FIN3CSF Finance: Fortescue Metals Group Limited Company Financial Policy Decision-Making Name Date  
Table of Contents 1. Working capital management policies. 3 Current asset investment. 3 Financing policies. 4 Cash conversion cycle. 4 2. Weighted average cost of capital (WACC). 5 Cost of Debt. 5 Cost of equity. 5 Cost of WACC. 6 3. Capital structure determination policy. 6 4. Earnings distribution policy. 9 Dividends declared/paid. 10 Dividend per Share. 10 Divided imputation. 11 Franking dividend policy. 11 5. Corporate financing policies employed by to Fortescue. 12 Reference list 13    

1. Working capital management policies

Working capital management policies allow the company to continue the day to day operations where the liquid assets are managed with a view of meeting the short-term responsibilities, while avoiding tying up the money as this would affect profitability. Working capital management makes it easier to meet production targets as Fortescue Metals Group Limited manages the short-term obligations as they fall due.  FMG uses a Working Capital Policy 0.5/1.5

 Current asset investment 

            Companies need to consider how the assets affect the performance and profitability, as limited liquated affects the ability of the firm to convert and use the cash. Being low on current assets and especially cash can constrain operations. In the current asset investment policies there are Relaxed (or “fat cat”) policy, Restricted (or “lean-and-mean”) policy and the Moderate policy. FMG combines a Restrictive policy and Moderate one  to minimize current asset holdings as mining companies  have lower account receivables while making huge sales and current assets are minimized. in choosing the moderate policy FMG neither has huge nor low account receivables  and combining the two policies maximize long-run earnings. In the financial year ended 2016, Fortescue Metals Group Limited’s share of the cash to total assets was 8.19%, but this was mainly because the company increased the plant and machinery assets. The total current assets were US$ 2,605 Million in 2017, while the current liabilities were US$ 2,202 Million (Fortescue Metals Group, 2017, p. 62).

	06/07	06/08	06/09	06/10	06/11	06/12	06/13	06/14	06/15	06/16
Current Ratio	5.85	0.72	1.29	1.91	3.13	1.71	2.59	1.37	2.09	1.48
Quick Ratio	5.85	0.63	1.13	1.70	2.75	1.42	1.91	0.92	1.63	1.14

   <Liquidity ratios: Current and Quick ratios> 

Financing policies

             The working capital mainly deals with current assets, but also includes permanent assets and the financing policies that influence how FMG funds the asset requirements. The difference between the current assets and current liabilities represents the working capital. In evaluating the financing policies adopted by the company the borrowing costs and the financing activities are considered as this provides insights on changes in the sources of financing and the financing costs. The cash flow statement indicates the interest expenses, which are the borrowing costs and the sources of financing. The cash flow statements highlight that in the financial year ended 2007, the company paid interest totalling 158,025,000, but this had reduced to 0, from 2011 and onwards. FMG utilises the maturity matching or self-liquidating approach with the fixed assets and permanent current assets being financed by long-term capital. The mining industry requires huge capital outlays and the financing policy is appropriate

	06/11	06/12	06/13	06/14	06/15	06/16
NCL - Long-Term Debt	4,336,296,675.	8,063,978,019.	13,461,994,609	9,981,953,290	12,257,812,500	8,992,728,252
Total Assets	8,032,280,473	14,780,688,843	22,498,113,207	24,091,295,116	27,812,500,000	26,039,590,627
LT Debt/ Total assets	0.54	0.55	0.60	0.41	0.44	0.35

 

Cash conversion cycle

Cash conversion cycle =Inventory conversion period +Average collection period -Payables deferral period=  In 2017 the cash conversion cycle was, 61.84days +6.9 days-25.49 days = 43 days  

2. Weighted average cost of capital (WACC)

            To determinate cost of finance being utilised by FMG, and determine the weighted average cost of capital (WACC) , it is necessary to calculate the different cost components for both short-and long long-term financing.    FMG has sought to reduce the debt holdings compared to equity as represented by the gearing ratio that has declined in the past five years . Borrowings and finance lease liabilities is US $ 121 M and Borrowings and finance lease liabilities is  US $4, 350 million the current portion of the long-term debt as found in the current liabilities section of the balance sheet and the long-term debt represent he debt holdings, and here is no mention of notes payable in the case of FMG. The gearing ratio was 0.45 in the 2016 financial year and is now 0.31 in the 2017 financial year, where gearing is the debt divided by the sum of debt and equity (Fortescue Metals Group, 2017).

Cost of Debt

Weight of debt =D/ (E+D) =0.31 Weight of Equity = E/ (E+D) = 1-0.31=0.69 According to the 2017 Fortescue Metals Group Limited Annual Report in 2017, FMG paid interest expenses of U.S. $ 430 million and debt was U.S. $ m 4,471 and so the cost of debt is 430/4471=9.62%

Cost of equity

Cost of Equity = Risk-Free Rate of Return + Beta of Asset * (Expected Return of the Market - Risk-Free Rate of Return) Share price as at 10th July 2017 is $5.09 and here are 3,113.798 shares Beta coefficient is 0.89 Since the -year  5 Australian Government Bond yields is 2.258% and 10 year Australian Government Bond yield is   2.784%, the 10 year bond is in the long term and is the risk free interest rate. The market premium is assumed to be 6%, then Cost of equity= i 2.784%+ 0.89(6) =8.124

Cost of WACC 

After tax cost of debt is Kd (1-T), where T is the Tax rate 30%
WACC=0.69 (8.124 %) +0.31 (9.62 %) 0.7=7.39% As the company generates returns on invested capital compared to the cost of raising capital, then it is likely that the firm will report better retur...