What Is The Performance Measures Of Shareholders Wealth?
The assignment is about the expansion plan of Saturn Petcare for which the company has two sites in mind where the company can incorporate plant for the purpose of production. The sites which are available for selection are Bathurst site and Wodonga Site. The company in order to select an effective site between the two sites available will be conducting capital budgeting techniques. The above figures which are given shows calculations for the capital budgeting techniques which are applied. As shown in the figures, the capital budgeting involves calculation of NPV of the options, payback period of the options, profitability index. While conducting the analysis on the basis of the capital budgeting techniques and computations, it is clear that the site at Wodonga is the best option which the company has and it is better than Bathurst site. The NPV of the Bathurst Site which is $ 58,44,567 which is much less to the NPV as calculated for Wodonga Site which is shown at $ 95,94,827. This signifies that the future discounted cash flows of Wodonga Site is much better than the results of Bathurst Site. In addition to this, the profitability index which is calculated shows that the profitability of Wodonga site is much more than the Bathurst Site which shows that the Business will be earning more profits in Wodonga Site. The payback period of the site is also lesser in comparison with Bathurst site which shows that the company will be able to recover its investments earlier in case of Wodonga site. management, it must be selected by the company.
Product Cannibalization is a technique which is used by companies in order to introduce a new product in marketing. In this process the sales volume and sales revenue which is generated from one product is reduced so that the such resources can be used in the introduction of another product in the market (Barroso & Giarratana, 2013). In this case, the company is engaged in manufacture of pet care products and therefore it is entirely possible that the business uses product cannibalization for introduction of new pet care products into the market.
As per the question, Nathan who is one of the director of Saturn Pet care is of the opinion that the estimated sales which is estimated by the marketing department is much higher than what it actually ought to be. The management of the company needs to ensure that such is rectified immediately as they misrepresented the plans of the management. The company can record certain expenses in excess so that the excess revenue which is shown by higher sales is neutralized.
Another concern of Nathan is that the value of property of Wodonga site should be taken as its original value. This is incorrect assumption as only the new property which the management is constructing for the project is to be considered a part of initial investment and not value of old property. If the original cost of the property is included than the results will be unrealistic and such will hamper the results of NPV, Profitability Index and Payback period (Rodrigues et al., 2016).In this part of the assignment significant ratios are to be calculated and the same is to be analyzed as well. The assignment will also be analyzing the capital structure of the ARB corporation ltd.in addition to this, the financial performance of ARB corporation ltd will be compared with a similar company which belongs to the same Industry as ARB corporation ltd. ARB Corporation ltd has a business of manufacturing of road motor vehicles and accessories.
Capital structure may be defined as the capital mix which is used by the business to finance different business operations and at the same time minimize the risks which are associated with different capital sources (Graham, Leary & Roberts, 2015). The capital structure of the company shows that the capital structure of the company is only made up of equity share capital and no portion of debt capital is included in the capital structure mix of the company (Campello & Giambona, 2013).
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CURRENT CAPITAL STRUCTURE: |
||
|
Particulars |
Amount |
Weightage |
|
(in ‘000s) |
||
|
Total Equity |
$2,72,341 |
100% |
|
Secured Borrowings |
$0 |
0% |
|
TOTAL CAPITAL |
$2,72,341 |
100% |
(Table Showing capital structure of ARB Ltd)
Source: (Created by Author)
As shown in the table above, the company as per current situation does not have debt capital but uses equity capital which is shown as $ 2,72,341.
The cost of equity for the current year following the general formula for computing cost of equity is shown as 18.05% which has reduced from the estimate of previous year which was 19.01%. As the business is not using any debt capital in the capital mix therefore the cost of debt of the company will be zero and thereby the cost of equity will be the Weighted Average Cost of Capital (WACC) for the year (Barth, Konchitchki & Landsman, 2013). However, when the cost of equity is calculated following Capital Asset Pricing Model (CAPM) the results are different and the cost of equity is shown at 7.906%. For the purpose of calculating Cost of equity following CAPM method, the company needs to consider market return rate which is 8.54% and also beta which is given as 0.84. Beta represents the risk factor in the CAPM model (Boujelbene & Affes, 2013). The cost of equity which is calculated under CAPM model signifies that the company is meeting the expectations of the shareholders as the market return is more than the expected cost of capital (Dempsey, 2013).
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Cost of Equity under CAPM: |
|
|
Particulars |
Amount |
|
Beta |
0.89 |
|
Market Return |
8.54% |
|
Risk Free Rate |
2.78% |
|
Expected Cost of Equity |
7.906% |
(Table Showing Cost of Equity under CAPM Model over the years)
Source: (Created by Author)
The company which is selected for this part is Modine ltd which is a manufacturing concern and also belongs to the same industry as ABR ltd. The capital structure of the company is made up by both equity share capital and debt capital. The equity share capital of Modine ltd is shown in the table below as $ 421.20 million and the debt capital of the company which is shown in the table below as $ 519.90 million. The capital structure of Modine ltd suggests that it is balanced and favorable as the company makes use of both debt and equity sources of capital. In this way the company is able to achieve a capital structure which can minimize the risks of the business. In the case of ABR ltd, the company only uses equity source of capital and thereby makes the capital structure of the business only equity based which can be risky. In addition to this, the interest which is paid on the debt capital of the company is a deductible expense under tax and therefore it can be said debt capital also provides tax advantage (Feld, Heckemeyer & Overesch, 2013). It can be concluded that the capital structure of Modine ltd is much better than ABR Corporation ltd.
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COMPARISON with MODINE MANUFACTURING COMPANY |
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|
ARB |
MODINE |
|||
|
Particulars |
Amount |
Weightage |
Amount |
Weightage |
|
(in ‘000s) |
(in million) |
|||
|
Total Equity |
$2,72,341 |
100% |
$421.20 |
45% |
|
Secured Borrowings: |
||||
|
Short Term Debt |
$73.4 |
|||
|
Current Portion of Long Term Debt |
$31.8 |
|||
|
Long Term Debt |
$405.7 |
|||
|
Total Secured Borrowings |
$0 |
0% |
$510.90 |
55% |
|
TOTAL CAPITAL |
$2,72,341 |
100% |
$932 |
100% |
(Table Showing Comparison between ABR Ltd and Modine Ltd)
Source: (Created by Author)
In the above table as it is shown that the WACC of the company is made up of equity share capital as shown in the year 2017 (Zeitun, & Tian, 2014). However, this was not the case always, as the table shows that the company had debt capital in the capital mix in 2015 where the WACC is 19.39%. The cost of equity has fallen from previous year’s estimate which was 19.01% and for the current year it is 18.05%. The changes in WACC of the company shows that there is decreasing trend when compared to the table shown above.
|
WACC: |
||||
|
Particulars |
2017 |
2016 |
2015 |
2014 |
|
(in ‘000s) |
(in ‘000s) |
(in ‘000s) |
(in ‘000s) |
|
|
Net profit after Tax |
$49,152 |
$47,439 |
$44,093 |
$42,570 |
|
Total Equity |
$2,72,341 |
$2,49,608 |
$2,26,348 |
$1,97,814 |
|
Cost of Equity |
18.05% |
19.01% |
19.48% |
21.52% |
|
Weightage of Equity |
100.00% |
100.00% |
99.12% |
100.00% |
|
Interest Expenses for secured borrowings |
0 |
0 |
220 |
0 |
|
Secured Borrowings |
$0 |
$0 |
$2,000 |
$0 |
|
Cost of Debt |
0% |
0% |
11.00% |
0% |
|
Weightage of Debt |
0% |
0% |
1% |
0% |
|
Tax Rate |
30% |
30% |
30% |
30% |
|
WACC |
18.05% |
19.01% |
19.39% |
21.52% |
(Table Showing WACC changes over the years)
Source: (Created by Author)
|
CHANGE in CAPITAL STRUCTURE: |
||||||||
|
2017 |
2016 |
2015 |
2014 |
|||||
|
Particulars |
Amount |
Weightage |
Amount |
Weightage |
Amount |
Weightage |
Amount |
Weightage |
|
(in ‘000s) |
(in ‘000s) |
(in ‘000s) |
(in ‘000s) |
|||||
|
Total Equity |
$2,72,341 |
100% |
$2,49,608 |
100% |
$2,26,348 |
99% |
$1,97,814 |
100% |
|
Secured Borrowings |
$0 |
0% |
$0 |
0% |
$2,000 |
1% |
$0 |
0% |
|
TOTAL CAPITAL |
$2,72,341 |
100% |
$2,49,608 |
100% |
$2,28,348 |
100% |
$1,97,814 |
100% |
|
Change in Total Capital |
9.11% |
9.31% |
15.44% |
(Table Showing Changes in Capital Structure of the ABR ltd)
Source: (Created by Author)
As per the calculations shown in the table below which is regarding the calculation of NOPAT (Fernandez, 2015). The shareholder wealth statement shows that the company has not achieved that much growth in recent years and therefore are not able to follow the wealth maximization principle of shareholders. The main reason which can be identified for the same is no using all resources to its fullest capability (Alam & Nizamuddin, 2013). The company does not use debt capital and this is the area where the business losses its advantage of leverage. The figure of NOPAT has increased from previous year, however there has not been a significant growth in the same.
|
SHAREHOLDER’S WEALTH: |
||||
|
2017 |
2016 |
2015 |
2014 |
|
|
Particulars |
Amount |
Amount |
Amount |
Amount |
|
(in ‘000s) |
(in ‘000s) |
(in ‘000s) |
(in ‘000s) |
|
|
NOPAT |
$49,152 |
$47,439 |
$44,313 |
$42,570 |
|
Total Capital Employed |
$2,72,341 |
$2,49,608 |
$2,28,348 |
$1,97,814 |
|
WACC |
18.05% |
19.01% |
19.39% |
21.52% |
|
Total Capital Cost |
$49,152 |
$47,439 |
$44,269 |
$42,570 |
|
Economic Value Added |
$0 |
$0 |
$44 |
$0 |
The following recommendation can be given to ABR ltd for further improving the capital structure and overall performance of the business:
Conclusion
Thus, from the analysis of the capital structure of ABR ltd, it is clear that the company needs to improve its capital structure in order to bring about a change and growth in the business. The company has increased its equity capital in 2017 and thus increasing the capital structure of the business. In order to improve the NOPAT and increase the shareholders wealth, the company needs to incorporate a debt capital in the capital mix of the business.
Reference
Alam, P., & Nizamuddin, S. (2013). Performance measures of shareholders wealth: An application of economic value added (EVA).
Barroso, A., & Giarratana, M. S. (2013). Product proliferation strategies and firm performance: The moderating role of product space complexity. Strategic Management Journal, 34(12), 1435-1452.
Barth, M. E., Konchitchki, Y., & Landsman, W. R. (2013). Cost of capital and earnings transparency. Journal of Accounting and Economics, 55(2-3), 206-224.
Boujelbene, M. A., & Affes, H. (2013). The impact of intellectual capital disclosure on cost of equity capital: A case of French firms. Journal of Economics Finance and Administrative Science, 18(34), 45-53.
Campello, M., & Giambona, E. (2013). Real assets and capital structure. Journal of Financial and Quantitative Analysis, 48(5), 1333-1370.
Dempsey, M. (2013). The capital asset pricing model (CAPM): the history of a failed revolutionary idea in finance?. Abacus, 49(S1), 7-23.
Feld, L. P., Heckemeyer, J. H., & Overesch, M. (2013). Capital structure choice and company taxation: A meta-study. Journal of Banking & Finance, 37(8), 2850-2866.
Fernandez, P. (2015). EVA and cash value added do not measure shareholder value creation.
Graham, J. R., Leary, M. T., & Roberts, M. R. (2015). A century of capital structure: The leveraging of corporate America. Journal of Financial Economics, 118(3), 658-683.
Palacín-Sánchez, M. J., Ramírez-Herrera, L. M., & Di Pietro, F. (2013). Capital structure of SMEs in Spanish regions. Small Business Economics, 41(2), 503-519.
Rodrigues, S., Torabikalaki, R., Faria, F., Cafôfo, N., Chen, X., Ivaki, A. R., … & Morgado-Dias, F. (2016). Economic feasibility analysis of small scale PV systems in different countries. Solar Energy, 131, 81-95.
Zeitun, R., & Tian, G. (2014). Capital structure and corporate performance: evidence from Jor
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