• Login
HIRE WRITER NOW

MINI-CASE STUDY: VALUATION OF AN IT SERVICE COMPANY

Pages:8

You have just been hired to assist the CFO of anIT Group (ITG), a family-owned IT service group which owns and manage 4 small branches scattered in the Kingdom. The ITG headquarter is in Jeddah. The company is owned by non-Saudi resident liable to income tax. ITG plans to sell 2 branches outside Jeddahto focus on its core business in Jeddah.ITG employs 66 full-time employees.

To accelerate its development in Jeddah, ITG plans to buy another family-owned IT company (called MH) with2 offices based in Jeddah.

For this purpose, the ITGboard asks you to briefly diagnose the MH company performance and assess its value.

All questions can be handled independently with the information provided in the appendices.

1.1 MH company performance (Appendix 1)

From the consolidated financial statements, you will determine the return on capital employed (ROCE)and the return on equity (ROE) for theMH Company. You will also computethe operating margin rate for the last three years. A 20% corporate tax rate willbe used.You will justify, explain and interpret each calculation.

 

To calculate the ROCE, we will divide the EBIT of the company by the total capital invested. In order to get the total capital invested we will substrate total current debt from the total assets.

 

For ROE, we will divide the net income by the total provided equity. And for operating margin, we will divide the EBIT by the total turnover.

 

N N-1 N-2
ROCE 10.64% 8.10% 11.18%
ROE 14.41% 13.34% 14.30%
Operating Margin 7.93% 7.32% 7.58%

 

 

1.2 The MH Company weighted average cost of the capital(Appendix 2)

Since the MH company is not listed on a stock market, it is not possible to easily compute its cost of capital. Using data provided in appendix 2, you will estimate the weighted average cost of capital (WACC) of the MH Company based on data from comparable listed companies.

 

For the calculation of WACC, we first need to determine the weightage of debt and equity in the respective capital structure. For the weightage, divide the amount of debt and equity by the total sum of debt and equity.

 

After getting the portions of debt and equity, we will use the following equation to calculate the WACC.

 

WACC = (Cost of Debt * Portion of debt) * (1- Tax %) + (Cost of Equity * Portion of Equity)

 

Cost of equity 16
Cost of Debt 8
Tax 20.00%
Rounded off debt 50% 60% 50%
Rounded off Equity 50% 40% 50%
WACC N N-1 N-2
11.20 10.24 11.20

 

 

 

1.3 The MH company business Plan (Appendix 3)

Based on the financial data projections, you will estimate the free cash flow to the firm (FCFF) over the next five years.

 

 

In this question, we have used the following formula to calculate the FCFF

 

FCFF = EBIT (1-Tax %) + Depreciation Expense – CAPEX – Working Capital Expense

 

N+1 N+2 N+3 N+4 N+5
Turnover 4400000 5060000 5566000 5844300 5961186
Operating Income 176000 253000 333960 350658 357671
Tax Expense 35200 50600 66792 70131.6 71534.23
EBIT After Tax 140800 202400 267168 280526.4 286136.9
Add: Depreciation 176000 202400 222640 233772 238447.4
Minus: CAPEX 176000 202400 222640 233772 238447.4
Working Capital 440000 506000 556600 584430 596118.6
Minus: ChangeWorking Capital 24000 66000 50600 27830 11688.6
FCFF 116800 136400 216568 252696 274448

 

1.4 The MH company valuation with the DCF method(Appendix 4)

Following multiple meetings and exchanges, MH’s weighted average cost of capital and its business plan are reviewed. Using Appendix 4 assumptions, you are asked to assess the MHequity value using the discounted cash-flowsmethod (calculations in thousands of SAR).

 

The first step for the DCF Valution, we need to discount back the projected FCFF by the provided WACC. After getting the discounted values, we need to project the Terminal value of the company as we assume that the company will grow till eternity. For terminal value, we used the following formula:

 

TV = FCFF(last Year) *(1+Growth rate%) / (WACC – Growth Rate)

 

After calculating TV, discount it back. After discounting all the cash flows, add all the values and subtract the net value of debt.

 

WACC 12 %
Growth Rate 2 %
Net Debt 1380000
N+1 N+2 N+3 N+4 N+5
FCFF            150,000        170,000        200,000        240,000            280,000
Discounted FCFF            133,929        135,523        142,356        152,524            158,880
Terminal Value        2,856,000
Discounted TV        1,620,571
Total value of the firm        2,343,783
Total value of the equity            963,783

 

 

 

 

1.5 The MH company valuation with multiples (Appendix 5)

You are also asked to assess the equity value of the MH Companywith the multiples of its operating income and net income using Appendix 5.

 

Multiple method is based on the assumption that the peer companies tend to perform similarly; hence we use the average multiple of industry to predict the value of equity of our company.

 

A B C Average MH MH
Operating income 60 70 80 350
Net income 50 64 45 230
Value of Debt (M SAR) 200 300 400 1380 1380
Value of Equity (M SAR) 400 500 400 2194 1894
Enterprise Value 600 800 800 3667 3241
EV/Operating income 10.00 11.43 10.00 10.48
EV/ Net income 12.00 12.50 17.78 14.09
Ve/Operating Income 6.67 7.14 5.00 6.27
Ve/Net Income 8.00 7.81 8.89 8.23

 

 

 

 

1.6 Conclude on the opportunity for the Group ITG to acquire the MH company. Write a brief note for the members of the Board of Directors in the form of a summary note to explain if ITG Group should buy or not the MH company (1-page max).

 

Based on the analysis performed, in my opinion, buying MH Company is a good opportunity.

 

As per the data provided, the company’s turnover is expected to grow by good percentages in next five years and also the free cash flow to the firms are positive numbers for the next five years. Moreover, the equity value we have calculated from three methods are very good and we expect that the company will do great in future. So ITG should acquire MH Company.

 

Furthermore, the decision to sell other branches of company which were outside Jeddah is a good and recommended step. Acquiring of MH Company will not only prove viable financially but also it will help ITG in its operations in terms of probable synergies.

 

Also, if we discuss the industry with regard to its multiples, it seems to be a very attractive industry. EV multiples are high which shows the further growth potential.

 

 

 

 

 

Appendix 1

 

Financial statements–MH company(in KSAR)

 

 

 

Note: Provisions for pensions can be considered as a Financial Debt to compute the Net Debt.

 

 

 

 

 

 

 

Appendix 2

 

Estimated Weighted Average Cost of Capital for the MH company

 

To estimate the weighted average cost of capital of the MH company, a cost of equity of approximately 12% plus a 4% illiquidity premium will be usedsince the company is not listed.Given its financial situation, the MH company management estimates that it can borrow at an interest rate of 8% before tax.The financial structure will be rounded to the nearest (for example, we will retain 40% instead of 38%).The corporate tax rate is 20%.

 

Appendix 3

 

Assumptions for the MH company Business Plan

 

The forecasted turnover for the year N+1 is estimated at 4.4 million SAR. You anticipate an increase in turnover in N+2 of +15%, +10% in N+3, +5% in N+4, then a stabilization of growth at 2% per year. The projected operating margin rate is +4% for N+1, +5% for N+2 and +6% for subsequent years. Depreciation expense is estimated at 4% of revenues, as well as CAPEX. The working capital requirement is assumed to equal 10% of the current yearly revenues.

 

Appendix 4

 

Business valuation using the discounted free-cash-flows method

 

After a complete analysis, it was decided to use a 12% weighted average cost of capital and the following free-cash-flows projections:

 

Beyond the year N+5 (and over an infinite horizon), it will be retained a constant growth rate of 2% per year for the FCFF. The net debt value will be equal to the accounting (balance sheet) value.

 

Appendix 5

 

Business Valuation using multiples

 

Asample of three comparable companies (A, B and C) has been selected to evaluate theMH company.

The value drivers (or multiples) used for comparison are following:

  • the forecasted(N+1) operating income,
  • the forecasted (N+1) net income.

 

 

 

Concerning the MH company, the forecasted operating income is estimated to be 350 kSARand the net income part of the group is estimated at 230 kSAR.

ANALYSIS OF GOOD ENERGY

Pages:15

Glossary:

 

OFGEM Office of Gas and Electricity Markets
CAGR Cumulative Average Growth Rate
ROE Return on equity
ROA Return on assets
EBIT

 

 Earnings before interest and taxes
CR Current ratio
GPM

 

 Gross profit margin
OPM Operating profit margin
NPM Net profit margin

 

1.    Introduction – Good Energy

Good energy is a vertically integrated power generation and supply company which is listed on London Stock Exchange. Good Energy started its operations in 1999 and after 20 years of successful journey, it has more than 1400 independent power generators, producing a total of 54.5MWs of electricity, which use only renewable sources likewind, solar, hydro and bio-generation technology to generate 100% renewable electricity. Currently the fuel mix of Good Energy constitutes of 57% from wind, 20% from bio-generation, 18% from solar, and 5% from hydro. (Good Energy Group PLC, 2018)

Core Values:

With technology, people and partnerships as its core values, Good Energy aims to excel in the field of clean energy.

Good Energy believes that the usage of technological sources to generate clean and renewable energy is the future of global power industry. GE considers its leadership and the people as the core element of its success and aims to continue investing in its human resource. GE’s final core value encompasses the arena of partnerships as GE believes that the future of power industry relies on the effectiveness of partnerships among the stake holders of generators, suppliers and the technological enterprises. (Good Energy Group PLC, 2018)

 

Business Model:

Good Energy is a vertically integrated power generation company. From generation of electricity to its supply and applicable services, GE has a well control over its value chain. Good Energy’s integrated value chain also allows it to interact, connect and engage with its customers and clients directly. (Good Energy Group PLC, 2018)

Strategic Overview – Electricity Sector:

2018 was a very important and crucial year for electricity sector. The industry became more competitive with shifting dynamics, introduction of new regulations, continued development, and inception of latest technological advances. All of these factors impacted the industry where Good Energy operates.
The local market witnessed one of the most important and prominent regulatory changes in 2018. From January 2019, prices for consumer gas and electricity, supplied through various tariffs, have been regulated and capped at a price set by the energy regulator, OFGEM. The period of first capped prices would be from 1st January 2019 to 31st March 2019. A further price hike of 10% has been already implemented by OFGEM, effective by 1st April 2019. The regulator, OFGEM, will review and revise the price cap at every six month intervals. (Good Energy Group PLC, 2018)

Table 1

Profit and Loss Statement
2013 2014 2015 2016 2017 2018
Revenues 40407 57618 64281 90437 104509 116915
Cost of Goods Sold -26822 -38782 -42982 -62905 -75178 -83466
Gross Profit 13585 18836 21299 27532 29331 33449
Administration Expenses -9727 -15045 -17065 -21582 -23739 -26800
EBIT 3858 3791 4234 5950 5592 6649
Interest Income 116 87 23 18 2 16
Interest Expense -719 -2590 -4129 -4534 -4860 -4361
EBT 3255 1288 128 1434 734 2304
Tax -586 520 -323 -51 566 -660
Net Income 2669 1808 -195 1383 1300 1644

 

Table 2

Balance Sheet
  2013 2014 2015 2016 2017 2018
Current assets 32055 30559 25957 37554 61852 60687
Non-current assets 23918 48759 67604 65379 60237 58103
Total assets 55973 79318 93561 102933 122089 118790
             
Current liabilities 14104 21684 20140 40927 46565 43127
Non-current liabilities 25405 39691 56478 40961 57437 56837
Total liabilities 39509 61375 76618 81888 104002 99964
Equity 16464 17943 16943 21045 18085 18827
             
Total Liabilities & Equity 55973 79318 93561 102933 122087 118791

 

Table 3

Key Ratios
2013 2014 2015 2016 2017 2018
Gross Profit Margin 34% 33% 33% 30% 28% 29%
Operating Profit Margin 10% 7% 7% 7% 5% 6%
Net Profit Margin 7% 3% 0% 2% 1% 1%
Coverage Ratio 5.37 1.46 1.03 1.31 1.15 1.52
Current Ratio 2.27 1.41 1.29 0.92 1.33 1.41
Debt to Equity 2.40 3.42 4.52 3.89 5.75 5.31

 

Financial Highlights – Good Energy:

Figure 1

 

Good Energy has performed well in increasing its revenue in last six years. The total revenue of GE has grown at a CAGR of 23.68% during the tenure from 2013 to 2018. However, GE has significantly struggled in controlling its cost of sales and maintaining its net income. Cost of sales since 2013 to 2018, grew at a much higher CAGR than that of revenue; that is at a CAGR of 25.49% which shows that the business has been facing tough challenges on cost side. Moreover, the GE has not been able to transfer the increment in the revenue over the period to the net income. The net income during the tenure faced a decline at CAGR of -21.37%.(Good Energy Group PLC, 2018)

Figure 2

Good Energy has shown a keen approach towards constantly increasing its asset base. Since 2013, Good Energy has grown its assets by average yearly rate of 17%. This trend shows the positive intend of the company. However, in order to fund this growth, Good Energy has relied on raising new debts, on a yearly basis, Good Energy’s long term debt has increased by an average rate of 22% since 2013 till 2018. Constant increment in debt has played its negative role in shrinking the overall net income as with increasing debt comes higher finance costs.

Good Energy’s non-current assets mainly include lease hold lands, electricity generation assets and other equipment. (Good Energy Group PLC, 2018)

 

 Critical Analysis:

Figure 3

 

 Being an electricity generating and supplying company, it is really crucial that you keep updating and expanding your electricity generating assets in order to keep yourself in the competition. Good Energy has not only been successful in maintaining its electricity generating assets base but also it has reinvested and expanded its asset base. Last considerable investment in electricity generation assets has been witnessed in 2015, where Good Energy increased the electricity generating assets from £35 million to £65 million. During the period from 2013 to 2015, Good Energy increased its electricity generating assets at CAGR of 135.82%. (Good Energy Group PLC, 2018)

 

 

Figure 4

 With time, the trade and bill receivables of Good Energy has increased at a drastic rate, which can be quiet devastating for the effective management of liquidity of the company. Moreover, further intensifying the situation, the provisions against the trade and bill receivables, haven’t kept the pace with the rapidly increasing receivables.(Good Energy Group PLC, 2018)

Figure 5

Receivables as a percent of total revenue also has increased from being 13% in 2013 to 27% in 2018 which represents the problem that Good Energy has either supplying more electricity on receivable basis or is not effectively collecting its receivables. In any scenario, this might presents issues to Good Company like liquidity crunches which is quiet important to manage well in electricity generating and supplying businesses. (Good Energy Group PLC, 2018)

Figure 6

On the other hand, the company’s management has been reluctant in increasing the provisions against the increasing trade and bill receivables.

Figure 7

On a positive side, Good Energy is a good stock to keep for investors who wants constant and stable dividends. Good Energy has been paying a constant amount of dividends every year since 2013 irrespective of its profitability as in 2015, even when GE didn’t make any profit, it still paid dividends quiet similar to that of previous years. In 2013, the dividend payout ratio of Good Energy was 14%, however in 2018, this metric was 28%, almost doubled.

Ratio Analysis – Peer Group:

To analyze the performance of Good Energy over the period from 2013 to 2018, we will dig deep into its financials and compare its ratios with those of its comparable peers.

Profitability Ratios:

  • Gross Profit Margin Ratio:
Figure 8

While industry average of Gross Profit Margin has witnessed ups and downs since 2013, Good Energy’s GPM ratio has been more or less constant which shows that GE has somewhat control of its input costs. In 2013, the industrial average of GPM was above that of GE, however, with passing years, GE maintained its margin quiet effectively whereas the margin of industry deteriorated with increasing fluctuations in raw material costs. Fluctuations in the gross profit margin in attributed to variations in commodity prices. (Good Energy Group PLC, 2018)(YU Group PLC, 2018)(AMP PLC, 2018)(OPG , 2018)(Green and Smart Energy, 2018)

 

  • Operating Profit Margin:
Figure 9

 Operating Profit Margin shows how effectively the company has managed its operating expenses with respect to its operating profits. Higher the margin, higher the effectiveness. Whereas, the industrial average witnessed a massive decline in the OPM, Good Energy has very effectively managed and maintained its OPM which shows that GE has kept costs like administrative expenses in control. (Good Energy Group PLC, 2018)(YU Group PLC, 2018)(AMP PLC, 2018)(OPG , 2018)(Green and Smart Energy, 2018)

  • Net Profit Margin:

 

Figure 10

 

The Net Profit Margin comparison has also followed the same trend as of GPM and OPM. Industrial average deteriorated with time but GE has at least been successful in maintaining its profit margins. (Good Energy Group PLC, 2018)(YU Group PLC, 2018)(AMP PLC, 2018)(OPG , 2018)(Green and Smart Energy, 2018)

Liquidity Ratios:

  • Current Ratio:
Figure 11

 Current Ratio tells us about how effectively a company manages its current assets and current liabilities. A company should have enough current assets to cover up its current liabilities at any given time of the year. Usually, anything below than 1 in CR is not acceptable. Current ratio of Good Energy has been on a decline since 2013 with going below than 1 in 2016. However, it recovered slightly from being 0.9 in 2016 to 1.40 in 2018. (Good Energy Group PLC, 2018)(YU Group PLC, 2018)(AMP PLC, 2018)(OPG , 2018)(Green and Smart Energy, 2018)

 

  • Debt to Equity Ratio:
Figure 12

 Good Energy’s balance sheet has more debt than the industry average. The debt level of GE has significantly increased since 2013, the debt to equity ratio increased from 2.3 in 2013 to 5.3 in 2018. Higher debt level has contributed to increase the financial cost which has shrunk the net profit. The finance cost of Good Energy has increased at CAGR of 43.41% during the tenure from 2013 to 2018.(Good Energy Group PLC, 2018)(YU Group PLC, 2018)(AMP PLC, 2018)(OPG , 2018)(Green and Smart Energy, 2018)

  • Interest Coverage Ratio:
Figure 13

 

Interest coverage ratio tells us about the company’s ability to cover and fulfill its interest payment liabilities. Anything below 1 is a sign of severe distress; however, ideally the number should be above 5. Interest coverage ratio of Good Energy also has declined since 2013, showing that the either the EBIT has declined drastically or the finance cost has increased. Good Energy has invested heavily in its electricity generating assets in 2013 and 2014 after taking new debts which resulted in higher D/E ratio and lower interest coverage metric. We expect that this ratio will improve in coming years as expansionary projects will start generating electricity which will help increasing the EBIT and with time, the finance cost will also decrease. (Good Energy Group PLC, 2018)(YU Group PLC, 2018)(AMP PLC, 2018)(OPG , 2018)(Green and Smart Energy, 2018)

Other Important Ratios:

Table 4

  Green Energy (As per 2019) Industry Average
P/E Ratio TTM 14.08 19.81
Price to Sales TTM 0.29 1.8
Price to Cash Flow MRQ 2.61 89
Price to Free Cash Flow TTM 2.05 89.04
Price to Book MRQ 1.69 2.68
Price to Tangible Book MRQ 2.14 4.37
Return on Equity TTM 12% 15.98%
Return on Equity 5YA 7.12% 16.31%
Return on Assets TTM 1.94% 3.76%
Return on Assets 5YA 1.34% 3.72%
Return on Investment TTM 2.96% 4.63%
Return on Investment 5YA 1.99% 4.6%

(Anon., 2019)

 

Non-Financial Ratios:

 

Table 5

  2017 2018
Customer Meter Growth 4.3% 0.2%
Business Customer Volume Growth 46% 23.2%
NPS 46< 46<

 

Good energy has continued the good work of enlarging its customer base of both, domestic and business customers. However, the growth has slowed down in 2018 as compared to that in 2017. Customer meter growth shows the growth in meters supplied to domestic customers whereas business customer volume growth presents the number for meters sold to business customers. NPS is a measurement of how likely is that a customer of Good energy would recommend the services to someone else. (Good Energy Group PLC, 2018)

Corporate Governance:

Corporate governance means keeping in mind the interests of all stakeholders while making crucial decisions. A corporation has several stakeholders and their interests may vary from one another; the goal of a corporation is to effectively manage the relationships among all the stakeholders and make the best possible choices for the long term betterment of each stakeholder.

Good Energy has taken several steps which portrays its effective management of “Corporate Governance”

GE sources all of its electricity from certified and proved renewables sources of energy like solar power, wind power, hydroelectric power and biofuels. All of the Good Energy’s suppliers are based in United Kingdom and Green Energy pledges that it will always deal with UK suppliers only. Gas used by GE is carbon neutral where 6% of the total gas comes from bio-methane and the rest through the Green Gas Certification program. The projects of GE delivers wider benefits to the local communities, including helping out local poverty and empowering local women.

Furthermore, GE shares all the important information to its shareholders in a timely manner. GE’s board of directors include professionals who look after key decision makings and manage enterprise risk.  (Good Energy Group PLC, 2018)

Aligning to the goals of effective corporate governance has become so essential in this era of social media where any mishap can damage the reputation of the organization in the longer run.

Strategies to become a FTSE 100 Company:

 

Following are few strategies, the management of Good Energy can adapt to become a FTSE 100 company.

  • Invest in research and development. The energy sector is very rapidly evolving and to become competitive and remain relevant, GE should increase its investments in R&D to find better, cheaper, and cleaner ways of generating electricity.
  • Envisage future. Good Energy should start planning for future beforehand. In future data will empower homesand businesses to control and store electricity, GE should prepare itself for future to take a competitive edge.
  • Invest in human resource. Great companies are made and run by great people. In order to be a FTSE 100 Company, GE should bring industry best practitioners and experts in to its top management team.
  • Build better and sustainable partnerships. In an era full of uncertainties and variations, to grow and thrive, GE should build better relationships with its suppliers and distributors.
  • Good energy should be well prepared to any changes in regulations and compliance of government or regulatory organizations. As the electricity and power sector is very exposed and vulnerable to such changes, any drastic change in the policies can harm the operations and profits of Good Energy. Hence the management should be well prepared for such changes.

Caveats and Methodology:

  • In order to make the numbers comparable, financial results of 2018 of all companies have been used in the analysis presented in this report as complete results of 2019 have been not published for few of the peer companies.
  • Peer group includes OPG Power Ventures, Aggregated Micro Power Holdings PLC, YU Group PLC, and GREEN & SMART HOLDINGS plc
  • In order to normalize the results from all peers, certain elements have been neglected like impairment provisions, other income, non-recurring items, gain on sale of assets Etc.
  • Few of the peer companies were in losses in few years.
  • Peers companies might vary slightly with the subject company in terms of operational size, geography and operations.

Annexes:

Table 6

  Net Asset
2013 11733
2014 35239
2015 65247
2016 64732
2017 62051
2018 62081

 

Table 7

Interest Coverage Ratio
Good Energy
2013 5.366
2014 1.464
2015 1.025
2016 1.312
2017 1.151
2018 1.525

 

Table 8

D/E Ratio
Good Energy Peer Group Average
2013 2.400 0.699
2014 3.421 1.170
2015 4.522 2.007
2016 3.891 2.496
2017 5.751 1.714
2018 5.310 1.481

Table 9

Current Ratio
Good Energy Peer Group Average
2013 2.27 2.06
2014 1.41 4.52
2015 1.29 1.69
2016 0.92 1.62
2017 1.33 1.47
2018 1.41 1.14

 

Table 10

NPM
  Good Energy Peer Group Average
2013 6.61% 14%
2014 3.14% 14%
2015 -0.30% 5%
2016 1.53% 7%
2017 1.24% 4%
2018 1.41% -4%

 

Table 11

OPM
  Good Energy Peer Group Average
2013 10% 24.69%
2014 7% 26.82%
2015 7% 7.79%
2016 7% 13.20%
2017 5% 7.22%
2018 6% -1.52%

 

 

 

Table 12

GPM
  Good Energy Peer Group Average
2013 34% 38%
2014 33% 46%
2015 33% 27%
2016 30% 38%
2017 28% 30%
2018 29% 19%

 

Table 13

Dividends Paid
2013 377
2014 472
2015 451
2016 491
2017 459
2018 462

 

Table 14

Total Receivables to Net Revenue
2013 15%
2014 18%
2015 18%
2016 19%
2017 32%
2018 27%

 

Table 15

Dividends Paid
2013 14%
2014 26%
2016 36%
2017 35%
2018 28%

 

Bibliography

AMP PLC, 2018. Annual Report, s.l.: s.n.

Anon., 2019. Investing.com. [Online]
Available at: https://www.investing.com/equities/good-energy-group
[Accessed 31 december 2019].

Good Energy Group PLC, 2018. Annual Report, s.l.: s.n.

Green and Smart Energy, 2018. Annual Report, s.l.: s.n.

OPG , 2018. Annual Report, s.l.: s.n.

YU Group PLC, 2018. Annual Report, s.l.: s.n.

 

 

 

 

 

 

COST OF CAPITAL – VOSSLOH

Pages:8

COST OF CAPITAL - VOSSLOH

 

 

  1. How can the business activity of the company be best described? Is the market risk implied by these business activities expected to be above or below average?

Business Activity:

Vossloh is a global firm which operates in around 20 countries and primarily deals with products and services pertaining to railway infrastructure. The products of Vossloh include track fastening systems, concrete ties, switch systems and the innovative services associated with the life cycle of rail tracks. With over 30 production sites, Vossloh segregates itself into four basic divisions.

  • Core Components: This division of Vossloh manufactures standard and common products for railway infrastructures on an industrial level. The products of this division include railway fasting, screw-fastened and maintenance-free elastic systems which are applicable and required for all kind of railway tracks ballasted and slab tracks, mainline and conventional lines, high-speed lines, heavy haul and local transport.
  • Customized Modules: This division manufactures products which are customized to different clientele needs. Products of this division includes turnouts and crossings, manganese frogs, switch blade, switch actuators and locking devices, signaling products and rail monitoring systems; such products are unique and different for every other project.
  • Lifecycle Management: This divisions incorporates providing railway track services in order to increase the life of the tracks and keep them well maintained. Services of this division includes welding and transportation of long rails, the corrective milling and the preventative care of tracks and switches and reconditioning and recycling of old rails.

 

 

Market risk of “Vossloh”:

Market risk is the uncertainty which arises from external factors and which impact the whole financial system as a whole, also known as “Systematic Risk”. Market risk includes events and incidents like recessions, political turmoil, changes in interest rates, natural disasters and terrorist attacks etc.

Vossloh’s market exposure and risk are above average as compared to firms operating in other sectors for the following reasons:

  • Companies operating in infrastructure industry highly depends on the performance of governments of countries where they operate. Government only invests in infrastructure projects when they have budget surplus or enough room from lending so to invest in projects like railways which are not considered as important as providing the basic necessities like food, education, and health. So a recession, regional or global, can really hamper the business and financial performance of Vossloh.
  • The other external factor which can impact negatively the financials of Vossloh is increment in the interest rate. Operating in construction and infrastructure industry, sometimes require accumulating huge debts, which can result in higher finance cost. Vossloh’s net interest expense increased from £12.5 million in 2017 to £13.4 million in 2018 which tells that Vossloh has a significant amount of debt in its balance sheet and any hike in interest rate can shrink the net profit. However, this risk can be mitigated as Vossloh enjoys a fine reputation in the industry which can result in negotiated, better and fixed markup rate.
  • As Vossloh operates in 20 different countries and has supplied its products to more than 65 countries, fluctuations in foreign exchange rates can also impact the final profits if not hedged properly.

Above mentioned aspects show that the market exposure of Vossloh is slightly higher than the average but as with higher risks come higher profits, Vossloh has been mitigating such risks pretty well since its inception and we expect the same to continue. (Vossloh , 2018)

  1. What is the cost of debt of the company? Describe the critical issues you are facingand propose a well-founded solution.

Cost of Debt of Vossloh:

Total Outstanding Debt:

Net Interest Paid:

Source: Vossloh Annual Report 2018

The cost of debt of Vossloh should be (14.9/267.9 = 0.055), 5.5%.

Issues in calculating cost of debt:

One issue we faced in calculating the cost of debt of Vossloh is that Vossloh hasn’t provided the breakdown of its “Other interest expense” so we can’t be so sure that this amount only includes interest paid for its debt as companies also tend to pay interest on its outstanding account payables and other trade debts. In order to deal with this issue, we will add a caveat regarding this. However, this issue is not severe as the probable amount of interest paid for trade debts are not usually so high.

So, the cost of debt of Vossloh is 5.5%.

 

  1. What is the cost of equity of the company? Please identify a Beta-factor based onyour own calculations. For that purpose collect the appropriate stock quotes (e.g. onariva.de) and explain your approach. Moreover, discuss the problems in identifyingthe risk-free rate and the market risk premium and explain your solution.

Cost of Equity:

In order to calculate the cost of equity, we will take a step by step approach, which is the following:

Step 1: Calculate the risk free rate:

We are taking the rate of USA Treasury Bill – 10 years as our risk free rate which is currently 2.21%. (Source: US Department of Treasury)

A risk free rate is one which guarantees a certain rate of return and doesn’t have any uncertainty. US Treasury Bill – 10 Year offers the qualities of risk free rate as it is free from all kinds of risks including default risk, liquidity risk, and time horizon risk.

Step 2: Calculate the Beta.
In order to calculate the beta, we need to extract the closing stock price of Vossloh and the closing index value of the stock market where Vossloh trades. The data should at least be of last 4 years as having data of a shorter span may not truly portray the risk of the stock as it might not be enough to take into account all the ups and downs the company has went through.

After collecting the data, we will use the following formula to calculate the beta.

With the above mentioned formula, the beta of Vossloh is calculated as 0.50. We took the data from December 2015 to December 2019.

Step 3: Calculate the market premium.

Market premium is the extra return Xetra has provided over the risk free rate.Xetra’s last 1 year return has been taken as taking a return of longer horizon, i.e. 10 years, may take into account financial crisis period of 2008/09 which may distort the return the market has provided recently. Also, as per industry practices, market premium should reflect the current scenario rather than historical years.

Step 4: Using the equation of CAPM to calculate cost of equity:

CAPM equation is, Cost of equity = risk free rate + (Beta*Market Premium)

CE of Vossloh = 2.21% + (0.50 * 22%) = 13.21%

So, the cost of equity of Vossloh as per the CAPM model is 13.21%.

 

  1. How do you determine the weight of equity and the weight of debt? Again, describethe problems you are facing and propose a solution.

Weightages:

In order to calculate the weight of equity and debt, we first need to determine the total amount of funding Vossloh has acquired in form of both, debt and equity. After calculating the amount, we will calculate the share and weightage of each, debt and equity, in that amount.

Total Funding:

Hence, the total amount of funding for Vossloh is 512.5+267.9 = £780.4 million

Weightage of debt:

= 267.9/780.4 = 0.343

Weightage of Equity:

= 512.5/780.4 = 0.656

  1. What is the WACC of the company? Discuss your result in terms of robustness andreliability.

WACC of Vossloh:

WACC = (13.21% * 0.656) + (5.5% * 0.343 * (1-0.15))

WACC = 10.26%

As per our calculations, the WACC of Vossloh is 10.26%. We believe this is accurate and reliable as we have extracted all the data from relevant sources and used methodologies which are used by professionals. 

Bibliography

Vossloh , 2018. Annual Report , s.l.: s.n.

 

    FEELING PANICKED ABOUT YOUR ASSIGNMENT?

    GET PROFESSIONAL HELP IN NO TIME

    GET YOUR PAPER NOW
    Our free essay samples can be used to generate ideas and to get aid in doing your reports. This service is for those students who are either busy or find difficulty writing reports.

    Menu Links

    USEFULL LINKS

    • Free Citation Generator
    • Free Online Plagiarism Checker
    • About Us
    • Privacy Policy
    • Acceptable Use Policy

    REACH US

    • +1 302 2022739
    • info@essaysupport.com
    • 23 Street, New York, NY 5500
    Facebook Twitter Instagram Youtube

    Copyright © Essay Support – All Rights Reserved 2020 — Designed by IT Daftar

    Crazy Offer!

    25% off

    on your first order

    ORDER NOW