Rexam Programmable Logic Controller and GlaxoSmithKline Pharmaceuticals Limited - Essay Example

Corporate Finance Table of Contents a) Rexam Plc and GlaxoSmithKline (GSK) Pharmaceuticals Limited 3 Calculation of total shareholder return (TSR)3 2) Calculation of mean return of each company (2007-2013) 6 3) Calculation of standard deviation (2007-2013) 8 4) Calculation of correlation coefficient 9 5) Risk and return portfolio 10 6) 10 b) 10 c) 11 Reference List 13 Appendix 1: Calculation of mean return of Rexam Plc and GSK Plc 15 a) Rexam Plc and GlaxoSmithKline (GSK) Pharmaceuticals Limited For the accomplishment of project, two companies are chosen Rexam Plc and GlaxoSmithKline Private Limited. Both the companies are from different sector: packaging and pharmaceutical sector. Rexam Plc is regarded as one of largest beverage can manufacturer and leading plastic packing producer in the world. It is a multinational corporation, based in United Kingdom (UK) and it is listed on London Stock Exchange (LSE) (Rexam Plc, 2014c). GSK is regarded as the world’s sixth largest pharmaceutical company, which is based in Brentford, London. The company is also listed on LSE (Glaxosmithkline Group of Companies, 2014a). 1) Calculation of total shareholder return (TSR) TSR is defined as a measure that helps in evaluating the performance of different company’s shares and stocks over the passage of time. It takes into account appreciation of share price and payment of dividends in order to show the total shareholder’s return and is expressed as percentage. It is calculated after considering capital gain, which is accrued after purchase of company’s share. In calculating TSR, it is assumed that the dividends are reinvested in the company shares (Rexam Plc, 2014b). Through calculation of TSR, the performance of share is compared over the period of time. This is the main advantage of calculating TSR as it shows the exact position of the share even if it has high growth and low dividend or low growth and high dividend. The formulae employed for calculating TSR is as follows: TSR = (Share price at the end of the year – Share price at the beginning of the year + Dividend for the year)/Share price at the beginning of the year After collecting relevant information from the annual reports of the two companies mentioned above, TSR is calculated. The information needed for the same are share price at the end and beginning of the year along with the dividend that are paid out to the shareholders. This information has helped to calculate the TSR of the companies, which are provided in the following table (Rexam Plc, 2014a): Figure 1: TSR of Rexam Plc. (Source: Author’s creation) The above table reflects the change or fluctuation in the value of TSR over the 7 years. It is observed that the TSR value of Rexam Plc has increased over the years from a negative value since 2007. During the period 2007-2009, the company was unable to maintain a positive TSR mainly due to its poor performance in the industry, which occurred mainly due to the insufficient sales. However, positive TSR after 2009 indicates that the company has improved its share price performance, which is the result of increase in sales. Presently, the company has satisfied customers by offering them with good return and higher dividends, which are reinvested in company shares that are issued for them. Figure 2: TSR of GSK (Source: Author’s creation) From the above table it is evident that GSK has encountered fluctuating sales over the years from 2007-02013 which is reflected in the TSR value. The investors of the company had to receive decreased dividend during the period when TSR was negative. However, it is observed that GSK, like Rexam, has also concentrated in improving the TSR by increasing the amount of sales and decrease the expenditure as a whole (Yahoo Inc., 2014). Figure 3: TSR of Rexam Plc and GSK (Source: Author’s creation) From the above figure it can be deduced that Rexam Plc has provided higher TSR to its shareholders in the recent years 2012 and 2013 than GSK. It is also evident that the company has concentrated in improving TSR from 2009 onwards by stabilising the dividend and share price. Nevertheless, TSR of GSK has sharply increased in 2011 which results from increase in share price and dividend; but the TSR has decreased drastically in 2012 and revived its position in 2013. Thus, it can be stated that share price performance of Rexam Plc is better than that of GSK and thus the shareholders are expected to be satisfied with its performance. Rexam Plc is a packing company whereas GSK is a pharmaceutical company; both have different company standard pertaining to TSR in their industries. Hence, it will be difficult to analyses the situation exactly. However, from the shareholder’s point of view Rexam Plc is profitable than GSK. 2) Calculation of mean return of each company (2007-2013) The mean return of the companies is calculated by considering the TSR values of the same for the past years. Firstly, the monthly average is calculated and then the mean return for each year is evaluated by dividing them by 12. The following table highlights the mean returns of both the companies over the seven years (Refer to Appendix 1 for calculation): Figure 4: Mean Return of Rexam Plc (Source: Author’s creation) From the above table it can be stated that the mean return of Rexam Plc has not performed well over the years; it has decreased and this indicates the fact the company has failed to deliver good return to its investors. The investors are not satisfied with the return that is obtained from the shares of the company and hence the company should aim at revising the returns. Figure 5: Mean return of GSK (Source: Author’s creation) From the above table it is evident that the performance of GSK is weak and the investors are not supported with increased returns. By comparing the mean returns of both the companies, it can be stated that Rexam Plc have performed better than that of Rexam Plc with respect to mean returns over the last 7 years. 3) Calculation of standard deviation (2007-2013) When an investor invests in a particular stock of a company there is a chance of losing or gaining from the same. The reason behind this is the daily fluctuation in the stock market. Thus, it is important to calculate the volatility of a certain stock before investing. The volatility is measured by standard deviation of the returns that are obtained by the company. The standard deviation for the two companies is calculated as below: Figure 6: Standard deviation of Rexam Plc and GSK (Source: Author’s creation) From the above figure it can be stated that the standard deviation of both the companies are fluctuating over the years to a great extent. This indicates that the stocks of the two companies are volatile as the value of standard deviation is on the higher side. It is expected that the investors of the company are not at all satisfied with the provided returns and dividends. Here, standard deviation indicates the risk associated with the company shares. If both are compared, it can be stated that the stocks of Rexam Plc are less risky than that of GSK. 4) Calculation of correlation coefficient Correlation Coefficient (CC) of stocks is expected to move within the band between 1 to -1; it is not an oscillator. The value of CC is observed to fluctuate between negative and positive correlation. This indicates the manner in which the share prices moves together. CC of +1 reflects positive correlation between the stocks and they are observed to follow definite synchronization. However, a CC of -1 reflects that the stocks are negatively correlated and they move in opposite direction. These two extremes are rare and CC is seen to fluctuate between +1 and -1. The CC of 0 indicates there is no correlation between the two stocks. The correlation coefficient of both the company’s stock is calculated in the table below: Figure 7: Correlation Co-efficient (Source: Author’s creation) The correlation coefficient (r) of both company stocks are evaluated as below: r = [n (∑XY) – (∑X) (∑Y)] / √[n∑X2 - (∑X)2] [n∑Y2 - (∑Y)2] = [7 * 260.03 – (17.4*49.33)] / [7*1412.6 – 17.42] [7*101950 – 49.32] = (1820.21 – 858.342)/ (9888.2 – 302.4) (71650-24304) = 961.868/ 47346 = 0.02 The CC of both the companies reflects that there is no correlation between the two. Both the share prices and returns tend to move in opposite direction. 5) Risk and return portfolio The risk return portfolio of the two portfolios is as given below: 6) From the above table it can be stated that the risk and return portfolio of GSK is better than that of Rexam Plc. b) The Capital Asset Pricing Model indicates the relation between expected return and risk that is used for pricing the risky assets. The general formula is: R = rf + β (rm – rf) + abnormal rate of return Here, rf = Risk free rate of return rm = expected return from the market β = beta or the risk associated with the security The formula provided above helped to calculate the abnormal return of stocks of both the companies. Rexam Plc Year Risk free Return Market Return Beta(standard deviation) Expected Return Abnormal return 2013 3.39% 15.41088581 1.064296442 -16.33177127 31.74265708 2012 3.39% 19.17112299 1.341691374 -25.64234702 44.81347002 2011 3.39% 5.651537335 0.738882363 -4.11687315 9.768410485 2010 3.39% 13.60453484 1.076384014 -14.57331441 28.17784925 2009 3.39% 2.916666667 0.293094912 0.898696078 -3.815362744 2008 3.39% 13.38268657 0.836201015 11.2528633 -24.63554987 2007 3.39% 20.0744186 1.213443555 24.43420962 -44.50862822 GSK Plc Year Risk free Return Market Return Beta(standard deviation) Expected Return Abnormal return 2013 3.39% 11.50231754 0.640246704 -7.308716528 18.81103406 2012 3.39% -5.278085106 0.171508365 0.94494988 -6.223034986 2011 3.39% 30.44244572 0.567643078 -17.22730049 47.66974621 2010 3.39% 1.973448418 0.365130973 -0.6742892 2.647737618 2009 3.39% 8.240262403 0.177577013 -1.423361321 9.663623723 2008 3.39% 8.711928934 0.08936776 -0.741636005 9.453564939 2007 3.39% -6.261318681 0.488603638 3.109766747 -9.371085428 c) The difficulties that arise from Portfolio Theory and Capital asset Pricing Model (CAPM) are discussed below: Allotting definite values to the CAPM variables: In order to use CAPM, the values of return of market, risk-free rate of return or the equity risk premium and beta are required. The yield obtained from the short-term Government debt is employed as the risk free return and thus it is not fixed, keeps on changing according to the economic circumstances. In this regard the value of risk free return is hard to obtain as it keeps on changing daily however a value is randomly chosen (Black, Jensen and Schloes, 1972; Black, 1970, Black, 1986, Lakonishok, Shleifer and Vishny, 1994; Lintner, 1965, Pastor and Stambaugh, 1999). The return on a stock market is referred as the sum of average profit that is obtained by the investors along with the dividend. It can be observed that at short run, a particular stock market aims at providing a negative return only if the impact of decreasing share price exceeds dividend yield. Therefore, it is recommended to use long term average value for the risk free rate. CAPM in investment appraisal: One of the main disadvantages of employing CAPM for investment appraisal is that the predictions relating to “single period time horizon” (Roll, 1997) is not correct which is associated with “multi period nature of investment appraisal” (Roll, 1997; Sharpe, 1964; Hill, 2010; Levy, 2012; Satchell and Knight, 2001). Reference List Black, F. Jensen, M. and Schloes, M., 1972. The Capital Asset Pricing Model: Some Empirical Tests. Studies in The Theory Of Capital Markets. Black, F., 1970. Banking and Interest Rates in a World without Money: The Effects of Uncontrolled Banking. Journal of Bank Research, 1, pp. 8-20. Black, F., 1986. Noise. Journal of Finance, 41, pp. 529 – 543. Glaxosmithkline Group of Companies, 2014a. Who We Are And What We Do. [online] available at: < http://www.gsk.com/uk/about-us/who-we-are-and-what-we-do.html > [Accessed 28 July 2914]. Hill, R., 2010. The capital asset pricing model. New York: Cambridge University Press. Lakonishok, J., Shleifer, A. and Vishny, R., 1994. Contrarian Investment, Extrapolation and Risk. Journal of Finance 49, pp. 1541-1578. Levy, H., 2012. The capital asset pricing model in the 21st century. New York: Cambridge University Press. Lintner, J., 1965. The Valuation of Risk Assets and the Selection of Risky Investments in Stock Portfolios and Capital Budgets. Review of Economics and Statistics, 47, pp. 13-37. Pastor, L. and Stambaugh, R., 1999. Costs of Equity Capital and Model Mispricing. Journal of Finance, 54, pp. 67-121. Rexam Plc, 2014a. Share Price. [online] Available at: < http://www.rexam.com/index.asp?pageid=104&tool=excel > [Accessed 28 July 2914]. Rexam Plc, 2014b. Share Chart. [online] Available at: < http://www.rexam.com/index.asp?pageid=104 > [Accessed 28 July 2914]. Rexam Plc, 2014c. What we do. [online] Available at: < http://www.rexam.com/index.asp?pageid=412 > [Accessed 28 July 2914]. Roll, R., 1997. A Critique of the Asset Pricing Theorys Tests Part I: On Past and Potential Testability of the Theory. Journal of Financial Economics, 4, pp. 129-176. Satchell, S. and Knight, J., 2001. Return distributions in finance. Woburn: Reed Educational and Professional Publishing Ltd. Sharpe, W., 1964. Capital Asset Prices: A Theory of Market Equilibrium under Conditions of Risk. Journal of Finance, 19, pp. 425- 442. Yahoo Inc., 2014. Historical Prices. [online] Available at: < https://in.finance.yahoo.com/q/hp?s=GSK.L > [Accessed 28 July 2914]. Appendix 1: Calculation of mean return of Rexam Plc and GSK Plc Read More