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How Effectively Has Scottish Power Company Delivered Shareholder Value - Assignment Example

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The paper "How Effectively Has the Company Delivered Shareholder Value?" counts company's effectiveness of shareholder value compared to the FTSE100 over the period, calculates Cost of Capital, compares the firm's market capitalization to a valuation based on discounted cash flows, etc…
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How Effectively Has Scottish Power Company Delivered Shareholder Value
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S F M: Scottish Power Type of order: work Number of pages: 14 Deadline: Style: a) How effectively have we delivered shareholder value compared to the FTSE100 over each of the last 3 years As per London Stock Exchange The FTSE 100 Index is a share index of the 100 most highly capitalized companies. The index was introduced from 1984 where the companies must meet a number of criteria's to set out by the FTSE Group. This index has been considered as a barometer of British economy success of the and also the leading share index in Europe which holds about 80% 1. Scottish Power is one of the world's largest energy company headquarters in Glasgow, Scotland and listed both in London and New York Stock Exchanges. The Group provides electricity distribution and transmission to residential and commercial users of UK. It operates electricity generation, gas storage and relevant energy management activities in UK, US and Canada. With an investment of 4.8 billion, the vision of Scottish Power is to be the UK's best-integrated energy supplier and a world leader in Renewable as a vertically integrated energy company. In May 2005, Scottish Power sold it's regulated US business for 2.25 billion in cash and had returned to the shareholders in June. In 2006, it achieved profit before tax 675 million, which was 47%, increase of the previous year. Adjusted earnings per share for continuing operation at 27.9 pence, which were 46% ahead. The adjusted earnings per share for the group at 44,1 pence were 22% ahead. Dividend payable on the new ordinary shares in issue following the return of cash capital reorganisation, was 9.4 pence per share bringing the total dividend for the year to 25.0 pence in respect of each ordinary share held on the relevant record date for last three years. Shareholder Value Creation: Scottish Power Plc Financial Data 2 The value of a firm is the market value of its assets, which is reflect in the capital markets through the market values of equity and debt. Thus, shareholder value is: Shareholder value = Market value of the firm = Market value of debt. The Market value of the shareholder's equity is directly observable from the capital markets. In theory, the market value should be equal the warranted economic value of the firm. The true economic value of a firm or business or division or project of any strategy depends on the cash flows and the appropriate discount rate. Here we shall discuss briefly three most commonly advocated methods of shareholder value. The first method, called the free cash flow method, uses the weighted average cost of debt and equity 3 to discount free cash flows. You can recall that free cash flows are calculated as follows: Here, PBIT= profit before interest and tax, T= corporate tax rate, DEP= tax depreciation, ONCKI= other non-cash items, NWC+ change in net working capital 4, CAPEX= incremental investment. Terminal or residual value reflects the value of post-planning cash flows. Thus, the economic value or simply value of a firm or a business is: The value of a firm or a business generating perpetual FCF will be as follows: We may recall that FCF estimates do not make any adjustment for interest charges. Thus, FCF do not include financing 5 effect. The weighted average cost of capital (WACC) includes after tax cost of debt. Hence, the financing effect is incorporated in WACC rather than cash flows. WACC, you may, recall, is calculated as follows: We may recall that WACC is based on assumptions that the firm has an optimum 6 capital structure and that debt is perpetual. The second method calculate the economic value of a firm or a business into two parts: Notice that ku is the cost of capital of an un-levered firm. For the levered firm, the second part includes the value of interest tax shields (VITS): Thus, the value of levered firm of business is: Value of a levered firm = Value of a un-levered firm+ Value of interest fax shield We can obtain value of shareholders' equity as the difference between the economic value of the firm and the claims of debt-holders. The value per share (VPS) can be obtained by dividing the value of shares (E) by the number of shares (N): The share price of the company in 2006 is gained by D/K. Here D is 25 pence and k is .05 so the share price is 25/. 05=500 pence And the dividend given by the company is 25 pence per share, which we can get from annual report 7. We can summarize the steps involved in the second method of estimation of the firm's total value and the shareholder value as follows: 1. Estimate the firm's un-levered cash flows and terminal value. 2. Determine the un-levered cost of capital. 3. Discount the un-levered cash flows 8. 4. Calculate the present value of interest tax shield discounting at the cost of debt. 5. Add these two values to obtain the levered firm's total value. 6. Subtract the value of debt from the total value to obtain the value of the firm's shares. 7. Divide the value of shares by the number of shares to obtain the economic value 9. b) Can you provide calculations showing "Cost of Capital" our and explain exactly what this means Why is it important for us to know what this figure is The cost of capital is defined as the rate of return that a company would receive if it invested the money anywhere with comparable risk. The company can raise money through a borrowing, stock issue or a mix of the both 10. General Formula For Cost of Capital: The required rates of return are market-determined. They are established in the capital markets by the actions of competing investors. The influence of market is direct in the case of new issue of ordinary and preference shares and debt. The market price of securities is a function of the return expected by investors. Thus, the opportunity cost of capital is given by the following formula: Where, I0 is the capital supplied by investors in period 0 11, Ct is returns expected by investors 12 and k is the required rate of return or cost of capital. Weighted average Cost of Capital vs. Specific costs of Capital A firm obtains capital from various sources. As explained earlier, because of the risk differences and the contractual agreements between the firm and investors. The cost of capital of each source of capital is known as component, or specific cost of capital. The combined cost of all sources of capital is called overall, or average cost of capital. The component costs are combined according to the weight of each component capital to obtain the average cost of capital. Thus, the overall cost is also called the weighted average cost of capital 13. Cost of Debt: A company raises debt in various ways. It may borrow funds from financial institutions or public either in a form of public deposits or debentures for a specified period of time at a certain rate of interest. A debenture or bond may be issued at par or at a discount or premium as compared to its face value. The construal rate of interest or the coupon rate forms the basis for calculating the cost of debt. Debt issued at Par: The before tax cost of debt is the rate of return required by lenders. It is easy to compute before-tax cost of debt issued and to be redeemed at par; it is simply equal to the contractual 14 of interest. Where k is the before-tax cost of debt, i is the coupon rate of interest, b is the issue price of the bond (debt) and in Equation (2) it is assumed to be equal to the face value (F), and INT is the amount of interest. The amount of interest payable to the lender is always equal to: Interest = face value of debt x Interest rate We could arrive at same results as above by using Equation (1): Scottish Power Plc cash outflow are US$ 15 interest per year for 7 years and US$ 100 at the end of seventh year in exchange for US$ 100 now. Thus; By trial and error, we find that the discount rate (k) which solves the equation, is 15 percent: Clearly, the before-tax cost of bond is the rate, which the investment should yield to meet the outflows to bondholders. Debt Issued at Discount or Premium: Equation (1) and (2) will give identical results only when debt is issued at per and redeemed and can be written as follows top the before-tax cost of debt 15: Where B is the repayment of debt on maturity and other variables as defined earlier. Equation (3) can be used to find out the cost of debt whether debt is issued at par or discount or premium, i.e., B0=F or B0>F or B0 5. Microsoft Corporation: < www.microsoft.com > Read More
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