International Financial Management

Question

You are required to write a report that critically evaluates each concern individually.

a. Mr Amiable has heard of the large balance of payments deficit of the United States
economy. He argues: “Surely this means that there is a larger supply of dollars for
imports than demand for dollars for US exports, so the value of the dollar is bound to
fall.” Mr Happy adds: ”No, the dollar will not necessarily devalue” to which Mrs
Supreme says: “Even if it did, the balance of payments would not necessarily
improve, it could even get worse”
b. Mr Henny makes the following point: “I am more concerned about the how the
Australian government might make it more difficult for us to operate should we
decide to move our smelting operation to Frustralia.
c. Mrs Pomona remarks: “You are wandering off the point. Our choice does not depend
on the US balance of payments or whether we produce in Australia but on how we
generally manage our currencies. Only against that background can we make a
choice.

Answer

Executive Summary
This report decimates the financial management constituents of Smelts Plc which
propagates factors that are to be paid whether in US dollar or Australian Dollars. For Mr.
Amiable to consider deficit in their balance of payment with the United States economy it is
surely to contradict with demand and supply aspect for importing and exporting US dollars.
While considering this scenario, Mr. Henry will need to make necessary sacrifices in order
to understand how Australian Government needs to take its current operations from the US
to Australia. As a result of which Mrs. Pomona needs to ascertain whether the impact on
managing currency is necessary for depicting the background history of Australian
Government.

Introduction
International financial management mainly refers to financial economics which
mainly deals with monetary interactions taken place between various countries. The report
undertaken on International financial management focuses on critically analysing the
impact of deficit of balance of payment and the ways they can be probably rectified. This
follows a discussion on the way Australian government might make it difficult for economy
of US to carry on its operations effectively. This also includes a discussion of ways or means
that can be adopted to manage its currencies in an efficient manner.

Findings and analysis

A. Evaluate critically the impact of deficit on balance of payments with the

economy of United States

“Mr Amiable has heard of the large balance of payments deficit of the United States
economy. He argues: “Surely this means that there is a larger supply of dollars for
imports than demand for dollars for US exports, so the value of the dollar is bound
to fall.” Mr Happy adds: ”No, the dollar will not necessarily devalue” to which Mrs
Supreme says: “Even if it did, the balance of payments would not necessarily
improve, it could even get worse”

As stated by Mr. Amiable that the situation of deficit in balance of payment situation
faced within the economy of US is a result of incidence of greater supply of dollars for
the purpose of imports than amount available for that of export cannot be
contradicted fully. This statement might be backed by the sole fact that depreciation
can also be a result of decrease in external purchasing power of the economy
concerned. As mentioned by Yahaya et al. (2015), the concept of depreciation often
tends to exist in free market mechanism in which foreign exchange demand out ways
the level of foreign exchange supply within the market for foreign exchange.
Exchange value of dollar can be visualised as summary statistics that tends to
incorporate in it a number of factors and forces. The factors might include potential
long-term growth in GDP, monetary policy stance and relative productive level
within US in comparison to other countries. Increment in demand for foreign goods
usually tends to use up a huge amount of financial resources which usually tends to
play a major role on part of the business organisations associated with the economy
concerned to carry out all their business or production related activities smoothly
and efficiently. As mentioned by Marti & Scherer (2016), efficient level of production
is largely required for purpose of maintaining a sustainable position within economy.
Maintenance of sustainability tends to play a prime role in case of effective survival
within the world filled with immense competition. As opined by Avdjiev et al. (2016),
an attempt on part of the economy concerned to utilise the resources available in an
optimum manner can be highly beneficial in this case for purpose of correction of
such a situation of deficit. This might be backed by the fact that it is the financial
resources that tends to play a vital role in case of involvement in process of
production thereby carrying out production as per the level of comparative
advantage can contribute to this.

The concept of balance of payments mainly shows an overall summary of all financial
transactions taken place within structure of an economy by government bodies,
companies or individuals residing within the economy at large. As opined by Petty et
al. (2015), the transactions mainly consist of export and import of goods, remittances
as well as transfer of payments.

From the point of view of Mr. Happy, it is clear that he suspects the incidence of BoP
deficit in US might not result in a fall in dollar value. This can be reasonable from a
laissez-faire perspective, that argues that BoP deficit do not matter in long run. This
implies that this school of thought is expecting that although BoP can be prevalent at
times in any economy, it itself will erase its existence over a course of time. If the
argument of BoP as a macroeconomic element with no severe significance is
considered to be true, it can be understood that BoP deficit will not hold the power to
affect dollar value. Understanding this laissez-faire perspective requires laying
deeper attention to understanding the economic structure associated with it. This
economic structure makes private parties free from government obligations.
Therefore, these entities can make rules and strategies that favour them yet in time
of BoP deficit. However, this structure for an economy can be highly dangerous as it
supports capitalism without paying any regard to ethics and other values essential
for running an economy. This way, while it makes the powerful entities of an
economy powerful, it suppresses any scope of progression that weaker agencies can
avail. However, in US, the economic structure supports and controls trade and
business performance. Therefore, it is obvious that in prevalence of BoP deficit, there
has to be some effort on part of US government in controlling the deficit. However,
as Mr. Happy mentions, this does not necessarily indicates a fall in US dollar value.
Deficit in balance of payment within the economy might be a result of prevalence of
high inflation rate. Existence of high rate of inflation might have led to making the
foreign goods cheaper in relation to those domestically produced ones. As stated by
Wild et al. (2014), this might led to outflow of greater amount of financial resources
that might have resulted in occurrence of deficit in its balance of payment situation.
Such a situation might be guided by the sole fact that high level of inflation might
have made the people dwelling within the economy of US desire for goods or services
that are foreign to it since these people found them to be relatively cheaper when
compared to domestic ones. On other hand, sudden change in taste or preferences of
customers might also contribute to this. Such excessive outflow of financial resources
might result in degradation of productivity level of the economy which might often
lead to contraction.

Besides this, such a deficit might be the impact of cyclical fluctuations. It might be
the case that the economy might be in a booming phase. This, often prevents the
concerned economy satisfy the demand domestically prevalent within the economy
(Richards & Van Staden, 2015). Such incapability on part of the economy concerned
might have resulted in creation of the situation of balance of payments. As suggested
by Martínez-Ferrero & Frías-Aceituno (2015), existence of an unstable political
situation within the economy concerned often leads to arousal of some level
disequilibrium in balance of payments position as a result of lower inflow of foreign
funds than outflow. This might be owing to inadequate support from government of
the economy concerned.

On other side, it is Mr. Happy who is found to state that devaluation of dollar would
not necessarily improve as a result of devaluation of dollar would not lead to any
kind of improvement in the deficit in balance of payment situation faced by the
economy of US. Such an opinion might be guided by the sole fact that devaluation of
dollar mainly refers to weakening of dollar value of US in comparison to currency
value of various other economies largely prevalent all over the world. As stated by
Yahaya et al. (2015), it can be the case that devaluation of US dollar might lead to
enhancement in level of demand for goods or services manufactured by the economy
to a great extent. However, this might not be effective enough in case the economy
fails to involve itself in manufacture of goods or services taking into consideration
the taste or preferences of its targeted customers. As mentioned by Barrell et al.
(2017), failure to do might make it unable to earn profit as per its level of
expectation. Such incapability on part of the economy concerned might tend to make
the economy come out of its deficit in balance of payment in the long term. Taking
this fact into account, it can be stated that good quality production backed by the
type of goods or services tends to play an essential role on part of the economy
concerned to benefit from devaluation of its currency value. This might be guided by
the fact that taking into consideration both the concept of comparative advantage
 and taste or preferences of customers targeted could have helped it attract a greater
number of customers worldwide. As cited by Marti & Scherer (2016), such attraction
might be owing to the fact that the customers concerned might find it cheaper to
import goods or services from the economy of US as a result of such devaluation. In
opinion of Avdjiev et al. (2016), the economy facing such an increased demand level
is likely to act on part of the economy concerned to come out of its deficit in balance
of payment since this would lead to increment in level of export in comparison to
that of import level. The level of import is likely to remain at a low level in such a
situation as a result of the fact that the impact of devaluation is unlikely to be
enjoyed by the people dwelling within the economy of US itself owing to the fact that
the currency value of other economies of the world have not shown a tendency to
show any kind of devaluation in their currency value. Thereby, no such profitable
position can be enjoyed by the people of US willing to import goods or services from
abroad.

B. Analyzing the decision for moving smelting operation to Australia

“Mr. Henny makes the following point: “I am more concerned about the how the
Australian government might make it more difficult for us to operate should we
decide to move our smelting operation to Australia.”

In order for Mr. Henry to understand how the Australian Governmental plans have
made it difficult for them to operate on whether to move their smelting procedure
towards Australia. There is certain consequence that lacks sophistication research
system so as to conduct research into internationalization of business firm into other
territories. The primary first three consequences that relates to three dimensions
have more impactful situation in relation to big MNE theories. If on the other hand
Mr. Henry proposes to move his smelting business to Australia, then he has to firstly
identify the three clusters for internationalization. For this motivation in order to
drive forces that will initiate goal oriented behavior of the concern will distinguish
each types of motivation like intrinsic, extrinsic and mixed motives.

Intrinsic motivation:
This is referred to as the efficiency gaining proposition while considering
internationalization across different domestic borders. This involves different
exploration of necessary resources which are to locate and transfer coordinating
assets or firm based advantages in that particular location. This will benefit Mr.
Henry to gain efficiency while proposing integration possibilities in a closed market
structure. Due to the BoP deficit that the US economy is facing, it is reasonable for
any performers of US economy to export their good and earn good return. A B.O.P
deficit is expected to discourage export in US economy. Therefore, organizations
thinking of exporting products in international market can get affected due to this
falling value of US dollar.

Extrinsic motivation:
This refers to a particular home point or host country location that is considered to
recreate motivation in abroad states. One can possibly find relevant resources for
conducting neutrality approach under this motive. However most of these
approaches are based upon narrowing the sets of neo-institutional idea formation
 and are consecutively difficult in order to translate such motivation factor among
managers.

Mixed motives of Australian Government:

This motive refers to be using a structural format so as to synthesize both of the other
motives like Intrinsic as well as extrinsic motive at the same time. In real world
practice such motives are used by governmental regulations for referring sector
dynamics prior to internationalization. These processes are quite different from one
sector to another and might not involve resource base planning.

In order for Mr. Henry to fully understand how much impact does Australian
Government has over them so as to create obstacles for operating their smelting
business in Australia he needs to identify the first line of defense for economical
importance that got initiated during IMF crisis. As ascertained by Cremers et al.
(2016), for this IMF (International Monetary Fund) will necessarily provide forecast
advice on how to overcome such crisis through proper management of their financial
transactions according to Australian Government.

As per policy reformist is concerned Titman et al. (2017) stated that there are
financial management principles and their application in relation to policy reforms
will help Mr. Henry to focus upon providing advice to developing countries like
Australia in correlation to achieve macroeconomic stability and to continue accessing
world finance markets. If such considerations are not covered by the Australian
Government during transferring process then attainment of rapid economic growth
are also considered to be farfetched from reality.

C. Decision on making choice that does not depend on US balance of

payment instead should depend on management of currencies

"Mrs. Pomona remarks: “You are wandering off the point. Our choice does not
depend on the US balance of payments or whether we produce in Australia but on
how we generally manage our currencies. Only against that background can we
make a choice.”

For Smelts Ltd it does not depend on the Balance of Payment structure that operates
in US or to even produce in Australia instead of how to manage their current
currency norms. In contrast to this its implications are based upon international
monetary format (Brooke, 2016). This turbulence began during the time of former
Soviet Union through passing of Tequila crisis in Mexico. As a result of which Mrs.
Pomona contradicted that wandering off from a certain point while depending on US
balance of payments are not to be considered as the primary cause for such
deferment, instead management of general currency contingencies are highly
debatable for taking such contingencies before Smelts Ltd opts for moving their
operation in Australia.

Understanding the purchasing power of parity (P.P.P) has been considered as one of
the primary arbitrage laws for pricing of assets on an international basis (Altman et
al. 2017). For this reason building block of P.P.P as per Australian Government will
contend in absence of laws such that identical goods can be sold at a same price in
the domestic territories of the country. It is thus provident to ascertain equilibrium
relationship for real exchange rate (R.E.R) that will be nominal while propagating
exchange rates. If for some reason the purchasing power parity holds equivalent to
the relative pricing level then the nominal exchange rate for that period needs to
adjust in such a manner so that real exchange rate will remain constant. In words of
Cavusgil et al. (2014), conducting international business has to have propensity
between different continents and their currency depiction. While considering such
factor it is crucial for Mrs. Pomona to give prior importance to their P.P.P structure
while conducting international finance. This will eventually eradicate limited
understanding approach on the behavior of real exchange rate. For this Mrs. Pomona
needs to extensively research upon the root cause of change in R.E.R. By proposing
different R.E.R behavior upon different states it has become relevant so as to emerge
for understanding the potential of different speeds that are to be adjusted while
considering positive as well as negative deviation from R.E.R towards P.P.P
equilibrium.

In recent years questions have started to initiate U.S dollars preeminence with
respect to international currency presence. The emergence of euro currency has
proposed changes in the dollar value, as a result of which its financial market caused
drastic decreasing trend in views of facing many challenges along with currency
standing position in different economies. Factors like inertia in currency usage, large
size economic stability among U.S economy has caused oil prices to perpetuate the
role of dollar as a medium for conducting international based transactions. A simple
change in the dollar valuation for a particular time period would have created
consequences for the currency transaction and the status will help to insulate the
economy of U.S from foreign stocks of Nigeria, thus reducing the transaction cost
while trading and financing. Utilization of dollar in reserves will typically result in
greater sensitivity of trade along with inflation and asset valuation while conducting
exchange rate. In words of Deresky (2017), conduction international management
across borders will necessarily help Mrs. Pomona to better implement international
management regulations of Nigeria.
 Figure 1: Exchange rate of US Dollar in the year, 2002

In contrary to this it was first identified that depreciation of dollar value was
observed in the year 2002 which focused upon euro, yen’s currency stability. Such
exchange value of each dollar valuation can necessarily be viewed as a summary for
incorporating different factors like implications of monetary policies, domestic term
savings and long term GDP growth possibility. This is the primary reason as to why it
has become difficult for Mrs. Pomona stating that the Smelts Plc business import
notion of bauxite from Australia has drastically impacted due to monetary changes
with US balance of payments and their managing propensity of home currency. For
U.S government to account for considering deficit in Gross Domestic Product its
ratio helps to assess overall danger zone for a two year time span just prior to
starting of depreciating of dollar value. This is significantly relevant for conducting
net cash flow sustainability along with global investor proposition for purchasing of
asset at a current price which will necessarily become lower than what the U.S
economy has proposed. Such deficit under foreign investment will create higher
demand in return to sell investments in US economy.

Recommendation and conclusion

In order for Smelts Plc to conduct import of bauxite from Australia there are certain
implications that are necessary so as to consider whether payment is to be made in US
dollars or in Australian Dollars. Such creates concerning factor for Mr. Amiable in order to
comply for deficit in the overall balance of payment structure of the US economy. Following
of International Monetary Fund policies along with equilibrium stages between R.E.R and
P.P.P will promote greater returns to them and will necessarily not create any form of
contingencies during currency transaction. Likewise, for Mr. Henry the situation is a bit
different as he is more concerned towards how Australian Government will react to a more
difficult change so as to decide upon moving their smelting business into Australian
territories. Such implication creates identification of first three consequences which can
impact the three dimensions of motivational theories that are related to big multinational
enterprises. On the contrary for choosing what factors have created dependence between US
balances of payment structure, whether it is related to produces in Australia or based upon
managing other forms of currency implications, Mrs. Pomona needs to conduct background
research as to when depreciation on dollar value cased European and Japanese currency to
fluctuate.

References

Books
Brooke, M. Z. (2016). Handbook of international financial management. US Springer.

Cavusgil, S. T., Knight, G., Riesenberger, J. R., Rammal, H. G., & Rose, E. L. (2014).
International business. Australia Pearson

Deresky, H. (2017). International management: Managing across borders and cultures.

London: Pearson Education

Petty, J. W., Titman, S., Keown, A. J., Martin, P., Martin, J. D., & Burrow, M. (2015).
Financial management: Principles and applications. Australia Pearson Higher Education

Titman, S., Keown, A. J., & Martin, J. D. (2017). Financial management: Principles and
applications. Australia Pearson.

Wild, J. J., Wild, K. L., & Han, J. C. (2014). International business. London Pearson
Education Limited.

Journals
Altman, E. I., Iwanicz?Drozdowska, M., Laitinen, E. K., & Suvas, A. (2017). Financial
Distress Prediction in an International Context: A Review and Empirical Analysis of
Altman's Z?Score Model. Journal of International Financial Management & Accounting,
28(2), 131-171.

Avdjiev, S., McCauley, R. N., & Shin, H. S. (2016). Breaking free of the triple coincidence in
international finance. Economic Policy, 31(87), 409-451.

Barrell, R., Karim, D., & Ventouri, A. (2017). Interest rate liberalization and capital
adequacy in models of financial crises. Journal of Financial Stability, 33, 261-272.

Cremers, M., Ferreira, M. A., Matos, P., & Starks, L. (2016). Indexing and active fund
management: International evidence. Journal of Financial Economics, 120(3), 539-560.

Marti, E., & Scherer, A. G. (2016). Financial regulation and social welfare: The critical
contribution of management theory. Academy of Management Review, 41(2), 298-323.

Martínez?Ferrero, J., & Frías?Aceituno, J. V. (2015). Relationship between sustainable

development and financial performance: international empirical research. Business Strategy
and the Environment, 24(1), 20-39.
Richards, G., & van Staden, C. (2015). The readability impact of international financial
reporting standards. Pacific Accounting Review, 27(3), 282-303.

Yahaya, O. A., Kutigi, U. M., & Mohammed, A. (2015). International financial reporting
standards and earnings management behaviour of listed deposit money banks in Nigeria.
European Journal of Business and Management, 7(18), 70-82.

Tags:  Financial ManagementEconomicsAustralia

NEXT SAMPLE
Australian Taxation System Assignment Help
Question

Question 1: This question relates to material covered in the Topics 1 to 3. This question
addresses the 5th and 6th subject learning outcomes.

For the following numerical problems, detailed answers must be shown. This involves
providing a brief description of the problems, formulae used, progressive and final answers
to the questions. For assignments you are expected to show your workings using the
appropriate formula.

a. Sandy expects to receive the following stream of cash flows from an investment over
the next 5 years:

End of year Cash flow ($)

1 400

2 800

3 500

4 400

5 300
If the relevant rate of interest is 9% per annum on this investment, how much should
she pay for this investment opportunity?

b. Lee has taken out a loan of $100,000 with an interest rate of 10% per annum. The
loan is to be paid off by 20 equal quarterly payments; the first payment is due today.
How much will Lee’s quarterly payment be?.
c. Dianne won a lottery prize of $200,000. She invested the entire amount and expects
a yearly return of 10% per annum compounded monthly on her investment. Dianne
will receive 150 equal monthly payments with the first payment due to be paid to her
in exactly 2 years. Find the size of the monthly payments that Dianne will receive.
Question 2: This question relates to material covered in the Topics 1 to 3. This question
addresses the 5th and 6th subject learning outcomes.

Following is an example of a cash flow timeline developed using the Table Function within
MS Word. Please use this example as a means to develop a similar timeline in your answer
to the following question.

Example only:

%  5%

Year 0 2

CFi $0 $1,000

Below are the expected cash flows and interest rates expected from an investment over the
next ten years. Cash flows will occur at the end of the nominated years.

Cash Flows

Year 0 Years 1 - 2 8%

Year 1    

Year 2    

Year 3 Years 3 – 8 6%

Year 4    

Year 5    

Year 6    

Year 7    

Year 8    

Year 9 Years 9 - 10 7%

Year 10    
  Using the Table function within MS Word, draw a time line showing the above cash
flows and interest rates (following the example above)
 What will be the value of all these cash flows at each of the following times:

Time1

o               Time5
o                Time10

Question 3 :) Australian Corporate Tax Cuts

This question relates to material covered in the Module 1 particularly the Australian
taxation system and the dividend imputation. credits. This question addresses the 1st, 2nd,
3rd and 4th subject learning outcomes.

Students are expected to conduct their own research and develop their own opinions about
the merits of this topic. There is no single correct answer and students will be marked on the
depth of their research, the quality of their arguments (for and against), and their
demonstrated understanding of the issues involved. In this complex area of financial policy .

Write an essay of between 600 and 1,000 words discussing the following topic. The
Australian federal government plans to eventually lower the Australian corporate tax rate to
25%. The government believes that this will improve the economy and ultimately taxpayers
by stimulating business investment and creating jobs. Internationally, many countries are
lowering their corporate tax rates including, most recently, Donald Trump’s United States.

Is lowering the Australian corporate tax rate good policy? Discuss. Give particular
consideration to the Australian dividend imputation system and how the Australian
corporate tax rate impacts on Australian taxpayers.

There is a large number of resources available for students to access reflecting a variety of
views on this topic. There are many items in the mainstream online media which canvas the
Government’s view and also items that support the view of those opposing. However,
students should research widely and not limit themselves to any particular source for their
information. For example, community activist group Get Up! produced this humorous
advertisement querying the value of providing such a large tax break to large multinational
companies:

https://www.facebook.com/GetUpAustralia/videos/10154926758921455/?
hc_ref=ARQcaLC4GaIaKB94Z_J_iQgnVS66WwEft6R_SnTxBjiOPrdWCxUI-zaTg3d-
jyPKiJY&pnref=story.
Remember, there is no correct answer and individual students will be assessed on their
demonstrated understanding of the issues and the depth and quality of their individual
research.

Question 4:This question relates to material covered in Topics 1-5. This question
addresses the 1st, 2nd and 3rd subject learning outcomes.
  Find the monthly holding period returns for 2016 for National Australia Bank (NAB),
BHP Billiton (BHP) and the market (MKT) as proxied by the All Ordinaries index.
The monthly holding period return is the return you would receive if you bought an
asset on the first day of the month (opening price) and sold it on the last day of the
month (closing price). Using Excel, graph your % return results on one graph with
returns on the y axis and time on the x axis to enable comparison between options.
(Use 'Close' rather than 'Adjusted Close' for the selling price.) Note: Opening price
MUST equal previous month closing price
 For each investment, what is the average monthly holding period return?
 For each investment, what is the annual holding period return?
 . Calculate the standard deviation of the monthly rates of return for each share and
the market
 Using Excel plot your results from (iii) and (iv) above with risk on the x axis and
return on the y axis
 If the 10 year government bond rate is 2.95% and the long term return on the market
is 6.5%, assuming the beta (?) for NAB is 1.23 and for BHP is 0.90, use the Capital
Asset Pricing Model (CAPM) to find the expected returns for NAB and BHP
 Construct and graph the Security Market Line (SML) showing where NAB and BHP
lie
 Based on your findings construct a portfolio made up of 30% CBA and 70% RIO.
Calculate the estimated return and ? for this portfolio
 Based on your understanding of the CAPM and the SML, which of these asset(s) or
portfolio(s) would you invest in and which would you not invest in. Explain your
choice

Rationale
This assignment directly addresses some of the key learning outcomes for ACC515 including
that on successful completion of the subject students will:

 be able to evaluate and explain the congruence of accounting, finance and treasury
functions;
 be able to explain and critique the objectives of financial management in
contemporary organisations;
 be able to critically evaluate mainstream financial theory and concepts;
 be able to discuss and evaluate ethical considerations in financial dealings;
 be able to demonstrate appropriate communication skills in the context of corporate
finance; and
 be able to demonstrate specific technical competencies and skills in utilising
quantitative techniques in financial analysis.

The requirements of this assignment cover up to and including Topic 5 of the Online
Learning materials. The assignment is designed to develop your financial analysis and
problem solving skills and develop your written communication skills. The questions
require you to apply the knowledge and tools covered in the subject topics in order to
demonstrate your understanding of the subject content. This first assignment has a heavy
focus on fundamental financial mathematics which is a critical building block to develop
your capacity to understand and resolve complex finance problems.

Answer
The holding period return, or HPR, is the total return from income and asset appreciation
over a period of time expressed as a percentage. The holding period return formula is: HPR
= ((Income + (end of period value - original value)) / original value) * 100.

Answer-1

a. Calculation of Investment opportunity-

Sandy wants to invest in an investment opportunity. The predicted cash inflows from
the said investment are given. The rate of interest is 9% per annum for the
investment. For calculating the value of the investment required, the present values
of the estimated cash inflows shall be calculated.

Estimated
Present Value Present Value of
Year Cash
Factor @ 9% Estimated Cash Inflow($)
Inflow($)

1 400 0.917 366.80

2 800 0.842 673.60

3 500 0.772 386.00

4 400 0.708 283.20

5 300 0.650 195.00

    Present Value- 1904.60

This means that Sandy needs to invest $ 1904.60 at present so that he can get the
estimated cash inflows for next five years.

b. Lee has taken a loan of $ 1,00,000 at an interest rate of 10% per annum. This loan
has to be repaid in 20 quarterly instalments which is 5 years tenure. For finding out
the quarterly payment, following steps shall be followed :
o Total interest calculation- $ 1,00,000 * 10%* 5 years= $ 50,000
o Interest calculation for 1st year= $ 1,00,000 * 10% = $ 10,000
o iii. Add your interest rate to your principal then divide the total by total
tenure and further by 4 quarters per year= $1,50,000/ 5 years/ 4 quarters= $
7,500.
c. Calculated in separate sheet of Excel

Answer-2

 Timeline showing Cash Flows and interest rates :

%             8%                                       6%         7%

 Year 0 1 2 3 4 5 6 7 8 9 10

                       

$-
CFi $0 $0 $6,500 $1,500 $0 $0 $0 $0 $ 10,000 $0
2,500

 Calculation of Value of Cash Flows at the given times.

For finding out cash flows value at present for later years, we shall use present value
factors using the rate of interest given for the relevant years.

Formula to be used for Present Value = Future Cash Flow * [1/(1+interest rate) number of
year
]

Time 1 (Year 1)
Present Value of Cash Flow at Year 2= $ 6500 * [1/(1+0.08) 1 ]= $ 6019.00
Present Value of Cash Flow at Year 3= $ 1500 * [1/(1+0.06) 2 ]= $ 1335.00
Present Value of Cash Flow at Year 6= $- 2500 * [1/(1+0.06) 5 ]= $ -1867.50
Present Value of Cash Flow at Year 9= $ 10000 * [1/(1+0.07) 8 ]= $ 5820.00

Time 5 (Year 5)
Value of Cash Flow Year 2= $ 6500 * [(1+0.08)3 ]= $ 8190.00
Value of Cash Flow Year 3= $ 1500 * [(1+0.06)2 ]= $ 1686.00
Present Value of Cash Flow at Year 6= $- 2500 * [1/(1+0.06) 1 ]= $ -2357.50
Present Value of Cash Flow at Year 9= $ 10000 * [1/(1+0.07) 4 ]= $ 7630.00

Time 10 (Year 10)

Value of Cash Flow Year 2= $ 6500 * [(1+0.08)8 ]= $ 12031.50
Value of Cash Flow Year 3= $ 1500 * [(1+0.06)7 ]= $ 2256.00
Value of Cash Flow Year 6= $- 2500 * [(1+0.06) 4 ]= $ -3155.00
Value of Cash Flow Year 9= $ 10000 * [(1+0.07)1 ]= $ 10700.00

Answer- 3
The Australian government is planning to lower the Australian Corporate Tax to 25%. The
motive behind the reduction of corporate tax by the government is increasing business
investment and creating jobs. The benefits of corporate tax reduction may be summed up in
following points:

 Capital infusion may be increased as the companies will be left with more in hand
funds when there will be less tax rate and thus less reduction from the earned profits.
The companies which are currently paying a tax rate of 30% on the final net profit
earned by the company will pay 5% lesser tax after tax rate deduction to 25%. This
5% of the gap in taxation amount will be further invested by the company either in
the existing business or a new business venture. Although 5% seems a very small
amount in case of big multinational companies, this can make substantial al amount.
This will contribute towards the growth of the economy of the country.
  The shareholders will get to enjoy more dividend as there will be a lesser deduction
from the final profits of the companies. The companies will either retain the amount
left out from lower tax rate or will distribute the same to its investors. In the latter
case, the investors will get benefitted. They may also invest the money in one or the
other form thus contributing to the country’s economy (Brigham & Daves, 2014).
 More companies will get set up as a result of lower tax rates. The tax rate reduction
will promote the set up of more companies as the companies shall have to pay lesser
tax on their profits. A newly formed company struggles to meet out even its revenue
expenditure. It will be a treat for such new ventures if the tax rates are also reduced
(Bodie et. al, 2014).
 Foreign investors will get attracted and more foreign investment will get promoted
because a reduced tax structure helps the newly incorporated companies to pay fewer
taxes and keep invested the remaining funds in the business itself which they can use
for other investing and financing opportunities (Carmichael & Graham, 2012).

Apart from benefits, the reduction of tax rates will result in lower contribution towards
government revenues which will lead to a hit on the economy of the country. But this loss to
the government revenue will get compensated through the above-said benefits (Ferris et. al,
2010).

In Australia and other few countries, a system known as Dividend imputation system is
prevailing in which a portion of the tax paid by a company is distributed to the shareholders
of the company in the form of tax credit that the company has already paid on the profits
before distributing dividends (Deegan, 2011). This helps in reducing the taxes on dividends
received by the company shareholders. Other countries such as New Zealand, Canada,
Korea etc have also implemented this system.

The purpose of this system is to avoid double taxation of the profits of the company as once
the profits of the company are taxed at the end of the company and then in the hands of the
shareholders.

Every economy wants capital infusion from big corporate houses. So in order to attract big
corporate, they need to be given incentives in form of subsidies, incentives, tax holidays and
rate cuts like income tax, corporate tax or any other taxes. Countries like Japan, Germany,
and India have resorted to reducing corporate taxes in order to invite corporate investments
but in countries like Australia, where there is a concept of Dividend imputation, it shall not
be a good idea because dividend tax paid is given as a credit against corporate taxes (Leo,
2011). Giving further rate cuts shall reduce the government’s revenue as there shall be
reduced funds available with the government for public expenditure (Davies & Crawford,
2012). Hence rate cuts, on one hand, will invite corporate investments from global
companies while on another hand it may also reduce government earnings in form of taxes.

So, the government should predict all the consequences of rate cuts as it shall have a direct
impact on their spending. Also, the corporate sector may try to declare higher dividends to
their shareholders because it will allow them tax credits against corporate taxes paid by
them. Further, this will also enhance their corporate reputation and increase their share
prices (Laux, 2014).
References
Bodie, Z., Kane, A. and Marcus, A. J. (2014) Investments. McGraw Hill

Brigham, E. and Daves, P. (2012) Intermediate Financial Management. USA: Cengage

Learning.

Carmichael, D.R. and Graham, L. (2012) Accountants Handbook. Financial Accounting and
General Topics, John Wiley & Sons.

Davies, T. and Crawford, I. (2012) Financial accounting. Harlow, England: Pearson.

Deegan, C. M. (2011) In Financial accounting theory. North Ryde, N.S.W: McGraw-Hill

Ferris, S.P., Noronha, G. & Unlu, E. (2010) The more, merrier: an international analysis of
the frequency of dividend payment. Journal of Business Finance and Accounting. [online].
37(1), pp. 148–70. Available from https://doi.org/10.1111/j.1468-5957.2009.02174.x [7
April 2018]

Laux, B. (2014) Discussion of The role of revenue recognition in performance reporting.

Accounting and Business Research. [online]. 44(4), 380-382. Available from Leo, K. J.
(2011). Company Accounting. Boston:McGraw Hill

Tags:  TaxationAustraliaFinancial ManagementAccounting

NEXT SAMPLE
Australian accounting standards - Financial Reporting
Assignment Sample
Question

Instructions for the report

AASB 9 (and IFRS 9) Financial Instruments was initially released in December 2014, but it
will become effective from financial reporting periods beginning on or after January 1, 2018.
This will bring fundamental change to financial instrument accounting when it replaces the
existing accounting standard: AASB 139 (IAS 139) Financial Instruments: Recognition and
Measurement. Entities reporting financial instruments will need to make several decisions
and choices in relation to the transition to the new standard. Many businesses, especially
banks and other financial institutions, will be affected by the implementation of the new
standard. You can find more information regarding some changes made by the new
accounting standard in 2018 and industry impact for various entities from the following
links:
https://www.pwc.com.au/ifrs/new-standard-financial-instruments.html
https://nexia.com.au/news/accounting/aasb-9-financial-instruments-understanding-the
basics.

This task requires you to prepare a report to evaluate and comment on information
regarding financial instruments provided in the annual report of a company listed on the
Australian Stock Exchange (ASX). Your comments or evaluation should comply with the
requirements of relevant Australian accounting standards (AASBs)

Part A

1. Discuss the recognition for financial instruments including financial asset, financial
liabilities and equity instruments according to relevant AASBs.
2. Discuss the measurement of finical instruments according to related to relevant
AASBs.
3. Identify different types of financial instruments available in the chosen company.
Provide at least one example of each type of financial instrument available in the
chosen company and specify recognition and measurement of that financial
instrument.

Part B
From the perspective of the investors, discuss the potential impact of the adoption of new
AASB 9 on assets, liabilities, financial performance and one of selected financial ratios (such
as debt/equity ratio) of the chosen company.

Answer

Executive Summary
The increased globalization and cross-border business relations have made it mandatory for
the financial reports of different countries to communicate a similar language. This is
achieved through the convergence to IFRS which makes interpretation of financial
statements easier and more apt to suit the business requirements. With the effective
implementation of the IFRS, entities could have significant changes in their financial
reporting. Its implementation is not just restricted to equity instruments or such other long
terms loans and receivables but can extend to a few items on the profit and loss account
also. This report discusses the financial instruments concepts that are in tune with the IFRS
with practical examples from the annual report of a listed company.

Part A

Financial instrument recognition

IFRS 9 specifies an entity’s classification and its measurement. Further it relates to financial
asset or financial liability and other contracts to buy or sell non-financial items. IFRS 9
allows an entity to account for an asset or liability of financial type only when it has become
a party to the contract in accordance with the contractual provisions affected by the relevant
instruments. At the prior stage, the financial asset recognition and financial liability is made
at the fair value with an addition of the costs of transaction that are incurred to acquire the
asset or issue the liability. Hence, it is imperative that the recognition should happen at the
time when the entity links to obligations of contractual nature, unlike the other IFRS where
the emphasis is laid on the future economic benefits (Horton & Serafeim, 2010).

Derecognition of financial asset or removal happens from the financial statements when the
expiry happens from that of contractual rights or cash flows or when there is a transfer of
the entity and such a transfer leads to the qualification for derecognition (Deegan, 2005).
Derecognition of a financial liability happens when it gets extinguished or in other words, its
obligations are discharged or canceled or expires.

1. Measurement of financial instruments according to the relevant AASBs.

Financial Assets: Every entity is expected to follow a business model to manage its
financial assets and the cash flows of contractual nature arising and flowing from the assets.
Based on this business model, the financial asset recognition is made according to the
following criteria:

a. Amortized Cost:The financial asset recognition is done at the cost of amortization

only if both the conditions listed below are met:
o The asset is held by the entity for the purpose of collection of cash flows of
contractual nature and the entity aim is to hold the assets for business
purposes.
o Due to the possession of the financial asset, cash flow arises that are solely
payments of principal and interest amounts outstanding on the assets
(Landsman et. al, 2011)
b. FV from a different comprehensive income: In a business model when the
aim of holding financial assets is both for the generation of cash flows and for selling
financial assets, the classification happens through fair value through income of
comprehensive nature (IFRS, 2016).
IFRS 9 also provides guidance on whether the business model is meant for managing
the assets or for the contractual cash flows or collection of both.
c. FV through P/L:If the recognition of financial assets is not done in any of the
above two methods, then the financial assets are recognized at FV through P/L.
IFRS 9 states that when the business model changes, then a reclassification of all the
financial assets has to be done.

Financial Liabilities: Financial liabilities are ascertained in the following ways:

a. At FV through PL: The financial liabilities that are not ascertained at amortized

cost fall in this category like derivative instruments, other financial liabilities for
trading and such liabilities that the entity has specifically classified to be evaluated at
the concept (Lai et. al, 2013).
b. At cost of Amortization: All financial liabilities are evaluated at amortized cost
leaving those measured at fair value through profit and loss (Maria, 2016).

Equity Instruments: IFRS 9 states that the measurement of equity instruments has to be

done at FV. The changes in the equity instruments have to be recognized in the P/L account.
The exception being for the equity instruments that the entity has opted to present the
variances in the comprehensive income.

IFRS 9 provides the option to designate the instrument of equity at FV through other
comprehensive income and this option can opt at the initial time. It is an irrevocable option.
This classification will result in all the gains and losses being presented under the other
comprehensive income except the dividend income which is seen in the income statement.
IFRS 9 even projects way on when the cost might is feasible for FV and when should not be
used for fair value.

Thus these are the measurement criteria laid down in IFRS 9.

2. Different types of financial instruments available in ARB Corporation

Limited
The company selected for discussion and analysis is ARB Corporation Limited. It deals with
the manufacture, design, and other engineering matter related to motor vehicles.

The performance of the company has been pretty good and in a growing phase. The revenue,
profits, and dividends have all seen a steady increase. It needs to be noted that the
companies demand for the products are healthy. It is thus well poised for a long-term
business growth (ARB Corporation, 2017).

The financial statements notes contain the details and explanations about the financial
assets, financial liabilities, and equity. The below has been extracted from the same. The
derivatives that are designated as effective hedging instruments are forward exchange
contracts and these are carried at fair values (ARB Corporation, 2017).

a. Derivative Financial Instruments are classified under Current Assets.

Example – Loans & Receivables
Recognition – These financial assets are recognized when the company enters into a
contract and the other party is under an obligation and also bound by the
performance of the contact.
Measurement – These assets are ascertained at the fair value at inception. The
subsequent measurement is at the cost of amortization utilizing the method of
interest rate. It is tested for impairment at the date of reporting and any impairment
gain or loss is recognized in the profit and loss account (ARB Corporation, 2017).
b. Derivative financial instruments are classified under current liabilities.
Recognition – On similar lines as a financial asset, financial liabilities are recognized
upon entering into contractual obligations where both the parties agree to undertake
their obligations (Hanlon et. al, 2014).
c. Measurement – The financial liabilities mentioned above from third parties are
measured at the amortized cost since these are fixed sums of liabilities and do not
alter with time (ARB Corporation, 2017). Hence fair value measurement is not
adopted for these liabilities. The amortized cost is checked for on the reporting date
and the amount of liability outstanding is disclosed in the statement.
d. Consolidated statement of changes in equity presents the movements and profit or
loss made by the company. Retained Earnings recognize and take into account the
movements in FV of cash flow hedges, net of tax (Goodwin, 2008).

Example – Cash Flow Hedges

Recognition – There are derivatives of specific nature that are allotted to be instruments of
hedging and such derivatives are recognized as Cash flow hedges. For classification under
this category of cash flow hedge, the items that generate the cash flows should be realistic
(Hanlon et. al, 2014).
Measurement – The changes in the FV of the derivatives on the reporting date are
recognized under the equity account in a reserve of hedging of cash flow. The profit or loss
arising is passed on to the Income Statement during the same period when such
transactions occur, thus mitigating the chances of fluctuations of exchange rate that would
have occurred when hedging is not present (Goodwin, 2008).

Part B
As the adoption of IFRS is at a phased stage, there are a few standards that are currently in
force and being adopted by the company whereas the other IFRS are not currently to be
mandatorily followed but available for early adoption by the company (Byard, 2011).

As IFRS 9 simplifies the approach towards the financial assets and liabilities classification
and measurement in comparison to AASB 139, there could be a change in the recognition,
classification, and measurement of financial assets when the standard is adopted (ARB
Corporation, 2017). The change is due to the fact that the standard allows the provision of
the fair value of gains or losses in income of comprehensive nature that are not held for
trading. This would be the impact of the change in the financial assets recognition and
measurement (Byard et. al, 2011).

As per the needs of IFRS 9, the financial liabilities accounting that are provided at FV
through PL will only be influenced. Hence no influence will be there on the accounting for
entity’s for financial liabilities (ARB Corporation, 2017).

With reference to the cash flow hedge, the requirements of IFRS 9 state that a new model
has to be developed which is deeply aligned with the risk management and application will
be easy. The implementation cost will be reduced but the model requires extended
disclosures. Thus the impact of this new hedge accounting model is yet to be assessed by the
company as it is applicable from 1 January 2018.

Out of the items discussed above, financial assets like loans and receivables will not be
influenced by IFRS 9. Financial liabilities like trade payables, other creditors and liabilities
will also not undergo a significant change in the adoption of IFRS 9 (ARB Corporation,
2017).

The debt-equity ratio of the company is currently Nil as the company is not having
borrowings as per the statement of financial position.

Hence another ratio is discussed which is a return on equity which is currently 18.83. Upon
adoption of IFRS 9, it is possible that due to the recognition of the financial assets and
liabilities which are to be concerned at FV through P/L account, the net profits of the
company might increase or decrease (ARB Corporation, 2017). This increase or decrease is
largely dependent upon the measurement of fair value which is a result of the overall market
conditions on the reporting date. Hence the ratio will accordingly increase or decrease.

Conclusion
The significance of IFRS 9 is thus seen in terms of recognition and measurement of financial
assets, financial liabilities, and equity. The accounting and disclosure for cash flow hedge is
the only item that will require more efforts in terms of the development of a model and
extended disclosures. From the investor perspective, it would be evident that the adoption
of IFRS 9 will bring the financial statements closer to the current market scenario. Most of
the items that were being shown at the current or historical cost figures will now be
disclosed at fair values and hence the profitability of the company can either increase or
decrease. It will also not facilitate one on one comparison with the prior year figures due to
the changed recognition and measurement criteria.

References
ARB Corporation. (2017). ARB Corporation Annual report and accounts 2017. Retrieved
from: http://www.annualreports.com/Company/ARB-Corporation-Limited [Accessed 25
May 2018]

Byard, D, Li, Y, & Yu, Y. (2011). The effect of mandatory IFRS adoption on financial
analysts’ information environment. Journal of Accounting Research, 49(1), 69-96.

Deegan, C. (2005). Australian Financial Accounting. McGraw Hill, Sydney.

Goodwin, J, Ahmed, K & Heaney, R. (2008). The Effects of International Financial

Reporting Standards on the Accounts and Accounting Quality of Australian Firms: A
Retrospective Study. Journal of Contemporary Accounting & Economics, 4(2), 89-119.

Goodwin, J. & Ahmed, K. (2006). The Impact of International Financial Reporting

Standards: Does Size Matter?. Managerial Auditing Journal, 21(5), .460- 475.

Hanlon, D., F. Navissi & G. Soepriyanto (2014). The value relevance of deferred tax
attributed to asset revaluations. Journal of Contemporary Accounting & Economics, 10(2):
87-99.

Horton, J. & Serafeim, G. (2010). Market reaction to and valuation of IFRS reconciliation
adjustments: first evidence from the UK. Review of Accounting Studies, 15(4): 725-751.

IFRS. (2016). IFRS Application around the world jurisdictional profile. Retrieved from:
http://www.ifrs.org/Use-around-the-world/Documents/Jurisdiction-profiles/Australia-
IFRS-Profile.pdf [Accessed 25 May 2018]

Lai, C., Lu, M & Shan, Y. (2013).Has Australian financial reporting become more
conservative over time?. Accounting & Finance, 53, 731-761.

Landsman, W. R, Maydew, E. L & Thornock, J. R. (2011). The information content of annual

earnings announcements and mandatory adoption of IFRS. Journal of Accounting and
Economics, 53(2), 34-54.

Maria, W. (2016). The Big Consequences of IFRS: How and When Does the Adoption of
IFRS Benefit Global Accounting Firms?. The Accounting Review , 91(4), 1257-1283

Tags:  Financial ReportingAccountingAustraliaFinancial Management

NEXT SAMPLE
Research Project: Strategic Briefing On The
Management Finance Policy Decsion-Making For
Fortescue Metals Group Limited
Question

Task: Your current role is the Manager of the Finance Division of Fortescue Metals Group
Limited, and you report directly to the Chief Financial Officer (CFO) of the company. The
CFO has requested you to attend a strategic retreat being held by the company to present to
the Senior Leadership Group, including the Chief Executive Officer (CEO) and the Board of
Directors, on the current financial policy platform of the company, the nature of the linkage
or association between these policies adopted by the company, and how they integrate to
influence the operating and share performance outcomes for Fortescue Metals Group
Limited.

Fortescue Metals Group Limited (FMG) is a leading iron ore production and exploration
company which operates in the Pilbara region of northern Western Australia. The company
is the fourth-largest listed resources company in Australia, behind BHP Billiton Limited,
Rio Tin to Limited and Woodside Petroleum Limited, and the largest pure-play iron ore
mining company listed in Australia. The company currently has two primary production
sites in operation, namely the Chichester Hub located in the Chichester Ranges in the
Pilbara region comprising the Cloudbreak and Christmas Creek mining projects, and the
Solomon Hub, which is located 120 kilometers west of the Chichester Hub and comprises
the Firetail and Kings Valley mines. The company’s current operational objective is to
achieve iron ore production of at least 155 million tonnes per annum (Mtpa), and it has
undertaken an aggressive expansion program in the last decade in pursuit of this objective.
The iron ore produced by the company’s mining operations is transported to their port
facilities at Port Hedland and is shipped for spot market or futures contract trading in a
number of overseas locations, but predominantly China.

The following table provides a summary of financial and structural information for
Fortescue Metals Group Limited for their recent June 30th year ends (All figures, except for
per share, issued capital, and percentage statistics, are expressed in A$Million):
Further detailed overall summary, structure, financing, and performance information can
be obtained from the 2016 Annual Report document for Fortescue Metals Group Limited,
which is available from the subject LMS site. Prior year annual report documents and other
filings and announcement information relating to the company can be obtained from the
Fortescue Metals Group Limited website (www.fmgl.com.au) or from the DatAnalysis
Premium database available through the Databases link on the University Library website.
Other relevant information relating to Fortescue Metals Group Limited or the wider
corporate sector is as follows:

 Assume this analysis is being undertaken as at Monday 10th July 2017

 Fortescue Metals Group Limited’s share price on Monday 10th July 2017 is $5.09 per
share, and there are3,113.798 million issued ordinary shares on this date.
 Fortescue Metals Group Limited is part of the Materials Sector based on the Global
Industry Classification Standards(GICS), and its GICS Industry is Metals and
Mining.
 Fortescue Metals Group Limited’s beta coefficient on July 10th, 2017 is 0.89,
compared to the beta coefficient for the overall industry of1.04.

Required:

The CFO has requested you to submit two documents in preparation for the strategic retreat

1. A Background Briefing Report providing detailed explanation of the required

content.

The documents, prepared employing information from the annual report documentation
and any other documentation or sources of information considered to be relevant, are
required to identify and outline the following aspects of Fortescue Metals Group Limited’s
management finance policies:

 The nature of the firm’s working capital management policies. Focus in this
determination should be on overall current asset investment and financing policies,
rather than the company’s adoption of policies relating to specific current asset
categories, such as inventories or receivables.
 The nature of the firm’s capital structure determination policy, including
identification of specific policy adoption or usage if relevant, whether the firm
appears to have target or optimal capital structure ratios, and the determinants of
the firm’s capital structure choice.
 The nature of the firm’s earnings distribution and dividend payout policies. This
should include discussion of the type of dividend policy employed, whether the firm
has a target dividend policy or payout ratio, changes in dividend payout amounts or
patterns, and the consideration of taxation, dividend imputation and franking credit
issues and any other relevant elements associated with the firm’s overall earnings
management and distribution practices.
 The nature of the firm’s corporate governance structure, and particularly the board,
committee, and key decision-making structures and mechanisms in place, and any
changes in this corporate governance structure in recent years.
  The nature of any association or relationship between these various financial
management policies employed by the firm, and how this may relate to Fortescue
Metals Group Limited’sshareand/or accounting performance outcomes.

Answer

Executive Summary: The working capital of a firm determines its operations and
success. Hence, the working capital of the firm needs to be managed in an effective manner
and the management needs to stress on this factor. Along with the working capital, the
company needs to project on the concept of capital management, capital structure, and the
risk management strategy. It is imperative that all must happen in a coordinated manner to
ensure a smooth functioning. In the report, Fortescue Metals Group Limited (FMG) is
considered and studied for preparing the report. The financial policies, working capital,
dividend policies, etc are studied in the light of Fortescue Metals Group.

1. Ascertainment of financial policies and working capital investment

undertaken by the company
Working capital is calculated by deducting current liabilities from the current assets of a
company. Moreover, a company requires more of its current assets to carry out a smooth
flow of operations by addressing all its obligations. Further, the ratio of working capital is
also the same as a current ratio that sheds light on the company’s capability in discharging
its debt obligations. Based on the report of Fortescue, it can be seen that the company has a
working capital of more than one throughout the five-year period that shows effective short-
term liquidity on the part of the company. Nevertheless, the company’s current assets have
witnessed an increasing trend until the year 2015 portraying an expansion in the company’s
affairs. However, the current liabilities witnessed both increasing and decreasing trend
throughout this five-year period.

The company’s working capital ratio is under huge mess when an enormous value gets
blocked in the segment of inventories. The reason behind this can be attributed to the fact
that such stocks must be sold off to dispose or discharge all the obligations (Choi & Meek,
2011).
Hence, the quick ratio has been calculated and such ratio reflects that a quick ratio of more
than 1:1 is the standard rate. Moreover, in all the five-year tenure apart from 2014, the quick
ratio remains at more than 1:1 reflecting that the organization’s one dollar of current assets
for every one dollar of current liabilities is intact in nature (Fortescue Metals Group, 2016).
In relation to Fortescue Ltd, the working capital can be regarded as stagnant in nature. This
sheds light on the fact that the company has been able to maintain its level of current assets
and liabilities at a moderate phase. Furthermore, such working capital has remained more
than one throughout the period of five years ensuring that the company is safeguarded from
the danger of obstruction of the smooth flow of operations (Fortescue Metals Group, 2016).
The capital investment and management policy further signify enhanced utilization of
resources to address the debt obligations in future. Overall, the company’s strategy remains
conservative in nature as it has more cash resources to address its obligations in the
upcoming tenure.

2. Ascertainment of capital structure measure that is adopted by the company

Fortescue’s size is enormous in nature as it resources have reported an amount of

A$10897.02 billion that facilitates in the attraction of investors and creditors, thereby
facilitating in enhancing its reputation as well. In consideration of the last five-year period,
it can be said that the company’s overall reliance on debt has reduced. Besides, such debts
have declined from $12257.81 to $8992.73 that signifies addressing of debt obligations
effectively. This also sheds light on the fact that paying off debt obligations will provide
operating cash in the hands of the company that is free from future obligations (Fortescue
Metals Group, 2016).

Nonetheless, the company’s capital structure can be ascertained with its debt-equity ratio.
The component of debt and equity of the company projects that the company had previously
emphasized debt capital structure to carry out its operations. However, it must be noted that
a higher debt-equity ratio is not a favorable position for any company as it signifies huge
obligations that are altogether a negative indicator for the shareholders (Vaitilingam, 2010).
In simple words, such high reliance on debt structure is a massive risk for the company.
Moreover, based on the numbers, in the current scenario, both total liabilities and long-
term debt have significantly declined but still, the debt-equity ratio has remained more than
0.5 stating that Fortescue must square of its debts to pursue a balanced ratio (Volcker,
2011). Nevertheless, it must also be noted that since Fortescue is a bigger company and it
can easily manage its payments to carry out its overall state of affairs.

In relation to Fortescue, it must be taken into consideration that the company’s net revenue
has enhanced throughout the period but it has also witnessed a decline in the year 2016.
Moreover, the net profit of the company also witnessed an increasing trend and the reason
behind such enhancement can be attributed to its enormous sales and production measures
(Fortescue Metals Group, 2016). Besides, when there was a fall in the level of debt within
the company, it can be seen that the net profit subsequently witnessed a major increment
(Christensen, 2011). Overall, since Fortescue Ltd has been an enormous organization, it
possesses a benefit in relation to a small cap in a way that its cost of capital is lesser due to
the measures of cheap financing undertaken by it. Nonetheless, the size of the company is
bigger in nature and hence, it can easily pave a path for itself to cover its interest payments,
thereby shedding light on the fact that the company’s state of affairs is effective in nature
((Burke et. al, 2010).

In relation to the previously mentioned statement, it can be commented that companies

with much of resources often possess an advantage over companies with small market
capitalization. The reason behind this can be attributed to the fact that such large companies
can easily attain benefits through lower costs of capital owing to cheaper sources of finances
(Wagenhofer, 2014). This means that even though the debt structure of the company is
higher in nature if it pursues an ability to cover its entire payment of interests, it can be
regarded as an efficient and benevolent organization that can utilize its additional leverage
possibility to sustain in the industry (Scapens, 2012).

3.Determination of the earnings distribution and dividend policy employed by

the firm
The earnings distribution and dividend policy can be commented with the help of dividend
and dividend payout ratio. As per the information, it is noted that the dividend payout ratio
has an uptrend in 2013 and 2014 meaning that the company provided a dividend in every
year. However, in the year 2015, the net income declined to lead to a drop in the dividend
factor. This means that the dividend is directly related to the net income of the company.
When the profit scenario of the company is good, the dividend payout is strong (Arnold,
2010). Further, from the financial statement, it is observed that the business showcased the
high growth and thereby the dividend payout is strong (Fields, 2011). This indicates that the
future prospect of the company is high and the investors can select this company.

The system of tax imputation was proposed by Australia in the year 1987 and impacts the
dividend policy of Australian companies. The major benefit resides in the fact that double
taxation on the dividend on income can be removed. The shareholders of Fortescue will
have a major benefit because of after-tax net and franking credit. In the year 2016, the
dividend per share of the company was $0.07 and the number of shares that were issued
was 3113.80. Hence, the overall dividend that was paid by the company amounted to
$217.966 ($0.07x3113.8). As per the trend of the company in terms of share price, it can be
seen that the net income of the company increased while the dividend declined in 2016. The
share price did not project a higher volatility because the debt level kept on increasing, as
well as decreasing owing to the addition and squaring up of debts. Such factors are a clear-
cut indication of the fact that the variation is directly associated with the global scenario and
the performance of the product line (Ferris et. al, 2010). Fortescue has immense stability
and as peer the performance it can be stated that the company will continue its formidable
run in the coming future.

4. Determination of the corporate governance structure and policies employed

by the firm
A detailed description of the policy to be employed and also defining the corporate structure
governance- for having a long-term success it is very important for Fortescue to have good
corporate governance. Not only the boards but also the management level people are giving
efforts to attain the company mission and vision (Parrino et. al, 2012). The company has a
formal corporate governance as it follows the requirements which are specified under ASX
corporate governance principles and recommendations. From this, it can be summarized
that integrity, transparency, stewardship and corporate accountability are regularly followed
by the company. In the company a subcommittee is there whose work is to see whether
policies and procedures comply. The subcommittee includes remuneration and nomination
committee, audit and risk management committee, audit and risk management committee
and finance committee. In order to develop shareholder interest, the board is combined
with executive and non-executive director both. With the help of such corporate governance,
Fortescue attains capital projects, international experiences, sales and marketing, and
infrastructure, resources, and mining experience. In order to address the shareholder skill
and experience of directors are also important. The company selects the candidate without
discriminating them according to gender, race, age, physical capabilities, etc.

The Board keeps a strict eye on the senior post executives. Many matters like ownership
structure, significant affairs and involvement in the international market have seen
corporate governance structure’s domination. The company has caught hold of qualms
which have had an impact on the company and this is possible because of the positiveness of
the corporate governance structure. The top rule for a formal industry is to check the ideas
that the company has been planning to undertake. Changes in Board composition had first
maintained that there are many independent directors in 2017 but is now ruling that their
majority is lesser than expected. Even though such changes have been made, the Board is
satisfied that their directors exercise sovereign judgment for the interests of stakeholders
respectively.

5. Associations and relationships between the various management policies

employed by the firm
The Fortescue Company has summoned up different management policies that have made
the company a very competitive one in the entire market. The company has been providing
dividends to its shareholders over the last five years which shows that the company has been
following a well-maintained dividend policy. This can be said on the basis of the data
accumulated and analyzed over the years. Another data shows that the company has been
continuously providing a rise in the amount of dividend paid each year. The working capital
management of the company can be related to the payment of such high dividends that
show that over the years, the company has been successful because of which the liabilities
have been decreased and the profit margins have increased. In simple words, the liabilities
and dividends have shown an inversely proportional relationship towards each other
(Damodaran, 2010). It would not be wrong to say that according to the dividends paid, the
debt over the company has also been decreased. Furthermore, it can be observed from the
annual report of the company that it has a relaxed fat cat policy for the year 2013 and 2014
together with a conservative policy stance wherein long-term sources of finance have been
majorly used to finance permanent current assets, fixed assets, and few temporary current
assets (Fortescue Metals Group, 2016).

Huge debts have been bothering the company over the years and capital structure is shown
more importance and dependence rather than opting for equity financing (Gibson, 2012). It
was in the year 2014 that the company saw an increase in its profits as compared to the year
2012, but this profit level has again been reduced to low in the year 2015 and 2016 after
paying the tax in all the years. This data is enough to say that the plan that the company has
been executing for the past years had a negative impact on the profits which only increased
the liabilities of the company and has whacked the profits on a set back after the tax
deduction. Accumulation of the retained earning has been at the top of the to-do-list for the
company which has been a fool in utilizing its debts to gain assets as seen for the previous
years (Carmichael & Graham, 2012). It is advised that the company must eliminate or
suppress the use of debt financing and encourage equity financing so that the interest
payment that has accumulated to a huge chunk over the year can be controlled effectively
and thus enhancing dividend paid and net income (Ferris et. al, 2010).

The summary shows that the portfolio policy of the company is risky in nature and because
of that; debt funding has been the major support to execute the tasks which it has been
planning. Financial management policies of the company show such signs which make it
clear that that the corporate governance structure gives a welcomed entry to threat struck
ventures. So all the point mentioned above has caused the performance of the company to
get deviated on a large scale.

References
Arnold, G 2010, The Financial Times Guide to Investing, Prentice Hall.
Burke, A., Van, S. A., & Thurik, R 2010, ‘Blue ocean vs. five forces’, Harvard Business
Review, vol. 88, no. 5, pp. 28-29.

Carmichael, D.R. & Graham, L 2012, Accountants Handbook, Financial Accounting and
General Topics, John Wiley & Sons.

Choi, R.D. & Meek, G.K 2011, International accounting, Pearson .

Christensen, J 2011, ‘Good analytical research’, European Accounting Review, vol. 20, no. 1,
pp. 23-32

Damodaran, A 2010, Applied Corporate Finance: A User’s Manual, New York: John Wiley &
Sons

Ferris, S.P., Noronha, G. & Unlu, E 2010, ‘The more, merrier: an international analysis of
the frequency of dividend payment’, Journal of Business Finance and Accounting, vol. 37,
no. 1, pp. 148–70.

Fields, E 2011, The essentials of finance and accounting for nonfinancial managers, New
York: American Management Association.

Fortescue Metals Group 2016. Fortescue Metal Group Annual report and accounts 2016.
[Online] Available at: https://www.fmgl.com.au/ [Accessed 25 April 2017].

Gibson, C 2012, Financial statement analysis, Mason, Ohio: South-Western.

Parrino, R., Kidwell, D. & Bates, T 2012, Fundamentals of corporate finance, Hoboken, NJ:
Wiley

Scapens, R.W 2012, Commentary: How important is practice-relevant management

accounting research? Qualitative Research in Accounting & Management, vol. 9, no.3, pp.
293 – 295.

University Press

Vaitilingam, R 2010, The Financial Times Guide to Using the Financial Pages, London: FT
Prentice Hall.

Volcker, P 2011, Financial Reform: Unfinished Business, New York Review of Books.

Wagenhofer, A 2014, The role of revenue recognition in performance reporting, Oxford

University Press

Appendix
Ratio

 Working capital 2012 2013 2014 2015 2016

 Current Assets 3,581.59 3,948.25 4,752.65 4,595.05 3,262.86
Current liabilities 2,096.95 1,524.53 3,471.34 2,197.92 2,200.38
Working capital =
1,484.64 2,423.72 1,281.32 2,397.14 1,062.48
CA- CL
 

Particulars 2012 2013 2014 2015 2016

Current Assets 3,581.59 3,948.25 4,752.65 4,595.05 3,262.86
Current liabilities 2,096.95 1,524.53 3,471.34 2,197.92 2,200.38
Current ratio
1.708002 2.589817 1.369113 2.090639 1.482864
=CA/CL
           
Particulars 2012 2013 2014 2015 2016
Current Assets 3,581.59 3,948.25 4,752.65 4,595.05 3,262.86
Inventory 617 1036 1557 1007 746
CA- inventory 2,965 2,912 3,196 3,588 2,517
Current liabilities 2,096.95 1,524.53 3,471.34 2,197.92 2,200.38
Quick Ratio =
1.413765 1.910262 0.920583 1.632478 1.143831
Quick Assets/CL
 

  2012 2013 2014 2015 2016

           
Total equity 3,691.49 5,702.53 8,049.89 9,813.80 11,319.69
Total debt 11,089.20 16,795.69 16,041.40 17,998.70 14,719.90
Debt equity
ratio=
0.3328909 0.3395232 0.5018199 0.5452506 0.7690056
Total equity/
total debt
 

  2012 2013 2014 2015 2016

Div 0.11 0.06 0.29 0.19 0.07

Div payout ratio 0.49 0.6 0.93 0.13 0.43

Tags:  Financial ManagementFortescue Metals Group

NEXT SAMPLE
Financial Instruments Report for ARB Corporation
Limited
Question

Instructions for the report

AASB 9 (and IFRS 9) Financial Instruments was initially released in December 2014, but it
will become effective from financial reporting periods beginning on or after January 1, 2018.
This will bring fundamental change to financial instrument accounting when it replaces the
existing accounting standard: AASB 139 (IAS 139) Financial Instruments: Recognition and
Measurement. Entities reporting financial instruments will need to make several decisions
and choices in relation to the transition to the new standard. Many businesses, especially
banks and other financial institutions, will be affected by the implementation of the new
standard. You can find more information regarding some changes made by the new
accounting standard in 2018 and industry impact for various entities from the following
links:
https://www.pwc.com.au/ifrs/new-standard-financial-instruments.html
https://nexia.com.au/news/accounting/aasb-9-financial-instruments-understanding-the-
basics.

This task requires you to prepare a report to evaluate and comment on information
regarding financial instruments provided in the annual report of a company listed on the
Australian Stock Exchange (ASX). Your comments or evaluation should comply with the
requirements of relevant Australian accounting standards (AASBs).

Part A

1. Discuss the recognition for financial instruments including financial asset, financial
liabilities and equity instruments according to relevant AASBs.
2. Discuss the measurement of finical instruments according to related to relevant
AASBs.
3. Identify different types of financial instruments available in the chosen company.
Provide at least one example of each type of financial instrument available in the
chosen company and specify recognition and measurement of that financial
instrument.

Part B
From the perspective of the investors, discuss the potential impact of the adoption of new
AASB 9 on assets, liabilities, financial performance and one of selected financial ratios (such
as debt/equity ratio) of the chosen company.

You should include the examples that you have identified in part A3) in your discussion.

Answer

Executive Summary: The increased globalization and cross-border business relations

have made it mandatory for the financial reports of different countries to communicate a
similar language. This is achieved through the convergence to IFRS which makes
interpretation of financial statements easier and more apt to suit the business requirements.
With the effective implementation of the IFRS, entities could have significant changes in
their financial reporting. Its implementation is not just restricted to equity instruments or
such other long terms loans and receivables but can extend to a few items on the profit and
loss account also. This report discusses the financial instruments concepts that are in tune
with the IFRS with practical examples from the annual report of a listed company.

Part A
Financial instrument recognition: IFRS 9 specifies an entity’s classification and its
measurement. Further it relates to financial asset or financial liability and other contracts to
buy or sell non-financial items. IFRS 9 allows an entity to account for an asset or liability of
financial type only when it has become a party to the contract in accordance with the
contractual provisions affected by the relevant instruments. At the prior stage, the financial
asset recognition and financial liability is made at the fair value with an addition of the costs
of transaction that are incurred to acquire the asset or issue the liability. Hence, it is
imperative that the recognition should happen at the time when the entity links to
obligations of contractual nature, unlike the other IFRS where the emphasis is laid on the
future economic benefits (Horton & Serafeim, 2010).

Derecognition of financial asset or removal happens from the financial statements when the
expiry happens from that of contractual rights or cash flows or when there is a transfer of
the entity and such a transfer leads to the qualification for derecognition (Deegan, 2005).

Derecognition of a financial liability happens when it gets extinguished or in other words, its
obligations are discharged or canceled or expires.

1. Measurement of financial instruments according to the relevant AASBs.

Financial Assets: Every entity is expected to follow a business model to manage its
financial assets and the cash flows of contractual nature arising and flowing from the assets.
Based on this business model, the financial asset recognition is made according to the
following criteria:

a) Amortized Cost: The financial asset recognition is done at the cost of amortization only
if both the conditions listed below are met:

 The asset is held by the entity for the purpose of collection of cash flows of
contractual nature and the entity aim is to hold the assets for business purposes.
 Due to the possession of the financial asset, cash flow arises that are solely payments
of principal and interest amounts outstanding on the assets (Landsman et. al, 2011)

b) FV from a different comprehensive income:In a business model when the aim of

holding financial assets is both for the generation of cash flows and for selling financial
assets, the classification happens through fair value through income of comprehensive
nature (IFRS, 2016).

IFRS 9 also provides guidance on whether the business model is meant for managing the
assets or for the contractual cash flows or collection of both.
c) FV through P/L: If the recognition of financial assets is not done in any of the above
two methods, then the financial assets are recognized at FV through P/L.

IFRS 9 states that when the business model changes, then a reclassification of all the
financial assets has to be done.

Financial Liabilities: Financial liabilities are ascertained in the following ways:

a) At FV through PL: The financial liabilities that are not ascertained at amortized cost
fall in this category like derivative instruments, other financial liabilities for trading and
such liabilities that the entity has specifically classified to be evaluated at the concept (Lai et.
al, 2013).

b) At cost of Amortization: All financial liabilities are evaluated at amortized cost

leaving those measured at fair value through profit and loss (Maria, 2016).

Equity Instruments: IFRS 9 states that the measurement of equity instruments has to be

done at FV. The changes in the equity instruments have to be recognized in the P/L account.
The exception being for the equity instruments that the entity has opted to present the
variances in the comprehensive income.

IFRS 9 provides the option to designate the instrument of equity at FV through other
comprehensive income and this option can opt at the initial time. It is an irrevocable option.
This classification will result in all the gains and losses being presented under the other
comprehensive income except the dividend income which is seen in the income statement.

IFRS 9 even projects way on when the cost might is feasible for FV and when should not be
used for fair value.

Thus these are the measurement criteria laid down in IFRS 9.

2. Different types of financial instruments available in ARB Corporation

Limited
The company selected for discussion and analysis is ARB Corporation Limited. It deals with
the manufacture, design, and other engineering matter related to motor vehicles.

The performance of the company has been pretty good and in a growing phase. The revenue,
profits, and dividends have all seen a steady increase. It needs to be noted that the
companies demand for the products are healthy. It is thus well poised for a long-term
business growth (ARB Corporation, 2017).

The financial statements notes contain the details and explanations about the financial
assets, financial liabilities, and equity. The below has been extracted from the same. The
derivatives that are designated as effective hedging instruments are forward exchange
contracts and these are carried at fair values (ARB Corporation, 2017).

a) Derivative Financial Instruments are classified under Current Assets.

Example – Loans & Receivables
Recognition – These financial assets are recognized when the company enters into a
contract and the other party is under an obligation and also bound by the performance of
the contact.

Recognition – These financial assets are recognized when the company enters into a
contract and the other party is under an obligation and also bound by the performance of
the contact.

b) Derivative financial instruments are classified under current liabilities.

Recognition – On similar lines as a financial asset, financial liabilities are recognized
upon entering into contractual obligations where both the parties agree to undertake their
obligations (Hanlon et. al, 2014).

Measurement – The financial liabilities mentioned above from third parties are measured
at the amortized cost since these are fixed sums of liabilities and do not alter with time (ARB
Corporation, 2017). Hence fair value measurement is not adopted for these liabilities. The
amortized cost is checked for on the reporting date and the amount of liability outstanding
is disclosed in the statement.

c) Consolidated statement of changes in equity presents the movements and profit or loss
made by the company. Retained Earnings recognize and take into account the movements in
FV of cash flow hedges, net of tax (Goodwin, 2008).

Example – Cash Flow Hedges

Recognition – There are derivatives of specific nature that are allotted to be instruments
of hedging and such derivatives are recognized as Cash flow hedges. For classification under
this category of cash flow hedge, the items that generate the cash flows should be realistic
(Hanlon et. al, 2014).

Measurement – The changes in the FV of the derivatives on the reporting date are
recognized under the equity account in a reserve of hedging of cash flow. The profit or loss
arising is passed on to the Income Statement during the same period when such
transactions occur, thus mitigating the chances of fluctuations of exchange rate that would
have occurred when hedging is not present (Goodwin, 2008).

Part B
As the adoption of IFRS is at a phased stage, there are a few standards that are currently in
force and being adopted by the company whereas the other IFRS are not currently to be
mandatorily followed but available for early adoption by the company (Byard, 2011).

As IFRS 9 simplifies the approach towards the financial assets and liabilities classification
and measurement in comparison to AASB 139, there could be a change in the recognition,
classification, and measurement of financial assets when the standard is adopted (ARB
Corporation, 2017). The change is due to the fact that the standard allows the provision of
the fair value of gains or losses in income of comprehensive nature that are not held for
trading. This would be the impact of the change in the financial assets recognition and
measurement (Byard et. al, 2011).

As per the needs of IFRS 9, the financial liabilities accounting that are provided at FV
through PL will only be influenced. Hence no influence will be there on the accounting for
entity’s for financial liabilities (ARB Corporation, 2017).

With reference to the cash flow hedge, the requirements of IFRS 9 state that a new model
has to be developed which is deeply aligned with the risk management and application will
be easy. The implementation cost will be reduced but the model requires extended
disclosures. Thus the impact of this new hedge accounting model is yet to be assessed by the
company as it is applicable from 1 January 2018.

Out of the items discussed above, financial assets like loans and receivables will not be
influenced by IFRS 9. Financial liabilities like trade payables, other creditors and liabilities
will also not undergo a significant change in the adoption of IFRS 9 (ARB Corporation,
2017).

The debt-equity ratio of the company is currently Nil as the company is not having
borrowings as per the statement of financial position.

Hence another ratio is discussed which is a return on equity which is currently 18.83. Upon
adoption of IFRS 9, it is possible that due to the recognition of the financial assets and
liabilities which are to be concerned at FV through P/L account, the net profits of the
company might increase or decrease (ARB Corporation, 2017). This increase or decrease is
largely dependent upon the measurement of fair value which is a result of the overall market
conditions on the reporting date. Hence the ratio will accordingly increase or decrease.

Conclusion
The significance of IFRS 9 is thus seen in terms of recognition and measurement of financial
assets, financial liabilities, and equity. The accounting and disclosure for cash flow hedge is
the only item that will require more efforts in terms of the development of a model and
extended disclosures. From the investor perspective, it would be evident that the adoption
of IFRS 9 will bring the financial statements closer to the current market scenario. Most of
the items that were being shown at the current or historical cost figures will now be
disclosed at fair values and hence the profitability of the company can either increase or
decrease. It will also not facilitate one on one comparison with the prior year figures due to
the changed recognition and measurement criteria.

References
ARB Corporation. (2017). ARB Corporation Annual report and accounts 2017. Retrieved
from: http://www.annualreports.com/Company/ARB-Corporation-Limited [Accessed 25
May 2018]

Byard, D, Li, Y, & Yu, Y. (2011). The effect of mandatory IFRS adoption on financial
analysts’ information environment. Journal of Accounting Research, 49(1), 69-96.

Deegan, C. (2005). Australian Financial Accounting. McGraw Hill, Sydney.

Goodwin, J, Ahmed, K & Heaney, R. (2008). The Effects of International Financial
Reporting Standards on the Accounts and Accounting Quality of Australian Firms: A
Retrospective Study. Journal of Contemporary Accounting & Economics, 4(2), 89-119.

Goodwin, J. & Ahmed, K. (2006). The Impact of International Financial Reporting

Standards: Does Size Matter?. Managerial Auditing Journal, 21(5), .460- 475.

Hanlon, D., F. Navissi & G. Soepriyanto (2014). The value relevance of deferred tax
attributed to asset revaluations. Journal of Contemporary Accounting & Economics, 10(2):
87-99.

Horton, J. & Serafeim, G. (2010). Market reaction to and valuation of IFRS reconciliation
adjustments: first evidence from the UK. Review of Accounting Studies, 15(4): 725-751.

IFRS. (2016). IFRS Application around the world jurisdictional profile. Retrieved from:
http://www.ifrs.org/Use-around-the-world/Documents/Jurisdiction-profiles/Australia-
IFRS-Profile.pdf [Accessed 25 May 2018]

Lai, C., Lu, M & Shan, Y. (2013).Has Australian financial reporting become more
conservative over time?. Accounting & Finance, 53, 731-761.

Landsman, W. R, Maydew, E. L & Thornock, J. R. (2011). The information content of annual

earnings announcements and mandatory adoption of IFRS. Journal of Accounting and
Economics, 53(2), 34-54.

Maria, W. (2016). The Big Consequences of IFRS: How and When Does the Adoption of
IFRS Benefit Global Accounting Firms?. The Accounting Review, 91(4), 1257-1283

Tags:  AccountingFinancial ReportingArb CorporationFinance

NEXT SAMPLE
Case Study: Business Assessment And Valuation For
Fortescue Metals Group Limited
Question

Case Study: Fortescue Metals Group Limited (FMG) is a leading iron ore production and
exploration company which operates in the Pilbara region of northern Western Australia.
The company is the fourth-largest listed resources company in Australia, behind BHP
Billiton Limited, Rio Tinto Limited and Woodside Petroleum Limited, and the largest pure-
play iron ore mining company listed in Australia. The company currently has two primary
production sites in operation, namely the Chichester Hub located in the Chichester Ranges
in the Pilbara region comprising the Cloudbreak and Christmas Creek mining projects, and
the Solomon Hub, which is located 120 kilometres west of the Chichester Hub and
comprises the Firetail and Kings Valley mines. The company’s current operational objective
is to achieve iron ore production of at least 155 million tonnes per annum (Mtpa), and it has
undertaken an aggressive expansion program in the last decade in pursuit of this objective.
The iron ore produced by the company’s mining operations is transported to their port
facilities at Port Hedland and is shipped for spot market or futures contract trading in a
number of overseas locations, but predominantly China. Fortescue Metals Group Limited’s
largest shareholder is Mr. Andrew Forrest with a 33.32% ownership interest in the
company’s ordinary share capital. Andrew Forrest was also the founder and former Chief
Executive Officer (CEO) of the company, and is currently the Executive Chairperson of the
Board of Directors. There are also a number of other key cornerstone shareholders,
including international mining interests and consumers of iron ore resources.

The company’s Board of Directors are seeking input from its Finance Division regarding the
future strategic direction of the company. In March 2016, the company announced the
signing of a Memorandum of Understanding (MoU) with the Brazil-listed Vale S.A, the
world’s largest iron-ore mining company, to blend FMG’s lower grade iron ore with the
Vale’s higher grade iron ore at Chinese ports to produce a premium iron ore blend designed
to meet the long- term steel requirements of Chinese customers. One part of the MoU
involved Vale S.A purchasing up to a 15% ownership interest in FMG on the sharemarket.
However, updates in December 2016 suggested that this joint venture is unlikely to be
operationalised any time in the near future. FMG is also in early stage discussions with
Hancock Prospecting Pty. Ltd, in relation to taking an ownership interest in the newly-
operationalised Roy Hill 1 iron ore project located in the Chichester Ranges area of the
Pilbara near one of its current operations. This would potentially involve the purchase of up
to a 25% share in the project, and the provision of access to its refining and railway
infrastructure. Based on current financing arrangements and indicative valuations for the
Roy Hill 1 project, the cost of purchasing this project share would be approximately $2.6
billion.

The follow table provides a summary of financial and structural information for Fortescue
Metals Group Limited for their recent June 30th year ends (All figures, except for per share,
issued capital and percentage statistics, are expressed in A$Million):
Further detailed overall summary, structure, financing and performance information can be
obtained from the 2016 Annual Report document for Fortescue Metals Group Limited,
which is available from the subject LMS site. Prior year annual report documents and other
filings and announcement information relating to the company can be obtained from the
Fortescue Metals Group Limited web-site (www.fmgl.com.au) or from the DatAnalysis
Premium database available through the Databases link on the University Library web-site.
Other relevant information relating to Fortescue Metals Group Limited or the wider
corporate sector is as follows:

 Assume this analysis is being undertaken as at Monday 10th July 2017.

 Fortescue Metals Group Limited’s share price on Monday 10th July 2017 is $5.09 per
share, and there are 3,113.798 million issued ordinary shares on this date.
 Fortescue Metals Group Limited is part of the Materials Sector based on the Global
Industry Classification Standards (GICS), and its GICS Industry is Metals and
Mining.
 Fortescue Metals Group Limited’s beta coefficient on July 10th 2017 is 0.89,
compared to the beta coefficient for the overall industry of 1.04.
 The 5-year and 10-year Australian Government Bond yields are 2.258% and 2.784%,
respectively, on July 10th 2017.
 The 1-year London Interbank Offered Rates (LIBOR) on June 30th 2016 and July
10th 2017 were 1.2302% and 1.465%, respectively.
 The S&P/ASX 200 Accumulation Index, including dividend and franking credit
components, has provided an average annual return of 8.668% over the most-recent
five- year calendar period to July 10th 2017.
 The Australian dollar to US dollar (AUD/USD) exchange rates on June 30th 2016
and July 10th 2017 were 0.7782 and 0.7602, respectively.
 Fortescue Metals Group Limited is subject to a corporate tax rate of 30%.

The following table provides financial and operational information for a number of leading
international mining and resources companies based on current market capitalisation levels
and 2016 annual report information (figures in $Million, except for iron ore production,
which is in Million metric tonnes):

Note that Vale S.A and Cliffs Natural Resources Inc. are pure-play iron ore mining firms,
whereas BHP Billiton Limited and Rio Tinto Limited are diversified mining companies and
iron ore mining is only a part of their overall mining activities.

The Director of the Business Development Division of Fortescue Metals Group Limited, Mr
Peter Lynch, has requested you to prepare an analysis and options report regarding the
company, which will be used as an important input into the Board’s future strategic
decision-making. The report is required to include the following components:

 An analysis of the performance of Fortescue Metals Group Limited and the wider
iron ore industry over the last five-year period at a minimum, and a risk assessment
associated with an expansion of investment and activities in the iron ore sector in
Australia.
 The determination of the current weighted average cost of capital (WACC) of
Fortescue Metals Group Limited.
 The determination of the current weighted average cost of capital (WACC) of
Fortescue Metals Group Limited.
 A recommendation for how an investment in the Roy Hill 1 Project should be funded,
taking account of the company’s current capital structure, recent financing actions,
and the wider economic and financial environment.

The due date for submission of this Case Study task is provided in the subject learning guide
and on the subject LMS site. This Case Study will represent 30% of the final assessment for
this subject and is to be submitted using the upload facility provided on the subject LMS
site. This Case Study is an individual assessment task, and should be a maximum of 1,500
words, excluding any calculations, tables or other exhibits. The Case Study should be
prepared in a professional manner and include informative and logical information to
justify any decision-making and recommendation conclusions drawn. Relevant calculations
employed should be fully explained and be understandable and interpretable by the reader,
and any important assumptions made should be clearly stated. Any resources used, besides
the Fortescue Metals Group Limited 2016, and prior year, annual report documents, should
be appropriately identified and referenced.

Answer

Executive Summary: The report discusses the business activities of FMG. It discusses the
industry in which it operates and its performance over the past few years. The areas of risks
have been identified and their potential impacts have been also assessed. The weighted
average cost of capital of the company has been calculated. The valuation of the company
has been done using the dividend discount model and peer comparison to compare it with
the current market capitalization and identify the differences. Lastly, funding decision for a
new project has been also recommended keeping in mind the current financial position of
the company and the viability of the sources available for finance.

Introduction: The growth of a company is dependent upon both financial and non-

financial factors. Therefore, to assess the performance of a company it is vital that both
these factors are considered. The valuation of a company is impacted by the internal factors
like the working and performance of the company and the external factors like the industry
in which it operates and the stock market factors.

Analysis of Company and Industry Performance: The company is involved in the

business of production and exploration of iron-ore in the northern region of Australia. The
company is the fourth-largest resources company in the country and has two production
sites.
The reduction of the iron-ore price in the year 2016 resulted in decrease in the revenue of
the company as compared to the year 2015. However, it can be witnessed that the company
has strived to reduce its C1 costs on a continuing basis in last ten quarters which has
drastically impacted the profit of the company. Therefore, even with decrease in the revenue
in the year 2016 the company has witnessed an increase in the net profit of the company by
210%.

The other important parameters of the company like mining, processing and shipments
have witnessed an increase for the past five years. It implies that the business of the
company in terms of volume has increased in these years even if the amount of revenue
earned has reduced.
The mining industry has experienced a fall in the prices for the past few years (IBIS World,
2018). The output of the industry has however increased in these years (IBIS World, 2018).
The industry in Australia was meeting the high demand of iron-ore in the past years that
had increased the world prices of the iron ore. However after mid-2014, the industry started
experiencing oversupply which reduced the overall revenue of the companies in the industry
irrespective of the increase in the volume.

Major of the production of Fortescue was exported to China. Therefore, we can witness the
decline in the revenue of the company after the year 2014. The sudden decline in revenue
had also impacted profit in the year 2015 after which the company started gradually
reducing its operating cost which improved the profitability of the company in the year
2016.

Risk Assessment:The risk to which a company is exposed comprises of both the internal
and external factors. We have conducted a SWOT Analysis in the given case to understand
the strengths and weaknesses of the company and then relate it to the involved risks.

Strengths – The Company is one of the pioneers in the industry. The company operates in
north Western Australia where major of the iron ore is mined. The company has formed
various committees to ensure efficient operations like risk management committee, taxation
committee, employee safety committee.

Weaknesses – The constant decline in the prices of the iron-ore due to oversupply is a
matter of concern for the company. If the prices of the iron-ore decrease further they might
have an adverse impact on the profitability of the company.

Opportunities – The Company has been sufficient cash reserves therefore, it can consider
investing in different ventures. The company has been in the industry for long and is a well-
known entity therefore, it would have the benefit of brand image in the instances of
acquisition and it would provide the company with a competitive edge. The company can
consider investing in the ventures that would help in adding higher value to its company.
For instance, if the company invests in ventures from which it is able to convert its low
grade products into superior products it can sell them at a premium price and it would
generate value for the company.

Threats – The Company is involved in the industry where employee safety is given vital
importance. It has to ensure that slavery is not practiced in any of the concerns which are in
the supply chain of the company. Therefore, if instances of slavery are identified it would
pose a threat to the company. The company supplies major of its extracts currently to China.
If the demand of iron-ore decreases in China it would impact the business of the company.

From the SWOT Analysis, it can be stated that the iron-ore industry is currently witnessing
a reduction in oil prices which has to be compensated by curtailing the cost and increasing
the volume of sale. The company has adopted both these measures. However, the company
has to ensure that the safety of the workers is adequately met even with curtailed expenses
otherwise it might have an adverse impact on the brand image of the company. It has to also
ensure that the slavery is not practiced across the supply chain. Therefore, even after
reducing the expenses it cannot curtail its expenditure related to these factors to a great
extent.

Weighted Average Cost of Capital Determination: The weighted average cost of

capital for the company has been determined hereunder:-
Note: The interest expense including the finance lease cost was provided together in the
notes to the financial statements therefore, they have been considered as a whole for the
computation of the after-tax cost of debt.

Company Valuation: The company has been valued according to the various methods to
compare the theoretical valuation of the company with the current market valuation.

Dividend Discount Model

The growth of the dividends has remained in the past few years. The market is even
witnessing oversupply of the iron-ore. Therefore, keeping in mind the above factors the
perpetual growth of the company has been estimated at 5%.

Peer Comparison:For the peer comparison we have only considered Vale S.A and Cliffs
Natural Resources Inc. have been considered as they are involved only in the business of
iron-ore mining.

If the valuation as per Dividend Discount Model is observed, we can assess that the market
share price of the company is less as compared to the share price that has been obtained by
the application of Dividend Discount Model. One of the factors for such difference might be
difference in the growth rate that has been applied in the given case as compared to the
growth rate that is perceived by the market.

If the peer comparison is observed, it can be assessed that the market capitalization to book
value is less for FMG as compared to its competitors. The company is earning satisfactorily
as can be observed in NPAT/Iron Ore Production ratio. However, the market capitalization
to book value is less for the company as compared to its peers. It implies that the equity
shares of the company are undervalued.

Funding Decision:The company is considering funding the Roy Hill 1 Project. In the
current scenario, the company can consider financing a mix of debt and equity. The iron-ore
prices are declining currently therefore the margins of the future years are uncertain. If the
entire funding is made through debt, it will increase the financial commitments by the
interest amount. The cost of equity is higher than the cost of debt. However, the equity is
currently under-valued in the market. Therefore, the company would be able to procure
funds from equity at a lower price. In this manner, the company would be able to utilize all
the available benefits in a balanced manner and funding the project through debt and equity
mix would generate optimum benefit.

Conclusion: The company is performing well and has the potential to cater to the current
requirements of the company. It also has the potential to change its course in changing
environment like curtailing costs in the instance of reduction in the iron-ore prices.
However, the future of the industry and company depends upon the demand and supply of
iron-ore in future. Since the company only deals in iron-ore products the economic impact
on the product would have a direct impact on its revenue and margins.