Finance essay

The company under consideration produces smartphone gloves. It is really innovative and technological problem. That is why the company can get a lot of benefits from expansion of performance to new regions. As we know, this industry is one of the most promising and profitable nowadays. It is not surprising that such companies like Apple and Samsung are making significant profits. However, the industry is also characterized with high degree of competition. Second, the existing markets are really saturated. That is why companies are forced to look for new markets. Such an opportunity can be proposed by the so-called emerging markets. These markets are characterized with a lot of advantages. They have sufficient demand, cheap labor force and support of governments. That is why the company under consideration has chosen to enter one of such markets – South African.

To begin with, it would be reasonable to provide the background information about the region under consideration. South Africa is one of the most developed regions among African countries. This region has a favorable economic and geographical position, situated at the crossroads of three continents – Europe, Asia and Africa. Trade has always played an important role there. Probably, the most developed country of the region is the South African Republic. The country has all the features to propose sufficient demand on the company’s products. It has great population with appropriate financial possibilities. A significant role in the development of the country has been played by transnational corporations.

 

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Transnational corporations have played a decisive role in the globalization of the world economy. The scope of their activity shows presence of their disposal costs that often exceed the size of the national income of the nation states. TNCs control 40% of industrial production in the world, half of international trade. They employ about 73 million employees, every tenth engaged in the world other than agriculture. 500 most powerful multinationals sell 80% of output electronics and chemistry, 95% pharmaceuticals, 76% of engineering products.

In the modern conditions, operations of TNCs are becoming increasingly global and acquisition of the factors of production, goods and market are oriented on the global volume. Placement of the majority of production and numerous branches abroad, integrated into a single network producing goods and services, allows the multinational corporations to use resources and competitive advantages in many countries. This is due to the fact that the global economy is characterized by operation of its business, based on the priority investment tied to international relations. Development of globalization reduces barriers to the cross-border movement of goods, capital and services, promotes uniform regulation that facilitates access to foreign markets, provides standardized requirements for the movement of capital and payment and settlement transactions. The effect of these factors contributes to the intensification of investment and financial flows.

Activity of TNCs provides flow of capital, where there is an excess in the country, where its lack of providing satisfying the interests of both countries based TNCs and host countries. However, on the other hand, transnational capital rather often can act contrary to the national security of statehood countries, impacting negatively on the political and economic situation in them. Creating competition of nation states, TNCs can make negative impact on the development of national business that generates obstructionism of the national economies.

Acting as powerful resource owners (equity TNCs in host countries is about 200 billion), MNCs use different means of pressure on the state governments for the purpose of reducing the probability of investment risk.

More controversial is the relationship between TNCs and governments of the countries where they are based, although the unconditional recognition is of great opportunities of TNCs and their essential role in capital investment in the national economy.

The task of this particular stage of the research is to describe the essence of the term ‘agency problem’. In our opinion, one of the most appropriate definitions of the term ‘agency problem’ is the following:

“Agency problem is a conflict of interest inherent in any relationship where one party is expected to act in another's best interests. The problem is that the agent who is supposed to make the decisions that would best serve the principal is naturally motivated by self-interest, and the agent's own best interests may differ from the principal's best interests. The agency problem is also known as the "principal-agent problem" (Agency problem definition).

Simply speaking, agency problem is a conflict of interests between different stakeholders of a company. For example, there is a constant conflict of interests between the company’s shareholders and managers. Shareholders are interested in growing dividends and prices of shares. Managers are interested in higher salary and bonuses. That is why shareholders usually try to control actions of managers. There may be a significant agency problem in the case under consideration. This may be a conflict between the head office and overseas branches. Of course, the possibilities of control are limited in such conditions. We would recommend using a standardized online platform of control and monitoring, appointment of the top manager from the head country and constant reporting to the shareholders. We believe that such actions are going to minimize agency problems in the case under consideration.

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The task of this particular stage of the research is to describe the essence of the term ‘agency problem’. In our opinion, one of the most appropriate definitions of the term ‘agency problem’ is the following:

“Agency problem is a conflict of interest inherent in any relationship where one party is expected to act in another's best interests. The problem is that the agent who is supposed to make the decisions that would best serve the principal is naturally motivated by self-interest, and the agent's own best interests may differ from the principal's best interests. The agency problem is also known as the "principal-agent problem" (Agency problem definition).

Simply speaking, agency problem is a conflict of interests between different stakeholders of a company. For example, there is a constant conflict of interests between the company’s shareholders and managers. Shareholders are interested in growing dividends and prices of shares. Managers are interested in higher salary and bonuses. That is why shareholders usually try to control actions of managers. There may be a significant agency problem in the case under consideration. This may be a conflict between the head office and overseas branches. Of course, the possibilities of control are limited in such conditions. We would recommend using a standardized online platform of control and monitoring, appointment of the top manager from the head country and constant reporting to the shareholders. We believe that such actions are going to minimize agency problems in the case under consideration.

In order to overcome the agency problem it is important to define potential areas and relations, where it can occur. These areas and relations are the following:

• Relations between the head office and subsidiaries;
• Relations between the top-managers of the company and managers of the branches;
• Relations between the company’s top-managers and regulative institutions of South Africa;
• Relations between the top-managers and employees;
• Overall relations between two cultural and institutional environments.

We must say that the agency problem may be solved via establishment of effective system of the so-called corporate governance and conceptual framework. The term conceptual framework is related to such term and concept as corporate governance. A formal definition of the term “corporate governance” can be the following.

“Corporate governance contains specific rules and practices companies follow to ensure the accountability and fairness in transparency in relationships with business stakeholders. Business stakeholders include individual investors, customers, managers, employees, government agencies, and the general public. The conceptual framework of corporate governance often covers the contractual agreements, conflict of interest reconciliation procedures, and guidelines for governing internal employees” (What Is a Conceptual Framework?).

In other words, corporate governance defines the character and the principles of a company’s relations with its stakeholders. A company’s stakeholders consist of its shareholders, managers, partners and creditors, regulative bodies and society, in general. Conceptual framework, in this context, is used to establish and maintain contractual agreements with the mentioned stakeholders. For example, it ensures that a company won’t exceed its resources and abilities and will provide desired return on investments in a company’s performance. In general, conceptual framework defines a company’s goals and responsibilities.

The most effective structure of corporate governance for the company under consideration will be the following:

• The Board of directors;
• Top-managers and regulators of the head office;
• Regulators and supervisors;
• Local managers;
• National supervisors.

Of course, any project should be economically beneficial. There is even a question whether the project will be accepted in the end. In order to be accepted, the project has to propose higher final benefits than the initial costs. For the purpose of evaluating it we have to compare possible revenues and costs. Approximate calculations are provided in the following table. The project is believed to bring first profits in 4 years. This is the horizon of our calculations. All the numbers are provided in ZAR units:

As we can see, the project is going to become profitable in the fourth year of its realization. We believe that such payback period is quite satisfying for the industry under consideration. That is why the project should be realized for sure. The project’s realization requires the capital budget analysis. Detailed capital budget analysis is provided in the following table.

The Capital Budget Analysis

The company can be called as transnational company. It has decided to enter new markets which are less saturated. In order to realize this objective effectively, the company has to develop the appropriate strategy, including marketing strategy.

At this particular stage of development of our marketing plan we are going to consider a marketing strategy for our product. Marketing strategy should show the way of reaching the stated goals, using different marketing approaches and techniques. The formal definition of the term ‘marketing strategy’ is the following:

“Marketing strategy is a written plan (usually a part of the overall corporate plan) which combines product development, promotion, distribution, and pricing approach, identifies the firm's marketing goals, and explains how they will be achieved within a stated timeframe. Marketing strategy determines the choice of target market segment, positioning, marketing mix, and allocation of resources” (Marketing strategy definition).

Thus, simply speaking, marketing strategy shows the way from the current positions on the market to the desired ones, using marketing instruments.

First of all, we have to define the mission of this marketing strategy. The mission of the chosen marketing strategy is to promote and differentiate the product, to make the customers familiar with it for the purpose of increasing its sales. This marketing mission should contribute to achieving the overall strategic mission of the company – increasing the company’s share on the market and making it one of the leaders. This is the overall mission. It should be achieved via realization of the tactical objectives. These objectives should be the following:

1. Creation and launching of an effective advertisement campaign in all the possible media;
2. Effective positioning and differentiating of the product among the other similar ones;
3. Making the customers familiar with the product, its features and characteristics;
4. Explaining all the competitive advantages of the product to the customers;
5. Creation of some positive associations with the product in the customers’ consciousness;
6. Making the customers also familiar with the company and its other brands;
7. Creation and maintaining a positive image of the company. For example, in this context, it is very important to be socially and environmentally responsible in the modern circumstances.

At this stage of our report we have to talk about the target markets. First of all, we have to talk about the target markets in the regional aspect. The company sells its products in the United States of America. We believe that it is not necessary to describe the size of this market, because it is tremendous. However, it is also quite saturated. That is why the company will be forced to look for new markets in the nearest future. We can suppose that the regional markets are going to be expanded soon.

The proposed product is quite technological. That is why we can say that the target audience is young people 20-40 years old. These people are usually keen on new technologies. Brand new headphones are one of such technologies. Taking this into account, we can say that the marketing strategy should be targeted on this audience. For example, we can claim that the Internet is the most effective way of promotion of the product, since people of this age usually prefer the Internet to TV and newspapers.

Positioning consists of two interdependent sides – creation of some particular perceptions of the product in the customers’ consciousness and differentiating of the product among other similar products, produced by the company’s competitors.

As for us, the analyzed product should be positioned as a brand new technology that proposes a lot of advantages for customers in the modern crazy world. The main its advantage is a possibility to save time in a fast-moving society and to stay in contact with all the people the customer needs. Proposing these advantages, the product, at the same way, is quite cheap. It also should become one of the company’s competitive advantages.

Now we have to talk about the so-called marketing mix. Marketing mix is a set of marketing instruments that are used to reach the marketing objectives. This is also a set of tactical elements of marketing plan. Marketing mix is also known as 4P’s. These four P’s are the elements of marketing mix and include Price, Product, Place and Promotion.  We have already said about main features of the product. Now it is time to talk about the other three elements.

There are a lot of pricing strategies. Among them we may point out the following ones: the premium pricing, penetration pricing, economy pricing, price skimming, optional product pricing and captive product pricing. Taking into account the fact that this type of product is not new, we believe that the company is not going to be able to set up high price. Setting up high price will not let the company stand out competition, since there are lots of similar and even same products. That is why the most appropriate pricing strategy would be penetration pricing.

The other element of marketing mix is place. Apart from traditional places to sell the product, for example, specialized supermarkets and exposures, the company should use the so-called e-commerce. The Internet has become an integral part of our life. We cannot imagine our daily life without Internet. According to statistics, the number of Internet users is about 2 billion in the world. It is about 30% of the world’s population. On the one hand, it is a tremendous number. On the other, there are so many ways for growth. The number of Internet users is only going to grow in the nearest future. The size of this market is really tremendous.

Realizing these trends, a lot of companies establish such direction as e-commerce. It means that they open their online stores, where customers can not just view the products, but order and purchase them. It creates a lot of benefits for the customers. For example, they can save money and time needed to go traditional shopping. Companies also benefit from this process, because they do not have to open traditional stores and pay salaries to sellers. That is why the company under consideration should also open its own online store.

Hedging strategies

The company is going to perform on international market. As a result, it is going to face such a problem as foreign exchange rate. The native currency for the company under consideration is the USD. The currency of South Africa is rand. The company will be forced to conduct all the operations in rands. Respectively, the company will convert dollars into rands. Economic effect of all the company’s operations will depend on the exchange rate and its movement. Such movement for the last five years is provided in the following chart:

As we can see from the chart above, the exchange rate of rand has been declining for the last two years. This is bad sign for the company under consideration. This country is importer, and import is becoming more expensive in such situation. Thus, the products will be more expensive for the local citizens. Of course, it will reduce demand for smartphone gloves.

We also have to determine the fundamental factors that may influence the movement of the exchange rate. Among the factors the following ones may be pointed out:

1. Conditions of international financial markets;
2. Economic development of both countries;
3. Speculative attacks on the local currency, etc.

Of course, such factors may significantly influence the company’s strategy. That is why it has to use the so-called hedging instrument in order to minimize potential negative influence of the changes on the exchange rate. In our opinion, one of the most appropriate definitions is the following:

“Hedging is a risk management strategy used in limiting or offsetting probability of loss from fluctuations in the prices of commodities, currencies, or securities. In effect, hedging is a transfer of risk without buying insurance policies. It employs various techniques but, basically, involves taking equal and opposite positions in two different markets (such as cash and futures markets)” (Hedging definition).

Thus, in other words, hedging is one of the strategies of risk management. Among other similar strategies we may point out, for example, diversification. This strategy is usually used in the financial markets. However, it is also popular in business.

Its popularity has grown in the circumstances of global financial crisis and economic fluctuations, when risks are quite significant. That is why companies try to minimize these risks, entering different hedging positions.

Simply speaking, hedging strategy is usually associated with holding two equal positions in two different financial or business assets. It is based on the assumption that the situation when these two assets cause losses is almost impossible. For example, when an investor puts his/her money in some particular stock, he/she can hedge the risks via investing also in the short position on the index future.

Talking about investments in the foreign markets, we should not forget about financial risks, associated with changes in the exchange rates. That is why the company should also hedge this particular risk via investing in appropriate financial instruments.

One of the instruments of hedging is derivative. Derivatives derive their fair values from one or more under­lying assets or specified reference values. Examples of derivatives include contracts for future delivery in the form of futures or forwards, options on shares or indices, interest rate options, such as caps and floors, and swaps relating to born interest rates and non-interest rate markers.

The use of derivatives is a key strategy that should be used by the company to manage its market and investment risks. Derivatives are used by both organizational levels of the company – the top-management (head office) and individual subsidiaries.

We have to evaluate the company’s efficiency, using CAPM and WACC. The main idea of CAPM for investors is that they should be compensated in two ways: time value of money and risk. The first part of the mentioned formula represents the time value of money. It is represented by the risk-free rate that describes the value that investors should receive in any case.

The second part of the formula represents risk of investing money in some particular assets. In fact, it demonstrates the amount of compensation the investor needs for taking on additional risk.

The main message of CAPM for investors is that if the expected rate of return on some asset, which is calculated, taking into account its risk, risk-free rate and rate of return on the market portfolio, does not meet a desired level then the investment should not be undertaken. Thus, it is a great instrument of evaluation, whether an investment should be made or not. Also it shows a possible profitability of investments and allows investors to prepare some strategic investment plans.

We have calculated the expected rate of return for the investment opportunities, using both the WACC and CAPM models. Both methods define some discount rates that can be used as an expected rate of return and indicator whether the project is efficient or not. We had one particular investment opportunity. We suppose that the risk free rate is equal 10%. WACC is calculated according to a traditional formula:

WACC = ((E/V) * Re) + [((D/V) * Rd)*(1-T)]

E = Market value of the company's equity

D = Market value of the company's debt

V = Total Market Value of the company (E + D)

Re = Cost of Equity

Rd = Cost of Debt 

T = Tax Rate 

According to our calculations, the overall expected rate of return is 19.7%. It is higher than the current WACC of the company. That is why the project may be considered as the one that can increase the company’s value of business, and this is the reason why it can be accepted.

Finally, we have to evaluate the country, where the company is going to enter. It is the so-called external environment of the company. Analysis of the external environment should be conducted, using the mentioned PEST instrument. It is provided below.

Political and social factors. The country under consideration is probably one of the most stable countries in the world. It has been always characterized with stable politic and social situation. All the governments try to maintain this stability and they really do it. That is why political risks of the country are really low. The country also has stable social environment.

Economic factors. First of all, the country under consideration is a country with supportive business environment. Its national economy is a free market, where the government supports business, on the one hand, and protects the interests of customers, on the other. Second, the country has stable pace of economic growth. Of course, the country has suffered because of the global financial crisis, but now it is overcoming the consequences of it.

Technological factors. As it has been already mentioned, the industry under consideration is a bit technological. That is why the degree and opportunities for technological development are essentially significant.

After conducting the PEST analysis, we can say that the country is characterized with a stable and supportive external environment. The country is politically and socially stable. It has an influential middle class. The pace of economic growth is very stable. Such institutional and business environment is supportive for development of business.