Business Analysis and Valuation - Essay Example

Financial Analysis Report Author Tutor’s Name Course Grade Institution 23rd December 2011 Introduction The company recorded gross revenue of AED 630, 225, 000 at the end of 2006. In the year 2007, the company recorded AED 2, 320, 961, 000 as compared to AED 3, 723, 428, 000 in year 2008. However, in the proceeding years of 2009 and 2010, the company recoded a decrease. In year 2009, it obtained revenue of AED 3,102, 708, 000 which further reduced to AED 1, 205, 176,000 in year 2010. The company has been recording fluctuating revenues throughout the 5 years period. This could be caused by increased current liabilities. In December 2006, the company had a liability of only AED 592, 020, 000 which increased rapidly to AED 1, 966, 849, 000 by the end of 2007. The company recorded a further increase in the current liability which hit up to AED 7, 914, 883, 000 and later reduced to AED 5, 547, 272, 000. In addition, the long term liabilities have increased at speedy rate throughout the five years period. In year 2006, the company had a liability of only AED 53, 165, 000 as compared to an increased liability of AED 326, 034,000 in 2007. The liability further increased to AED 2, 117, 435, 000 in year 2008, later decreased to AED 1, 119,964, 000 in year 2009. However, the liability further increased to AED 1,649,940,000 in year 2010. On the other side of assets, the company recorded a total of AED 1, 158, 720, 000 in year 2006 as compared to a total of AED 1, 474, 690, 000 in year 2007. This is a substantial growth for a period of one year. In the subsequent year, the company recorded a growth of the fixed assets adding up to AED 2, 190, 556, 000 in year 2008 which later reduced to AED 1, 679, 941, 000 in year 2009. However, this reduction did not persist as in year 2010; the company’s fixed assets had grown substantially to AED 2, 160, 065, 000. The rapid growth in liabilities has caused reduction in revenue for the last 5 years. Due to prolonged instalments of the debt payment, the company is left with little to invest the real estates for the subsequent years, causing a reduction in revenue. This has also prevented the company from expanding further. Finding beta Beta is the measure of stock risk comparative to overall risk of stock market (Elaine et al, 2009 and Krishna, 2007). It is also known as financial elasticity. It is calculated using the movements of prices of the stocks. The calculated results are used do a comparison with the overall market indicator (David, 1998 and Charles et al, 2008). Β = (covs,m)/(varm) The table below shows the results of the statistics as per the data provided regarding the price index and the market prices of the company. price index (X) market price (Y) XY total 341. 51 403339. 13 529733. 8111 average 1. 3034732 1539. 462328 2021. 884775 Price index mean * market price mean 1.30347328 * 1539. 462328 = 2020. 643 Covariance = 2021. 884775 - 2021. 643 = 0. 242 To calculate the variance we use the following formula Var. = 12.306 / 262 = 0.0467 Beta = cov. / var. = 0. 242 / 0.0467 = 5.18 Therefore, the ‘beta’ for the company is 5.18 Estimating inputs Historical position of the company In table below is an income statement of the company as per the year indicated, that is the year 2006 to year 2010. 2006 2007 2008 2009 2010 current assets 2, 543, 767, 000 5, 362, 060, 000 12, 022, 663, 000 10, 073, 976, 000 10, 350, 206, 000 fixed assets 1, 158, 720, 000 1, 474, 690, 000 2, 190, 556, 000 1, 679, 941, 000 2, 160, 065, 000 total assets 3, 702, 487, 000 6, 836, 750, 000 14, 213, 219, 000 11, 753, 917, 000 12, 510, 271, 000 current liability 592, 020, 000 1, 966, 849, 000 7, 914, 883, 000 5, 547, 272, 000 5, 042, 808, 000 long- term debt 53, 165, 000 326, 034, 000 2, 117, 435, 000 1, 119, 964, 000 1, 649, 940, 000 owners equity 3, 470, 238, 000 4, 462, 996, 000 5, 949, 666, 000 6, 026, 621, 000 6, 121, 790, 000 liability + equity 3, 702, 487, 000 6, 836, 750, 000 14, 213, 219, 000 11, 753, 917, 000 12, 510, 271, 000 2006 2007 2008 2009 2010 Revenue 630, 225, 000 2, 320, 961, 000 3, 723, 428, 000 3,102, 708, 000 1, 205, 176,000 COGS (excluding depreciation) 643, 114, 000 1, 001, 343, 000 1, 426, 924, 000 2, 179, 703, 000 673, 534, 000 Gross Profit 130, 545, 000 1, 074, 318, 000 1, 665, 490, 000 510, 803, 000 162, 783, 000 Depreciation 1, 390, 000 2, 962, 000 2, 993, 000 5, 676, 000 99, 545, 000 Operating Expenses 0 0 0 0 0 Earnings Before Interest & Taxes 975, 530, 000 1, 257, 391, 000 1, 858, 158, 000 482, 785, 000 7, 439, 000 Interest expense 0 0 73, 890, 000 12, 213, 000 8, 740, 000 Earnings Before Taxes 975, 530, 000 1, 257, 391, 000 1, 784, 268, 000 470, 572, 000 -1,301,000 Income Taxes 0 0 0 0 0 Net Income 975, 530, 000 1, 257, 391, 000 1, 784, 268, 000 470, 572, 000 -1,301,000 Expected position of the company Therefore accounting for the growth of the company 3% in all the preceding years the income statement will be as follows. 2011 2012 2013 2014 2015 Revenue 649, 131, 750 2, 390, 589, 830 3, 835, 130, 840 3, 195, 789, 240 1, 241, 331, 280 COGS (excluding depreciation) 662, 407, 420 1, 031, 383, 290 1, 469, 731, 720 2, 245, 094, 090 693, 740, 020 Gross Profit 130, 545, 000 134, 461, 350 1, 715, 454, 700 5,261, 270, 900 167, 666,490 Depreciation 1, 431, 700 3, 050, 860 3, 082, 790 5, 846, 280 102, 531, 350 Operating Expenses 0 0 0 0 0 Earnings Before Interest & Taxes 100, 455, 900 1, 295, 112, 730 1, 913, 902, 740 497, 268, 550 7, 662, 170 Interest expense 0 0 76, 106, 700 12, 579, 390 9, 002,200 Earnings Before Taxes 1, 004, 795, 900 1, 295, 112, 730 1, 837, 796, 040 484, 689, 160 -1, 261, 970 Income Taxes 0 0 0 0 0 Net Income 1, 004, 795, 900 1, 295, 112, 730 1, 837, 796, 040 484, 689, 160 -1, 261, 970 The table below shows the return on equity as per the year 2010. EBIT (earning before interest and tax) 1, 211, 722, 900 Tax Rate 0.4 NOPAT ( net operating profit after tax) 484, 689, 160 Change in Fixed assets 1, 001, 345 Free Cash Flow (2010) 449, 183, 000 Expected growth rate of free cash flows = year 2011 0.03 year 2012 0.03 year 2013 0.03 year 2014 0.03 year 2015 0.03 Required rate of return on equity (based on CAPM Model) Risk-fee rate (T-Bill rate) 0.04 Market Risk Premium 0.08 Beta (Average of 3 competitors' betas) 5.18 Required rate of return on equity 0.03 Cost of Debt 0.14 After-tax cost of debt 0.084 In the following table we sought to analyse the weight of the capital employed and calculate the weighted average cost of capital (WACC) Weights Debt 6, 692, 748, 000 Equity 6, 059, 214, 000 12, 751, 962, 000 WACC 11.81% In the table below we forecast the free cash flow (FCF) of the year 2011 to 2015 and project the price of the shares of the company as at the year 2015. Therefore the dividend per share will be as follows: Growth rate Dividend during non-constant growth phase 1 0.03 1.65 2 0.03 1.75 3 0.03 1.8 4 0.03 1.91 5 0.03 1.93 6 0.03 1.99 Conclusion In calculation of WACC, we have used the cost of debt as well as the cost of equity. This is based on the US Treasury bond used in calculation of risk free rate. In addition, calculation of the cost of capital has been achieved through the use of historical returns on UAE market index. A 3 % terminal growth rate has been chosen because it is significant to United Arabs Emirates. Within an average of five years, the real estates investments are expected to grow substantially. This will lead to sequential growth in Sorouh Real Estate Investment Company. Valuation of shares and stocks is largely based on the terminal value which helps in the use of conservative growth rate of 3 %. In the calculation of beta, we have used the security price index versus the market index value of Sorouh Real Estate Investment Company, a member of United Arab Emirates. The indexes show an average growth of 1.3 throughout the twenty four months within two years. The company is strongly correlated to the United Arabs Emirates index and this has made it move in line with the overall trend of the shares market. Using the two year historical data, there is an expected future growth in the share price for a period of 5 years. Although the company has been experiencing fluctuations in terms of revenue, gross profit as well as total liabilities, the expected constant growth rate is expected to bring stableness. The revenue will grow substantially as the long term and current liabilities reduce gradually. By so doing, the return on capital will increase leading to increased profit in the long run. Since the depreciation, tax and interest are minimal, the company is likely to grow at a considerable rate and hence a good room for expansion (Shannon et al, 2003 and John et al, 2009). References Charles M., James R., McGuigan, & William J., (2008). Contemporary Financial Management. New York. Cengage learning publisher. David L., (1998). An A to Z guide to investment terms for today's investor: Wall Street words. New York. MacGraw – Hill Publishers. Elaine H., Thomas R., & John D., (2009). Equity Asset Valuation. Texas. CFA publishers.  John G., Scott B., & William L., (2009). Corporate Finance: Linking Theory to What Companies Do. New York. John Wiley and sons. Krishna G., (2007). Business analysis and valuation: Text only. New York. Cengage learning publisher. Shannon P., Robert F., & Robert P., (2003). Valuing small businesses and professional practices. New York. John Wiley and sons.  Top of Form  Bottom of Form Read More