they will sell the building or equipment to

pay the loan. Another source is borrowing financial capital is a bond. A financial contract of

bond that the firm consents to reimburse the amount combine a rate of interest thought the period

at a future date. The manufactures issue a corporate bond, but government also issues it. A bond

identifies charges that will be acquired, the interest rate that must be paid and the time till

compensate.

There are two types of capital a company can use to support its operations: debt and equity. And

as mentioned above, the company mobilizes capital through debt by borrowing from the bank

and will return it to the bank at a specified time. But the downside of debt is the additional

interest rate. In the worst-case scenario, a company with a highly leveraged will have to pay off

debts that exceed its sales. Next, equity. A company can raise capital by selling more shares if

borrowing more debt is not financially viable. They may be common shares or preferred shares.

The benefit of borrowing equity is that the company does not have to repay shareholder

investment. Shareholder investment will expect the return on investment based on large market

performance. The disadvantage is that each shareholder owns only a small portion of the
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company, so the ownership is diluted. The company must be responsible for earnings to maintain

a high equity valuation towards its shareholders while continuing to pay any expected dividends.

Long-term and short-term financing must be analyzed to determine many factors affect external

financing requirements. Referring to funding, there will be two types of financing: short term and

long term:

Long-term loans for more than one year. Enterprises and organizations in the process of

expansion, innovation, research, or development must request a long-term funding source. In

addition, long-term financing finances long-term investments and repayment throughout the life

of the firm. Long-term debt used for making acquisitions, opening a new production facility,

financing internal events (like share repurchases) as well as preparing for rising interest rates.

Some of the long-term sources of finance are: Equity Shares; Preference Shares; Plowing Back

of Profits; Debentures; Financial Institutions; Lease Financing; Term Loans; Debt Capital;

Internal Sources; Foreign Capital. There are some major advantages of long-term loans, the most

important being the amount you can borrow, the relatively low repayment installments and that

you can use them to consolidate smaller debts, which saves you money because it lowers the

combined interest rates into one smaller payment.

Short-term financing refers to the need to finance a short period of time (less than a year). It is

also known as working capital financing. It is suitable for the seasonal pattern of business of

uneven flow of cash into the business, the seasonal pattern of business and so on. In most cases it

is used to settle inventory, accounts receivable. The short-term financing in three circumstances:

seasonality, negative cash flow shock and positive cash flow shock [ CITATION Ber172 \l 1033 ].
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The seasonal effect on short-term cash flows is inventory management on the grounds that

consumer demand has increased and decreased dramatically. Managers of seasonal companies

have discussed capital risk in using financial assets to prepare for previous seasonal order

demands to receive clear signals of the economic climate. According to example from [ CITATION

Dou19 \l 1033 ], AeroGrow International, Inc. discussed this risk in their 2016 10-K:

approximately 65.7% of their total sales took place in the calendar months (October to January).

They must estimate sales prior to the peak months and run their work to meet product demand

during this peak month. They incur operating and marketing costs and general costs, using cash

and other capital costs to invest in inventories. No one thinks seasonal inventory management is

easy. There are so many variables, not except for the weather. When inventories are seasonal

orders ahead of time, working capital pressure will emerge if the sales are not enough to cover

costs. The main source of income during the seasonal sale is the receivables. Internal receipts are

paid quickly, to consider the effectiveness of working capital in the sales process, it is extremely

important to collect overdue payments. Cash flow management during and after the season.

Annual cash flow forecast with a spike in seasonal demand. If the business exceeds the amount

of money on hand, then it reinvests its money cash equivalent investments. Short-term financing

is considered despite forecasting the minimum amount of cash requirements fall [ CITATION

Mer13 \l 1033 ].

Negative cash flow shocks - Every business makes money, and they use cash, it is important to

understand how important cash flow is for a business. If a firm has positive cash flow, it means

money is earned rather than spent. In contrast, cash flow negative is a business that is facing a

cash deficit. When you run a business with negative cash flows, your cash reserves will be used

to meet your debts and expenses. If the company operates but does not bring in more cash than it
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is spent, you will run out of all your reserves. Risk of default if you do not have cash reserves

and negative cash flow threatens your business. Negative cash observations need special scrutiny

as they represent cases of investment falling to the lowest possible level and cannot fall further

with further declines.

A business is said to have a positive cash flow when the cash inflows to a business for a

particular period are greater than the cash outflows during the same period. In the longer term, a

positive cash flow will generally be the direct result of a profitable business and for the most part

the term 'positive cash flow' is used to describe a business considered to be long-term profitable.

But profit and cash flow are not directly linked when viewed in shorter term intervals or in the

foundation stages of a business. In the shorter term, it is possible for a business to have a positive

cash flow yet be losing money. For example: Startups with positive cash flow may be describing

a business model where customers pay for services up front but where the costs for the delivery

of that service are to be paid in the future. (i.e., gym memberships). This will create a positive

cash flow in the early period, but it will only be sustained if the future costs are less than the

upfront fees received. A growth startup like GROUPON may trade for a long time with positive

cash flows although they are losing money. Established businesses with positive cash flows may

not be describing a profitable business at all - it may well be describing a business that is running

down its inventory or increasing its creditor terms or selling its fixed assets or managing its

debtors more efficiently. These actions will result in positive cash flow and may well be covering

for the fact that the business is unprofitable. Still at the end of the day, a positive cash flow is

king. In other words, a profitable business that does not have the available cash to pay its bills
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when they become due (negative cash flow) will be out of business long before the unprofitable

one that is managing to maintain a positive cash flow.

Types of Agency Conflict

Agency Conflict or Agency Problem: In theory, shareholders, the true owner of a company,

should be the ones who run its operations. But it is extremely difficult to unify thousands of

shareholders of a company, each holding a very small number of shares of the company, to make

a certain decision. In fact, the shareholders of large corporations today are very fragmented and

therefore the right to executive is essentially in the hands of the CEO (director). Executives are

the people authorized by the shareholders to run the company, bringing benefits to both sides.

However, it is the above authorization that causes the separation or separation of ownership and

management rights of an enterprise. The dichotomy between ownership and corporate

governance raises concerns that managers will pursue goals that are very attractive to them, but

not necessarily in the interests of shareholders, for company.

[ CITATION Jen76 \l 1033 ] define an agency relationship as a contract under which one or more

people (principals) engage with another (agency) to perform certain services on their behalf,

including commissioning some decision-making rights authority over agents. Representatives in

your property refer to a conflict of interest between the principal and the agent. This problem

arises due to the separation between ownership and control many public limited companies have

a certain number of shareholders that invest in the firm and contribute to the establishment and

operation of the firm. However, the ownership of shareholders does not include control because

only most shareholders have control. Theoretically, the company should follow the shareholders'

deviations, but the company's opinion from the shareholders will differ significantly, and this

leads to a conflict. Therefore, it is necessary to have effective control from a collective

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comprising a majority of shareholders or will raise an opinion in the event of a decision by the

company. This is also the case with any decision that is taken by the board of directors and the

shareholders as control is in the hands of those who can drum up the required numbers of votes.

However, this does not mean that shareholders with more than one vote will have control. The

problem is that the shareholders are the owners of the company thus learning to have control

over the firm. But in any democracy, they should have people on their side to have a say in

running the company. In recent years, there have been many conflicts between shareholders and

the company because of the company's scandal. Hence, shareholder controls are needed to

prevent the company's management from making decisions in favor of the shareholder. In short,

shareholders should protect themselves, not passively let the board of directors or the board of

directors decide for them.

The Equity holders have an agency relationship with the Debt holders. Cash flow is the cause of

the fierce conflict between them[ CITATION Jen86 \l 1033 ]. Creditors have a fixed claim on the

cash flow (interest on their debt) while equity holders will have a residual claim [ CITATION

Zha08 \l 1033 ]. Creditors can restrain the firm from investing in high-risk (high return) projects

(while equity holders will favor such projects. Generally, both equity and debt holders want the

company to create enterprise value - the debt holders are being de-risked, and the equity holders

are creating equity value, so it is a win-win. Once a company is in distress, incentives can end up

misaligned. Debt holders will start to focus more on either 1) protecting their current investment,

or 2) trying to take over strategic decisions for the company due to the failures of existing equity

owners. Could mean that debt holders do not want the company to invest in major projects

because they would rather the company just use the cash to pay back their debt. The equity

holders, on the other hand, knowing that they do not have much equity value anyway, will try to
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use the cash on hail mary projects that could potentially strike gold and create equity value. And

if they fail, well, their equity was not worth much anyway. Another is a scenario where the

creditors want the company to default so that the creditors can exercise their rights through a

restructuring and take over the equity of the firm. There are debt investors that see this as a

strategy, effectively buying debt in distressed companies with the goal of taking over the

company through a restructuring. They then implement their own strategic plan to try and create

value for themselves as the new equity owners of the business.

The situation of agency conflict, that will concentrate on the impact of ownership toward firm

performance.

One particularly famous example of the Agency problem is Enron. Enron is one of the major

companies in the United States. However, it started to lose money in 1997. Enron's directors had

an obligation to protect the law and promote growth, but they did not. The Ponzi scheme

represents the agency problem's popularity, including the scams of Bernie Madoff and Luis

Felipe Perez. It has very real legal and financial consequences for both the perpetrator and the

investor. Enron's board of directors did not perform properly in a managerial role and declined

the responsibility of oversight, making the company illegal. The company stagnated after the

accounting scandal that led to billions of dollars in losses.

[CITATION xuW99 \l 1033 ] A listed joint-stock company in China has a mixed ownership structure

with three major groups of shareholders - state, legal persons (institutions), and individuals -

each holding about 30% of the shares. We see a high concentration of ownership: The five

largest necks account for 58% in China, 57.8% in the Czech Republic, 79% in Germany and

33% in Japan. It was mixed and had multiple ownership shares and it had a significant positive

effect on company performance. First, there is each profit correlation with ownership
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concentration and profitability. Second, returns are positively correlated with the proportion of

legal and state shares and shares that are translated by individual holders. Third, labor

productivity tends to decrease as the share of state shares increases. We can see that the

concentration of multiple ownership rights has a positive effect on corporate operations.

Part 2

Royal Dutch Shell Finally Delivers Big Stock Buyback, But Shares Break Support

Stock Repurchase

Introduction

Buyback of share is the choice of many companies. It helps businesses reduce capital costs,

benefit from cost of temporary equity capital, release profits to reward operators, consolidate

ownership, and increase the value of the shares that are remaining in the hands of investors.

It works like this. Let us say company x has a market value (market cap) of one billion dollars.

Let us say also there are 1 million shares outstanding. Then the company does a buyback of

100,000 shares. The company should still be worth on billion but now that billion is split in value

between 900,000 shares rather than a million, so each share represents a larger percentage of

ownership. That should theoretically increase the value of each share by that increase in

ownership share. If the company bought back half the shares outstanding each share would in

theory be worth twice as much. The value of the company would be represented by half as many

shares and shares represent ownership. If you bought all the shares of a company, you would

own the company.

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And one of the companies that repurchase the stock was Royal Dutch Shell PLC. Dutch Shell

company unified publicly traded petroleum corporation, one of the largest in the world, engaging

in crude oil and natural gas exploration, production, refining, and marketing in more than 90

countries around the globe. Royal Dutch Shell share buyback program has given the company a

bounce back from a serious, protracted recession. RDSA believes that stock repurchases could

continue to progress under debt reduction and oil price conditions.

The Importance of Stable Dividend Policies

The company always hopes to grow continuously, and one of the growths is to reinvest the

profits seen over a period, so it is important to set up a dividend policy. [ CITATION Zar19 \l 1033 ]

The stability of dividend distribution is being mentioned on the growth rate of the business.

Moreover, the stable dividend distribution policy shows that the company is on track to grow and

be promising. Company risk will also be lower for companies that are implementing unstable

dividend distribution policies. [ CITATION Blu19 \l 1033 ] RDS's yield increased rapidly in the

period 2015-16 after oil prices fell. The question arises about the sustainability of the dividends.

The company's cash flow gradually improved as oil prices recovered from 2017-18, along with

the reduction of investment capital, stocks improved. Until 2018-19, the interest rate increased

again after oil price volatility (1).

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So, the risk of falling oil prices affects the money flow being created? No matter how the

company operates, it will also negatively affect the company's cash flow as well as investor

sentiment. However, RDS has a process of considerable stability in maintaining and increasing

dividends over time. The chart (2) below shows that although historical dividends have

absolutely no hindrance to oil price volatility. The company has been successful in maintaining

the dividend and distributing it during the difficult times to get out of the dividend buffer.

Although the advantage of stable dividends is so much, it still faces certain limitations. When a

company has used a stable dividend policy for many years, it is very difficult to change to

another policy. If the company does not pay stable dividends to shareholders, including profits,

the financial situation of the business in the eyes of investors will be damaged. It also adversely
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affects the value of a company's stock. If the company still pays a stable dividend but later

cannot afford it, it will be suicidal in the long run.

There are other forms of dividend policies such as constant, residual. Constant dividends

demonstrate advantages. In case the company fails, the company will still pay the usual dividend

rate. In addition, stable and steady income is always desired by investors (the elderly, retired

people, women, or children), they prefer stability over dividend fluctuations. Moreover, it is easy

to mobilize outside capital because it shows loyalty and goodwill. The drawback of constant

policy is that investors cannot see an increase in dividends. The company pays a percentage of its

income as an annual dividend on a constant dividend. If the dividend increases, the investor

receives a larger dividend; otherwise, they may not receive the dividend. Constant dividend

restrictions are income fluctuations, so it is difficult to financially plan. Another is the residual

dividend policy has many changes, but for some investors this is acceptable. After paying for

capital expenditures (CAPEX) and working capital, they will pay the remaining dividends to

shareholders. Surplus dividend makes sense in terms of business operations, no investor would

want to invest in a business just always justifies increasing debt with the need to pay dividends.

Reasons behind Stock Repurchases

Stock Buyback describes the repurchase of shares that the company itself has previously issued

in the market with accumulated cash. Stock Buyback is also known as share repurchase. This is

also a way for a company to reinvest. This acquisition will be recorded to the Treasury stock

account (Treasury Stock or Reacquired Stock) after completion of the acquisition.

A company may repurchase shares for different purposes.

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Price stabilization: when the company's stock price has plummeted and there are signs of non-

stop selling from investors, the company will carry out a "buyback". Then, the Stock Buyback

will help prevent a serious drop. At the same time, there is also a need to drive up stock prices,

such as that of [CITATION fBr83 \l 1033 ]. A positive signal about a stock's value is the takeover

bid, so it increases the share's price, further ignoring the negative effect on the bid on the

payment expectation from a manager or seter price. Also, in the failed auction, the share price

was still higher than it was before the tender.

Capital restructuring: buying back shares will often help the company adjust its capital structure.

Accordingly, after the acquisition takes place, the company's debt ratio will increase, and the

equity ratio will decrease.

Return capital to shareholders: companies only implement Stock Buyback to repay capital to

shareholders when it is in a downturn cycle; or excess capital compared to demand. And thanks

to the buyback of that stake, the company can secure inefficient idle capital; Shareholders can

bring the returned capital to invest elsewhere.

Adjustment of shareholder composition structure: when selling shares, not all shareholders can

sell them. Therefore, the buy-back method will help the company adjust its shareholder structure

and composition.

Individual financial metric

Buyback stock is not too strange to businesses and it is the choice of most businesses. Big

investors like Warren Buffet and Jamie Dimon responded extremely well to this. [ CITATION

War19 \l 1033 ] Warren has commented many times in Bershire Hathaway's letter to Shareholders

regarding stock repurchases. "The buyback will benefit shareholders who no longer work at the
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company and those who stay", "The best use of cash is when the stock is bought below the value

of the company”. How does stock repurchase affect finance? Stock repurchase reduces the

number of shares in the market. In addition to income per share and Earning per share, other

financial metrics that are affected as well are return on assets and return on equity. When using

cash to buy stocks, the rate of return of assets increases, it reduces assets on the balance sheet.

Return on equity also increases because there is less equity on the balance sheet. The index

increase is considered a positive sign in the market, the shares of enterprises will also increase a

little bit.

Deeper look into the Apple company (AAPL). Latest quarterly report for analysis - December

28, 2019: transaction of share repurchases as part of shareholder equity.

The number of shares that Apple quickly pulled back was 70.4 million for $ 20 billion, as well as

30.4 million shares under the quick buyback agreement. Consider financial reporting, the

financial metrics is also affected. Here is a balance sheet, a two-step process:

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The retained earnings for Apple are 43,977 USD, so what should make the retained earnings.

The $20 billion of common stock purchases that were authorized.

Proxy repurchases, consider the implications of these repurchases on the financial metrics.
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From the earnings report, the earnings per share went up to EPS = 22,236,000 / 4,454,604 = $

4.99. Looking closer you will see net sales increase each year and net earnings, combine with

stock reductions. In addition, the decrease in price versus income is a good sign that Apple

becomes more attractive with a lower price than income, price versus income = end-of-quarter

price / TTM EPS = $23.20. An increase in property returns with a decrease in cash to buy back

stocks. Apple has seen a steady five-year profit increase, partly thanks to strong performance,

and because of continuous stock repurchases. The increase in return on equity with the decrease

in equity from stock repurchases, Apple will receive an increase in return on equity, leading to

customer acquisition.

Conclusion

Agency such as between trustees and beneficiaries; board members and shareholders; and

lawyers and clients. Strict legal relationships. The problem was nothing more than a mismatch of

interests between them. It is important that the parties work together to ensure that regular

business operations are not affected. That is the problem that always happens wherever you are,
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even in government agencies. Agent issues such as stockholder’s & management, stockholders &

bondholders & creditors, and stockholders & other stakeholders like employees, customers,

community groups, etc. Can be dealt with by good behavior, punishing bad actions, difficult

screening mechanisms. Although it is not eliminated, it can be minimized in similar times.

Besides, there are many reasons for a company to buy back stock because it is beneficial to the

buyer and the seller. Reducing the number of shares in circulation, giving ownership to the

company. Buying back at the right time can weaken and devalue competitors.

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