a) Company name: _____ Motors, in the car and motor industry
Advantages of going public:
i. Good method to further the growth of the company
ii. Generate capital needed for expansion
iii. This capital can be used to further Research & Development, fund capital expenditure or pay off existing debt
iv. Increase public awareness of the company and generate publicity
v. Increase market share of company
b) Necessary managerial roles in firm:Chief Executive Officer, Chief Financial Officer, Chief Operating Officer, Chief Marketing Officer, Head of Sales and the Chief Procurement Officer and Chief Risk Officer.
c) Shadow firm: BMW
i. Downloaded annual report
ii. German, Stuggart, Berlin, Munich, Hamburg, Dusseldorf
a. Automobile industry
iii. Earnings per share Jun 2012> 7.01
a. BMW’s 5-year growth rate is 3.07% (not so good)
b. The highest growth rate in the automobile industry is Toyota at 42.6%
d) Tax rate applicable in Germany for 2011 is 30.5% and 2012 is 30.2% (page 102 of annual report)
i. Goodwill is not tax deductible
ii. BMW defers taxes- they are recognized on the basis of management’s assessment of whether it is probable the relevant entities will generate future taxable profits, against which deductible temporary differences can be offset.
iii. Implications of this?
a) Obtain financial data->current, historical and market index info
b) BMW’s stock price 1 year ago: 10th Oct 2011 52.99
Price now: 59.55
1-year return based on change in price of 1 stock: 59.55-52.99/52.99= 0.1238= 12.38%
5 year return: 8th Oct 2007 price was 47.23: 59.55-47.23/47.23= 0.2609=26.09%
Compared to DAX:Price now 7285.89
Price 1 year ago: 14th Oct 2011 5967.2
Price 5 years ago: 15th Oct 2007 7884.12
1 year return: 5967.2-7285.89/7285.89=-18.09%
5 year return: 7884.12-7285.89/7285.89=8.21%
BMW is doing much better than the market average, and have been growing for the last 5 years unlike the market benchmarks. It was also not so affected by the recession last year.
c)
BMW years
Prices
Yearly return
TOTAL
79.66%
Expected return= returns/n=
79.66%/5=15.93%
BMW years
Prices
Yearly return
Expected return
Deviation
D without %age
TOTALS
Variance= deviations squared/n=
9654.48/5=1930.895
Standard deviation= √variance= 43.94%
d)
According to the diagram, they look positively correlated.
Correlation coefficient= Covariance/Standard Deviation 1* Standard Deviation 2
Covariance between 1 and 2= deviations of 1* deviations of 2/n
Years
Prices of DAX
Yearly return
Expected return
Deviation
D without %age
TOTALS
Standard deviation of DAX: √2665.26/5= 23.09%
Multiplying the deviations:
Years
Deviations of BMW
Deviations of DAX
Covariance= 4447.25/5= 889.45
Therefore, the correlation coefficient is 889.45/(43.94*23.09)= 87.67%
There is a positive correlation between BMW and the DAX of 87.67%
e) Re=Rf +B(Rm-Rf)
Rate on 3-month German Treasury bills (risk free rate): 0.44%
Beta for BMW=1.13
http://www.reuters.com/finance/stocks/overview?symbol=BMWG.DE
Market return:
12.38%=0.44%+ 1.13(Rm-0.44%)
12.38%= 0.44%+1.13Rm-0.4972%
12.38%+0.4972%-0.44%= 1.13Rm
12.4372=1.13Rm
12.4372/1.13= Rm
11.006%= Rm (Market return)
a) During the year, the BMW Group issued two benchmark bonds with a total issue volume of € 2.25 billion on European capital markets. Bonds were also issued in Canadian and Australian dollars, Norwegian krone, Swiss francs and other currencies for a total amount of € 4.5 billion. Issues of public ABS bonds raised 2.25 billion US dollar in the USA and 2 billion rand in South Africa. In addition, securitized private ABS transactions were used to raise € 200 million in Germany, 20 billion yen in Japan, 700 million Canadian dollars in Canada, 1.5 billion Australian dollars in Australia and 1 billion US dollars in the USA. The firm issued two-year bonds at 9.95%, three-year bonds at 10.05% and five-year bonds at 10.25%
http://www.bmwgroup.com/bmwgroup_prod/e/nav/index.html?http://www.bmwgroup.com/bmwgroup_prod/e/0_0_www_bmwgroup_com/investor_relations/fremdkapital_und_rating/ratings.html
a) Re=Rf +B(Rm-Rf)
10.05%= 0.44%+ b(9.95-0.44%)
10.05%=0.44%+9.51b
9.61%=9.51b
1.0105= b
Beta= 1.0105
e) According to the rating agencies such as S&P, Moody’s etc, BMW is a rather stable company thus it will be in a position to borrow funds easily. These funds will be borrowed at a rate of 6%per annum and will be used for the expansion of the firm. This investment is expected to place the fictitious company in a stable position so that she could compete fairly with the other auto giants. This investment is expected to generate returns at the rate of 13- 15% and that will be sufficient given the industry standards.
The bonds valuation is expected to go up in case there is a rise in the market following its issuance. This will be triggered by the subsequent demand on the securities.
a) The firm intends to consider two mutually exclusive investment opportunities. This is informed by the need to increase revenues firm so that it can firmly be in competition with other players in the automobile. The automobile industry is fast growing and any company that does not get innovative, through the design of new state of the art vehicles will be left out. That is majorly the reason why the firm intends to evaluate the proposals and see which one is likely to generate the best returns for the company
Proposal one is the design of Type A automotive that will be done by the company in its production plant. This will involve having the company engineers do the prototype and then production of the automotive. The second option is Type B car that will also be produced in the company but it a different design.
b) In the first proposal, it’s expected that the company will incur an initial cost of $5000, 000, while in the second proposal, initial investment is $10,000,000. Production costs will be
TYPE A
TYPE B
Initial investment
$5,000,000
Initial investment
$10,000,000
Capacity Year 1
Annual capacity
Selling price
Selling price
$8,000
$ 20,000
$7,000
$ 17,000
$6,000
$15,000
$5,000
$14,000
$4,000
$ 12,000
e
Note: Production is 80% of the previous periods will be incurred
There will be expenses that will be incurred in the projects
It’s also estimated that the scrap value of the projects will be nil
Cashflows
Project A
Capacity
Capacity
PROJECT A
a) Payback Period:
Car A
Car B
$5,000,000
$10,000,000
Car A
+
Car A
+*+++
Average cash flows
=Total cash flows/5
=Total cash flows/5
= 3.851178152 years
=$ 4.522169484 Years
Car A
++*++++++++++
In computing the net present values, we shall assume:
A) Cash flows are net of all expenses
b) Cost of capital is 10%
Car A
PVIF
Discounted
Initial investment
Cashflow
Investment
INTERNAL RATE OF RETURN CAR A
0
-$5,000,000
Car A
++++*+++++++
Using the payback method, its notable that the First project, Car A is a better investment as only 3.85 years are required to recoup the investment as opposed to 4.5 years for car B.
Car A
+++++
Car A
+++++
Car A
+++++
Car A
+++++
Car A
+++++
Car A
++
as compared to car B that has a NPV of $101,254
(Please ref to the excel file)
Car A
++++++
Car A
++++++
Car A
++++++
Car A
++++++
Car A
++++++
Car A
++++++*++
Its therefore notable that car A is likely to be much more beneficial as compared to the second car so the company should take it and leave the second option as its financially draining to the company.
a. Since the cash outflows are almost certain, the element of risk is generally in the cash inflows. This is because cash inflows are likely to be affected by a number of factors. These include variability in sales volumes, price changes, costs of sales, taxes etc. The risk arises with regard to the interaction of these underlying variables.
Car A
+++++++
Car A
+++++++
Car A
+++++++
Car A
+++++++
Car A
+++++
b) Year
Most
Car A
+++++
PVIF
Most likely
Project A
NPV
Car A
++++
Optimistic
Less Initial outlay
NPV’s Range from $62,400.92 to $466,019 for project A and between -$1,299,600.75 pessimistic to -$867,638.20 optimistic. This implies that project B is riskier of the two according to the sensitivity analysis above
b. Develop a simplified RADR by adjusting the discount rate originally chosen for the different levels of risk calculated in part c, and calculate the risk-adjusted NPV for each project.
Car A
++++++++++*++++++
PROJECT A
Optimistic
Less Intitial outlay
PROJECT B @12 Pc
Initial outlay
Considering all the above information, we can now make the decision in this investment proposal.
First of all, we have found that project A scores better than project B in both NPV, payback period and IRR. In this section, we consider the element of risk and then test the sensitivity of the project to these variables. As shown, project A is much more responsive to these elements of risk as compared to project B. Even after adjusting the rate of return, to 6%, we still find that project A is more responsive compared to B making it a more risky investment.
The high risk is however compensated by the equally high return for project A. Its therefore imperative that the company should still go ahead and invest in A
a. By looking at the balance sheet of your shadow firm, investigate how the firm has raised capital for investment opportunities. Begin by describing the mix of debt and equity, and calculate the proportions for each source of long-term funds.
The company finances its investments through a mix of equity and debt capital. Equity capital is majorly comprised of the issued shares, the capital reserves and retained earnings while other sources of financing include debt through financial credit extended by financial institutions. The proportion of each source of capital is explained below.
Car A
+++++++++++
Car A
+++++++++++
Car A
+++++++++++*++++++++++
Equity $ 27,103,000
Debt $ 96,326
Total liabilities =$123,429,000
Proportion equity= $27103/$123,429
= 22%
Proportion debt= 96,326/123,429
= 78%
b. Return to your group’s fictitious firm. Design a balance sheet that approximated the sources and uses of financing of your shadow firm.
Non current assets
$000
Intangible assets
$1000,
Tangible assets PPE
$18,550
Financial assets
$1,200
Deferred tax
$800,
Other current assets $
45,300
Total fixed asset 65,050
Current assets
Inventories
$9,600
Car A
++
$3,000
Other receivables
20,000
Cash and bank balances 7500
Other current assets 5,000
Total asset
110,150
Car A
+++++++++++++*+++
Share capital
1000
Car A
+++++++++++
2000
Car A
+++++++++++
25,000
Car A
++++++++++++++++
35,000
Other non current assets
19,650
Current liabilities
Financial liabilities
20,000
Trade payables
5000
Car A
+++++
1000
Car A
++++++++++++
1500
Car A
++++++++++++
110,150
C)
c. Assign rough cost estimates, rounding where necessary, and calculate the weighted average cost of capital for your fictitious firm.
WACC = wdrd (1-T) + wsrs
= Tax rate = 30.2%
Car A
wd= weights of the debt capital from our computation above
rd- this is the cost of capital in debt
T= rate of tax
Ws= this is the weight of the equity capital in the debt structure
Rs= it’s the cost of capital for the equity capital
=78%*10 %( 1-30.2%) +20%*8%
WACC = 7.0444%
d)
a. Return to your shadow firm and view its most recent income statement. Identify the important measures used in reporting leverage including EBIT and fixed and variable operating costs.
Fixed costs and variable costs are some of the most important measures of reporting leverage. Leverage is the ration in which the company utilizes both fixed and variable costs to maximize profits. There is both operating leverage and financial leverage. Ratios such as Earnings before interest and tax and fixed and variable costs are also important variables used in reporting.
b. Use your shadow firm’s information to design a similar set of numbers for your fictitious firm. Assign a simple per-unit price for your product.
Revenues
55000
50,000
Cost of sales
42500
41000
Car A
+++++++
12,500
9,000
Sales and administrative costs
5000 4500
Other operating income
500
500
Car A
+++++++++++++++++++
800
800
Profit / loss before financial result
6,200 3200
Result from equity accounted investments 100 100
Interest and similar income 700 600
Interest and similar expenses
800 900
Other financial result
600 200
Car A
+++++++++++++++++++++++
Car A
+++++++++++++++++++++++*++++
450
Car A
+++++++++++++++++++
9,200
5450
Car A
+++++++
2760
1635
Car A
++++++++++++
6740
3815
Car A
+++++++++
(1800)
(1100)
c)
Per unit price per product = $10,000
Car A
++++++
=
$6,300,000
Car A
+++++++++
= $7500
Operating breakeven
= fixed cost/ contribution
=$6,300,000/2,500
= 2,520 cars
Car A
++++++++++++++++++++++++++++++
Car A
++++++++++++++++++++++++++++++
Car A
+++++++++++++++++++++
2520 cars
Car A
+++++++++
Costs 4000
No of cars to break even
c) Calculate the degree of operating leverage for your fictitious firm at a base sales level.
d) Return to your shadow firm and calculate its degree of financial leverage at its current levels of EBIT and EPS. Likewise, calculate your shadow firm’s degree of total leverage at current sales and EPS levels.
EPS = 6740/10,000
Assuming number of shareholders =10 million
= 0.674
Previous year EPS = 3,815/ 10,000
Change in EBIT = 69
= 1.08
a. The company has consistently Paid dividends for the last two years, at least according to the financials. In the year 2011, the company paid dividend amounting to $852,000 while in the year
2010, dividends paid amounted to $197,000 according to the company’s 2011 annual report and financials. EPS for the consecutive years has been $7.45 and $4.93 for 2011 and 2010 respectively.
b) Please refer to WEEK 5 ACTIVITY SECTION 2 (b)
c) Initially, the company had always paid dividends as a percentage of profits earned during the year. This had the effect of making sure that the company paid dividends all the years that the company makes profits. The board of directors however decided that the company pays dividends if and only if the company has exhausted all the profitable investment options. When the company is paying dividends, it has to do so within two weeks after the date of the annual general meeting.
This is justifiable considering that the company is operating in a very competitive environment and requires making significant investments so as to be at par with other players in the industry.
e) The company’s equity account comprises of share capital that’s issued amounting to $655,000.capital reserves amount to $1,939,000 while revenue reserves for the company amount to $ 22,492,000. Accumulated other equity amounts to $1,182,000 while minority is $26,000
b. Use similar numbers in designing your fictitious firm’s equity account.
Car A
+++++++++++++++++++++
$550,000
Car A
+++++++++++
$1,800,000
Car A
+++++++++++
$21,000,000
Car A
+++++++++++++++++++
$1,500,000
Car A
++++++++++++
$15,000
c. There have not been any major changes in BMW’ in terms of financing. The company’s shares have not changed in the recent past. There have been no stock splits or repurchase in this company
Car A
+++++++++++++++++++++++++++++++++++++
Car A
+++++++++++++++++++++++
Besley, S (2008) Essentials of Managerial Finance, Cengage Learning
S&P rating index: Adopted from: http://www.bmwgroup.com/bmwgroup_prod/e/nav/index.html?http://www.bmwgroup.com/bmwgroup_prod/e/0_0_www_bmwgroup_com/investor_relations/fremdkapital_und_rating/ratings.html
http://www.reuters.com/finance/stocks/BMWG.DE/key-developments/article/2580058
Car A
++++++++++++++++++++++++++++++++++++++
Car A
++++++++++
