Financial Analysis and Management – Wolters Kluwer Company

Posted: April 05, 2017

Introduction

Shareholders’ wealth improvement is essential for any company. Businesses contemplating growth should take a keen look at the shareholders’ wealth, and relevant methods should be used when evaluating which projet to undertake in order to maximize shareholders wealth. The aim of this research is to find out the new investments Wolters Kluwer Company is contemplating, evaluate those investments and advise the management on the best way forward. Wolters Kluwer Company is conglomerate majors in legal, business, tax, accounting, finance and compliance and healthcare. They also audit the financial reports of other companies. Recently, the Wolters Kluwer Company is contemplating the introduction of a new product in the market. CCH International Tax Compliance Calendar is an integrated audit and tax program for audit and advisory companies involved in multinational operations, while the CCH Code Connect is new software for tracking and flagging counterfeit medical products packaged as Wolter Kluwer product. In this paper, we are going to discuss the importance of performance appraisal and how the appraisal process is conducted. The method to be selected will be based on its efficiency and how well it will help the management in the decision-making process. From the estimates obtained using the method selected, the management may know whether the project is viable or not. In case the project is viable, the company’s management can opt to go ahead and invest in the project, since this project will guarantee them profit in the future. On the other hand, if the project outlook does not look profitable in future, the management should cease this project. However, the management can go ahead with a project that is not viable because its deemed essential for the overall profitability of the company.

Importance of Investment Appraisal

Investment appraisal also known as evaluation is an initial indicator of the performance of a business. Investors use this information to gauge the future prospects of a business as well as chose the best investment to put their money into. According to Reeder and Colantonio (2013, p. 22), investment appraisal is an evaluation of a business project to know the returns and benefits that the firm will get by investing in a particular project. This assessment is important, and it must always be conducted before the firm decides to produce a new product or start a new project. Investment assessment is important in the following ways:

First, it offers the management an opportunity to assess the outcomes that are associated with investing in this project. The management ensures a detailed analysis of the results by looking at the potential successes and failures associated with the project in the short and long term. The management can thus use this outcome as the most basic factors during the decision-making process and deliberations with the board of directors and shareholders. The success and the failures of an investment are evaluated by looking at the projected profits, either annual or quarter profits. The profits are projected in the net present values perspective, calculated using the most realistic investment appraisal method. Investment evaluation also shows company management the levels of capital requirement at the present in order to achieve best results in future. If they have enough capital the firm can go ahead to invest but if the capital needed is not sufficient at the moment alternative decisions are taken. In the checking the feasibility of an investment, the management ought to assess whether the firm will be able to afford the additional capital contribution as needed to sustain the investment (Reeder and Colantonio, 2013, p. 30). Starting up an investment plan is not even, the maintenance and sustenance of the plan are what matters.

Secondly, investment assessment can help the administration to decide on what project to choose if they have a number of projects. For instance, the management of Wolters Kluwer can choose between the CCH International Tax Compliance Calendar and the CCH Code Connect if they do not have sufficient funds to support the two products. By evaluating the benefits associated with each project the company can choose which project will benefit the firm most. The investment returns are compared, and the one that offers satisfactory returns that satisfies is selected. The firm will choose such an investment since they can use the returns from this project to finance other projects or reward shareholders through increased dividends. This decision proves to be very important because it helps in the development and growth of the company and more so the shareholders’ wealth.

Investment appraisal is essential since it can show the risk that is associated with a particular investment. Risk consideration helps management to be prepared to face the risk in case its effects are felt upon the acceptance of the investment (Reeder and Colantonio 2013, p. 29). The methods used in evaluating the profitability of an investment, such as the discounted cash flow method; factor in a particular percentage to cater for inflation rate risks. The percentage is however not fixed, and it ranges to show the risks associated with different investments. The inclusion of this inflation rate provides a realistic illustration to show the way investment appraisal procedures takes into consideration the element of risk in investment.

Lastly, investment evaluation helps the firm to boost its image and reputation. When the management chooses a specific investment they want to invest in, they always consider not only the monetary benefits but also the reputation of the company as well. The administration will consider if the investment will please the shareholders or if it will upset them (Reeder and Colantonio, 2013, p. 32). If the project pleases company shareholders, they will not withdraw their support from the company but instead rally for the actualization of this project. Additionally, other public bodies’ approval ought to be sought before investing. Some of these bodies include the government and regulatory bodies. If the investment is against their approval, they will ensure they offer tough working conditions, and this action will affect the actualization of the project.

Determination of Project's Cash Flows

Wolters Kluwer Company is planning to invest in two products; the CCH International Tax Compliance Calendar and the CCH Code Connect. The initial cost of actualizing the CCH International Tax Compliance Calendar and CCH Code Connect is estimated at 1,200,000 and 1,600,000 euros respectively. The estimates of the initial cash outflow are obtained by adding the following expenses: the initial cost of the program (purchase cost or programmers fee), labor costs of running prototype, cost of utlities and initial overhead costs. The revenue from the CCH International Tax Compliance Calendar fluctuates because of competition, operational downtimes due to servicing, breakdown and peak and low seasons. CCH Code Connect has a steady stream of cash flows because it will be leased to a third party for a fixed price annually.

Net Present Value (NPV)

Note: the negative sign represent cash outflow, and the positive sign represents cash inflow

From the BETA of the Wolters Kluwer firm the discounted rate is 10%. Therefore in our calculations, we will use 10% to discount future cash flows and assume a financial year of 12 months.

The management should accept the above product because its Net Present Value is positive. The

product will earn the company profits, and the shareholder's wealth will therefore increase.

The Wolters Kluwer Company’s management should accept this product because its NPV is positive thus it will contribute to the company’s profitability.

In comparing the two products, CCH International Tax Compliance Calendar should be selected for implementation over CCH Code Connect because it earns the company more profit. However the realities could be more complicated and the company will only be forced see beyond the absolute NPV returns. Assumptions here include the constant discount rate, the company will be in business into the future (going concern), and absolute NPV returns would be the only decision factor. It is also assumed that business would be fairly predictable and competitors will not come in or leave the market.

Payback period

It’s the time necessary to recoup the initial investment in a project 

The payback period of CCH International Tax Compliance Calendar is 1.33 years and the payback for CCH Code Connect is 1.68 years. Since the two payback periods are less than six years, the products are, thus, profitable and should be considered. However, it is much advisable to invest in CCH International Tax Compliance Calendar, since its payback period is lesser than CCH Code Connect. The company should note this difference and seize the opportunity to choose an investment that returns the cost of investment faster (Kroes et al. 2014, 40).

The risk was considered when I included the discounted rate which normally account for the inflation that may occur (Kroes et al. 2014, 45).

Assumptions made

  1. The financial year consists of 12 months.
  2. Cash inflow for CCH Code Connect is constant, and it does not change from one year to the next
  3. The BETA of this company does not change.
  4. All the cash flows are assumed to occur at the end of that particular year.
  5. The company would be in business into the future (going concern)
  6. The company base its investment decisions solely in financial implications

Criticism of the Method

Financial and non-financial Factors

In investment appraisal process, financial factors include the factors that affect the business in monetary terms. Therefore, when decisions are being made, emphasis is placed on aspects that affect the financial/monetary status of the firm. On the other hand, there are non-financial factors. These are the factors, according to Kolawole et al. (2013), that do not have an effect on the business’ monetary position, but rather they affect the decision of a business or the operations that are not specifically about cash (Kolawole et al. 2013, p. 249).

Examples of financial factors that can be considered to affect Wolters Kluwer Company include; buying other machinery which might be worth the cost if they its efficient. Examples of non-financial factors include: matching of the standards of the industry and the good practice, improving the staff morale which makes is simple to recruit, and retain other workers. Also, the improvement of the suppliers and the customers’ relationship would be a non-financial factor.

The non-financial factors for my project include the positive factors: improvement of the customers and the suppliers’ relationship. This factor enhanced the existence of wholesalers for products that with time would improve the Wolters Kluwer Company’s profit and productivity. Another factor is the motivation of workers within the area of work. Negatively, the non-financial factor that was considered in the project is as following: there is no anticipation to dealing with the future threats within the outlined period; hence to this effect, it might be risky to invest consistently in the chosen product (Maksy and Chen 2013, p. 1).

Importance of Getting Realistic Costs and Revenue Numbers

Realistic revenue numbers are beneficial in order to avoid overstated returns which would be a violation of the prudence concept. Again, realistic revenues means viable projects are not rejected because the estimated returns are too dismal. Project costs must be realistic as well to avert negative cash flows in projections for an otherwise viable investment.

Importance of the Assumptions Made in Determining Appraisal Investment

The assumptions made would be essential for the company more so in the appraisal process as well (Maksy and Chen, 2013, p. 1). First, assuming that a financial year consists of 12 months would form a basic guideline towards planning within the company, both for product production and other operational activities. The calculations of the revenues and other cash flows within the business can also be done and report given at the end of the financial year, which is 12 months. Second, the assumption that the cash flow for each product would be used for establishing costs for the products and services that are provided by the company. Thirdly, the proper mixing of the capital investment is very important in appraisal investment determination in that it ensures an adequate return rate on investment (Kolawole et al. 2013, p. 249). This investment would call for a higher need to do capital budgeting. The assumptions did all work towards simplifying the overall business development.

Criticism of  NPV and Payback

Net Present Value (NPV)

Net Present Value is the most used means of determining the profitability of the project or investment. It has numerous advantages, and that is why it is preferred to some of the appraisal methods. However, it has its limitations that need to be considered (Kolawole et al. 2013, p. 249). The major weakness associated with NPV technique is the long process involved in calculating the Net Present value which will be used to investigate whether the firm is making a loss or profit (Reeder and Colantonio, 2013, p. 40). This method is tedious since each cash flow has to be discounted back individually especially if the cash inflow varies in amount. This work is tiresome and consumes a lot of time that could be used in other activities of the company. Another disadvantage of this method is that it is hard to rank and compare which project is most profitable when given some projects to choose from especially when the discounting rates vary. This method uses one discounted rate to compare between two or more investment plans. Additionally, NPV considers the financial aspect alone without regards to staff morale and maybe environmental impacts.

Payback Period

This traditional method, like all the other methods, is advantageous, but it also has some limitations. Some of these weaknesses include: first, this method does not take into account the cash flows after the repayment period. Once the payback time is determined all the other cash inflows are not considered to be important (Kroes et al. 2014, p. 40). This action is not appropriate since the cash inflows beyond the payback period still form part of the important cash flows. Secondly, it is not a good measure of profitability of the project, since it does not consider the entire cash flow yields by the project. A good investment appraisal method should consider all the cash flows produced by the venture. This method also is not consistent with the objective of maximizing the stockholder's wealth. The method does not seek to determine whether the project is profitable or not. Finally, the method does not provide a standard method of determining the payback period. The determination of the payback period is subjective which offers an opportunity for the administration to create administrative difficulties in setting it (Reeder and Colantonio 2013, p. 42).

Decision-making Process

The decision-making process is the most important part of the performance appraisal process. This process involves some steps. These steps include identification of the investment, evaluating the profitability of the investment plan and ranking of the investment regarding the profitability of the investment. Then the product is assessed to determine the profitability of investing in this product (Shollo 2013, p. 40). Lastly, the products are ranked if they are some they and the best is chosen. Otherwise, if there is only one product the management will have to make their decision based on the anticipated profits associated with this product. The decision to invest in a new product is mostly based on the method of evaluating the cash flow associated with the investment used. If the NPV method is used, the decision criteria will accept a product if the NPV is positive and reject the product if the NPV is negative. If the NPV is positive, it implies that the company is making profits from the new product. On the other hand, if the NPV is negative it means that the initial outlay cannot be compensated by the income the firm is getting from that particular product. In our case, we have accepted to invest in the two products since the NPV is positive. Wolters Kluwer Company is thus making profits by investing in these two products.

Conclusion

The financial and non-financial factors would provide an outline for the decision. The revenues and costs would affect the financial decisions (Shollo 2013, p. 50). I would advise Wolters Kluwer Company to invest in these two products if there is no resource constraint on the company. The NPVs for the two projects are as good as their payback durations. When we consider the payback period which is the time taken for the initial outlay or the capital invested to be repaid both prjects repays their initial cost quite fast. The NPVs for both projects are positive indicating that over the projectd tien frame, these projects would ehnace th company’s perfirmace.

However, of there is resource limitation on the company, one of the projects has to be terminated in favor of the other. In the scenario projected herein, choosing which project to abandon, basing on NPV particualy, may not be straight forwar. The reason is that while CCH International Tax Compliance Calendar has higher NPV,its cash flows are  very unpredictable and poses a risk to the company. CCH Code Connect has a lower NPV compared to CCH International Tax Compliance but its cash flows can be predicted with a greater degree of accuracy because it’s guided by contractual agreement. In arriving at a most favorable decision, the management might have to consider the entirety if the risk posed by fluctuating incomes vis a vis the maximum returns potential. Despite the reduced risk of CCH Code Connect, it does not deliver maximum value for the shareholders and might not be the best option for the shareholders whereas the management may prefer it because of the low risk profile. Eventually, the management in agreement with shareholders will have to choose which project afford them the maximum returns with comparatively low risk potential.

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