Strategic Corporate Finance - Essay Example

?Task a) Net Assets Value The following is the net asset value of Marks and Spencer for two years i.e. and Net Asset Value Net Asset Value Per Share = Net Assets = 2750 = 1.72   = 2677 = 1.69     No. of Shares Outstanding   1600         1584     The net asset value calculated above reflects the value of assets on per share basis. This estimate of asset valuation is the most conservative as it solely depends upon the book values of the assets. It is assumed that in the event of bankruptcy, the company is likely to receive at least this value of assets (Jaffe and Ross, 2004). If the above values are taken into consideration, it can be noted that M&S has performed well especially in terms of generating higher NAV per share. The company had ?1.69 worth net assets per share which has been improved to?1.72 in 2011. b) Cost of Capital The following are the computations in respect of calculating the weighted average cost of capital for Marks & Spencer. The cost of equity of M&S is found to be 4.5% whereas cost of debt is found to be 4%. The overall weighted average cost of capital after accounting for the value of equity and value of debt, is found to be 4.33%. Cost of Equity (CAPM)     Re = Rf + Beta (Risk Premium)       = 0.03 + 0.75 (0.02)     Re = 4.50% Cost of Debt     Rd = Annual Coupon   Current Bond Price       = 5   125     Rd = 4.00% Value of Equity Ve = Current Share Price x No. of Shares outstanding = 3.76 x 1600 = 6016 Value of Debt Vd = Current Bond Price x No. of Bonds Issued = 125 x 2489 = 3111                 100     Weights     Wd = Debt = 3111 = 34.09%   Debt + Equity 3111 + 6016       We = Equity = 6016 = 65.91%     Debt + Equity   3111 + 6016     WACC     WACC = [Wd x Rd] + [We x Re]       = [ 34.09% x 4%] + [65.91% x 4.5%]       = 4.33% c) Dividend Growth Model The following is the calculation of theoretical ex-right price by using Gordon’s dividend growth model. Two assumptions have been used in this regard such that 1) there is no growth in the current dividends, and 2) there is a growth of 2% in the existing growth. Gordon Dividend Growth Model     When g= 0   Price = D(1+g) = 17(1+0) = 377.8   K – g 0.045 - 0       When g=2   Price = D(1+g) = 17(1+0.02) = 693.6     K – g   0.045 - 0.02     From the above calculations, it can be noted that if the growth rate of dividend is zero, the theoretical ex-right price of the M&S share is around 377 pence. On the other hand, if the dividends are expected to grow at 2%, in that case there will be a massive growth in the share price of M&S such that it is likely to reach at 693 pence which is extremely high. Under the given circumstances, when the current share price id 363 pence, the theoretical ex-right price of 377 pence, seems to be more appropriate than the share price of 693 pence which seems quite optimistic. d) Value per sharing using the price earnings (p/e) ratio The following are the price earnings ratio of Marks & Spencer for the years 2011 and 2012. Price Earnings Ratio   31-Mar-12 11-Jan-13 P/E Ratio = 376 = 11.56923 = 363 = 11.2     32.5         32.5     It can be observed that the Price Earnings ratio of M&S was at 11.56 in the year 2011. However, it reduced to 11.2 in the last year because the share price of the company decreased. If the P/E ratio of retail industry is compared with that of M&S, it can be observed that the P/E ratio of M&S is significantly higher than that of the industry. The retail industry is following a P/E multiple of 8.5 times whereas M&S is having more than 11 times. This shows that the share price of M&S is over-valued as compare to other industry participants. Task 2 Introduction There are various views regarding a particular stock as different market participants look at the stocks with different objectives and views. However, the only thing which is followed by all the investors is the fundamentals (Babu, 2012). Fundamental is the concept in finance which deals with the performance of the company in the given period. Based on the fundamentals, the market analysts as well as the investors tend to anticipate the future performance of the company (Berk and DeMarzo, 2010). The expected future performance of the company determines the market price of the shares of the company. In other words, fundamental are the most critical factors in shaping up the existing market value of any company (Khan, 2004). The following discussion entails the fundamentals of Marks & Spencer regarding the valuation as well as future forecasts of the performance of the company with an objective of making either partial or full investment in the shares of Marks & Spencer. Marks & Spencer is considered as one of the largest companies in the retail industry of UK. The investors always keep an eye on the performance of this company as it is regarded as the major reflector of the UK’s overall retail industry. Not only the investors, the common public also track the performance of this company for motives other than investment such as inflation, consumer spending, the existing trends etc. These are the reasons due to which Marks & Spencer remains along with other top scripts. Marks & Spencer is listed in London Stock Exchange on 19 March 2002. The company covers almost all the major indices of London Stock Exchange such as FTSE 100, FTSE 350, FTSE All-share, etc. Investors take deep interest in the share price movements of M&S such that this share is famous for its turnover and its market capitalization. As it can be observed from the information given in the case study that the share price of M&S has remained between 300 to 400 pence which is the range within which the forecasts of the market analysts mainly lie. Valuation of Marks & Spencer The question whether to make investment in the shares of Marks and Spencer either partial or full given the offer of 380 pence by the rival firm is entirely dependent upon the existing fundamentals of the company. Various techniques can determine the market price per share of M&S such that these techniques give the expected share price of the company while incorporating the relevant factors. The techniques and calculations performed in Task 1, can assist in developing the overall scenario regarding the optimal share price of M&S. 1. Net Asset Value per share One of the most basic and fundamental technique of valuing any company is the net asset value of the share. This technique solely dependent upon the book values of the net assets of the company (Shim and Siegel, 2008). In order to perform NAV per share, firstly, net assets are computed by deducting the current liabilities from the total assets. These are the net assets of the company and then they are divided by the number of shares outstanding of the company. The reason why this measure is regarded as the most basic and fundamental approach to valuing the assets of the company because it is regarded that in the event of liquidation, the debt holders and shareholders of the company are supposed to receive at least this much amount i.e. the book value of their assets. If the existing net asset value per share of Marks & Spencer is taken into consideration, it can be noted during the year ended 2 April 2011, the net asset value per share of the company was around 169 pence, whereas in the year ending 31 March 2012, the net asset value per share of M&S was increased to 172 pence. Given these NAV per share, it can be ensured that the existing share price of the company should be at least more than 172 pence because this share price only reflects the book values of the assets of the company. However, it ignores the factors such as expected future earnings, growth in the assets of the company, the future business contracts etc. The current market share price also reflects these factors as well. 2. Gordon Dividend Growth Model The most important and considerable tool used by the analysts is the use of Gordon’s dividend growth model. This model is mainly criticized due to only pertaining to those stocks which pay dividends. There is no alternative presented under this model for non-dividend paying stocks. This technique mainly works in two major parts such that in first part, it is essential to determine the cost of equity of the company (Baker and Martin, 2011). Cost of equity can be obtained by the famous equation of Finch & Fama which is known as capital asset pricing model (CAPM). The cost of equity (in percentage) is then used as a discount factor in the dividend growth model. The dividend growth model assumes that if the future dividends until perpetuity are discounted by the cost of equity of the firm, then the result will be the share price of the firm. Gordon modified the formula slightly by taking into consideration effect of expected growth in the upcoming dividends. Under the existing scenario of the Marks & Spencer, it can be observed that the cost of equity of the firm is calculated as 4.5% which is quite low indicating that the firm is less risky. In the recent year ending on 31 March 2012, the current dividends of the company were 17 pence. There are two assumptions have been made such that the growth rate is kept at 0% in the first scenario followed by the second scenario with 2% growth. The results of first scenario show that the expected share price of the company at the end of the period in question should be around 377.8 pence. If this price is compared with the actual closing share price of that period, the closing price was 376 pence per share. This shows that how reliable the estimates of Gordon’s dividends growth model were in this scenario. Conversely, if the second scenario is taken into consideration, the results found are quite absurd such that expected share price of M&S has increased to 693 pence which is near to double the existing current share price. In this way, the second scenario should be discarded, as it is unlikely that the dividends are going to be increased by 2% every year perpetually. On these grounds, the share price of M&S seems to be quite fair with price of 376 pence for the year ending 31 March 2012. 3. Price/Earnings Ratio Another important technique to value the shares of the companies is price to earnings ratio. Under this technique, earnings, is considered as the basic factor in determining the share price of the companies (Sheeba, 2011). From the past share prices, there are two P/E multiples which have been calculated with the multiple of around 11 times. This shows that for every penny of earnings, the share price of the company should be 11 pence. However, if these results of M&S are compared with that of retail industry, it can be observed that the retail industry of UK is fluctuating at a multiple of around 8.5 times. This shows that the performance of share price of M&S is quite higher with that of industry. High P/E has the negative implication such that it is considered that the share price is increased by too much amount or it has been overly valued, thus indicating a possibility of a correction. The correction at a later stage can bring down the higher P/E at the moderate or even low level. Therefore, under existing scenario, the share price of M&S is overvalued and the investors should consider this fact seriously before taking any investment decision. 4. Other Valuation Measures There are other valuation measure as well which are used for this purpose such free cash flows techniques etc. However, this technique is quite complex and dependent upon the too many estimated figures which put the reliability of the expected share price in doubt (Brigham and Ehrhardt, 2008). Conclusion With the view of the above-discussed valuations and results inferred from the given case study, few factors should be considered before making investment decision. Firstly, NAV per share is not the ideal measure of valuation when the company’s future prospects are bright. Under Gordon’s dividend discount model, the expected share price is quite closer to the current market share price. However, based on P/E multiple, the existing share price of M&S is overly valued. Given all these factors, it is advised to the client that only partial investment should be made in Marks & Spencer as the very recent share price is also moving downward and the P/E is quite higher indicating the likelihood of future downside movement of the stock. Task 3 Tracking of Share Price Movements If the share price movements of Marks and Spencer are taken closely observed from the beginning of the year 2012 until April 2013, there are three main phases. The first phase starts the beginning of 2012 such that the share prices started increasing from a level of 300 pence. An upward sloping trend was followed by M&S until April 2012 when it reached to a level of nearly 390 pence. In almost a quarter, the company experienced a gain of 90 pence which is almost one-fourth of the total share price of the company. However, since April 2012, the share price of the company started travelling into declining zone with steeper trend such that it reached to the level of 310 pence in July. In nearly three months, M&S eroded all the profits which it gained during the previous quarter. The second phase of the performance of M&S started from July 2012 when it started gaining back the momentum that it lost. The share price started increasing swiftly and reached at 360 pence in around 45 days. After that, its growth experiences slowness nevertheless the share price was following an upward trend until the end of November last year when it almost touched 400 pence mark. Since then, the third phase of the share price movement begun until April 2013. During these five months, the share prices mainly remained volatile between the level of 360 and 390 pence. The previous month of April 2013 was the most attractive month for the company during its journey of almost 16 months where it crossed the 400 pence mark for the first time. The company is still enjoying the gains of above 400 pence level. On a concluding note, the share price of Marks & Spencer is mainly reaping the prevailing hike in the global equity market. However, once the global equity markets tend to remain at a steady level, then the local stock markets will follow the similar sentiments. In this way, the share prices of Marks & Spencer can be stable at a level of 400 pence. Works Cited Babu, G., 2012. Financial Management. New Delhi: Concept Publishing Company. Baker, H. K. and Martin, G. S., 2011.Capital structure and corporate financing decisions: theory, evidence, and practice. New York: John Wiley & Sons. Berk, J. B. and DeMarzo, P. M., 2010. Corporate finance. 2nd ed. New York: Prentice Hall. Bierman, H., 2003. The capital structure decision. New York: Springer. Brigham, E. F. and Ehrhardt, M. C., 2008. Financial management: theory and practice. 12th ed. New York: Cengage Learning. Eckbo, Bjorn Espen., 2008. Handbook of corporate finance: empirical corporate finance. Oxford: Elsevier. Jaffe, J. and Ross, R. W., 2004. Corporate Finance. New Delhi: Tata McGraw-Hill Education. Khan, M. Y., 2004. Financial Management: Text, Problems and Cases. 2nd ed. New Delhi: Tata McGraw-Hill Education. Siegel, J. and Shim, J, 2008. Financial Management, 3rd ed, Barron's Educational Series, Beijing. Sheeba, K., 2011. Financial Management. Mumbai: Pearson Education India. Shim, J. K. and Siegel, J. G., 2008. Financial Management. 3rd ed. Oxford: Barron's Educational Series. Read More