Ratio Financial Analysis and Evaluation - Woolworth Limited - Assignment Example

RATIO FINANCIAL ANALYSIS AND EVALUATION: WOOLWORTH LIMITED Students Name Name of College Date of Submission Ratio Financial Analysis and Evaluation: Woolworth Limited Company Background: Woolworths is a company that is based in Australia. The company mainly deals with liquor and food products used for resale in New Zealand and Australia supermarkets. The sales of the company have been increasing over the years. The increase in sales may be as a result of diversification of the company’s operations. The company does not base its operations in only one country and that increases the sales volume of the company. The sales volume of the company can also be associated with dynamic advertising Introduction: When potential investors embark on making relevant decisions pertaining to the form of a company’s portfolio in which to invest, it is safe that they seek services of a consultant or embark in conducting ratio analysis for the firm under consideration. There are usually different types of ratios which can be used to conduct this process. It should be noted that the main focus of conducting the operation is on identifying the worthiness of the firm as well as its ability to create wealth. The fundamental objective of any given firm lies with maximizing the amount of its profits as well as minimizing the possible losses. Nowadays, investors enjoy the variety of information which they use to make sound and safe investment options. The financial position of a firm is determined through a range of valid ratios which means that the process requires a substantial level of expertise. This means that there are certain possibilities for a company to depict irrelevant and negative ratios but in turn possess the credibility needed for worthwhile investment decisions. In this case, it is thus, wise for analysts to perform a substantial form of evaluation since computation of a few ratios might lead to insignificant decision pertaining the investment at hand. In that case, the research paper focuses on conducting the following operations: I) Valuation using Free Cash Flow of Woolworths: The use of conducting this operation is to determine the manner in which a firm conducts its operations in respect to its capacity to grow and translate sales volume to formidable profits which it can use to pay its shareholders. As noted earlier within the paper, potential shareholders investment in those companies whose portfolio is proven worthwhile in either short-term or long periods depending with the specific need of the investor at hand. The formula for conducting this valuation technique is determined by the formula: FCR= Earnings before Interest and Tax* EBIT, (1- Tax Rate) + Depreciation & Amortization- Changes in Working Capital – Capital Expenditure In our case, the figures seem to reduce though in an insignificant manner. This is depicted by the reduction from $ 1545.963 in the financial year period ending 2010 to $1329.229 in 2011. The fact that there is a reduction in the amount of cash flow activities of the firm does not necessary mean that Woolworth is performing worse since there are profitable companies which operate under a negative cash flow activity. II) Valuation of the Constant Growth Rate Model: This valuation is used to establish the perseverance of an entity in respect to the unfavorable working or rather operating conditions necessary for maximization of wealth. In that case, this valuation is used to determine the level of stability of the firm in the market upon which it is operating since market environments keep on changing in respect to the changes in technology, taxation or rather mode of conducting activities (Chandler and Hanks 1994, p 78-90). The valuation tests the validity and roots of the firm in the market niche at hand. Generally, it distinguishes the going-concern aspect of a company, that is, if it is placed at a fair position upon which it can continue its operations without being affected by the ever-changing business environment. Thus, the formula for evaluating the model is computed with the formula, Vo =Do (1+g)/k-g Whereby, Vo represents the present value of all future dividends, Do= most recent dividend paid, g=constant perpetual growth rate for dividends and k= risk adjusted required return on cash flows After calculation of the Companies constant growth rate, it is deduced that there is a significant percentage increase as the year progresses. In the financial year period ending 2010 the rate is placed at 17.72% which increases to 18.2 %. This is 0.48 % increase meaning that Woolworth is placed at a fair position upon which it can continue performing its operations without the fear for financial breakdown. III) Differential Growth Rate: In the effort to compute this figure, analysts utilize the shift method since it has always been impossible to formulate a computation strategy which allows mixing of percentages and nominal values. The formula used for calculating the shift method is availed as: Vo=Do (1+g1) t/ (1+k) t + Dt (1+g2)/ (k-g2) (1+k) T The differential growth rate calculated depicts an increment from 11.3 % in the financial period ending 2010 to 20.6% for the financial period ending 2011. This 9.3 % increase is a significant change that depicts the positive growth of the firm at hand. Valuation Using Relative Valuation Techniques: Price/Earnings Ratio, This is considered to be far-the-most form of ratio which is attributed to the immediate performance of the firm at hand. The ratio is utilized in formulating the form of relationship which exists between the prices of a company’s stock in respect to its earnings (Siegel 2007). The price/earnings ratio is used to determine the price of shares that the current market is willing and able to pay for the company’s stock. This means that whenever the price per earnings jumpstarts to a higher level then, it basically would mean that potential market investors are willing and able to pay a subsequent amount of the price stated (Anderson and Brooks 2005). A higher price per earnings ratio is also used to postulate the fact that the potential market is filled with great anticipations about possible raise of the stock price. On a subsequent note, the lower the value of price per earnings ratio is a possible indication that the market is in no way interested with purchasing the stock prices. On that note, there is no definite way of telling whether the price per earnings ratio is fit or not fit for investment and the investment decisions rely entirely on the individual decision of the potential investor. This depends on the goals of the potential whether in long term or short term basis. The price per earnings ratio is computed by the formula, Po/Eo= (1-b)* Eo*(1+b*ROE)/k-(b*ROE) The price/ earnings ratio is perceived to increase significant from a ratio of 0.0000569:1 in the financial period ending 2010 to a 0.00015:1 for the financial period ending 2011. The 0.00005 increment is significant enough to deduce the interest of the market to purchasing the stock in a fair price. Price-Book Value Ratio: The price per book value refers to the form of ratio which is used to establish the relationship between a company’s market share prices in respect to the book value of equity in that matter. Book value is the amount of resources usually a company’s assets which is normally presented in the firm’s balance sheet. In simple terms, it is deduced by finding the difference between the book value of assets and the book value of liabilities. The price per book value ratio is used to determine how lowly the company’s share price is placed at the share market. Whenever it is deduced that a company posts a P/B value of less than one there are possible scenarios to believe in two situations. For one, it might be that the asset base value of the company at hand is overstated- as par the point of view of investors or that the company is posting low earnings in respect to the rate of returns of the assets. This ratio is best suited to investors who seek growth and development of a particular firm. In the effort to make relevant decision, the potential investor is required to undertake a closer analysis into this ration in respect to R.O.E. In our case, the ratio increases from a ration of 1.14:1 in 2010 to 1.973:1 in 2011. This significant increase of 0.833 is a reflection that the company is placed at a better position upon which it can attract share investment. Other Relevant Ratios: Debt Equity ratio: this ration a gearing ratio which is usually computed by dividing the total debt by the total owner’s equity. This ratio is used to establish the definite amount of shareholder’s equity which is used to repay borrowed funds. In the case that the ratio is low indicates that the firm is utilizing most of its share capital to repay loan. It also means that the firm is making losses since revenues should be used to repay the amount borrowed plus the interest on the amount at hand. The reverse is also so that when the ratio is high, it depicts the positive performance of the firm to pay for loan debt. In this case, the shareholders equity is secured and a guarantee for future operations is showcased in that matter (McNair 1993). In our case, the debt to equity increase from a value of 46.79:1 in 2010 to 63.81:1 in 2011. The significant increase depicts a difference of 17.02 is a fair reflection of the company’s ability to repay its loans altogether. Inventory Days Held: this is ration which reflects the period of time through which a company’s inventory stays before it is sold. Whenever the period is depicted to be on the higher end, it basically means that the firm is translating inventories into profits at a much slower rate. This is not fair for positive performance since efficiently operating companies has a low period for its turnovers. The vice versa is also true, so that a small period of time for which inventory is held depicts a high turnover rate which translates to quick profits for the firm hence substantial volumes of revenue (Slater and Zwirlein 1996,p 245-264). In our case, the period slightly increases from 32 days in 2010 to 33 days in 2011. The difference of 1 day is somehow insignificant to effect negative performance of the firm. Estimating the required Return and WACC on each Component of Capital WACC, Weighted Average Cost of Capital, is a fair representation of a company’s investment portfolio. It is required that a company’s portfolio be assorted in different potential investment channel in order to minimize the amount of risks attributed to investing in share market. Companies, just like individual investors, are encouraged to differentiate their respective asset base in order to reduce failure to register profits. This diversification entails investment involve the putting of funds into similar and dissimilar projects. In this manner, diversified company’s portfolios are guaranteed of constant return revenue. Also, through this diversification criterion, companies are assured of the continuity of its operations (Business & Society 2001, p.327-367). Woolworth Company has diversified its operations both directly and indirectly. Directly in the sense that it has invested in both trading of food, liquor and petrol to different consumers present within the different market zones of Australia, Hong Kong, India and New Zealand. The Weighted Average Cost of Capital for the company is calculated at a figure of 0.029. This value is assumed to be similar to the subsequent number of capital portfolio’ deployed in that matter. It is safe to indicate that the value is a significant indication that the company can engage in the borrowing of financial resources for both long and short term goals and in turn be able to repay the loan effectively (Birnberge, Turopolec and Young 1983,p 123-132). In the e effort to provide an overview of the eligibility of the firm for any form of investments, it is evidently clear that the firm: Woolworth Ltd is placed at a fair position upon which to attract substantial investments. The financial performance of the firm is positive. Therefore, it is a better idea to invest with the firm since it’s at highest productivity rate and chances of its investment portfolio to attract dividends are regarded highly. References Anderson, K and Brooks, C. 2005. The Long-term price-earnings ratio, University of Reading Journal .Print Business & Society, 2001. Corporate social performance and firm risk: a meta-analytic review, vol.40, Issue 4, pp- 325-388 Birnberge, J, G, Turopolec, L and Young, S.M, 1983, the organizational context of accounting, Organizations and society, vol. 8, Issue 2, p 111-129 Chandler, G, N and Hanks, S, H, 1994. Founder competence, the environment, and venture Performance, vol. 18, Issue 3 p.77 McNair, J, 1993. World-class accounting and finance. 13th Ed. City West Main Collection Slater, S and Zwirlein, T, J, 1996. The structure of financial strategy: patterns of financial Decision making, managerial and decision economics, vol.17, Issue 3, pp 253-266 Siegel, J, J, 2007. Stocks for the long run, 4th Ed. New York: McGraw-Hill Read More