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BFF5954 Business Finance Assignment

This Business Finance Assignment was given by Monash University. In this assignment 3 questions were asked about financial aspects of Business Management.

Question- 1: General background of the firm

Adelaide Brighton Limited is one of the oldest established companies in Australia with major interests in the construction and allied industries in the country. Adelaide Brighton started in 1882 and is now involved in primarily clinker, lime derivatives, cement, premixed concrete production across all the Australian states(Official Website of Adelaide Brighton Ltd).

The company works closely with the construction industry and works hand in hand with the major construction companies in Australia. It has also been involved in multiple joint ventures across Australia with other companies to provide different products in different territories. The company has been the leading producer of concrete masonry products in Australia under the flagship name of Adbri Masonry. This is a well know brand across Australia in the construction industry(Official Website of Adelaide Brighton Ltd).

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The nature of the construction industry is closely linked with the way that economies operate and grow in the world. During positive economic environments, the spending capacity and the consumption of people increase which in turn increases the demand for spaces, both residential and commercial. This becomes the source of demand for the industry which in turn goes into a boom mode during such phases. An example of such a phase would be the early 2000s to 2007 when the boom was huge across the world. On the flipside, the same industry will also fail when the economies have a slowing down phase. This is because people stop investing in high investment goods like real estate and look for cheaper ways to invest. This puts a slow down on the demand and the supply with respect to the demand increases. In such cases, if the holding capacity of the suppliers is not much, the prices tend to spiral downwards leading to what is commonly known as a bust.

Given the age of the company, it has seen all the business cycles of the industry and the core competencies and the fundamentals of the business are sound and stable. That’s all about Business Finance Aa=ssignment’s question 1.

Question-2: Capital and business structure

  • Over the last few years there has not been a major announcement in the Australian stock exchange for Adelaide Brighton Limited. The company has not invited equity shares, common equity or preferred equity. There are no share rights offering in the last few years. What the company has done, in 2011, is the extension of bank debts from the existing banks. The largest funding that the company has raised in the last five years has been in 2011 when the company raised $100mn of additional debt (MorningStarDatAnalysis; Australian Securities Exchange Ltd). This debt extension of additional funds has been planned by the company in 2011 and has been taken with various different maturity levels. This has been in addition to the existing debt levels of the company and has given the company more flexibility with respect to the maturity levels of the debts. The initial existing debt of the company was $400mn on top of which, the additional $100mn has been taken by the company. The different maturity levels of the funds are as follows:
1-July-2013($mn) 1-July-2014 ($mn) 1-July-2015 ($mn) Total ($mn)
200 140 160 500
  • If we look at the announcement, the company has not clearly mentioned any specific purpose for the borrowings. However, the closure look in the annual report of the company for the year 2011, specifically it’s strategy section, it seems that this was done by the company with a forward looking approach as the company is expanding its operations and looking for acquisitions and organic growth opportunities (Annual Report of Adelaide Brighton Ltd, 2011). In 2011, looking at tightening capital markets and credit extensions of the industry, the company has extended this loan of $100mn so that it has its financial needs taken care of before the credit lines tighten for the economy in general.
  • The date of announcement for the above credit extension was 22-December-2011 (Australian Securities Exchange Ltd) and hence we can safely assume that the company has been working on it for some time prior to this announcement.
  • The following is the historical share price information of the company ((MorningStarDatAnalysis):
Date Open High Low Close Volume
Dec 28, 2011 2.91 2.93 2.86 2.87 317,495
Dec 23, 2011 2.93 2.95 2.88 2.90 457,222
Dec 22, 2011 2.89 2.93 2.87 2.89 574,501
Dec 21, 2011 2.97 2.97 2.93 2.95 882,000
Dec 20, 2011 2.91 2.97 2.86 2.91 1,440,839

As we can see the share price opened on 2.91 on Dec 20, 2011. We can also see heavy activity on this day along with the next trading day on the 21st. As on 22-Dec-2011, we can see that the share fell by 0.06 on opening of 2.89 on 22ndDecember, 2011. This will be primarily because of the announcement of raising of debt by the company. This gives us the pre and post window return of -1.02% which is the percentage bye which the share prices fell for the company. This can be understandable as the company is increasing the debts while keeping the equity at the same level. This reduces the assets available for the equity investors in the company and leads to devaluation of the share prices which can be seen here. However, it is pertinent not here that this effect on the share price is almost insignificant as the company has very strong financial health and capacity.

  • The S&P ASX 200 data for the same window can be given as ((MorningStarDatAnalysis):
Date Open High Low Close
Dec 28, 2011 4,139.40 4,142.60 4,086.20 4,088.80
Dec 23, 2011 4,103.00 4,140.40 4,103.00 4,140.40
Dec 22, 2011 4,139.50 4,139.50 4,084.80 4,090.80
Dec 21, 2011 4,053.10 4,147.40 4,072.70 4,139.50
Dec 20, 2011 4,060.60 4,076.30 4,050.30 4,053.10

Thus, the market return on the same window is 0.88%.

  • The market segmentation has occurs, it seems, has not taken the information too badly as the prices for the market are almost in tune with the way that the share prices have performed in the same window. However, it is important to note that the market index comprises of 199 other companies and have enormous number of factors contributing towards the index. Also, the change in the capital structure of Adelaide by way of this announcement is not of huge significance to the company itself. So, there were no chances of any impact on the market due to this announcement.
  • With regards to the debt to equity structure post the crisis, we have seen that the company has reduced its debts immediately post the crisis for two years before going into the markets for more funds in 2011 which was done again in 2012. The company has used the forecasts for the credit markets as a key indicator for the way that it has approached the debt markets. The company has relied more on the debt side for financial flexibility instead of raising additional equity as it gives the company more control on the way that the finance is used.With respect to peers and competition like Boral Ltd, we have seen similar trends where in the companies have reduced debts till 2010 and then taken on more debts in 2011 which has been paid off in the subsequent years(MorningStarDatAnalysis).

Question- 3: Valuations

(i) Calculation

There are various ways to value a stock. The value of a stock is nothing but the present value of all its future cash flows. The Dividend Discount model of valuation uses the concept of present value of all future dividends for a shareholder. Adelaide Brighton Ltd is a dividend paying company and it has a track record of paying dividends regularly to its shareholders. If a company is in its initial phase, it normally does not pay any dividend. In such cases Dividend Discount Model is not the appropriate way to value the stock of the company. But, for the companies which are paying dividends regularly, Dividend Discount method is the most appropriate method for valuation of stocks. So, let us use this method to value the stocks of Adelaide Brighton Ltd.

The Dividend Discount method uses different ways of calculations based on the growth characteristics of the company. So, let us start with analysing the growth rate of the company.

  • Growth (g): In this method, growth rate refers to the expected rate of growth in dividend pay-outs. If we look at the dividends paid by the company over the last 10 years (Appendix-A), the company has paid the dividends every year. The average year-on-year growth in the dividend is 15.72%. However, the variation in the amount of dividend paid is very high. So, it will be inappropriate to consider this average figure as the growth rate in the dividend. But, we can drive home a point that the company is paying dividend regularly. On the other side, the dividend forecast for the next 2 years suggests slow and steady growth rate in dividends(MorningStarDatAnalysis) (Appendix-B). Therefore, for the purpose of valuation of stock of the company, we will take analyst forecast as the value of constant growth till perpetuity. The forecast suggest a growth rate of around 6% for the company.

The formula to calculate value of the stock using Dividend Discount Model is:

Now, let us estimate the values of other components of value of stock i.e. R and D0.

  • R is the required rate of return for shareholders and investors. The required rate of return can be calculated from the values of Beta of the company, Risk Free Rate and Market Return.
    • Beta: Beta measures the riskiness of the stock. It is actually regression coefficient of stock return against market return. Beta of market return in 1 and the any value above 1 suggests that the stock is riskier than the market and any value below 1 suggests that the stock is less risky than the market. The beta of Adelaide Brighton Ltd is 86 (MorningStarDatAnalysis) (Appendix-C).
    • Risk Free Rate (Rf): The best measure to estimate the risk free rate is the rate of return on long term government securities. The 10-year Bond rate in Australia is 31% as on 15th October 2014(MorningStarDatAnalysis) (Appendix-D).Let us take that as Risk Free rate.
    • Market Return (Rm): The market is return in this case will be the historical market return on Australian Stock Market. Last 3 years figures suggest strong returns, but the world faced economic crisis during 2008 to 2011. Taking that into consideration will not give us accurate estimation of market return. The analysis of returns of last 20 years or even 100 years gives the average return of 3% (AXA Australia). Let us take that as market return for valuation purpose.
    • Above estimated values of beta, risk free rate and market return gives us the value of required rate of return as 90% (=Rf + Beta * (Rm – Rf).
  • The other component of dividend discount method is D0e. the last paid dividend.The company paid total dividend of 0.195 (19.50 cents) in the year of 2013(MorningStarDatAnalysis). As we are valuing the stock as on the end of 2013, this will be our D0.

Using the above estimates and formula, the value of the stock of the company comes out to be:

It is important to note that the stock is valued as on the 2013 year end.

(ii) Comparison with actual

The value of the stock calculated above is $3.50, while the closing price of the stock as on 31st December, 2013 was $3.67 and the closing price of the stock as on 14stOctober, 2014 was $3.19(MorningStar DatAnalysis).

The stock was overvalued at the time of 2013 year end as the closing price of the stock is higher than our calculated value. This difference in the calculated value and the actual price is because of many reasons. The actual price of the stock depicts the sentiments of the investors. They may be pricing this stock based on their own estimation, assumptions and expectations. Also, it was the time when the company was yet to declare its financial results and final dividend. It is a well-known concept that the share price increases at the time of declaration of dividend. All these points explain the difference between the actual share price and the calculated value of the share.

However, the company’s share experienced decline since then. The current share price is just $3.19. At this price, the stock is under-priced. But, it is important to note that the share prices have declined in last 2 months only, otherwise it was on upward path only. Again the reason for this difference is the difference in the market sentiments driven by the minds of individual investors. Further analysis of the recent events would give us more reasons for the decline in the prices.

Overall, we can say that the stock is under-valued at the moment and a strong buy is recommended based on the above valuation of the stock. However, the recommendation is based on the assumptions made in the valuation process and the accuracy of the data used from the secondary sources.

References:

MorningStarDatAnalysis, n.d., Company Reports: Adelaide Brighton Limited, Available at: http://datanalysis.morningstar.com.au.ezproxy.lib.monash.edu.au/af/company/corpdetails?ASXCode=ABC&xtm-licensee=datpremium>, accessed on 11 to 15 October, 2014.

Annual Report of Adelaide Brighton Ltd, 2011, Adelaide Brighton Ltd Annual Report for the year 2011.

Official Website of Adelaide Brighton Ltd, n.d., About Us, available at: http://www.adbri.com.au/, Accessed on 10th October, 2014.

AXA, n.d., 109 years of Australian share market returns, available at: http://www.crcfs.com.au/uploads/file/109%20years%20of%20All%20Ords%20returns.pdf, Accessed on 13th October, 2014.

Australian Securities Exchange Ltd, n.d., Announcement by Adelaide Brighton Ltd on 22.12.2013, available at: http://www.aspecthuntley.com.au.ezproxy.lib.monash.edu.au/asxdata/20111222/pdf/01255999.pdf#search=%22%22, accessed on 11th October, 2014.