The assignment is about financing decisions to be taken by the investor by considering various alternatives. JB Hi Fi Company has been considered for analysis of the variance in decision by making changes in the interest rates. The company was founded by Keillor east, in 1973 headquartered in Australia. The company provides consumer goods such as Blu rays, DVDs, Video games and many more.
Compound annual growth rate is a technique which is used to analyze the growth rate of the company by considering future years. It defines the relationship between the return on the investment and initial investment of the project. Compound annual growth rate can be calculated as follows:
(EV/BV)1/n -1
Here in the above formula,
EV is called as expected value at the end of the life of the project,
BV is called as beginning value at the initial stage of the project,
N is number of year for which the project is held.
In the given case of JB Hi Fi limited, the expected value has been taken of operating revenue for the year 2016, while the beginning value is considered as of 2012. The assignment has considered the operating revenue for 5 years (Hirschey, 2010).
|
Operating revenue of JB Hi Fi (m$) |
||
|
2012 |
312779 |
|
|
2013 |
330840 |
|
|
2014 |
348389 |
|
|
2015 |
365214 |
|
|
2016 |
395447 |
|
|
No. of year |
5 |
|
|
CAGR |
5% |
|
Operating revenue of JB Hi Fi (m$) |
||
|
2012 |
312779 |
|
|
2013 |
330840 |
|
|
2014 |
348389 |
|
|
2015 |
365214 |
|
|
2016 |
395447 |
|
|
No. of year |
5 |
|
|
CAGR |
5% |
|
|
Expected revenue for 2021-2021 |
$499,964.29 |
If the CAGR is assumed to be same as that in 2016, the expected revenue would be 499964.29$.
|
JB Hi Fi Limited (m$) |
||
|
2015 |
2016 |
|
|
Interest expense |
5.93 |
3.86 |
|
Long term debt |
139.46 |
109.74 |
|
Interest rate per annum |
4.25% |
3.52% |
|
Interest rate per month |
0.35% |
0.29% |
|
Loan amount |
800000 |
800000 |
|
Interest rate monthly |
0.35% |
0.29% |
|
Months |
12 |
48 |
|
Tax deduction during the financial year 1st July to 30th June 2017 |
||
|
Interest expense |
33600 |
|
|
Tax rate |
30% |
|
|
Tax deduction |
10080.00 |
|
|
Tax deduction during the financial year 1st July 2019 to 30th June 2020 |
||
|
Interest Expense |
111360 |
|
|
Future value of interest |
$919,297.95 |
|
|
Tax rate |
30% |
|
|
Tax deduction |
$275,789.38 |
The financial data has been calculated from the annual report of JB Hi Fi limited of 2015 and 2016. The tax rate in Australia in case of companies is 30%. By applying the given tax rate, the company would get tax advantage due to involvement of interest expenses is 10080 in financial year 2016-2017 (Australian government, 2017). In case of financial year 2019-2020, the company would get the future value of $919297.95. It has been assumed that the tax rate was same as 30% in financial year 2019-2020.
|
Particulars |
Option 1 |
Option 2 |
Option 3 |
|
Investment |
2000000 |
2000000 |
2000000 |
|
Interest rate |
4.20% |
4.14% |
|
|
Duration (in months) |
6 |
36 |
3 years |
|
Face value |
100 |
||
|
Current Price |
88.45 |
||
|
Number of bonds |
20000 |
||
|
Money need to be invested now |
$1,562,513.15 |
$464,298.58 |
$ 1,769,000.00 |
|
Future Value |
$2,559,978.45 |
$8,615,145.88 |
$2,000,000.00 |
The company has 2million with it at present which it wants to invest in various investments. By analyzing the three alternatives available to the company, it is advisable that company should opt for 2nd alternative, the reason being is the money would be least invested at present. While by analyzing the future cash flows from the investments, it is said that the company would receive highest amount of cash in case of 2nd alternative (Investing. Com, 2017).
|
Yield on 10 year bond |
2.67% |
|
Basis point |
3.25% |
|
Yield on bond |
5.92% |
Yield is a return which is expected by the investor from the project in which he has invested his money. Two type of yield exist in case of bonds which are market yield and current yield. The only difference between these two is price that is market yield considers the market price of the bonds, while current yield considers the face value of the bonds. By doing yield analysis of the company, yield on bond has been calculated as 5.92% (Fabozzi, Martellini, Priaulet, 2006).
|
Yield on 2 year bond |
1.73% |
|
Basis point |
3.25% |
|
Yield on bond |
4.98% |
By reducing the tenure of bonds, it has been analyzed that the yield on bond also got reduced. In case of the above calculations, the yield on bond has been reduced from 10 to 5 years, the yield on bond is also reduced from 5.92% to 4.98%.
Interest rate of a bond comprises of inflation, recession, risk free rate and risk premium of the bond. In the given question if Australian economy is assumed as having declining growth rate, it would lead to decrease in the interest rates on bonds. This is done by the reserve bank of the nation to bring a balance between the demand and supply of the bonds. If the investor would be having pessimistic attitude towards the economy, the interest rate of the bonds would lead to decrease due to which, the price of the bond would increase in the market.
If assumption of pessimistic attitude of the investors towards the economy of Australia is considered as true, it can lead decrease in the rate of bonds and as a result would lead to increase in price of the bonds. In the example if interest rate is reduced due to recession in the economy has lead to increase in the price of the bond by 1.01$ (The Bloombergm, 2017).
|
Face value |
100 |
|
Terms (Semi years) |
10 |
|
Coupon rate |
5.75 |
|
Yield to maturity |
5.75 |
|
Half yearly interest |
2.875 |
|
Yield to maturity (Half yearly) |
2.875 |
|
Price of bond |
$ 1.00 |
|
Face value |
100 |
|
Terms (Semi years) |
10 |
|
Coupon rate |
5.75 |
|
Yield to maturity |
3.5 |
|
Half yearly interest |
2.875 |
|
Yield to maturity (Half yearly) |
1.4375 |
|
Price of bond |
$ 2.013 |
CAPM is also called as capital asset pricing model. It is a technique used by the investor to get an analysis over risk and return of the securities of the company. The analysis between risk and return helps the investor in selecting the best project out of various alternatives. It helps the investor in calculating the required rate of return for undertaking the risk in the project. Capital asset pricing model can be calculated by the given formula:
Ra= Rf+ β (Rm-Rf)
Here,
Rf= risk free rate
β= beta
Rm= market risk
Here Rm-Rf is also called as risk premium
|
CAPM on 30th June, 2015 |
|
|
Risk free rate |
2.99% |
|
Market premium |
6.80% |
|
Beta |
0.55 |
|
CAPM |
6.73% |
In the above calculations, the risk free rate has been taken as yield to maturity of 10 year Australian government bond. The market price of the bond was given as of 6.80%. The risk rate of the bond is 0.55. According to these factors, the required rate of return as on 30th June 2015, of the company has been calculated as 6.73% (Giovanis, 2010).
|
CAPM on 30th June, 2016 |
|
|
Risk free rate |
2.01% |
|
Market premium |
6.80% |
|
Beta |
0.55 |
|
CAPM |
5.75% |
By analyzing the above calculation the capital asset pricing model of the company has been calculated as 5.75% which is lower than that of 30th June, 2015 due to fall in risk free rate.
|
Risk free rate |
2.99% |
|
Market premium |
6.80% |
|
Beta |
0.2 |
|
CAPM |
4.35% |
If the beta factor is reduced from 0.55 to 0.2, it would lead to reduction in required rate of the company to 4.35% as compare to that of in 30th June 2016 (Reuters, 2017).
|
JB Hi Fi Limited (in m$) |
||
|
Free cash flows |
||
|
2015 |
2016 |
|
|
operating cash flows |
179.9 |
185.14 |
|
Capital expenditure |
44.87 |
52.34 |
|
Free cash flows |
135.03 |
132.8 |
|
Return on invested capital |
||
|
2015 |
2016 |
|
|
Equity |
343.48 |
404.7 |
|
Debt |
139.46 |
109.74 |
|
Total capital |
482.94 |
514.44 |
|
Net profit |
137.63 |
152.81 |
|
Dividend |
87.17 |
43.2 |
|
Return on invested capital |
10% |
21% |
In the above calculations, the free cash flows have been calculated by subtracting the capital expenditures from the operating cash flows of the company. In case of return on invested capital, it has been calculated by (net profit – dividend) total capital of the company.
While analyzing the above calculation it has been analyzed that the free cash flows of the company have not major differences as from 2015 to 2016. In case of return on invested capital, in 2016 the return has increased by 11%, this was due to increase in the net profits, reduction in dividend paid and increase in the total capital of the company (Annual Report, 2017).
Conclusion
After analyzing the assignment, it has been concluded that the by reducing the risk aversion rate of the company, it would result into decrease in the required rate of return. Company can get sufficient tax advantages by investing in debt securities.
References
Annual Report (2017),. Annual report 2016 with chairman report. Retrieved on 28 March, 2017 from https://www.jbhifi.com.au/General/Corporate/Shareholder-Matters/Financial-Annual-Reports/
Australian government,. (2017) Company tax rates. Retrieved on 28 March, 2017 from https://www.ato.gov.au/Rates/Company-tax/
Fabozzi, F.J., Martellini, L., Priaulet, P,. (2006). Advanced Bond Portfolio Management: Best Practices in Modeling and Strategies. John Wiley & Sons.
Giovanis, E. (2010),. Application of Capital Asset Pricing (CAPM) and Arbitrage Pricing Theory (APT) Models in Athens Exchange Stock Market. GRIN Verlag.
Hirschey,. (2010). Investments : Analysis And Behaviors. Tata McGraw-Hill Education.
Investing. Com,. (2017) Australia 10- year bond yield. Retrieved on 3rd April, 2017 from https://www.investing.com/rates-bonds/australia-10-year-bond-yield-historical-data
Reuters,. (2017) JB Hi-Fi Ltd (JBH. AX). Retrieved on 3rd April, 2017 from https://www.reuters.com/finance/stocks/overview?symbol=JBH.AX
The Bloombergm. (2017) Government bond yields. Retrieved on 4th April, 2017 from https://www.bloomberg.com/markets/rates-bonds/government-bonds/australia
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