Free Term Paper About Capital Investments
Healthy cash flow is one of the objectives of all companies. Proper evaluation of the capital investments to come up with the sound capital expenditures will help an enterprise achieve that goal. Capital investments should be considered as long term contributors of the companies’ income. As such it is very important to determine which of the planned capital investments will yield a large amount of income to improve financial performance. This paper will analyse the capital investments of Johnson Controls Inc based on its 2012 Financial report and determine how it can reduce risk in its expansion plans.
Johnson Controls Inc. is a company engaged in the business of air condition, automotive, and power solutions for vehicles. It was established in Wisconsin in 1885 and currently operates in more than 150 countries in the world. The company registered a $ 1.2 billion net income in 2012, slightly lower than the registered $1.4 billion in the previous year. Johnson Controls Inc spent $1.8 billion capital investments of which 70% of it was allotted to growth and margin expansion. The said amount was an increase from the $1.3 billion capital investments made in 2011 (Johnson Controls Inc. Annual Report, 2012).
The company’s annual report considered the following as its capital investments: property plant and equipment, goodwill, other intangible assets, Investments in partially-owned affiliates, and other non-current assets. It has been the commitment of the company to invest for long-term growth and gainful strategies (Johnson Controls Inc. Annual Report, 2012).
During the reviewed period of 2012, the Johnson Controls Inc earned gainful net sales from various regions including North America, Europe, and Asia. It has the highest sales and asset in Europe, followed by North America. It had positive but lowest sales and assets from Asia where many emerging markets are located (Johnson Controls Inc. Annual Report, 2012). Such performance indicates that the company is doing well financially. However, we can further strengthen the growth by maximizing the profit particularly in Asia/emerging markets where sales and assets are lower.
Thomas Zeller and his colleagues from the University of Chicago noted in their research entitled Risk Manage Capital Investment Decisions: A Lease vs. Purchase Illustration emphasized that competitors, political instability/interruptions, environment uncertainty, market, and technological changes are important considerations in making capital investment. He added that the traditional approaches of managing risks in the capital investments are helpful but limited (Zeller, 2009).
In the annual report, Johnson Controls Inc stated that the economic uncertainty in the regions including Asia and other emerging markets may disrupt the markets and negatively affect the company’s capital investments and other financial facets (Johnson Controls Inc. Annual Report, 2012).
Zeller explained that discounting remains a useful traditional approach in managing the risks of capital investments. Acquisition of properties or equipment for example will be more valuable if there is a discount in the acquisition. However, he said that we cannot be limited to discounts. Zeller and his colleagues introduced the Distribution Theory in which it uses a mean and standard deviation to show the worse case and best case scenarios of acquisition. It also encourages cash flow estimates of the benefits and the planned purchases (Zeller, 2009).
In the case of Johnson Controls Inc, growth in the emerging market can be achieved through operational efficiency, competitive prices, and discounted acquisitions of capital investments, be it in land or property acquisition, equipment purchases, and marketing strategies for goodwill. It is also important to analyse whether it will be more cost-efficient and profitable to acquire property instead of lease, for example in terms of holding offices and expanding plants. Such can be determined through conducting return analysis for a specific period of time and projecting company stability in a specific area or country.
Application of the analysis of best case (stronger sales for a certain period of time) and worse case (shortest possible time of the life of the business given the available capital and funds) will be helpful. In such a way, we will be able to identify if it is more cost-efficient to purchase or lease a property or an equipment etc. We must estimate the capital and yield ratio for worse and best case scenarios to come up with sounder capital investment decision and minimize the risk of losing money.
Sheridan Titman, K. C. John Wei, Feixue Xie of the University of Washington School of Business Administration noted in their journal entitled Capital Investments and Stock Returns said that it is a common belief that companies with higher investment expenditures have higher risks. He noted that we need to have a benchmark analysis based on returns to identify risks. He noted that higher investments can lead to abnormal returns that which could be an indicator of unconsidered and uncalculated risks. Their research also revealed that the stock returns of the firms with lower capital investments outperformed the stock returns with higher capital investments (Titman, 2004).
As noted earlier, Johnson Controls Inc. spent 70% of its $1.8 billion capital investments for growth and margin. Applying what Sheridan Titman and his colleagues noted it will be advisable for the company to reduce the amount of its capital investments as it has tendency to over invest, and hence tantamount to higher risks. Decreasing the amount of its capital investment is also advisable to have higher stock returns for at least five years.
As the annual report explained, China population is having higher equity income which had a positive impact in the sales of the company particularly in the segment of Automotive Experience in Asia (Johnson Controls Inc. Annual Report, 2012). The inflation may reduce the amount of capital investment in China considering the exchange rate. However, such would not necessarily translate to lower returns from the said country given the robust growth in the disposable income of its citizen and its overall commendable economic growth. China remains to register as among the countries with highest GDP growth which is a good indicator of a profitable investment. An accurate evaluation approach for China, I think, is benchmarking as explained by Titman to identify the normal levels of investment and avoid abnormal returns and unconsidered risks given the good economic environment of China. It will be better to have controlled capital investments for lower risks and higher stock returns. Such will affect the management decision in so far as they will be more oriented and concern on ways to increase stock returns to help further expansion globally.
The consideration of the capital investments in relation to stock returns is also very important to apply in the North America particularly because Johnson Controls Inc. is headquartered in this region. Such is useful in acquiring internal capacity for global expansion. Nevertheless, it is also important to consider other evaluation methods to for a more successful growth. Among the methods that we can choose that are popular and proven useful are Net Present Value technique, Internal Rate of Return, Profitability Index, and Accounting Rate of Return (Brijlal, 2009). There is another method known Payback Period (Brijlal, 2009), but it is not quite applicable to the company in question due to its nature of business.
After successfully acquiring higher stock returns, the North American office can evaluate and calculate of the Net Present Value of the properties, equipment, and manpower necessary for new or additional operational investments in other countries. Analyse if the acquisition given the current position of the company in the competitive landscape. It is also useful to have an analysis or the graph of profitability index based on the capital investments level. Such can be done by analysing the past values of capital investments in the previous years and comparing it to the achieved profitability index. It will more likely indicate the potential profitability performance of a planned capital investment. In such a way, a manager can already calculate the risks and, hence can create risk management solutions for worse case profitability scenarios. Internal Rate of Returns of the capital investment will be useful in evaluating the extent of the contributions of the new acquisitions which will help estimate future financial performance.
In evaluating expansion projects from North America, external factors such as political stability, economic climate, and competition of a particular country should be carefully studied so the decision maker can determine if the expansion can help improve the growth of the company. Strategies such as local partnerships can also be applied if there are existing strong local players to take advantage of its name and profitable standing.
Sensitivity analysis is helpful in the projects of Johnson Controls Inc. as it will help determine the variables and factors that can affect the success of a specific project. Such approach can help the company formulate strategies that are appropriate in the current market conditions and right or better pricing. It can also help determine when an innovation can be timely and beneficial, competition wise. Sensitivity analysis can also help the manager to decide whether the company should further investments for product gearing to quality, quantity or both.
Brijlal, Pandeep, et.al. August 2009. The Use Of Capital Budgeting Techniques In Businesses: A Perspective From The Western Cape. University of the Western Cape, South Africa. Retrieved from http://cluteinstitute.com/ojs/index.php/JABR/article/download/1015/999
2012. Johnson Controls Inc. United States Securities And Exchange Commission, Washington DC. Retrieved from http://www.johnsoncontrols.com/content/dam/WWW/jci/corporate/investors/2012/FY12%2010-K%20-%20FINAL%20for%20web.pdf
Titman, Sheridan et.al. December 2004. Capital Investments and Stock Returns. University of Washington School of Business Administration. Retrieved from http://faculty.haas.berkeley.edu/kli/papers/titman_et_al-2004jfqa.pdf
Zeller, Thomas et.al. June 2009. Risk Manage Capital Investment Decisions: A Lease vs. Purchase Illustration. University of Chicago. Retrieved from https://www.google.com.ph/?gfe_rd=cr&ei=qKzuVKilHauL8Qffo4HIBw&gws_rd=ssl#q=traditional+evaluation+of+capital+investments+journal+
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