Evaluation for Honda 114.3 Deal Value and Finance of

Evaluation of investment opportunities for Honda MotorTable of Contents1. Introduction 32. Evaluation of Financial Performance 32.1 Profitability 32.2 Liquidity 63. Investment Appraisals 74. Potential Merger and Acquisitions 114.1 Rationale for Choosing the Target Company 114.2 The Synergistic Gain of the Acquisition for Honda 114.3 Deal Value and Finance of the Acquisition 124.4 The Potential Benefits of Acquizition on Firm Performance 124.5 Challenges and Risk Assessment of the Acquisition 135. Conclusion 136. References 147. Appendix 16? IntroductionHonda Motor Co., Ltd. is a Japanese public multinational conglomerate corporation, operating in the engineering manufacturing industry since 1948. Over the last 69 years, Honda has built it’s reputation as a trusted manufacturer of cars, aircraft, power equipment and motorcycles. This is due to pioneering manufacturing strategies and unique product designs. To maintain this reputation and strive towards long term profitability and industry position, Honda is aiming for a long term growth strategy incorporating an extension of its production line (Honda Ltd, 2017). The company is engaged in experimenting with new models to improve the competitive position of its products line, such as Acura.SUVs and cars form a significant part of Honda’s market share in the automobile industry. The company is focusing on new market trends related to the development of environmentally friendly and sustainable vehicles. There is the potential for making further investment in their current production line through introduction of Hybrid Electric Vehicle (HEV), requiring initial investment of £30,000,000 with a return over a period of 10 years. This report aims to introduce the potential investment opportunities in this area. The discussion is structured into three key sections; evaluation of current financial performance, investment appraisals and potential merger and acquisitions.  Evaluation of Financial PerformancePrior to discussing the quantitative and qualitative assessment of the investment opportunities available to Honda, it is necessary to evaluate the profitability and liquidity ratios. The critical evaluation of performance over the past five years (2013 to current) through selected ratios can aid evaluation of limitations currently faced by the company. ProfitabilityProfitability ratio is one of the most important ways in which Honda’s ability to generate earnings in relation to expenditure can be assessed. The importance of profitability ratio is limited based on seasonal influence (Goel, 2015; Rist, et al., 2014). Automobile business is associated with the seasonal fluctuations based on technology changes. With the change in manufacturing technologies, companies such as Honda need to be adaptive in order to maintain its responsiveness.  Return on Assets (ROA) and Return on Equity (ROE) are two important profitability ratios which have the power to effectively reveal a company’s profitability position in lieu of potential investment. In the ROA ratio, profitability of Honda over the past five years can be assessed relative to costs and expenses. It can help analyse how the company has been using its assets for profit generation. The ratio assumes that a company with a large amount of assets is capable of generating a higher portion of sales in the respective period, which can simultaneously result in the generation of higher profitability for the business. The five-year (2013-2017) analysis of the ROA for Honda shows a decline from 4% to 3% however fluctuations in the ratio are not high due to rise and fall in the net income of the company. Honda has increased its total asset base from £16,048,438,000 in 2013 to £18,958,123,000 in 2017. The increase is indicative of the rising power of Honda to generate sales from the deployment of these assets. Despite the increase in net assets, net income decreased in 2016. This can be attributed to the company’s efforts relative to the Honda Civic Transmission. The transmission required significant changes in the design of the new vehicle by updating the software. The changes might have affected the sales figure and led to additional expenses and the decline in net income (Torbjornsen, 2016).  Table 1: Return on Assets for Honda (Yahoo Finance, 2017)ROA Ratio Net Income Total Assets ROA Ratio2017 616,569,000 18,958,123,000 3%2016 344,531,000 18,229,294,000 2%2015 509,435,000 18,425,837,000 3%2014 624,703,000 16,048,438,000 4%2013  ROE ratio represents the ability of a company’s equity to make returns for investors. The ratio assumes that a company may have a high ROE despite a minor  increase in equity and credit goes to the larger asset base of the company. From the calculation of the return on equity ratio for Honda the ROE has decreased in 2017 (8%) relative to 2014 (10%). Like ROA, 2016 was an important year for shareholders due to the decline in equity. In the annual 2016 report, Honda reported that the company recorded higher sales but lower profits in the fiscal year. The reason stated for the decline in business profit was related with the depressed provisions for product warranties of about 436 billion. This provision was made because of an airbag inflator recall alongside the negative currency translation effects. Movement in foreign exchange currencies ultimately affected depreciation of Yen against the United States dollar (Honda Motor Co., Ltd. , 2016).   Table 2: Return on Equity for Honda(Yahoo Finance, 2017)ROE Ratio Net Income Shareholders’ Equity ROE Ratio2017 616,569,000 7,295,296,000 8%2016 344,531,000 6,761,433,000 5%2015 509,435,000 7,108,627,000 7%2014 624,703,000 6,335,534,000 10%2013  Positive profitability ratios suggest Honda Ltd has enough asset base and a strong enough financial health to back the decision to invest in growth opportunities. LiquidityLiquidity ratio measures the ability of a firm to meet short-term obligations. The evaluation of these ratios can assist in analysing the company’s condition related to bankruptcy (Tracy, 2012). A high liquidity ratio helps in clarifying that a business is operating efficiently. The two ratios that were chosen for analysis of the liquidity position of Honda was current ratio and quick ratio (Gallagher & Andrew, 2007). Current ratio can be used to understand the extent to which Honda is capable of paying its current liabilities from its current assets. A current ratio above 1 is indicative of the good liquidity position as a company has higher current assets. From Table 3 given below, it can be concluded that the current assets of Honda Ltd have increased since 2014 (5,549,158,000) in 2017 (6,555,467,000). The current liabilities of the company are showing significant increase over the period. Honda’s level of liquidity justifies its attempt to make investment in new growth opportunities.   Table 3: Current Ratio for Honda (Yahoo Finance, 2017)Current Ratio Current Assets Current Liabilities (CA/CL) = CR2017 6,555,467,000 5,428,842,000 1.212016 6,241,626,000 5,470,351,000 1.142015 6,296,140,000 5,301,054,000 1.192014 5,549,158,000 4,751,800,000 1.172013 #DIV/0!Table 4: Quick Ratio for Honda (Yahoo Finance, 2017)Quick Ratio Current Assets Inventories Current Liabilities (CA – Inv) /CL) = CR2017 6,555,467,000 1,364,130,000 5,428,842,000 0.962016 6,241,626,000 1,313,292,000 5,470,351,000 0.902015 6,296,140,000 1,498,312,000 5,301,054,000 0.912014 5,549,158,000 1,334,775,000 4,751,800,000 0.892013 #DIV/0!Liquidity ratios of Honda have demonstrated the company’s potential to invest in new growth opportunities. However, the limitations of financial analysis tools cannot be overlooked when examining how large firms such as Honda operate in different industries and can face difficulty in interpreting the performance of a single sector. Likewise, inflation can also distort companys’ financial information. Subsequent to the previous ratio analysis, the next section of the report demonstrates analysis conducted concerning investment appraisals.   Investment AppraisalsInvestment appraisal is a necessary step for effective decision making regarding Honda’s capital investment of around £30,000,000. Good investment appraisal techniques can assist in investigating the quantitative as well as qualitative findings related with further investment in the production line. The findings can support discussions of the risk and uncertainties in investment appraisals for Honda (Rist, et al., 2014). The two investment appraisal methods, Net Present Value (NPV) and Internal Rate of Return (IRR), have been used in this report for the evaluation of investment opportunity for Honda (Schindeldecker, 2017; Götze, et al., 2015). Net Present Value (NPV)Net Present value is the present value of cash inflow and the present value of cash outflow used in capital budgeting in order to project a specific investment (Götze, et al., 2015).   NPV= ?_(t-1)^T?C_t/?(1+r)?^t – C_0Where; C= Initial investment C T = Time period R = discount rateFrom the NPV table, it can be seen that the initial investment of £30,000,000 would be recovered over a 10 year period. The projected return is based on the following assumptions; The investment would start with a return of £5,000,000 in the first three years, £8,000,000 in the fourth, fifth and sixth years leading to a return of £10,000,000 for the final three years of the recovery period.The discount rate for the investment was  set at 15%. The NPV calculated from the given data was 5,769,046. The positive NPV of the investment appraisal is in itself indicative that investment in the project would be viable.  Table 5: Net Present Value for Investment ProjectParticulars Project A (1+r)^t ((1+r)^t)/CtInitial Cost 30,000,000  Year 1 5,000,000 1.15 4,347,826Year 2 5,000,000 1.32 3,780,718Year 3 5,000,000 1.52 3,287,581Year 4 8,000,000 1.75 4,574,026Year 5 8,000,000 2.01 3,977,414Year 6 8,000,000 2.31 3,458,621Year 7 10,000,000 2.66 3,759,370Year 8 10,000,000 3.06 3,269,018Year 9 10,000,000 3.52 2,842,624Year 10 10,000,000 4.05 2,471,847   Present Value 35,769,046Discount Rate 15%NPV 5,769,046Internal Rate of Return (IRR)Internal rate of return is a discount rate which is used for making the net present value (NPV) of all cash flows from a specific project equal to zero. IRR can be used to measure the profitability of the company related to performance measurement (Götze, et al., 2015). A similar NPV formula can be used for calculating the IRR for the respective investment project. NPV= ?_(t-1)^T?C_t/?(1+r)?^t – C_0Where NPV = zero (0) while all the other figures would remain same. The IRR calculated for the potential investment opportunity is 19%. An IRR greater than the discount rate or cost of capital (15%) reflects the feasibility of the project, as is shown here.Honda should also appraise its investment decision based on the substantial uncertainties in the market. The automobile market is heavily dependent on the changes in transportation advances therefore any change in technology would result in uncertainty and potentially unwise investment decisions. Environmental pressures as well as sustainability issues should be considered (Götze, et al., 2015). The company should assess its investment based on the integration of different appraisal techniques such as NPV and IRR as there is a possibility that an investment project having high NPV will have low IRR. In this case, there is a possibility that a project may be slow in returning investment for the firm but also add a great deal of value to the business (Barthwal, 2007). ? Potential Merger and AcquisitionsA potential investment opportunity could arise in the acquisition of a competitor in order to pursue its growth strategy. Subaru is another Japanese company dealing within the automobile industry and could be a target for a merger. Rationale for Choosing the Target CompanySubaru, the target company is an automobile manufacturing division of a Japanese transportation conglomerate and the brand is widely known for engine performance. The acquisition of the manufacturing division of this company could ultimately assist in enhancing the power and performance of engines in Honda vehicles. The popular Subaru boxer engine could enhance the production line by integrating the design of both Subaru and Honda engines within the car models. The use of symmetrical AWD in the vehicle design would further help Honda in the achievement of a low center of gravity (Subaru, 2017). Acquisition of Subaru could be a powerful tool for the achievement of growth, for entering new markets and expansion of the firm’s capabilities. This acquisition could further assist the company in improving its competitive market position (Krishnakumar & Sethi, 2012). It has been suggested that potential targets for acquisition should be identified and evaluated based on potential investment which would help evaluate value in this context (Jackson, 2007). The proposed acquisition of Subaru is expected to make overall improvements in the competitive position of the company and enhance the ability of the business to deliver strong profitability. The Synergistic Gain of the Acquisition for HondaSynergetic gain in acquisitions play a vital role in motivating a business towards merger or acquisition. Such gains illustrate how the companies combining would reap a larger sum of benefits relative to the gains for remaining separate individual parts (Malik, et al., 2014). The combined value of the target and acquiring company in this situation could lead to increase in sales and revenue for both companies. Honda would be able to strengthen its manufacturing and production line by introducing new models. It would also be able to achieve strategic benefits such as valuable technology, knowledge and skills (Wang & Xie, 2009). The synergetic firm would further be able to better deal with market frictions caused by the other competitors in the industry. For the achievement of the stated synergistic gains, it is highly necessary for the firms to nurture these benefits a part of merger or acquisition (Devos, et al., 2009). Whilst NPV can be used to indicate potential investment opportunities, a negative NPV can also suggest an unsuccessful merger or acquisition (Golubov & Petmezas, 2012). Deal Value and Finance of the AcquisitionThe market capitalization of Subaru’s manufacturing division would be realized by focusing on the total outsmarting shares of Subaru. The value of outstanding shares on the company’s balance sheet can assist in achieving the target more effectively. The market value of the total outstanding shares can be used to determine the value of acquisition. The obtained value would be used as a market capitalization value (Applebaum, et al., 2009).  The Potential Benefits of Acquizition on Firm PerformanceThe potential benefits of the acquisition can be determined by evaluation of the organization’s gain regarding the expected internal and external market efficiencies and benefits. The acquisition of Subaru would help the business in understanding new manufacturing processes and approaches. In addition, Honda would be able to increase its customer base by acquiring customers loyal to Subaru, offering a unique combination of automobile technologies. The use of technologies in the Subaru for safety, environment and performance could be subsequently used in Honda. The company would be able to develop new products, processes, applications, materials and services by using the subset of knowledge transfer. Synergetic effects of the new acquisition include the ability of Honda to deal with the market risks, legal risks and policy risks. The business would be able to expand its production line while lowering its expenditures per vehicle product. Effective planning would be needed for the successful achievement of targets set for the scale of operations. Use of information asymmetry in an effective way could help in achieving the target. The modifications in vehicles for safer and more environmentally friendly models can be achieved through the effective design and innovative materials. It would be able to integrate all the elements and features in the model design which could assist in meeting changing requirements (Vorobyov, 2013).  Challenges and Risk Assessment of the AcquisitionThere are challenges and risks for the company in the process of acquisition. These include poor communications among the target company and the acquiring company which could result in conflict and discrepancies during the transaction (Wang & Xie, 2009). Secondly, different stakeholder groups for Honda and Subaru can result in the changes to the overall organization and objectives of the business and can alter strategic outcomes. Thirdly, Honda may find a difference in the marketing and branding efforts of Subaru and therefore the company’s strategic management would be required to offset the key business strengths with the weaknesses of the marketing and sales strategies. The conflict between the development and manufacturing activities could potentially lead towards negative effects. Lastly, the acquiring company needs to assess the differences in two different cultures for dealing with staffing challenges. Inclusion and retention of core competencies can only be made through a comprehensive and effective strategy (Wang & Xie, 2009).  ConclusionIt can be concluded that Honda Co. Ltd could find growth strategy related investments as profitable and productive enough to make significant gains. Senior management should aim for the growth strategy and expand its production line. The positive NPV and favourable IRR suggest a return on investment by attracting a larger share in the market. Additionally Honda should target the acquisition of the Subaru in order to attain profitability and productivity. It should however bear in mind that achievement of competitiveness through acquisition can only be possible when the company is able to identify the risk and uncertainties associated with these investment opportunities. ReferencesApplebaum, S. H., Roberts, J. & Shapiro, B. 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AppendixSales Volume Unit (for example, £)   100Sales price per Unit 700,000Estimated Selling Price   70000000Variable costs:    Labour   Material   500,000 50000000  Variable Overhead   100,000 10000000  Total Unit variable cost   600,000 60000000  Contribution Margin 10,000,000Fixed Overhead per annum 500000Profit 9,500,000