Date:0 4-07-2021

ALLAMA IQBAL OPEN UNIVERSITY

Semester Terminal Exam 2020

Name Zainab Malik

Roll no BV560311
Level M.com
Course Corporate Finance (8524)
Registration no 19FID01224

Question No.1 :

Comment on the following statement companies that are organised as proprietorships or

part corporations.” Furthermore, discuss how the market efficiency level can be enhanced
with the presence of a secondary market (for example, stock exchange market).

Answer:

A corporation is an entity by law as possessing an existence to separate and distinct from its
owner that’s why it is a separate legal entity. It provides many of the rights and obligations
possessed by a person and a corporation that can enter into contracts with its own name to buy,
sell, or hold property to borrow money, hire and fire employees and sue and be sued.

Corporation have a remarkable ability to obtain the huge amount of capital necessary for large
scale business operations. Corporations acquire their capital by issuing shares of stock; these are
the units into which corporations divide their ownership. Investor buy shares of stock in
corporation of two basics reasons.

• Investors expect the value of share to increase over time so that the stock may be sold
in future at a profit.
• When investor hold stock, they expect the corporation to pay them dividend in return
for using their money.
 Advantages of the Corporate form of business

Corporation have many advantages over sole proprietorships and partnership. Although
Corporations may have more owners than partnerships both have a broader base of investment,
risk, responsibilities, and talent than do sole-proprietorships.

Easy transfer of ownership:

In a partnership, a partner cannot transfer ownership in the business to another person if the
other partners do not want the new person involved in the partnership. In a publicly held
corporation, share of stock are traded on a stock exchange between unknown parties; one owner
usually can not dictate to whom another owner can or cannot sell shares.

Limited liability:

Each partner in a partnership is personally responsible for all the debts of the business. In a
corporation, the stockholders are not personally responsible for its debts; the maximum amount a
stockholder can lose is the amount of investment.

Continuous existence of the entity:

In a partnership, many circumstances, such as the death of a partner, can terminate the business
entity. These same circumstances have no effect on a corporation because it is a legally entity,
separate and distinct from its owners.

Easy capital generation:

The easy transfer of ownership and the limited liability of stockholder are attractive features to
potential investors. Thus, it is relatively easy for a corporation to raise capital by issuing shares
of stock to many investors. Corporation with thousand of stockholders are not uncommon.

Professional management:

The partners in a partnership are also the main agers of that business, regardless of whether they
have the necessary expertise to manage a business. In a publicly held corporation, most of the
owners do not participate in the day-to-day operations and management of the entity. They hire
professionals to run the business on a daily basis.
Separation of owners and entity:

Since the corporation is a separate legal entity, the owners do not have the power to bind the
corporation to business contracts. This feature eliminates the potential problem of mutual agency
that exists between partners in a partnership. In a corporation, one stockholder cannot jeopardize
other stockholders through poor decision making. Furthermore, in order a expand an existence
Sole-Proprietorship or partnership business it is difficult capital for expansion, but in corporation
raising capital is comparatively easy.

Hence, it can be said keeping in view the advantages of corporation that “sooner or later, all
successful private companies that are organized as proprietorship or partnership must be
corporation.

Market Efficiency can be enhanced with the presence of a secondary market:

In secondary market investors exchange with each other rather than with the issuing entity. A
perfect example is the stock market. If you buy a stock, you are doing so with another individual
who already

owns the stock, as opposed to buying it from the actual company whose stock it is. The latter
would occur in a primary market through an initial public offering.

Secondary market is an important face of the economy. Through a massive series of independent
yet interconnected trades, the secondary market steers the price of an asset towards its actual
value through the natural working of supply and demand. It is also an indicator of a nation’s
economic health. The increase or decrease in price signals a growing economy or an economy
heading towards a recession.

Secondary market creates more economic value by allowing beneficial transaction to occur and
create a fair value asset. Secondary market also provide liquidity to the as sellers can sell quickly
and easily due to large number of buyers in the market.

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Question No. 2

Select any listed company from the following link https://www.psx.com.pk/market

Summary/ and download last five years data and make the following analyses:

• Liquidity ratios
• Activity ratios
• Leverage ratios
• Profitability ratios
You are advised to provide detail comments on each ratio?

Answer:

Fauji Fertilizer Company is a public company incorporated in Pakistan under the Companies
Act, 2017 and its shares are quoted on the Pakistan Stock Exchange. The Company is domiciled
in Rawalpindi. The principal activity of the Company is manufacturing, purchasing and
marketing of fertilizers and chemicals, including investment in other fertilizer, chemical, cement,
energy generation, food processing and banking operations.

The Company has grown through reinvestment in fertilizer sector and at present its production
capacity stands over 2 million tonnes through its three plants.

1. Liquidity Ratios:
2016 2017 2018 2019 2020
S. No Liquidity ratios FORMULA IN TIMES
1 Current ratio Current assets/Current Liabilities 0.91 0.95 0.95 0.91 1.37
2 Quick Ratio (Current assets- Inventory)/Current Liabilities 0.72 0.88 0.79 0.81 1.31
3 Cash Ratio Cash and cash equivalents/Current Liabilties (0.15) 0.30 0.26 0.30 0.71

Analysis:

Liquidity ratios are used to determine a company’s ability to pay its short-term debt obligations.
These ratios help determine if the company can utilize its current, or liquid, assets to pay off its
current liabilities. If a company is liquid, it can meet its payment obligations otherwise the
company might become insolvent as it is unable to pay off even its short term liabilities.

As indicated by the ratios above, the liquidity of the company is slowly increasing over the years.
This indicates better cash and asset management by the company as well as increased
profitability. In 2020 both the current and quick ratios are over 1 which indicates that the
company can pay off all of its current liabilities with ease. Although the cash ratio was negative
in 2016 however this has also improved in 2020 and the company maintains at least 71% cash to
meet its current liabilities.

2. Activity Ratios:

IN TIMES
S. no Activity Ratios Formula 2016 2017 2018 2019 2020
1 Inventory Turnover Cost of Goods Sold/Average value of Inventory 11.70 31.40 11.70 7.60 18.60
2 Account receivables turnover Total Revenue/ Average Account Receivables 23.97 22.60 28.64 12.34 12.40
3 Total assets turn over Total Revenue/Total assets 0.80 0.84 0.72 0.69 0.56

Analysis:

Activity ratios are used to measure how efficiently a company is using its assets and other
financial resources to generate revenues and cash. They are also called efficiency rations as they
also measure how a company handles inventory management and recovers money from its
debtors. These ratios can then be used to compare similar companies with each other to evaluate
which company has better and more efficient operations.

As indicated above, the operations of the company are slowing degrading as indicated by the low
activity ratios. Although the inventory turnover has improved however the receivable turnover
has degraded which show degradation in the ability of the company to make recoveries. The
asset turnover ratio also indicates this trend.

3. Leverage Ratios:
IN TIMES
S. no Leverage ratios Formulas 2016 2017 2018 2019 2020
1 Debt to equity ratio (Gearing ratio) Total liabilties/Total Shareholders equity 1.60 1.16 1.33 0.93 0.95
Earnings before interest and taxes (EBIT)/ Total interest
2 Interest cover ratio expense 8.23 7.44 14.25 10.59 16.79

Analysis:

Leverage ratios indicate indication of how the company’s assets and business operations are
financed. A company may finance its operations using shareholding equity or debt. If a company
obtains debt to finance its operations, leverage would increase indicating that the company is
utilizing more and more debt to run its operations. Continued usage of debt would lead to high
leverage ratios and might lead to insolvency.
As indicated above the leverage ratios of the company are steadily improving which show
increase cash generation by the company i.e. the company is using its own profits to finance its
operations instead of utilizing debt leading to low leverage ratios. This is also indicated in the
interest cover ratio as it is increasing which shows increase profits and low interest expenses
incurred by the company.

4. Profitability ratios:

In Times
Sr. No Profitability ratios 2016 2017 2018 2019 2020
1 Gross profit margin Gross profit/Sales 24.77% 19.95% 26.40% 29.06% 32.34%
2 Net profit ratio Net profit/sales 16.17% 11.81% 13.63% 16.17% 21.32%
3 Return on capital employed net Income/Equity 44.13% 40.48% 55.57% 62.39% 59.19%
4 Return on assets Net Income/Total assets 12.98% 9.86% 9.86% 11.15% 12.04%
Net income-Preferred Dividend/Common shareholder
5 Earning per share equity Rs. 9.26 Rs. 8.42 Rs. 11.35 Rs. 13.45 Rs. 16.36
6 Dividend per share (Total dividends-Special dividends)/Ordinary shares Rs. 7.9 Rs. 7 Rs. 8.85 Rs. 10.8 Rs. 11.2

Analysis:

Profitability ratios are used to measure and evaluate the ability of a company to generate profit.
The profit is compared to revenue, balance sheet assets, operating costs, and shareholders’
equity during a specific period of time to calculate these ratios. They show how a company uses
its assets to produce profit for the shareholders.

As indicated above the profitability ratios indicate an upward trend with the passage of time
which shows that the profitability of the company is increasing. The gross profit is increased by
almost 2% in 2020 whereas the net profit increased by almost 5%. Therefore there is a steady
growth in the return on capital and assets of the company. This return is translated into increased
dividends for the shareholders as indicted by the increase in the dividends per share.

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Question No. 3

Presumably the business case concludes that the merger/acquisition is good because it
increases revenues or decreases expenses, or both, and results in a net gain to the acquiring
firm. According to the recent information the merger and acquisition emphasize the
financial aspects of the target company. You are advised to figure out the importance of
integrating technology planning for value addition in merger and acquisition.

Answer:

Merger & Acquisition M&A:

The Term Mergers and acquisition has different meanings in practice. When a company takes
over another company and clearly becomes owner of the new business, the transaction is referred
to as acquisition. From the legal point of view, the target company ceases to exist and the buying
company will stand still to be traded, but the stock of the acquired company will disappear.

Value addition in Merger & Acquisition:

Value Creation through an M&A Transaction can occur in a multitude of ways companies
generally benefit from the excess value generated by Merger & acquisition. Value added can be
achieved by generating synergies and efficiencies from the consolidated of two or more
companies, which will not, established if the two companies operate separately.

There is a multitudinous way for companies entering in M&A and creating value. There are five
fundamental areas value creation in M&As that is Economies of scope, economies of scale,
market power, diversification, and coinsurance from the shareholder point of view there can be
four major reasons for M&A that are Efficiency gains, synergy gains, growth and diversification

The efficiency gains includes economies of scale, economies of scope and economies of vertical
integration with the rationale behind improving operating efficiency and reducing the cost of
production. On the other hand synergy gains include operational synergy, financial synergy and
managerial synergy. It can be concluded that if the post M&A Integration approach is successful,
it can lead to efficiency gains in combination with the strength to conquer synergy gains.
Many indicators are used to measure value creation, although they should be reduced to the truly
reliable ones these are:

• Accounting
• Economic
• Market
The accounting indicators are return on Equity ratio and return on capital employed, economic
indicator are Net present value and Economic value added, Total of Shareholder return and
abnormal Returns. The theory of efficiency asserts that mergers and acquisition create value
through synergies. A merger happens when two companies, usually equal in size, agree to
combine two companies. The stocks of both companies will stop trading and new stock will be
issued for the merged company. This is usually called “Merger of Equals.”

For examples:

when Daimler-Benz and Chrysler was created. A Purchase deal is also called a merger, which is
when both CEOs agree that joining together in business is in the best interest of both their
companies.

The Technology Challenges of Mergers and Acquisitions:

Information technology integration is a key activity during merger and acquisition but it is often
neglected during the M&A planning. Though many companies examine the success of merger &
acquisition based on financial measurement, they typically do not set their merger strategy based
on the information technology they are using. “It is known that most mergers fail to achieve
expected shareholder value. Multiple studies point to a number of rational explanations for these
failures, including poor target screening, insufficient due diligence, lack of executive support,
large cultural differences, and poor execution. One often overlooked reason is the failure to
engage the information technology (IT) group in M&A activities until it is too late.

The role of information systems in mergers and acquisition becomes increasingly important as
the need for speed of reaction and information is growing, mergers and acquisition may disrupt
the operation of the organization involved. Major issues include the need to integrate personnel,
business processes, Information and diverse information technologies across the merging
organization.

Executives who underestimate or disregard the cost and time associated with merging computer
application, Infrastructure or IT organization will face unpleasant surprises. However, if
carefully planned and properly managed, the merger & acquisition and the resulting integration
process can become an opportunity to strengthen the capabilities of the combined organization
and place it in a better competitive position.
 The following technology challenges are quite common when it comes to mergers and
acquisitions:

A lack of integration:

Typically, the acquired and the acquiring company come in with their own financial systems, partners,
applications etc. and making it difficult to integrate together in terms of technology. This often slow
downs operational processes from sales to HR and everything in between. It’s critical to synchronize and
standardize as soon as possible.

A lack of visibility:

If the acquired and the acquiring company are operating in a similar industry, they may have
duplicate customer information, but a lack of visibility can create difficulties in terms of sales
and business development. It’s helpful to obtain an updated, single point of view into the
customer data via a data integration system that combines and organizes everything.

A lack of compliance:

Unfortunately, it’s unlikely that both the acquired and the acquiring company have the same
levels of compliance in terms of policies, documentation, and other factors. If the acquiring
company is larger and more heavily regulated and they may need to get the acquired company
up-to-speed quickly to prevent.

A lack of security:

Similar to a lack of compliance, a lack of security with the acquired company can be nerve-
racking. If they don’t have any sort of security solutions, processes, and policies in place, the
acquiring company may need to assist with integrating new employees or planning to create a
multi-layered approach to protect against hackers.

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