Nature of the firm’s working capital policies

Fortescue's present asset investment policy entails a significant amount of cash and cash equivalents, as well as inventory. In both 2015 and 2016, the corporation maintained significant quantities of cash (bank and short term deposits) as well as inventories. For the year, the proportion of current assets relative to current liabilities has increased, and as a result, I would define their current asset investment levels as cautious, because the larger proportion of CA to CL tips the balance in favor of retaining liquidity.

Fortescue has a conservative working capital policy.

Some crucial observations are that since the year 2012 equity capital has been growing while investment in the fixed assets has been increasing over the period. Also, the investment in current assets has been steadily declining since 2011, and the ratio of the total CL to the total assets has been on the decline since 2009. When it comes to the CCC, it has been increasing since 2012 (when it was negative), but it is still low. The company finances the fixed assets, permanent current assets, and some part of the temporary current assets with long-term financing. Fortescue is maintaining liquidity by maintaining the cash and marketable securities, lessen the rate of short-term loans, and will make attempts to use the shareholder’s funds (Afza & Nazir, 2008).

Weighted average cost of capital

Cost of equity, Ke

Ke=Rf+β(Rm-Rf), where

Rf= risk-free rate, 10 year Australian Bond=2.784%

β=0.89

Rm=8.668%

Ke=2.784+0.89(8.668-2.784)=8.02076

Cost of various debt components

Senior secured facility

Kd=I(1-t)=(1.465+3.25)*(1-0.3)=3.3005%

Senior secured notes

Kd=9.75%(1-0.3)=6.825%

Senior unsecured notes

Kd=6.875(1-0.3)=4.8125%

Market weights

weights

Costs

Equity ($5.09*3113798*0.7602)

120485891.3

0.0188

8.0276%

senior secured credit facility

3631000000

0.5685

3.3005%

senior secured note

2152000000

0.3370

6.825%

senior unsecured note

483000000

0.07563

4.8125%

Total firm value

6386485891

WACC :(0.0188*8.0276)+(0.5685*3.3005)+(0.3370*6.825)+(0.0756*4.8125)=4.6917%

Nature of the firm’s earnings distribution and dividend payout policies.

Fortescue has a low-regular-and-extra dividend policy, where it” pays a low regular dividend which is supplemented by an additional dividend when the earnings are higher than normal in a given period”. A key observation is that when the company’s net income after tax after abnormals increases, dividends grow while a decrease in net income decrease the dividends.

The Australian dividend franking policy used by Fortescue will enable the shareholders to receive 100% of the tax paid on the dividends they receive, called a franking credit.Another critical issue is Fortescue’s dividend reinvestment plan which permits the stockholder’s to have their dividend payments automatically reinvested in the company’s stock.

The nature of the firm’s capital structure determination policy

Fortescue’s debt to equity ratio has been steadily declining since the year 2012, and consequently, it has reduced the level of long-term debt. Since the year 2008, the long-term debt equity ratio has been steadily declining. The company is committed to reducing its debt levels and has been spending cash to repay its debt. This is in light of the trade-off theory argues that debt is associated with bankruptcy costs (financial distress) which offset the tax deductibility benefits.

Fortescue has been determining its financing mix in a manner consistent with the pecking-order theory which argues firms prefer using internally generated funds over external finance. In this case, Fortescue pecking order of financing is the retained earnings, then the low-risk debt financing follows, and finally, raising share financing. Also, the use of long-term debt

The association between these various financial management policies

Fortescue dividend policy and the amount of debt financing used have a positive relationship because once the firm pay’s dividends, degree of internal financing decreases and as a consequence, it will require external funds. Also, the changes in debt levels are not consistent with the company’s working capital policy because it is at reducing the long-term debt portion that finances fixed assets, permanent current assets, and the temporary current assets. There have not been significant modifications in the firm’s policies, but an observation is that Fortescue has been using equity rather than long-term debt. The firm’s retained earnings have drastically risen from 2010 while the ratio of long-term debt to Total assets is falling, an indicator of a change in policy to finance assets the shareholder’s funds rather than long-term debt.

There is also a relationship between the low regular dividend plus extra policy with the stock price; the stock price rises when dividend per share increases and declines when the DPS falls. Also, the conservative working capital policy is reflected in the steady growth in borrowing costs (interest expense). However, no established pattern exists between the conservative policy and profits because profits are mostly affected by the cost of sales rather than borrowing costs. In conclusion, I would classify Fortescue Group overall risk profile as risk averse (low-risk approach) rather than a risk taking company.

References

Afza, T., & Nazir, M. S. (2008). Working capital approaches and firm’s returns. Pakistan Journal of Commerce and Social Sciences, 1(1), 25-36