Governance Environment Corporate Governance is a group of rules andpractices which companies is directed and controlled. One of the main reasonsfor Corporate Governance is for accountability and to ensure long term success.The board of directors who represent the interests of the company shareholdersare responsible for the governance within the company. Textron adopted its GovernanceGuidelines and Policies in 1996. Textron follows many corporate governancepractices such as director independence. When it comes to director independence,10 of Textron’s directors are independent with the CEO being their onlymanagement director. Textron’s three principal Board committees are eachcomposed entirely of independent directors (Governance).
The names of theTextron Board committees are Audit Committee, Nominating and CorporateGovernance Committee and Organization and Compensation Committee (Proxy, 16). TheNominating and Corporate Governance Committee has responsibility for corporategovernance matters. They also have the independent directors meet withoutmanagement present on many occasions throughout the year. Independent directors annually designate adirector from among the Committee chairs to serve as Lead Director (Proxy, 16).Textron also implemented some internal controls because the Lead Director isassigned clearly defined and expansive duties.
The Lead Director, among otherfunctions, presides at all meetings of the Board at which the Chairman is notpresent and all meeting between the independent Directors. The Lead Directoralso serves as liaison between the CEO and independent Directors. All directorsmust stand for election annually (Proxy,16). The non-employee directors conductan annual performance evaluation of the CEO.
The Board and the committeesperform annual self-evaluations and may not stand for reelection after their75th birthday (Proxy, 16).Textron also has a group of external auditorsfrom Ernst and Young, LLP that review and confirm financial statements to makesure there aren’t mistakes or misrepresentation in the Annual Reports as wellas the reports for the SEC. 2). Agency Conflicts Agency Conflicts are when interests of agentsand principals do not align with each other. The agent is a person who has theimplied or actual authority to act on the behalf of the other.
The owners whomthe agents represent are the principles. There are many consequences of agencyconflicts, a company’s reputation will diminish and the cost of capital will behigher. All these consequences make it hard for a company to do business.Textron has strict guidelines when it comes to agencyconflicts and ethics. The Board expects its Directors and other employees toact ethically at all times and to adhere to the Textron Business ConductGuidelines (Governance, 4). Directors are expected to avoid any action,position or interest that conflicts with an interest of Textron or that givesthe appearance of a conflict.
If any actual or potential conflict of interestarises for a director, the director must inform the Chairman, the CEO and thechair of the Nominating and Corporate Governance Committee (Governance, 4). Ifa significant conflict exists and cannot be resolved, the director shouldresign. Directors will recuse themselves from discussions or decisionsaffecting their personal, business or professional interests. Potential agencyconflicts would be a senior manager approves a certain project that goesagainst the opinions or interests of the Board of Directors. Another example, similarto the Microstrategy case would be a manager altering financials to make thecompany value look higher than it should. Though audits and internal controls,agency conflicts can be avoided.Textron makes sure that the Nominating andCorporate Governance Committee as well as the audit committee are working tomake sure that any director within the company remains independent to anycompany or affiliates that Textron conducts business with (Governance,16). Textron has Director IndependentStandards that each director must adhere to or subject for review due to lackof independence (Governance, 16).
3.) Auditors Having both internal andindependent auditors are very crucial to companies and their financial success.It is very important if you are a publicly owned company.
The SEC requires allpublic corporations to file financial statements and make them available to thepublic. The 10-K reports contain audited financial statements submittedannually to the SEC for the distribution to the public. The 10-Q reportscontain unaudited financial statements submitted quarterly, also for publicdistribution. Companies hire independent auditors for their financialstatements and their internal control of independent internal verification.Companies have to make sure their financial statements are reported correctlybecause it can drastically affect their value to investors and their reputationthroughout the world. External auditors have to assess a company’s financialstatements and publicly agree that the financial information is correct andreliable. External auditors help prevent companies into going to litigation orhaving internal company problems.
It also causes employees for work on thefinancial information to be more diligent because they will be held accountablefor potential mistakes that were seen by external auditors. Textronhas an internal committee that works with the company independent auditors.After the independent auditors have reviewed the financial statements, theymeet with the committee with and without management to discuss the results,their evaluations of the company internal controls and overall financialreporting (Proxy, 18). Textron chose Ernst & Young, LLP to be the company’sindependent auditor for 2017.
Textron has many guidelines and by-laws to makesure that any independent auditor remains independent. Even though there aren’tany independence issues occurring with Textron, an example of an independenceissue would be someone who is at Ernst & Young that has a major financialinterest in Textron. Another example would be someone at Ernst & Young isrelated in some capacity to someone who is on the Board or a committee ofTextron. 4.) Internal Controls InternalControls are the processes that a company uses to make sure that are compliantwith laws and regulations. By using internal controls, a company can become moreefficient and efficient as the controls are designed to streamline the processfor corporate governance and mitigation of agency conflicts.
There are sixprinciples of control activities. The principles are establishment ofresponsibility, segregation of duties, documentation procedures, physical,mechanical, and electronic controls, independent internal verification andhuman resource controls. With establishment of responsibility, control is mosteffective when one person is responsible for a given task. Differentindividuals should be responsible for related activities; best practice is toalways have segregation of duties.
Companies should always have documentationprocedures because documents provide evidence that transactions and events haveoccurred. With having important documents, you should have some sort of physical,mechanical and electronic control to help safeguard assets and enhance theaccuracy and reliability of the accounting records. Companies also should haveindependent personnel that are responsible for verifying the information.Companies should bond employees who handle cash, rotate employees’ duties andrequire employees to take vacations; conduct through background checks. Textron’s management is responsiblefor establishing and maintaining adequate internal control (10-K).
Theirinternal control structure is designed to provide reasonable assurance thatassets are safeguarded and that transactions are properly executed andrecorded. Textron’s management performs an evaluation of their internal controlsannually (10-K). Back in 2007, the SEChad filed Foreign Corrupt Practice and Internal Control charges against Textron(SEC).
One of their subsidiaries was receiving kickback payments in connectionwith its sale of humanitarian goods to under the U.N. (SEC). They had toforfeit over $2.
7 million dollars as well as pay about $2 million dollars infines (SEC). This is a great example of what happens when internal controls andexternal auditing is not used or not used effectively. 5.) Industry Textron conducts business in many differentindustries but their biggest industry is the global commercial aircraft manufacturing industry (Longo). Thisindustry produces complete civilian aircrafts, including aerospace engines,equipment and parts. Textron also works with aerospace products, aircraftconversions and complete aircraft or propulsion systems as well. (Longo)The industry has grown over the last five years. Increased air travel inemerging markets, combined with the need to replace aging aircraft hassignificantly increased demand for industry products over the past five years(Longo).
The industry was able to expand and the industry revenue increased atan annualized rate of 3.8% to $369.7 billion (Longo). The next five years areprojected to have growth as well. The industry revenue is forecasted to grow ata more moderate annualized rate of 2.
4% to $416.2 billion (Longo).Emerging markets and aircraft replacements drove the industry’s strongperformance over the past five years. Rapid growth in emerging markets gavemore consumers the means to take vacations and travel by air (Longo). As theglobal economy grows, the need for travel becomes more important which is greatfor the industry. Even though most of the industry is in Europe and NorthAmerica, some of the fastest-growing sources of industry demand are in those emergingmarkets (Longo). Airlines have also purchased more aircrafts to improveoperational efficiencies.
With companies like Textron who have been investingin more fuel efficient aircrafts, major commercial airlines have been highdemand for those kinds of aircrafts. This is due to the world price of crudeoil being extremely volatile (Longo). Another big risk to the industry besidesthe price of oil is the disposable income of consumers based on the economy. The consumer can be a business or a person whowants to go on vacation but if they don’t have the income, it will be hard totravel. When disposable income increases, consumers are more likely to spend moneyon tourism and travel (Longo). 6.) Beta Beta isthe measure of nondiversifiable risk.
Nondiversifiable risk is the portion of aportfolio’s total risk that cannot be eliminated by diversifying. Factorsshared to a greater or lesser degree by most assets in the market, such asinflation and interest rate risk, cause nondiversifiable risk. The stock markethas a beta of 1, Betas higher than 1 indicate more nondiversifiable risk thanthe market.
Betas lower than 1 indicates less risk than the market. Risk-freeportfolios have betas of 0. Companies in low-risk, stable industries likepublic utilities will typically have low beta values because returns of theirstock tend to be relatively stable.
Companies who deal with more volatileproducts or services will tend to have higher beta values. Icalculated Textron’s beta based on monthly returns to 0.18. What I did was goto Yahoo Finance and got the monthly ending prices for the last year for bothTextron and the S&P 500. After receiving those prices, I calculated themonthly returns for both. Then I divided the monthly asset returns of Textronby the monthly returns of the S&P 500 and got 0.177359 which by rounding upgives you a beta of 0.18.
I have the spreadsheet that in the appendix. Based onthis data, there is minimal market risk for investing Textron. This shows thatinvesting Textron would be a safe decision. 7.) CAPM The capital asset pricing model (CAPM)is a financial model that can be used to calculate the appropriate requiredpayment of return of an investment project, given its degree of risk asmeasured by beta. There are three components of the CAPM, the risk-free rate ofreturn, the market risk premium and the project’s beta. The beta in the CAPMreflects only the nondiversifiable risk of an asset, not its diversifiablerisk. Diversifiable risk is irrelevant because the diversity of each investor’sportfolio essentially eliminates that risk.
The return in a particular securitythat is measured by the CAPM and beta relates to the degree of nondiversifiablerisk in the security. Thecalculation for the CAPM is the risk-free rate of return plus the differencebetween the expected market rate of return and the risk free rate of returntimes the beta. We have the beta of 0.18.Since the beta was based on monthly returns for one year, I chose the risk-freerate based on a one year Treasury constant maturity series of 1.65%. Based onCNNMoney, the market rate of return for the S&P 500 Index is 18.
43%. Thatmeans the calculated for the CAPM will be: Cost of Capital/Equity = 1.65% +(18.43% – 1.65%) * .18. That equation gives us the required rate of return ofequity of 4.
5%. 8.) CapitalBudgeting Net present value of a capital budgetinginitiative is the dollar amount of the change in the value of the firm as aresult of undertaking the initiative. If an initiative has a NPV of zero, itmeans that the company wouldn’t lose money if the new initiative is started. Apositive NPV means that the company could gain money if the initiative isstarted. A negative NPV means the firm’s value will lose money the new initiativeis started. The internal rate of return is the estimated rate of return for apotential initiative based on the initiative’s incremental cash flows. Theinternal rate of return is similar to net present value as it considers allcash flows for an initiative and adjusts for the time value of money but it isexpressed as a percentage compared to NPV which is a monetary figure.
Shown inthe excel spreadsheet in the appendix, I created a scenario where Textron wouldinvest in a 6-year initiative. Projected cash flows for the next years would be$10,000, $12,000, $14,000, $16,000, $18,000 and $20,000. The company cost ofcapital would be estimated at 6.75%. After calculating the NPV, the presentvalue would be $70,227.
I also calculated the internal rate of return based onthe projected cash flows and periods which ended up being a return -0.10%.Since the internal rate of return is significantly less than the cost ofcapital is equal, the initiative would lose the company money and should not bestarted. 9.
) Peer Acompany that is very similar to Textron is Bombardier, Inc. Bombardier is alsoin the aircraft industry. While Textron is headquartered in Providence, RhodeIsland, Bombardier is headquartered in Montreal, Canada. I am not currentlyaware of any major issues facing the company right now. Like Textron,Bombardier has potential to grow with the globalization and the constant needfor travel. 10.) FinancialStatements Thebalance sheet is the financial statement that shows a company’s assets,liabilities and equity at a given point in time.
The balance sheet givesinvestors information on liquidity and solvency. It also shows equity of acompany compared to the company debt. On the balance sheet, the company’sassets are listed in order of their liquidity. The company’s liabilities arelisted by what is due earliest. When it comes to the equity section, itcontains the common stock, capital in excess of par and retained earnings.Another important part of the balance sheet is that Assets equal theliabilities and stockholders’ equity. The income statement is a financialstatement that presents the revenues, expenses and income of a business over a specifictime period.
Revenues represent gross income of the company during the periodof time. Expenses represent the cost of providing goods and services during agiven period of time. Net income is the remainder after expenses have beensubtracted from the revenues. The statement of cash flows is the financial statementthat shows how cash is flowing in and out of the company over a given period oftime. The statement of cash flows shows cash flows in a company’s operating,investing and financing activities.
It also shows the overall net increase ordecrease within the company. Accountantsand investors look at these financial statements to learn about a certaincompany and how they operate. There are many times that companies might lookgreat but when you look at their financial statements, a company can be losingmoney at a rapid rate.
Investors look at these statements because it shows thepotential value in a company. If it looks like the company has growing valuethen investors will be willing to invest in the company. Financial statementsalso reflect the reputation of the company and how they conduct business. Ithelps measure profitability, liquidity, debt and asset activity as well. 11.) FinancialAnalysis – Life Cycle Analysis A life cycle analysis is importantwhen evaluating a company or industry. A company’s life cycle is the movementthat the company has been doing since it was created.
You can estimate acompany’s stage within the life cycle by looking at the statement of cash flowof the respective company. There are four stages of the life cycle: introductory,growth, maturity and decline. In the introductory stage, the company is very youngand are most likely not generating a great deal of revenue. Their investment operations will have anegative cash flow because they are making major investments such as R&D todevelop the product. Cash flow from financing operations will be positive dueto the company taking out loans and other activities to get cash to operationthe business. During the growth stage, cash flow activities start to change.
The financial cash flow starts declining as they generating more revenue fromoverall operations and the need for loans decreases. When it is in the maturitystage, that is when sales and cash flow from investing start to reach its peak.Financing activities are declining as well. When a company is in their declinestage, it means that company is slowly ending.
All aspects of the statement ofcash flows are in the dropping. Afterlooking at Textron’s statement of cash flows, I believe that they are in thegrowth stage of the life cycle. Over the last three years, Textron’s cash flowfrom operations has increased which is great because it means that they aregrowing.
Their investing cash flows arestill negative. That is because Textron is growing and have to spending onresearch and development to stay competitive in the market and maintain steadygrowth. A key factor why I believe they are in the growth stage is becausetheir cash flow for financing activities has gone from positive to negative. I wouldsay that Textron’s life cycle stage matches my life and career stage. I amstill young and learning a lot. I haven’t figured out exactly what I want to dobut I believe that personal and financial growth is important if I want tofigure out exactly I want to do in my career. 12.
) FinancialAnalysis – Liquidity and Solvency Risk Liquidity means how quickly youcan turn assets into cash. Solvency is the ability to fulfill debt obligations.You want to perform a liquidity analysis because you want to measure theability of a firm to meet its short-term obligation. If a company can’t pay offdebts, it can lead to major problems for the company such as bankruptcy.Solvency analysis helps you determine whether the company can meet itslong-term obligations. When it comes to liquidityanalysis, you can use financial ratios such as a company’s current ratio or thequick ratio. The current ratio is current assets over current liabilities.
For Textron,the current ratio is $7,053/$3,893 which equals 1.81. That means that Textronhas $1.81 of current assets for every dollar of current liabilities. The quickratio is the current asset minus inventory over current liabilities. The quickratio is ($7,053 – $4,464)/$3893, which ends up being .66. When measuringsolvency, financial ratio is use is debt to total assets or debt to equityratio.
Debt to total assets is total liabilities over total assets: $9,784/$15,358= 63%. The debt to equity is: total debt/shareholder’s equity which equals1.76. 13.) FinancialAnalysis – Profitability Profitability is the ability togenerate profit and earning persistence is the ability to have income year toyear. Profitability is important when it comes to a company’s evaluation.
Whenthinking about investing, you do not have a company that isn’t capable of generatingprofit. If the company is in the introductory state of the life state of thecycle, the company might not always be profitable at the time but you canproject their future profitability. Companies that are in later stages in thelife cycle and are not generating profits are losing money and failing as acompany. That is something that investors do not want to spend their time on sothey calculated profitability ratios to help with their analysis.
Profitabilityratios measure how much company revenue is eaten up by expenses, how much acompany earns relative to sales generated, and the amount earned relative tothe value of the firm’s assets and equity. Stockholders have a special interestin the profitability ratios because profit ultimately leads to cash flow, aprimary source of value for a firm. There are five profitability ratios thathelp determine a company’s ability to generate profit: gross profit margin,operating profit margin, net profit margin, return on assets and return onequity.
The following are calculations for Textron and their profitability. Thegross profit margin is gross profit/sales: $2,477/$13,788 which equals 18%. Theoperating profit margin is the EBIT/sales: $1050/$13,788 which is 7.
6%. The netprofit margin is net income/sales which is 7%. Return of assets is netincome/total assets which is 6.2% and the return of equity is 17%. Thecalculation for return of equity is net income/stockholders’ equity. Earningspersistence is important as well for evaluating a company.
Price to earningsratio is a good ratio is to use for earnings persistence. It helps measures themarket’s perception of the future earning power of a company, reflected in thestock share price. The P/E ratio is market price per share/earning per share.The equation is $54.57/$3.55 which is 15.
This means that $54.57 is 15 timesthe level of its 2016 earnings per share and it will take 15 years to accumulatenet profits of $54.57 per share. That is the amount an investor would pay todayto buy this stock. 14.) FinancialAnalysis – Valuation The primary financial goal offinancial managers is to maximize the market value of their firm.
Accuratebusiness valuation is also a concern when a company contemplates selling securitiesto raise long-term funds. Companies do not want to undervalue their businessbecause they are working to raise the most amount of money as possible. The value of a business depends on its futureearnings power. To value a business, you should consider the size of cashflows, the timing of cash flows and the risk associated with the cash flows.