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FIN355 Equity Securities Assignment 1 - Individual Assignment January 2017 Presentation FIN355 Assignment 1 Individual Assignment This assignment is


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Security Type

   Market Value

Before-tax Required Return

Preferred shares

$200

7.0%

Bonds  

$500

7.5%

Common stock 

$700

13.0%

  • Bond interest payments: $40
  • Preferred share dividends: $14
  • Net income available to common: $115
  • Investment in working capital: $30
  • Investment in fixed capital: $100
  • Net new borrowing: $30
  • Depreciation: $50
  • Tax rate: 20%

(a) Compute the firm’s weighted average cost of capital. (10 marks)

(b) Compute the current FCFE for SP Shipping. (5 marks)

(c) Compute the current FCFF for SP Shipping. (5 marks)

(d) Discuss why the value of SP Shipping’s equity obtained by the single stage FCFE and single stage FCFF may be different. (5 marks)


FIN355

 

Equity Securities

 

Assignment 1 - Individual Assignment

 

January 2017 Presentation FIN355 Assignment 1 Individual Assignment

 

This assignment is worth 20% of the final mark for FIN355 Equity Securities.

 

The cut-off date for this assignment is 7 February 2017, 2355hrs.

 

In this assignment, you are expected to: Apply economic analysis, industry analysis and company analysis

 

Value a company’s shares

 

Formulate reports on equity analysis

 

Demonstrate the essential knowledge and interpersonal skills to work effectively in a

 

team Demonstrate proficiency in writing

 

___________________________________________________________________________ Question 1

 

Janet Tan is preparing a report on the U.S. based manufacturers in the electric toothbrush

 

industry and has gathered the information shown in Tables 1 and 2 below. Janet’s report

 

concludes that the electric toothbrush industry is in the maturity (i.e. late) phase of its life

 

cycle.

 

Analyse the fundamental factors in Tables 1 and 2 for the electric toothbrush industry and

 

select and justify the factors that support Janet’s conclusion.

 

(30 marks) Table 1: Ratios for Electric Toothbrush Industry and Broad Stock Market Index

 

2010

 

Return on Equity

 

Electric toothbrush industry index

 

Market index

 

Average P/E

 

Electric toothbrush industry index

 

Market index

 

Dividend payout ratio

 

Electric toothbrush industry index

 

Market index SIM UNIVERSITY 2011 2012 2013 2014 2015 12.5% 12.0% 15.4% 19.6% 21.6% 21.6%

 

10.2% 12.4% 14.6% 19.9% 20.4% 21.2%

 

28.5x

 

10.2x 23.2x

 

12.4x 19.6x

 

14.6x 18.7x

 

19.9x 18.5x

 

18.1x 16.2x

 

19.1x 8.8% 8.0% 12.1% 12.1% 14.3% 17.1%

 

39.2% 40.1% 38.6% 43.7% 41.8% 39.1% Assignment 1 – Page 2 of 4 FIN355 Assignment 1 Table 2: Characteristics of Electric Toothbrush Industry Index

 

and Broad Stock Market Index

 

Industry Sales Growth – Industry sales have grown at 15-20% per year in recent years and

 

are expected to grow at 10-15% per year over the next 3 years.

 

Non-US Markets – Some U.S. manufacturers are attempting to enter fast-growing non-U.S.

 

markets, which remain largely unexploited.

 

Mail Order Sales – Some manufacturers have created a new niche in the industry by selling

 

electric toothbrushes directly to customers through mail order. Sales for this industry

 

segment are growing at 40% per year.

 

U.S. Market Penetration – The current penetration rate in the United States is 60% of

 

households and will be difficult to increase.

 

Price Competition – Manufacturers compete fiercely on the basis of price, and price wars

 

within the industry are common.

 

Niche Markets – Some manufacturers are able to develop new, unexploited markets in the

 

United States based on company reputation, quality and service.

 

Industry Consolidation – Several manufacturers have recently merged, and it is expected

 

that consolidation in the industry will increase.

 

New Entrants – New manufacturers continue to enter the market. Question 2

 

Ivan Ho is reviewing the investment merits of Biogen, a fast-growing biotechnology firm.

 

Biogen has developed several drugs, which are being licensed to major drug companies.

 

Biogen also has several drugs in final stage trials before FDA approval. Ivan notes that two

 

drugs recently received approval which should provide Biogen solid revenue growth and

 

generate predictable cash flow well into the future. Based on the potential for the two drugs,

 

Biogen’s estimated annual cash flow growth rate for the next two years is 25%, and longterm growth is expected to be 12%. Because of Biogen’s attractive investment opportunities,

 

the company does not pay dividend. Biogen’s current weighted average cost of capital is 15%

 

and its stock is currently trading at $50 per share. Financial information for Biogen for the

 

most recent 12 months is provided below: Net working capital excluding cash increased from $7,500,000 to $9,900,000.

 

Book value increased from $81,250,000 to $101,250,000.

 

Biogen currently has no debt.

 

Research facilities and production equipment were purchased for $8,500,000.

 

Biogen held non-operating assets in the amount of $900,000.

 

Net income for the 12 months was $20,000,000.

 

Biogen has a marginal tax rate of 40%.

 

Noncash charges for depreciation and restructuring for the 12 months were

 

$1,300,000. SIM UNIVERSITY Assignment 1 – Page 3 of 4 FIN355 Assignment 1 Biogen’s management has indicated an interest in establishing a dividend and will fund the

 

new drug research by issuing additional debt.

 

(a) Compute the current free cash flow to firm and free cash flow to equity for Biogen (to

 

the nearest million).

 

(15 marks) (b) If Biogen decides to start paying a dividend, discuss the impact of the decision on

 

FCFF and FCFE.

 

(15 marks) (c) If Biogen issues additional debt, discuss the impact of this decision on FCFF and

 

FCFE.

 

(15 marks) Question 3

 

An analyst following SP Shipping has compiled the following information in preparation for

 

additional analysis she has to include in a report she has been asked to produce (data is in

 

hundreds of millions of dollars ($)):

 

Security Type

 

Preferred shares

 

Bonds

 

Common stock Market Value

 

$200

 

$500

 

$700 Before-tax Required Return

 

7.0%

 

7.5%

 

13.0% Bond interest payments:

 

Preferred share dividends:

 

Net income available to common:

 

Investment in working capital:

 

Investment in fixed capital:

 

Net new borrowing:

 

Depreciation:

 

Tax rate: (a) Compute the firm’s weighted average cost of capital. $40

 

$14

 

$115

 

$30

 

$100

 

$30

 

$50

 

20% (10 marks)

 

(b) Compute the current FCFE for SP Shipping.

 

(5 marks) (c) Compute the current FCFF for SP Shipping.

 

(5 marks) (d) Discuss why the value of SP Shipping’s equity obtained by the single stage FCFE and

 

single stage FCFF may be different.

 

(5 marks)

 

---- END OF ASSIGNMENT ---- SIM UNIVERSITY Assignment 1 – Page 4 of 4

 


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