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3 Assessment of the company’s capital structure decisions

3 Assessment of the company’s capital structure decisions

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Final thesis



Academy of finance



Understanding high debt ratio, the firm is trying to improve this

situation of capital structure. It issued 100% new shares to double the

capital invested by the owners to increase



equity and lessen the



proportion of debt in capital structure by reducing account payable and

deferred revenue. It helps the firm make up the difference of capital and

limit the affect of debt financing to the company. This decision makes

the company reduce dependence on outside and avoid not paying

within required period or going bankruptcy or pressure of payment.

2.3.2 The shortcomings and reasons

2.3.2.1. The shortcomings.

- Although the firm is trending to use more equity in capital

structure but its debt ratio still is at high level. This make the investors

worry about investment in the company, the creditors will express

reservasion about lending money. It makes financing be more difficult.

- The company has net working capital at high level and it usually

over than zero with great difference. This situation helps the company

advoid payable pressure but it can increase financial risk and WACC of

the company. In 2015, the company reduced financing short term debt

while it developed borrowing long term debt. Because short term debt

has the cost of capital is lower than long term debt and rate of interest

in long term usually be fixed or higher than short term .This situation is

explained that the long term debt has the period of payment is longer, it

uasually is affected by the fluctuation of



interest rate, inflation,



monetary policy or prices of the goods or services in the market. So it is

clear that long term debts are riskier than short term debts. So the cost

of long term debts is higher. Therefore, it can make the WACC of the

company higher than using short term debt. Morever, if the firm can

not afford to pay for creditors, it will be difficult for the company to not



Tran Thi Minh Nguyet



CQ50/11.18



Final thesis



Academy of finance



go bankruptcy.

- In 2015, the firm decided to issue new shares to double the

capital invested by the owners. Although it helps the company improve

its capital structure and reduce the interest cost, financial risk and

pressure of payment, it makes the right in management of previous

shareholders decrease because the new shareholders take part in the

firm. It can affect to the management operation of the company. This

source of capital is one of the highest cost source because its risk is

higher than anothers. So when the firm raises equity, it means that the

company has to pay for more cost of capital to the investors. This

activity can make the market price of the stocks do down because of the

increase in quantity of shares.

2.3.2.2. The reasons





Internall reasons.

- Stability of sale and profit of the company: The company has the



stability of sale and profit in the operation, usually at more than

300.000 -400.000 million VND. With good reputation of the company,

this figure doesn’t change too suddently from year to year. So the

earning from business is able to pay for the loans. It is reason why the

company has more debt in capital structure.

- Gearing of the company is too high, which makes the suppliers

expresse reservasion about selling before payment. This situation

causes the decrease in short term debt, so the company has to find long

term loans from commercial banks.

- The company doesn’t have a department which is specializes in

management of finance. So this situation is reason why the company’s

establishing capital structure is not stusied carefully.





Externall reasons



Tran Thi Minh Nguyet



CQ50/11.18



Final thesis



Academy of finance



- Fiscal 2015 is one of the years in which the government supported the

real estate after economic crisis. So the commercial banks lends the company

money with preferred rate of interest. So the company borrowed more debt to

finance the business operation from commercial banks.

- The characteristics of transform of capital is one of the reasons

explaining the capital structure of the compay. Because revenue from

projects depends on rate of finish constructions while the value of them

is too great, the time to finish the projects is usually very long. The

company has to use money from account payable or deferred revenue.

When they worry about the company’ability to pay for loans or the

customers don’t transform money for the company, it has to borrows

money with long term.

- The features of business operation of the company: because the

firm operates in construction and mechanical industry, its projects are

mainly roads, brigdes, steel structure,… and their value are great. While

the money of the owners is limited, it is obvious for the firm to raise

debt with high level.

- After economic crisis, many firms still have difficult recovering

operation. Therefore, it may be that they don’t have enough money for

payment in this year. Because the partners of the company can’t pay

within short time so it is obsivious for the compapny to borrow more

money.



Tran Thi Minh Nguyet



CQ50/11.18



Final thesis



Academy of finance



CHAPTER 3

SOLUTIONS FOR ESTABLISHING THANG LONG MECHANICAL

FOUR AND CONSTRUCTION JOINT STOCK COMPANY ’ TARGET

CAPITAL STRUCTURE



3.1. The development strategies of Thang Long mechanical four and

construction joint stock company

3.1.1 Social and economic background.

Vietnam has boosted its international economic integration as it

enters into more free trade agreements with the Eurasian Economic

Union, the European Union, South Korea and the Trans-Pacific

Partnership. At the same time, the ASEAN Economic Community was

established on December 31, 2015, and is likely to create more

opportunities for the country to integrate into regional and global

economies. This situation brings more opportunities for our companies

to develop their business and learn morden technology from developed

countries in the world.

But while global integration has advanced well, with Vietnam

embedding itself in global value chains, the benefits are constrained by

the absence of linkages with domestic firms. This means that the

companies in local area will have to face to the competitions agains the

foreign coperations. It requires the company to innovate its technology

and improve its competiveness by increasing quality of projects and

training labour more carefully. To make those requirements come true,

the company has to face to the econimic conditions. After economic

crisis, the economy is still recovering slowly and the real estate of

market also has trouble restoring. This condition will cause much

difficulty for the company in construction and mechanical projects.

Morever, in the future, the price of material such as steel, cement,

iron… will be not stable because of approaching from the firms in



Tran Thi Minh Nguyet



CQ50/11.18



Final thesis



Academy of finance



China. The supply of material can be limited when there are a lot of

constructions performed. This makes the company have difficult

working the new projects. Beside, the real estate market hasn’t

recovered strongly, preferred policy of 30.000 billion VND exprises in

April 2016. It means that the company in construction industry will

have difficulties to develop.

3.1.2. The development strategies of Thang Long mechanical four and

construction joint stock company

3.1.2.1. Objectives of business operation

In 2016, the company will have to continue finishing the projects

from previous years, including:

- Bo Ao bridge project which is begun in July 2015.

- Rach Chiec Bridge project which is begun in 2015

- 10A project begun in May 2015.

- 1A highway in Nha Trang – Khanh Hoa

3.1.2.2. The orientation of business

- To direct the implementation of projects with required period.

- To improve the ability to organize and manage of the staffs in

departments , factories and the production team.

- To renovate equipments, technology and machines to increase

the quality of projects.

- To establish more sensible capital structure and decrease gearing

of the company.



Tran Thi Minh Nguyet



CQ50/11.18



Final thesis



3.2.



Academy of finance



Solutions for



establishing Thang Long mechanical four and



construction joint stock company ’ target capital structure

3.2.1.Improving capital structure by decreasing gearing.

Accorrding to chapter 2, we can see that the firm raises mainly

debt inspite of equity to finance for business. It can cause financial risk

and insolvency or bankruptcy for the firm. So in the next year, the

company should improve capital structure by decreasing gearing.



 Adjusting devidend policy

Because in fiscal 2016, the company issued new common shares

to raise money for building a new factory and some projects, so it is

possible to raise fund from profit of the years. The company is applying

fixed devidend policy with 10% of capital invested by shareholders. It

is reason why the company usually spends almost earning for sharing

devidend and the amount of retained earning is limited. To increase the

proportion of equity in capital structure, the managers should establish

a sensible devidend policy. It means that the company needs to retain

more profit to reinvest the next years. The average gearing of industry

is 0,72 so the firm should adjust to the same level.

Accorrding to the development plan of fiscal 2016, some financial

items:

- Revenue in 2016: 400.000 million VND

- Net income: 5.500 million VND

The company should spend all profit to reinvest in business: 5.500

million VND.

If the shareholders want to receive devidend, the company can apply the

form of devidend in shares. However, in 2015, it issued new common shares,

this policy can face to difficulty and make the price of shares in the market

reduce.



Tran Thi Minh Nguyet



CQ50/11.18



Final thesis







Academy of finance



Raising capital with the target gearing for each projects.

Example, in 2016, the company will have a project with the value



of 18.000 million. To finance for this project, the company establish capital

structure with gearing of 0,72.

- Total demand of capital: 18.000 millon VND

- Target gearing : 0,72.

The company can raise money accorrding to this solution:

- Borrowing money from banks or different sources:

18.000 x 0,72 =12.960 million VND.

- Raising equity: 18.000 – 12.960 = 5.040 million VND.

The firm can do that with orthers to establish target capital structure. If

the equity is not enough , the company can finance for this project by

requiring the owners to contribute money in the form of fixed assets, raw

material or orthers. This solution helps the company reduce pressure of

raising capital.







Liquidating fixed assets which are not in good productivity



Beside, the company should liquidate the asset which is ancient or its

effectiveness of production is not good. This can generate revenue for

purchasing new equipments.







Improving management of expenditure in business operation



The cost price of the company almost is at high level, it appropriate

more than 90% of annual revenue. The firm needs a policy to

reduce expenditures in production, as a result, retained earning for

reinvestment increases and it can limit to borrow money from the

banks. To manage the cost price, the managers can apply some

solutions:

- The cost price of construction projects depends on the price of



Tran Thi Minh Nguyet



CQ50/11.18



Final thesis



Academy of finance



raw material in the market. This items usually change very quickly

because the demand of customers. Therefore, the company should store

enough raw material and establish the relationship with the suppliers

who provide at stable price.

The company can determines the quantity of raw material by

Economic Order Quantity ( EOQ):

C: Relevant total cost

C1: Total holding cost

C2: Total ordering cost

c1: Holding cost per unit

c2: Ordering cost per order

Qn: Annual demand quantity

QE: Economic optimal quantity

Relevant total cost:

Example : in fiscal 2016, the demand quantity of raw material

( Steel) will be 500.000 ton.

c1 = 5000 VND/kg, c2 = 8000 VND/Kg. ( This figures are

caculated by the author from the information of the company)

we can caculate the economic order quantity of steel :

Therefore, the company should order 4000 ton of steel for an order

to reduce cost of holding. With others, the firm can apply this model to

determine the quantity for a purchase. This activity can help the

company control the holding cost to decrease expenditure.

- It is possible to have the plan of maitaining and repairing

equipments,machines,…to advoid breaking down of them.

- The manager should adjust to pay salary for workers by job wages, or

strengthen to supervise at work. It can make effectiveness of production

increase and advoid misuse of resources.

3.2.2. Reducing gearing of the company to decrease financial



Tran Thi Minh Nguyet



CQ50/11.18



Final thesis



Academy of finance



risk and insolvency of the company by borrowing less money and

establishing a flexible devidend policy

Finding the source of capital which will be used to finance the

project and decrease gearing of the company.

-



The manager should limit to borrow new loans from other the



partners if the company can find the other sources of capital. It means that the

company should consider to raise capital from available sources like retained

earning from previous years.

To spend more money for business, the company should

establish a flexible devidend policy inspite of the fixed policy which is used at

moment with 10% of net income .

3.2.2.Strengthening



the management of recievable account to recover



capital in short term.

If the company can reduce the period of recovery recievable

account, it will have more capital to finance for business inspite of

borrowing money. This makes gearing of the company and interest

expense go down. Therefore, it helps the company decrease WACC and

NWC.

The fact is that cash flow is a crucial element of overall financial

perfomrnace. Managing your accounts receivable well doesn’t just keep

your business running smoothly from day to day; it also helps ensure a

long and profitable future for your company. To improve management

of recievalbe account to ensure the company has enough money for

business, the managers can considers these ways.

 Reduce Payment Terms

Reducing payment terms is one motivator, but it works even better

if you do it with email. One of the many benefits of invoicing via email

is that it allows companies to reduce their payment terms. Because of



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CQ50/11.18



Final thesis



Academy of finance



the delays that accompany paper mail, businesses used to allow 30 days

or more for payment. However, the immediacy of email invoicing

means that businesses can now specify that payment be due upon

receipt rather than allowing for net 30 billing.

 Maintain a Healthy Work Relationship

Happy customers are more likely to pay their bills on time. In the

event that a customer is short on cash, he will likely prioritize those

companies with whom he has a positive relationship over the ones that

regularly underperform. If you want to avoid late collections, strive to

fulfill your obligations and develop strong working relationships with

all your business clients. Just making a few personal calls to the

payment departments can ensure you never wait on a late invoice again

As a result, the company can collect on bills faster, ensuring

sufficient cash flow for the coming weeks. Additionally, the firm should

send your invoices as soon as a project is completed rather than waiting

until the end of the monthly billing cycles. This helps keep work

"fresh" in clients’ minds.





Offer Multiple Payment Methods

If you want to get paid on time, then give your customers as many



options as possible to satisfy their debts. While sending a check each

month is still commonplace, some clients may prefer to pay invoices

via PayPal or credit card.

Additionally, the company may want to consider utilizing

electronic funds transfer (ETF), which allows customers to transfer

payments from their bank accounts to yours for a fee, provided they

have your bank name and account number. You may want to include

this information on your invoice to make EFT an easy option for paying



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CQ50/11.18



Final thesis



Academy of finance



bills.

 Set Clear Credit Policies

If the company has worked with a customer for years, you may be

tempted to offer a credit on your products and services. Extending too

much credit, however, can take a serious toll on your accounts

receivable. Before setting up a credit account, check a business’ credit

history to ensure it has a record of paying bills on time. Additionally,

you should set up clear terms and inform your clients of all the details

before any agreements are made.

3.2.3. The solutions to improve the situation of net working capital of the

company.

Although the construction company should establish the finance

model with long term sources of capital more than short term because it

usually has to recover capital in long time, the company still needs to

control this situation carefully. When the firm uses mainly long term

sources, net working capital will be greater than zero. In 2015, Thang

Long mechanical four and construction joint stock company has net

working capital of more than 120.000 million VND. The company

raised capital with almost long term debt. It results in the increase in

WACC and financial risk. To improve this situation, the company

should perform these solutions:

- Defering payment long term debt which is stagnant. If the company

also has any debt which is not spent on working projects, the managers need

to pay it back for the creditors to advoid wasting resources. Example, at the

end 2015, the company borrowed the amount of money from Seabank to

finance a bridge project of over 5.000 million VND, but this project was

cancelled. So the managers should pay 5.000million VND back for the banks

or creditors to decrease interest expense.



Tran Thi Minh Nguyet



CQ50/11.18



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