Strategic Corporate Finance - Assignment Example

Corporate Strategic Finance a) Net Asset Value Per Share = Net Asset Value Number ofOutstanding Shares For 2014; Net asset = 4,692,000,000p Number of outstanding shares = 234,000,000/10 = 23,400,000 shares NAVPS = 4692000000/23400000 = 200.5 pounds For 2013; Net Asset = 5,230,000,000p Number of shares outstanding = 235,000,000/10 NAVPS’ = 5,230,000,000 / 23,500,000 = 222.6 pounds Net Asset Value Per Share represents the Company’s value per share. This is normally calculated by dividing the net asset value of the company by the total outstanding shares as done above. This therefore shows the value for a single unit, or share of a fund. In the context of corporate financial statements, the publicly traded companies refer to the Net Asset Value per Share as the book value per share. This value is normally below the market price per share. However, looking at the case at the Morrison’s plc, one would realize that this is not the case. This is because the financial statements of the Morrison’s state that certain assets have recently been realized to be understated while others have been over stated. This explains the reason why the NAVPS’ or the book value per share is not below the market price per share. b) i. Cost of equity using Capital Asset Pricing Model: Cost of Equity = Risk Free Rate + Beta Coefficient x [market rate of return – risk free rate] = 3% + 0.5 x [5% -3%] = 3 + 1 = 4% Cost of equity which is also known as the cost of common stock is the minimum rate of return that a company must generate when it wants to convince investors to invest in the company’s common stock at its current market price. This is sometimes called the required rate of return (Obaidullah, 2013). For the case of Morrison’s plc, the cost of equity is 4% as calculated above. ii. Cost of Debt capital = coupon rate on bonds (1 – tax rate) When tax is ignored, cost of capital remains equal to the coupon rate of bonds; Cost of capital = coupon rate of bonds = 5% iii. Weighted Average Cost of Capital (WACC) = Weight of Equity x Cost of Equity + Weight of Debt + Cost of Debt For 2013; Market value of Equity = 235,000,000 Market value of debt = 107,000,000 / 252p x 100 = 42,460,318p Total market value for equity and debt = 235,000,000 + 42,460,318 = 277,460,318 Weight of equity = 235,000,000/277,460,318 = 0.85 = 85% Weight of debt = 42,460,318 / 277,460,318 = 0.15 = 15% Cost of Equity = 4% Weight of debt = 15% Cost of debt = 5% WACC for 213 = weight of equity x cost of equity + weight of debt x cost of debt = 85% x 4 %+ 15% x 5% = 0.0415 = 4.15% For 2014; market value of equity = 234,000,000 Market value for debt = 127,000,000/240 x 100 = 52,916,667 Total market value for equity and debt = 234,000,000 + 52,916,667 = 286,916,667 Weight of equity = 234,000,000 / 282,916,667 = 0.81 = 81% Weight of debt = 52,916,667 / 282,916,667 = 0.19 = 19% Cost of equity = 4% Cost of debt = 5% WACC = weight of equity x cost of equity + Weight of debt x cost of debt = 0.81 x 0.04 + 0.19 x 0.05 = 0.0324 + 0.0095 = 0.0419 = 4.19% A company normally has several sources of finance or capital. Some of these include debt, equity, common stock and preferred stock. The weighted average cost of capital normally is the after tax cost of all these source of finance brought together. This is done by multiplying the weight of each source by its relevant cost and summing all of them up. In the case of Morrison’s, we are only presented with two sources of finance, namely; equity finance and debt finance. For us to get the weighted average cost of capital, we multiply the relevant weight of these two sources by their respective costs and sum them up. The weighted average cost of capital represents the average risk that an organization is faced with. For instance, in the case of Morrison’s, this company’s capital is faced by a risk of about 4.19%. This value can also be used when discounting cash flows for calculation of NPV and other valuations used for company analysis. For the case of calculating NPV for a company which has more risk than the company’s average project, the value of WACC is normally upward adjusted. In the case of the less risky projects, the value is normally downwardly adjusted. c) Dividend growth model: Ke = d1 / po + g. Ke ; cost of equity = 4% D1 : expected dividends in one year = Po : share price today g : expected growth of dividends Current price per share = ? Current annual gross dividend per share = 12p Expected average growth rate of dividends = 0,2 Therefore; When g = 0 Ke = 12 x 1.0 / po + 0 4 = 12/po P = 3p And when g = 2% Ke = 12 x 1.03 / po +2 4 = 12.36 / p +2 4p = 12.36 + 2p 4p -2p = 12.36 2P = 12.36 P= 6.18 By the use of dividend growth model, several parameters can be calculated. As we can see from the calculation above, we can always vary the expected annual growth rate to come up with different theoretical prices per share. The first calculation refers to the zero growth dividend models in which we assume a perpetual dividends at zero growth. It also shows that, at zero growth, the theoretical price of the shares will have to depend on the values of the expected dividends in the year as well as on the equity capital. On the other hand, as the expected dividend growth rate increases to 2%, the theoretical price per share also shoots to 6.18 pounds. This shows that the theoretical price of a share is directly proportional to the expected dividends growth rate. d) Value per share using the price earnings (p/e) ratio: Calculating the price earnings ratio, we divide the share price by the company’s earnings per share (EPS). Therefore; P/E = Share Price/ EPS For the case of Morrison’s PLC, we will calculate the P/E when the share prices are at 240p and 208p and the EPS = 10p. P/E = share price /EPS At 2 Feb 2014; P/E = 240/10 = 24 And at 20 March 2014; P/E = 208 / 10 = 20.8 As calculated above, the P/E of the Morrison’s company is higher at 2 Feb 2014with 24 and it is reduced to 20.8 at 20 March 2014. Generally, P/E shows what the market is willing to offer for the company’s earnings. The higher the P/E, the more the market is willing to offer for the company’s earnings. The figures above therefore mean that the market is willing to offer more for the company’s earnings in Feb than in March. The value of the company’s earnings seems to be reducing when the two figures are compared. However, if the retail industry sector containing Morrison has a P/E of 15.0, this means that Morrison is still highly valued and can attract more from the market than its competitors in the same industry (Rosemary, 2012). This gives Morrison a better chance and an upper hand in the industry as a competitive strategy. If the P/E is low, it shows that the company is a sleeper which the market has ignored hence it is given a ‘’vote of no confidence’’ in the company. Comparing the P/E of the Morrison’s and that of the retail industry sector, that of the Morrison’s shows that the market has high hopes for its stocks in the future and has bid up the price. In other words, high P/E makes the market believe that the Morrison’s has good long term prospects over and above its current position. However, this point does not stand when the value of P/E at Feb is compared to that at March since this value was supposed to be increasing, but on the contrary, it is decreasing (Richard, 2013). P/E is without any doubt a number that many investors are looking at with a lot of interests. It is normally regarded as if it tells the whole story about what one really needs to know about investment but of course it doesn’t tell the whole story. This is because it is the most popular metric for stock analysis. Investors really need to consider other numbers also to be as important as the P/E when making investment decisions in various portfolios (Ken, 2013). Task 2 a) When valuating shares, selecting the method of valuation depends on the purpose for which the valuation is done. There are three common methods known for valuation of shares including: net assets method, yield or market value method, and the earning capacity method of valuation of shares. For the Morrison’s Plc. we will use the net asset valuation method for valuation of shares as detailed below: Net Asset Valuation Method To find the value per share using this method, the net value asset will be divided by the number of equity shares. Value per share = (net assets – preference share capital) / equity shares. For 2013; = 5,230,000,000 / 23,500,000 = 222.6p For 2014; = 4,692,000,000 / 23,400,000 = 200.5p Looking at these figures critically, we find that the historic share prices are higher than the current share prices. The historic share prices stand at 240p and 252p for 2013 and 2014 respectively. Therefore, it is evident that there is a great loss in the value of the shares of the Morrison’s Plc. under the net asset method. Under this method, for one to determine the net value of assets, it is important that they estimate the worth of the assets and the liabilities. Goodwill as well as the Non-trading assets should also be included in the net worth of assets. When using this method, several points must be taken into consideration; a) Goodwill must be valued properly b) Fixed assets should be taken at their realized value c) The fictious assets like preliminary expenses, discounts on the issuance of shares and debentures, accumulated losses and such like, should be eliminated. d) Provision for bad debts and depreciation must be considered e) All the unrecorded assets and liabilities in case there are, must be considered. f) Floating assets to be taken at market value, and g) External liabilities should be deducted from the value of assets to get the net value of assets. b) After valuation of the shares of this company, I would advise the customer to invest in this company even though the trend of the value of shares shows that the shares are losing their value. I would only advice the investor not to invest in the company if through share valuation was the only way to value or judge the company’s performance. However, bringing other factors to play, there are other factors that also determine whether a company would expect a good market value in the future. As we had seen previously, the P/E ratio is one such factor that really gives investor some hope that the company’s earnings are highly valued in the market and have a prospectus that they might pay more in the market in the future valuations. Therefore, by looking only at the value of shares, I would advice an investor not to invest in the company since its shares are losing value in the market. However, if P/E ratio is also considered, it seems like the future looks promising for anyone who would like to invest in the company. Nevertheless, the advice or not to invest in the company can also be supported by the fact that the P/E for the company is reducing from 2013 to 2014. This also shows a weakness in the company’s earnings even though these ratios are still higher than those of the retail industry where Morrison’s is. Task 3 During the period when the shares were being tracked, the trend so far show that the share values were not at all depict any uniformity at any particular point in time. If the time period can be taken to be in months, and starting from the scale area, we can say that the market value for the Morrison’s shares begun at a very bad note where the their values were less and kept on reducing until it went to below the average value in the market. This trend continued during the earlier months as the company tried to regain its value in the market above the average market value. The company is seen to put more effort day by day, and hence month by month to increase its share values in the, market during the mid early months until this reached maximum, around 300p around the middle months. The share values could shoot at any time and at another time it could be down again. This kept on the same way and sees the value of the shares go down again during some months just after the middle months. The company aggressively put on some strategies that would see this drop in value be prevented so that the share values can climb up the ladder again. This was very successful during the third quarter of the year when the company regained its high values of shares until a maximum. It would then take the company only a few months to make its share values drop down again to the lowest points as when it started during the early months. This phenomenon of observation shows clearly that, the share prices are not constant nor uniform. But most importantly, it shows that the share prices do not depend on any trend so as to predict the future values of the share. This is best explained using the random walk theory. The random walk theory states that, the stock price fluctuations are independent from each other, and they have the same probability distribution, but that, over a period of time, prices maintain an upward trend. As can be applied to the Morrison’s scenario, this theory can best explain the fact that the fluctuation in the share values are actually meant to be since the fluctuation does not depend on each other. If they depended on each other, may be the trend could have been different in that, when the value of a previous month increase, it would be an obvious case that the value of the following month would increase the with the same magnitude (Investopedia, 2014). It means therefore that, when making decisions using the value of shares, it would be much appropriate to make decisions that are much about the values of that particular month but not those of the preceding months. However, when the Dow Theory is considered, the earlier performance in the share values can be used to predict the current performance of shares (Michael, 2013). This can also be seen to be true as the share value at both tails of the year is seen to be low showing some uniformity. Again, there are two particular periods when the price increased to the maximum; this also explains that it is possible to predict a future performance of share values using the trends of the previous months. References Investopedia. (2014). Financial Concepts: Random Walk Theory. Investopedia University Cioncepts Journal , 1-2. Ken, L. (2013). Understanding Price to Earnings Ratio. About Evaluating Stocks , 1-2. Michael, J. (2013). Dow Theory. ChartSchol Journals , 1. Obaidullah, J. (2013). Cost of Equity. Terms Explained Journal , 1-2. Richard, L. (2013). Investing Valuation Ratios:Price/Earning Ratio. Investopedia University Ratios , 1-2. Rosemary, P. (2012). Market Price Per Share. Bizfinance , 1. 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