The Business Performance and Financial Situation of Sky City Entertainment Group - Coursework Example

1. Introduction The report provides a comprehensive assessment of the company using the forecasting tool that is considered important for better appraisal of the company. the assessment of the stock valuation of sky city entertainment limited is important since, it provide an evident platform for appraising the business performance for an historic trend as well as providing an opportunity to anticipated them future business situation and coming with a conclusion of whether to invest in the company or not. An investment that deem invest in stock for sky city limited is risky but would consider as well as investing in the company should therefore ensure that investment risk is minimized. This possibly by holding asset diversities. Diversification is holding a portfolio of asset in different sectors in order to minimize investment risk. An investment will diversity his investment security in different sectors in order to ensure that returns and risk of different security as not consistent hence saving the investor from investment downfall consequential from holding single return investment. The impact of diversification portfolios that there is a reduction in volatility of the returns and at the same time the reruns of the portfolio returns. IN this regards, it can be observed that the holding a portfolio investment returns is ideal since, there is less security risk as depicted by the value of variance and with maximum retains of investment (Stimes, 2011,p 86).There are two justification why we choose the portfolio as an ultimate investment strategy. Firstly, as the expected return of market is high with low cost of capital as depicted in the table for portfolio return and risk. The expected return of market after using CAPM formula (Regression Approach). The is small fluctuation of in holding portfolio of the expected return of different portfolios About the company Sky City Entertainment Group is a New Zealand as well as Australian registered company in the stock exchange with a principal gaming and entertainment business activity. The company was registered in the year 1996 and at present as employees totaling 6100 transversely in New Zealand and Australia. The center trade of Sky City Group is amusement and the casinos. In addition, the trade of Sky City Group entailed in three sumptuousness hotels, over 50 eating-place, bars, and conference centers. 2. Prospective analysis and valuation In understating the business performance and financial situation of the company, the relevant financial, analysis such as the free cash flow model analysis is conducted. The company’s prospective analysis has been evaluated and the conclusion reached based on the company’s financial report. Some of the valuation technique adopted in the report is the use of free cash flow method, the residual income approach, as well as ascertaining the asset discounted dividend model. These are a key fundamental tool in valuing and understanding the company business situation. The prospective analysis for sky city entertainment is made on the basis of ten years trend using the above valuation model in order to appraise on the relevance of the business operation as well as aid in making an investment decision. Sales growth and cost of debt It is assumed that the sales growth rate will grow by 8.5% and cost of debt will improve by 10% from 2015-2016 as observed below. While the dividend payout will be maintained at 12%. For SG&A we forecasted it to be 8.5% of sales because historically SG&A has been approximately 8.5% from 2012-2015. One short-term catalyst mentioned in the case that could affect SG&A is the minimum wage increase being. If minimum wages were to increase then the company would see an increase in their SG&An expense. Predicting what government will do is like flipping a coin, so we decided to hold SG&A at its historical percentage of sales. For taxes we used the previous year’s tax rate of 39%. We have no real understanding of the current political environment of Harriman so we can only assume that taxes will remain constant. Gross profit Margin For gross margin we forecasted gross margin to increase from 52% to 52.5%. This slight increase is due to company increasingly shifting the product mix to adjust for the increase in demand for more manufactured goods. In the case the company is planning on shifting the product mix to these higher margin plants. Asset turnover The asset turnover of the company is anticipated to grow by 10.27% for the next ten years due to growth in sales level. Asset Turnover (ATO) 2016 2017 2018 2019 2020 2021 2022 2023 2024 2025 Net Operating Assets (NOA) / Sales 174.9 169.0 172.5 177.5 195.7 215.8 237.07 243.4 249.9 256.6 The following model was used to perform the above forecast in evaluating the company using the stock and value of the firm. The result of the forecast is observed in the appendices below. 1. Residual Operating Income Model The residual income method provides both positive as well as negative when compared to frequently employed dividend discount approach. The model make use of data from the financial report of the company and thus residual income look at the economic viability of the business instead of just accounting profitability. 2. Discounted Dividend Model This the procedure of valuing the worth of stock by employing the anticipated dividend as well as discounting them in the present year or year zeros. The notion is that of the worth obtained from the dividend discounting model is higher as compared to what the share are presently trading at then the stock is undervalued. The share of the company is undervalued as per the trend in the present value of stock for sky city as observed ion the data below. This is a signal that the stock price for the company is not ideal on that the security is undervalued and thus they will drop after the purchase. The result of the discounted dividend model provides that the company depict a value of dividend which isles unlike the market trends. This therefore implies that the company stock is und revalued and thus implying that the securities are going to decline in value is bought now. This is risky to the investors which further imply that the company is not a viable investment opportunity. 3. Discounted free cash flow model Discounted cash flow valuations are one pricing approach that potential investors with expertise skills use to appraise the worth of stocks. Proponents of this appraisal technique argue that you can get a precise image of a firm's accurate worth only if you approximate its present and future cash flow (Damodaran, 2007). Other proponents argue that this valuation technique has numerous drawbacks that include the fact that the approximation are based on protrusion and forecast rather than concrete data. FCF= (operating cash flow-capital expenditure} FCF= (230,773- 166,623=$64150 Negative free cash flow in itself is not terrible since it implies that the business has a huge capital investment that will a high returns in the near future. The company is having a high value of free cash flow worth $64,150.This implies that the business has sufficient finance and thus the reserves will be used to finance future investment projects if an informed investment decision is made in order to save the company from experiencing a declining trend in reported net profit. The comprehensive free cash flow for the ten years is depicted in the data analysis below. The stock of the company therefore as observed using the free cash flow model provides a negative cash flow that implies that the capital of the company is less and it might be due to huge capital expenditure that renders the capital negative or the company is facing liquidity risk. for our case, sky city do have any huge capital expenditure that renders the company capital negative and thus it is an indication that the company capital structure is at risk due to lack of sufficient funds. This implies therefore that the company stock price will decline and consequently as an investor one will incur loss on investment consequential from stock undervaluation by firm to raise more funds to finance it s business operation. 4. Residual Income model (Abnormal Earnings Valuation Model) The residual income model tries to change a firm's prospect earnings approximation, to recompense for the equity cost and place an extra precise worth to a firm. Even though the return to equity holders of sky city entertainment is not an official prerequisite for the return to shareholderss, in order to draw investors firms ought to recompense them for the investment threat exposure. In scheming, a firm's residual income the major calculation is to conclude its equity charge (Gabehart, 2002). Equity charge is merely a firm's total equity capital grow by the required rate of return of that equity, The model can be ascertained as well using the capital asset pricing model {CAPM model}. The formula below depicts the equity charge equation employed for the current year. The comprehensive appraisal of the company using the ten year analysis using the residual i9ncpme model in the appendices. Equity charge= {Equity capital*cost of capital} Equity charge= {773,885*10%} =77,388.5 Residual income= (equity charge-Net income) Residual income= {77,388.5- 84,915) =-7526.5 It can be concluded therefore that, the residual income valuation method is a practical and progressively more accepted technique of valuation and can be put into practice with no trouble by even apprentice investors. Residual income valuation can give a comprehensible approximation of what the true intrinsic value of a firm may be. The Assumption made in coming with the model for valuing sky city entertainment is that it is anticipated the revenue will grow each year at the rate of 5-10% with net profit growing at the rate of 5-9% each year. Net working capital, fixed asset turnover as well as the net operating asset to equity ratio will be comparable to the financial year 2013. Employing the cost of equity for sky city is {5%+1.26*7.5%=14.45% hence the value of equity is -0.3 which depict a decline in the value of equity per share. and consequently, investment in this company is risky since, return on capital employed is not sufficiently guaranteed. An investor ought to appraise the future performance of the company in order to anticipate the extent to which he can invest in the company since, the analysis is made on the ten year historic trend and the model anticipate future performance of the company which is unknown. Application Among the Quantitative strength, is the company’s steady growth in revenue high net profit consequential of high operating profit. The company depicts an 8.5% growth rate which is a strong and steady growth to the company performance, this is one of the strongest characteristics in the firm as well as the growth rate is strongly connected to company’s strength. It is assumed that the sales will grow at 8.5% for the next 10 years. This assumption is estimated based on economical factor that is favorable to growth of the business. The company anticipates that the inflation rate will remain stable and favorable from 2015-2025 and consequently, it is a good platform for the company to capitalize on its sales level. Good customer relation combined with the company’s product that meets customer’s expectation in terms of unique product branding, quality product and stable pricing are some of the factors that currently make customers to buy more of the company’s product. This is a good platform for making an analysis on the future growth rate in the level of the sales. based on the forecasted cash flows, it can be concluded that the company is going to realize return by way of profit from investment due to the fact that the company working capital is sufficient enough to finance the daily operation of the business is absorbed form the cash from operating activities. The value of the company is high and consequently the liquidity position of the business will not put the company’s operations at threat since, the earning per share depicts an increasing trend. In this regard, the company is going to realize profit form Capital investment and consequently the going concern assumption will be relied upon in making investment decision on whether to invest on the business or not. Factors to take into consideration that might affect the forecast of the company valuation The rise of inflation renders the economy stunted and makes companies to close some of its production operation or reduce the numbers of goods to be sold. In this regard, the budgeted estimates will not be realized and thus there will be emergence of variances. Check on the general economic condition as well as perform cross sectional and trend analysis of the company in current economic conditions. Adverse competition will make the business not to realize its desired end result since, their competition will make their product more affordable and pleasing to the customers hence reducing the level of sales since, the company will not reduce beyond the break-even point. In this regards, there will be emergence of variance either favorable or adverse from the actual figures and the budgeted one, consider the performance of the competitor and ascertain the efficiency of their marketing strategy. The government might pass a law that will affect the general performance of the company and hence making the company not to realize its objectives as well as budget attainment. Possible opportunity for improvement The budget committee should formulate the budget by coming up with realistic budget estimates. This is achieved by considering the goals of the company as well as ascertaining gm the general economic condition that will affect the achievability of budget estimates And concluding on factors to be understating incase of adverse economic situation that might affect the achievability of the budget. 4. Conclusion Potential investors therefore should consider investing in Sky city Company since the business situation is favorable in terms of capital base and funds available for investment. In ascertaining the financial situation of the company using the free cash flow method, per share of 0.65 is envisaged in the analysis (Henschke, 2009). This implies therefore that for every one share of potential investors, there is discounted free cash flow of $0.65.this is a good indication that the business does not have any financial difficulties despite the fact that the business is spending heavily on research and development of their product. This is a positve corealtion that the business is a going concern and will thus continue into unforeseeable future due to strong financial position depicted by growth in asset as well increase in net cash flow as well as the growth in profit margin. An investor should therefore consider investing in shares in the company since they will be assured of positive returns in the near future from their investment. The future business operation is certain for sky city and this positive free cash flow implies that the future business performance will be affected by the adequacy of the capital to funds its business operation. The value of the stock at the moment is undervalued and it implies that the flock of purchase will make eventually makes the sock price to be overvalued hence turning to be priceless. This implies a loss to an investor. As a result, sky city business performance is steady and posse some investment opportunity of the future business performance. In making an intent to invest in this company, a comprehensive risk analysis of the future business performance is important in order to remove doubt that is portrayed by the past year trend of the company performance as well as the in adequacy of the free cash flows. The company is having a strong financial position as depicted by its size of asset and market capitalization. In this regard, the business is viable for investment since it depicts an increase in asset capital as well the revenue. The company is a having a massive venture on capital so as to realize improved returns in the future. This is observed by free cash flow model assessment of the company data in which the assessment portray that the value of net income is declining every for sky city limited. this as a result implies that the company returns will rarely cater for investors wealth maximization as well as investors safety will be at risk since, the business performance do not guarantee retains on investment as per the above trend analysis. As a result, a comprehensive assessment of the business performance must be appraised prior to making intention of in vesting in sky city entertainment limited, the difficulty arises when the company report negative assessment outcome such as the frequent decline in reported net profit as well as it portray the intricacy the company is facing by way of financial constraint and considering the necessities for of stakeholders returns by way of dividend so as to capitalize on their wealth in sky city limited. Cash flow control is one of the basic decision that manager should take into consideration because an effective cash flow management means that the company is portraying an effective working capital which is a good indication for the going concern assumption for the company. Ideal cash flow control is key to making sure that there is positive cash flow at end of the financial period. Data Analysis and Assessment 1. Discounted dividend model Input for the 10 years projection Inputs from current financials   Net Income = $127000 Book Value of Equity = $1.35 Current Earnings per share = $0.12 Current Dividends per share = $3.58     Inputs for Discount Rate   Beta of the stock = 0.95 Risk free rate= 2.00% Risk Premium= 5.49%     Inputs for High Growth Period   Length of high growth period 10 years Output of the result for 10 years Cost of Equity = 6.04% Net Income = $99000 Earnings per Share = $0.12 Growth rate in EPS = 16.21% Payout Ratio for high growth phase 116.9% The dividends for the high growth from 2015-2025)   2016 2017 2018 2019 2020 2021 2022 2023 2024 2025 Expected Growth Rate 16.31% 17.31% 17.31% 17.31% 17.31% 14.25% 11.18% 8.12% 5.06% 2.00% Earnings per share $5.12 $4.83 $5.67 $6.65 $7.80 $8.91 $9.91 $10.71 $11.25 $11.48 Payout ratio 41.31% 41.31% 41.31% 41.31% 41.31% 48.51% 52.72% 62.92% 73.13% 93.33% Dividends per share $2.74 $3.04 $3.40 $3.81 $4.30 $5.68 $7.21 $8.81 $10.35 $10.71 Cost of Equity 8.23% 8.23% 8.23% 8.23% 8.23% 9.06% 7.90% 7.73% 7.57% 6.40% Cumulative Cost of Equity 109.23% 116.97% 126.28% 135.19% 151.74% 161.74% 172.21% 183.12% 184.49% 196.29% Present Value $2.62 $2.78 $2.94 $3.13 $3.33 $4.08 $4.83 $5.51 $5.07 $5.46 2. Residual income Model Cost of capital   10.00%               Initial book value 12/31/2002 $4,299,750 Dividend payout   12%               Forecasted ROE on beginning equity 14.00%                       Forecasted results (rounded to nearest $)   2016 2017 2018 2019 2020 2021 2022 2023 2024 2025   Forecasted earnings $825,000 $850,000 $875,000 $900,000 $925,000 $950,000 $975,000 $1,000,000 $1,025,000 $1,050,000   Beginning book value 4299750 $5,025,750 $5,773,750 $6,543,750 $7,335,750 $8,149,750 $8,985,750 $9,843,750 $10,723,750 $11,625,750 + Forecasted earnings 825,000 850,000 875,000 900,000 925,000 950,000 975,000 1,000,000 1,025,000 1,050,000 - Forecasted dividends -99,000 -102,000 -105,000 -108,000 -111,000 -114,000 -117,000 -120,000 -123,000 -126,000 Ending book value $5,025,750 $5,773,750 $6,543,750 $7,335,750 $8,149,750 $8,985,750 $9,843,750 $10,723,750 $11,625,750 $12,549,750                       Forecasted earnings (from above) $825,000 $850,000 $875,000 $900,000 $925,000 $950,000 $975,000 $1,000,000 $1,025,000 $1,050,000 - Normal earnings -429,975 -502,575 -577,375 -654,375 -733,575 -814,975 -898,575 -984,375 -1,072,375 -1,162,575 Abnormal earnings $395,025 $347,425 $297,625 $245,625 $191,425 $135,025 $76,425 $15,625 ($47,375) ($112,575) x Discount factor 0.683 0.6209 0.5645 0.5132 0.4665 0.4241 0.3855 0.3505 0.3186 0.2897 Present value of abnormal earnings $269,807 $215,724 $168,002 $126,044 $89,301 $57,264 $29,465 $5,476 ($15,095) ($32,609)                         Initial book value $4,299,750                   PV of abnormal earnings over 10 years 913,379 Estimated value of equity $5,213,129                   Number of shares (millions) 307 Predicted share price $16,980.88                     Actual high $64.00                   Actual low $56.00 3. Residual Operating Income Model（RoIM） ReOI = NOPATt – (Cost of Equity Capital * Net Operating Assetst-1) 2016 2017 2018 2019 2020 2021 2022 2023 2024 2015 Cost of equity 0.0604 0.08 0.11 0.15604 0.16 0.18 0.2 0.21 0.22 0.25 Net operating Asset 1831000 1950000 2050,000 2150500 2255000 235000 2450000 2650000 270500 285000 NOPAT 99780.8 101646.4 103646.4 110592.4 120564 123450 124500 126500 128000 130500 REOI 11592.4 27219.2 35353.6 21346.8 28500 30000 35500 38500 40000 45500 4. Discounted free cash flow Model       Initial Cash Flow: $820,000         Years: 1-5 6-10 Growth Rate: 6.8% 10%       Terminal Growth Rate: 1%         Shares Outstanding: 738,000   Debt Level: $528,000             Year Flows Growth Value 2015 820,000 7% $713,043 2016 860,000 7% $650,284 2017 852,000 7% $560,204 2018 803,000 7% $459,118 2019 800,500 7% $397,990 2020 789,500 10% $341,323 2021 743,500 10% $279,509 2022 750,000 10% $245,176 2023 712,500 10% $202,537 2024 745,800 10% $184,350 2025 756540 12.5 208540                 Terminal Year $753,258             PV of Year 1-10 Cash Flows:     $4,033,534         Terminal Value:     $1,329,956         Total PV of Cash Flows:     $5,363,490         Number of Shares:     738,000         Intrinsic Value (IV):     $6.55         Margin of Safety IV:     $4.59         What Percentage of IV comes from the Terminal Value     25% References Damodaran, A., 2007. Valuation Approaches and Metrics: A Survey of the Theory. Gabehart, S., 2002. The Business Valuation. Gedde, R., 2002. Valuation and Investment Appraisal - Page 75. Henschke, S., 2009. Towards a more accurate equity valuation: An empirical. Parkinson, A., 2012. Managerial Finance - Page 175. Pereiro, L.E., 2012. Valuation of Companies in Emerging Markets: A Practical. Stowe, J.D., 2007. Equity Asset Valuation - Page 60. Read More