Strategic Financial Management - Assignment Example

Strategic financial management Part A Contents Contents 2 Answer 3 Answer 2 5 References 8 Appendices 9 Appendix Forecast value drivers 9 Appendix 2: Calculation of FCF 9 Appendix 3: Calculation of terminal value at end of competitive advantage period 9 Appendix 4: Calculation of shareholder value and EVA 10 Answer 1 The shareholder value analysis model is applied on the selected company which is Boots Plc. to understand and gauge the feasibility of the acquisition of the selected company. Also the use of the shareholder value analysis model is done so as to determine the purchase price of the company, Boots Plc. The acquisition decisions can be adeptly taken by determining the purchase value of a company through the shareholder value analysis model. Boots UK Limited is a multinational pharmacy chain based in the United Kingdom. The company merged with Alliance Unichem in the year 2006 which resulted in the creation of Alliance Boots Plc. The company was one of the first FTSE 100 companies to have been bought by any Private equity firm. Today, Alliance Boots Plc. is a famous pharmacy chain which primarily deals in retail store formats in the shopping centres and high streets of the United Kingdom. The creation of value of the shareholders is an important corporate objective for any company. The shareholder value analysis model takes into consideration the common measures like economic profits and Economic Value Added (EVA) to understand how the purchase price of the company can be decided by the potential buyers. The shareholder value analysis model is based on the management principle of value based management. As per this management principle, the management of a company are supposed to primarily consider the interests of the shareholder groups during taking the decisions regarding the activities, objectives and functions of the business. Thus, the profit levels, revenues, sales growth, and other margin levels of the company have to be selected as the primary drivers of shareholder value creation. There are certain key drivers that have to be considered for calculating the shareholder value and for the valuation process of the company (Kochan and Rubinstein, 2000). In case of finding out the purchase price of Boots Plc., the key drivers taken into consideration include the residual value calculated on the basis of the cash flows from the sixth year. The beta factor calculated from the market factors, the FTSE market return from all shares, the risk free rate of return, the capital structure of the company as calculated on the basis of the data available from the last financial year, the cost of debt and equity of the company, the fixed asset investments, the forecasted sales, sales growth rates, tax rates, operating margin percentage, the working capital requirements and the cash tax rates as applicable for the selected company. The growth levels of each of the selected drivers of company value are considered in the process of the determining the purchase price of Boots Plc. The valuation of the company is done by considering a six year planning period. The FTSE market return is found out to be 10%, the risk free rate of return from the investment is identified to be 4% and the cost of debt for Boots Plc. is taken as 6%. Similarly, the corporate tax rate of the company is calculated on the basis of the taxes paid by the company in the six years of its operations. The shareholder value analysis model works in different phases of calculation. These include the selection of the competitive advantage period, the base year and forecasted year of planning, the forecasting of the value drivers, the calculation of FCF, the determination of the terminal or residual value at the end of the specified period and the final calculation of shareholder value and Economic Value Added (EVA) for the company (Sundaram and Inkpen, 2004). The EVA of the company is calculated by the following formula EVA= PAT - WACC * opening invested capital. The working of the shareholder value analysis model for Boots Plc. is given in Appendices 1-8. The calculation of the shareholder value for the company starts by assessing the forecasted value drivers for the company which is given in Appendix 1. This is followed by the calculation of the Free Cash Flows (FCF) for Boots Plc. in the selected period. These calculations are given in Appendix 2. A six year period is taken for the analysis from 2009-2014 out of which the year 2009 is selected as the actual base year for the development of the model, the years 2010-2013 are selected as the competitive advantage period and the year 2014 is selected as the future planning year because the value drivers and shareholder value are computed from the year 2014 onwards. All the values taken for the computation of the value drivers are in GBP millions as given in the financial statements of Boots Plc. The shareholder value of the company Boots Plc. is calculated by using the formula Shareholder value = Competitive advantage period value – Terminal value –Market value of debt held by the company. The competitive value of Boots Plc. as calculated through the use of the Weighted Average Cost of Capital (WACC) and the Free Cash Flows (FCF) in the company for the selected period of analysis. The competitive value of the company is determined to be GBP 27948.95 million. The terminal value or residual value of the enterprise subtracted from the competitive advantage period value gives the enterprise value of the company. By using this formula, the eEnterprise value for the company is found out to be GBP 9156.95 million. The shareholder value for the company is calculated as GBP 3925.95 million. The Economic Value Added (EVA) for the same is found out to be GBP 13216.56 million. The calculations of these values are given in Appendix 3 and Appendix 4. Answer 2 As per the shareholder value analysis model, the purchase price of a company during any merger or acquisition is decided on the basis of the value created and delivered by the business to the existing shareholder groups. Because the shareholder value created in a company is difficult to calculate on the basis of any single component, therefore, the calculation of shareholder value is done by breaking down the components of the value creation into several categories which are known as value drivers (Weston and Weaver, 2007). There are seven common value drivers selected for the purchase price calculation of the selected company, Boots Plc. These value drivers are the main causes of creation of shareholder wealth in the company and as such are necessary for consideration in the shareholder value analysis model. These drivers are revenue, investments in working capital, cash tax rate, operating margin percentage, sales growth percentage, incremental capital expenditure, Weighted Average Cost of Capital (WACC) and competitive advantage period (Rowley and Moldoveanu, 2003). The main value drivers that are referred to in the process of the analysis of shareholder value, Economic Value Added (EVA) and thereby determining the purchase price of Boots Plc. are sales growth percentage, operating profit margin, sales as compared to the net book value of fixed assets, cash tax rate percentage, the working capital investments as compared to the sales volumes and the depreciation as a percentage of the net book value of fixed assets (Appendix 1). The growth level for the selected value drivers are assumed on the basis of the trends of the base year and the competitive advantage period selected for the company. The Weighted Average Cost of Capital (WACC) is determined because it referents the level of risk associated with investing in the company. The Free Cash Flow (FCF) is calculated on the basis of the discounted factor so that an appropriate measurement of the same can be found. This helps to calculate the terminal or residual value of the company at the end of the planning period of six years. Technically, for determining the value of a company in an accurate manner, the future cash flows for the whole planning period should be calculated by dividing the planning period into the actual base year, the competitive advantage period and the future year (Hill, 2008). The selection of drivers and the appropriate assumptions reading the growth of the drivers is critical in the SVA model. As such, the determination of the growth patterns of the key value drivers should ideally be done by studying the last few years of operational and financial values of the company so that a proper trend and patterns of the changes in the value driver components can be identified and implemented over the planning horizon. The selection of the key value drivers like the cash tax rate, operating profit margin, working capital investment, revenue growth and sales as compared to fixed assets are critical components for deriving the ultimate shareholder value or purchase price of the company. Therefore, a sensitivity analysis for each of the value driver components is performed to understand how these drivers are likely to change as per the market responses as well. Both the internal trend patterns and the external affecting factors from the market are to be taken into account while deciding the growth of the drivers which is adequately done for the SVA model implementation in the case company. References Hill, R. A. 2008. Strategic Financial Management. Copenhagen: Bookboon. Kochan, T. A. & Rubinstein, S. A. 2000. Toward a Stakeholder Theory of the Firm: The Saturn Partnership. Organization Science, Vol. 11(4), pp. 367–386. Rowley, T. & Moldoveanu, M. 2003. When Will Stakeholder Groups Act? An Interest- and Identity-Based Model of Stakeholder Group Mobilization. Academy of Management Review, Vol. 28(2), pp. 204-219. Sundaram, A. K. & Inkpen, A. C. 2004. Stakeholder Theory and “The Corporate Objective Revisited”: A Reply. Organization Science, Vol. 15 (3), pp. 370–371 Weston, A. & Weaver, S. 2007. Strategic Financial Management: Application of Corporate Finance. Stamford: Cengage Learning. Appendices Appendix 1: Forecast value drivers   Actual Competitive advantage period     2009 2010 2011 2012 2013 Forecast value drivers           Sales growth   13.23% -13.16% -9.98% 49.10% Operating profit margin % 0.78% 1.82% 0.93% 1.33% 0.47% Sales/NBV of fixed assets 38.73% 44.54% 39.19% 33.20% 45.74% Working capital investment/sales % 0.00% 0.03% 0.04% 0.04% 0.04% Cash tax rate % 50% 29% 33% 17% 28% Depreciation/NBV of fixed assets % 16.36% 14.67% 17.57% 20.78% 14.66% Appendix 2: Calculation of FCF Calculation of FCF Actual Competitive advantage period Future Sales 116,524 131,944 114,583 103,147 153,794 153,794 Operating profit 907 2,396 1,065 1,367 719 719 Depreciation 3,327 3,024 2,994 2,996 3,086 3,086 Earnings before interest, tax, depreciation and amortization (EBITDA) 16,058 22,280 24,705 15,825 24,279 24,279 Tax -5,926 5,395 5,323 2,326 5,143 5,143 Expenditure on fixed assets 427.8 358.78 372.8 377.29 366.82 344.00 Increase in working capital   42,226 5,216 1,022 10,584 0 Free cash flow 21,556.20 -25,699.78 13,793.20 12,099.71 8,185.18 18,792.00 Appendix 3: Calculation of terminal value at end of competitive advantage period   Actual Competitive advantage period     2009 2010 2011 2012 2013 Free Cash Flow -21,556.20 67,925.78 -8,577.20 -11,077.71 2,398.82 Discounted factor (4%) -862.248 2717.031 -343.088 -443.1084 95.9528 Discounted cash flow -20,693.95 65,208.75 -8,234.11 -10,634.60 2,302.87 Appendix 4: Calculation of shareholder value and EVA Calculation of shareholder value   Competitive advantage period value 27,948.95 Terminal value 18,792.00 Enterprise value 9,156.95 Market value of debt 5,231.00 Shareholder value 3,925.95     EVA= NOPAT - WACC * opening invested capital 13,216.56 Read More