- 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?
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 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)
- What is the cost of debt of the company? Describe the critical issues you are facingand propose a well-founded solution.
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%.
- 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.
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%.
- How do you determine the weight of equity and the weight of debt? Again, describethe problems you are facing and propose a solution.
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.
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
- What is the WACC of the company? Discuss your result in terms of robustness andreliability.
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.
Vossloh , 2018. Annual Report , s.l.: s.n.