Strategic Corporate Finance - Serco Group Plc - Essay Example

?Task 1) Net Assets Value Net asset value measures the value of the firm’s assets, excluding the liabilities. It is usually calculated based on pershare (Babu, 2012). The Net Assets Value of Marks and Spencer for 2011 and 2010 are mentioned in the table below. Net Asset Value 2011 2010 Net Asset Value Per Share = Total Net Assets = ?2,750 = 172 pence = ?2,677 = 169 pence No. of Ordinary Shares Outstanding ?1,600 ?1,584 The above-mentioned Net Assets Value measures the value of assets based on per share. This is a conventional way of measuring the valuation of assets since it only relies upon the book values of assets (Jaffe and Ross, 2004). From the above-mentioned table, it is quite evident that Net Asset Value of Marks and Spencer have increased for 0.03 bases point and is higher in 2011 than 2010. The company has net assets worth of ?1.72 in 2011 and ?1.69 in 2010, which clearly explains that the Net Asset Value is improving. 2) Cost of Capital (CAPM) In the table mentioned below, the computations have been shown for the weighted average cost of capital of the company, Marks and Spencer. The cost of debt of the company is 4% whereas the cost of capital of the company was found as 4.5%. The weighted average cost of capital of the company, which incorporated the value of debt and value of equity was found to be 4.33%. Cost of Debt     Rd = Annual Coupon   Current Bond Price       = 5   125     Rd = 4.00% Value of Equity Ve = Current Price of Share x Number of Shares outstanding = 3.76 x 1,600 = 6,016 Value of Debt Vd = Current Price of Bond x Number of Bonds Issued = 125 x 2,489 = 3,111                 100     Weights     Wd = Debt = 3,111 = 34.09%   Debt + Equity 3,111 + 6,016       We = Equity = 6,016 = 65.91%     Debt + Equity   3,111 + 6,016     3) Dividend Growth Model (DGM) In this section of the paper, computations for Gordon’s dividend growth models have been shown. In this regard, there are two assumptions, which have been considered. In the first assumption, there is no growth in the present amount of dividends. In the second assumption, there is a growth of 2%. Gordon’s Dividend Growth Model     When g= 0   P = D(1+g) = 17(1+0) = 377 p.   K – g 0.045 – 0       When g=2   P = D(1+g) = 17(1+0.02) = 693 p.     K – g   0.045 - 0.02     From the above-mentioned table, this information can be extracted that if the growth rate is zero, then the hypothetical ex-right price of share price of Marks and Spencer is approximately 377 pence. In contrast to that, if it is assumed that dividend grow at the rate of 2%, then there is an enormous increment in the share price of the company, which is around 693 pence. It can be stated that at the growth rate 0, the share price of the company of 363 pence is more appropriate than the share price at growth rate 2%, which is 693. The share price of 693 pence is highly optimistic. 4) Price Earnings Ratio (P/E Ratio) The following table demonstrates the Price Earnings Ratio of Marks and Spencer. Price Earnings Ratio   31-Mar-12 11-Jan-13 P/E Ratio = 376 = 11.56 times = 363 = 11.2 times     32.5         32.5     In the year 2011, the Price Earnings Ratio of the company is 11.56. Nevertheless, it reduced in the last year to 11.2 because there was a reduction in the share price of the company. The average price earnings ratio of the respective industry of Marks and Spencer is 8.5 times, on the other hand, the P/E of Marks and Spencer is 11.2 times. If the P/E of Marks and Spencer is compared with the industry average, then it can be stated the Price Earnings ratio of Marks and Spencer is substantially higher than the industry average. It reveals that the share price of the company is over-values as compared to its industry competitors. Task 2 Investment in stocks is something which can be extremely tricky for ordinary investors. This is because the investors lack in having capabilities regarding the pricing of the stocks. The pricing of stocks have turned out to be a key factor as a minor mistake in assessing the price of a stock can lead to massive losses for investors. In order to judge the correct price of the stock, there are mainly two techniques used for such pricing analysis such as 1) fundamental analysis, and 2) technical analysis. Fundamental analysis is established based on the past financial performance of the firm. The past performance is highly assessed and it leads to estimate the future performance of the firm. The expected future performance is a base for current market share price. In this way, the fundamental analysis is conducted to reflect whether a stock is priced correctly and what would it future movements be as per the past performance of the company. The other technique is named as technical analysis which is used to deploy in such a manner that past performance of the share price alone is analyzed on technical grounds. This technique is developed with the help of charting tool such that different kinds of charts are drawn to in order to analyze the past movement and to determine the future trends of the stock. This task is based on fundamental analysis in order to check the financial performance and future projections regarding the value of Marks & Spencer. The company in consideration is Mark and Spencer which is considered as a giant in UK’s general retail industry. Investors keep a close look at the performance of M&S such that its performance is regarded as benchmark proxy of the overall retail industry. Not only the investors, the retail industry participants are fond of the financial performance of M&S as they are somehow linked with M&S. In case of any disturbance in the financial performance of M&S, other industry participants may not feel their positions secured enough and therefore they try to track its performance. Investors, market analysts and retail industry participants are in fact the most highly linked shareholders. As far as the company Marks & Spencer is concerned, the company was listed in London Stock Exchange on 19 March 2002. The ticker symbol of the company is MKS. The company is included in the major indices of London Stock Exchange some of which are FTSE All-share index, FTSE 350, FTSE 100, etc. The overall perception regarding M&S stock is the one having sound market capitalization along. The investors give key importance to this stock because of its liquidity. The stock shows meager risk element, however, still investors want their investments to be safe and thus interested in its fundamental analysis. Assets Valuation of Marks & Spencer The decision of making investment in the shares of Marks and Spencer highly depends upon its past performance as it leads to future projections regarding the appropriate estimates of the pricing of M&S. One of the rival firms have placed an offer of 380 pence and the client needs the recommendation whether it is justified to make partial or full investment in the shares of M&S. There are different techniques which are used in fundamental analysis. Some of those techniques have been used in the above Task 1. Those techniques and their results are discussed in detail as under: Net Asset Value Net asset value is regarded as the most fundamental technique in evaluating assets of the company. This technique assists the analysts in determining the book value of the assets. The formula used under this technique is net assets divided by the number of shares (Khan, 2004). Net assets are calculated by subtracting the amount of current liabilities from the total assets of the company. This technique does not provide the most appropriate share price of the company, but it provides the most conservative price as it assumes that the share price of any given stock should not be less than its book value per share. The technique is more useful at the time of bankruptcy such that the finance providers believe that they should be given the proportionate residual relating to net asset value per share. Under the given scenario, two net asset values per share for Marks & Spencer are calculated such that for the year 2010, net asset value per share for M&S was 169 pence followed by 172 pence in the year 2012. These prices can be interpreted in such a manner that the share prices of Marks & Spencer can be at least around 170 pence. How, it is important to note that this share price is not exhaustive by any means, as it does not contain the future prospects, goodwill, business growth and other factors which are duly reflected in share prices prevailing in stock markets. Dividend Growth Model Dividend growth model is considered as the most reliable method of valuation of assets especially of those companies which pay dividends regularly. This model assumes that the company is going to pay dividends over the perpetually (Siegel and Shim, 2008). However, this model does not work for the companies which do not pay any dividends. The model is developed in such a manner that firstly the cost of equity of the company is determined through Capital Asset Pricing Model (CAPM). That cost of equity is the used to compound the upcoming dividends for the perpetuity. For those companies which increase the size of dividends every year, a modified form of the model is used (Bierman, 2003). In the given case of Marks & Spencer, the cost of equity of the company is computed as 4.5% which is quite low indicating that the shareholders of the company considers their investments in the safe heaven. M&S has current dividend per share of 17 pence. The dividend growth model under the give case is applied by considering two assumptions such that first one holds that the growth rate of dividend is zero whereas the other one believes that the dividends are expected to grow by 2%. Under the first assumption, dividend growth model provided a figure 377 pence which is approximately equal to the existing share price of 376 pence. Conversely, the other assumption of growth rate of 2% is applied, then the results are wayward such that the price of 693 pence is calculated which is in fact double the existing price. In this way, the price generated through first assumption seems more realistic for M&S. Price to Earnings Multiple This ratio is considered as an easy measuring of assessing the existing share prices. Under this technique, the current share price of the stock is divided by the latest earnings to obtain P/E multiple (Jaffe and Ross, 2004). The P/E multiple is then compared with the P/E multiple of the industry. If the multiple is higher than that of the industry, it means that the stock is overly valued and a likely correction in the share price can be observed. On the other hand, if the P/E multiple is found to be lower than that of industry; it means that the stock is undervalued and it has the potential of gain in the near future (Eckbo, 2008). If the P/E multiple of Marks & Spencer is considered, the company is having the P/E of around 11 times which shows that the stock is worth 11 pence on earning one penny. If this P/E is compared with the P/E of general retail industry, the P/E multiple of general industry is quite low i.e. around 8.5 times. This shows that M&S stock is overly valued and there is likelihood that in fear future, it may tumble and travel in downward direction. Other Assets Valuation Models Besides the above discussed asset valuation types, there are other types as well such as free cash flow to firm, free cash flow to equity in determining the correct price of the stocks(Sheeba, 2011). These techniques are not only comprehensive but quite complex as well. Huge amount of estimations and judgments are required in order to compute the most appropriate figure for the stock prices (Brigham and Ehrhardt, 2008). Recommendation The client is recommended to purchase only a few stocks of Marks & Spencer because of the P/E multiple estimations. Net asset value per share provides only the conservative estimates of the share prices. Dividend discount model provides the appropriate price given the assumption of 0% growth rate in the expected dividends which is quite unlikely. However, P/E multiple provides the better estimate indicating that the stock is not stable and moving at a higher price and it can be predicted that it may experience corrections which can bring it more closer to the general retail industry’s P/E multiple. Task 3 Tracking of the Share Price of Serco Group PLC The share price of Serco Group PLC (SRP) has remained within the range of 557 pence and 630 pence during the previous four months. During the first two months, the share price of Serco Group PLC was moving above 550 pence and below 600 pence mark. During this period, the stock reached at the highest of 588 pence and at the lowest 557 pence. From beginning of March 2013, the stock crossed the hurdle of 600 pence. This level was achieved on 8 March 2013. Since then the stock of the company has been on a consolidated side i.e. above the 600 pence level. The stock reached at 630 pence level during this period which is the highest point. Overall, the stock is found to be tracking on the growth stage in the past four months. However, further corrections can be estimated in near future once the hike of global stock markets is settled. Works Cited Babu, G., 2012. Financial Management. New Delhi: Concept Publishing Company. Baker, H. K. and Martin, G. S., 2011.Capital structure and corporate financing decisions: theory, evidence, and practice. New York: John Wiley & Sons. Berk, J. B. and DeMarzo, P. M., 2010. Corporate finance. 2nd ed. New York: Prentice Hall. Bierman, H., 2003. The capital structure decision. New York: Springer. Brigham, E. F. and Ehrhardt, M. C., 2008. Financial management: theory and practice. 12th ed. New York: Cengage Learning. Eckbo, Bjorn Espen., 2008. Handbook of corporate finance: empirical corporate finance. Oxford: Elsevier. Jaffe, J. and Ross, R. W., 2004. Corporate Finance. New Delhi: Tata McGraw-Hill Education. Khan, M. Y., 2004. Financial Management: Text, Problems and Cases. 2nd ed. New Delhi: Tata McGraw-Hill Education. Siegel, J. and Shim, J, 2008. Financial Management, 3rd ed, Barron's Educational Series, Beijing. Sheeba, K., 2011. Financial Management. Mumbai: Pearson Education India. Shim, J. K. and Siegel, J. G., 2008. Financial Management. 3rd ed. Oxford: Barron's Educational Series. Read More