|
Calculation of weighted Average Cost of Capital (WACC) of CFTP |
|||
|
Sources |
Cost (%) |
Weightage (%) |
Proportionate cost (%) |
|
Cost of equity |
4.81 |
90.94 |
4.38 |
|
Cost of debt |
4.44 |
9.06 |
0.40 |
|
Weighted Average Cost of Capital |
4.78 |
|
Calculation of weighted Average Cost of Capital (WACC) of TP Division |
|||
|
Sources |
Cost (%) |
Weightage (%) |
Proportionate cost |
|
Cost of equity |
10.94 |
90.94 |
9.95 |
|
Cost of debt |
4.44 |
9.06 |
0.40 |
|
Weighted Average Cost of Capital |
10.35 |
Since the beta of equity of TP Division of 1.9 is same with that of the industry beta the business risk of TP Division is lower than the industry. Generally an organization having same beta will be considered to be less risky to invest than the industry as the industry as a whole provides an overall average of risk of different firms and organization in it (Baker and Wurgler 2015).
|
Forecast Free Cash Flow for SP without expansion ($’000) |
||||||
|
Year |
1 |
2 |
3 |
4 |
5 |
6 |
|
Sales |
45,000.00 |
46,800.00 |
48,672.00 |
50,132.16 |
51,636.00 |
52,668.72 |
|
Variable cost |
(20,250.00) |
(21,060.00) |
(21,902.40) |
(22,559.47) |
(23,236.20) |
(23,700.92) |
|
Fixed cost |
(4,050.00) |
(4,131.00) |
(4,213.62) |
(4,297.89) |
(4,383.85) |
(4,471.53) |
|
Depreciation |
(2,000.00) |
(2,050.00) |
(2,100.00) |
(2,150.00) |
(2,200.00) |
(2,250.00) |
|
Operating income |
18,700.00 |
19,559.00 |
20,455.98 |
21,124.80 |
21,815.95 |
22,246.27 |
|
Tax (30%) |
(5,610.00) |
5,867.70 |
6,136.79 |
6,337.44 |
6,544.78 |
6,673.88 |
|
Net income |
13,090.00 |
13,691.30 |
14,319.19 |
14,787.36 |
15,271.16 |
15,572.39 |
|
Depreciation |
2,000.00 |
2,050.00 |
2,100.00 |
2,150.00 |
2,200.00 |
2,250.00 |
|
Operating cash flow |
15,090.00 |
15,741.30 |
16,419.19 |
16,937.36 |
17,471.16 |
17,822.39 |
|
Investment in fixed assets |
(1,400.00) |
(1,400.00) |
(1,400.00) |
(1,400.00) |
(1,400.00) |
(1,400.00) |
|
Investment in working capital |
(180.00) |
(187.00) |
(187.20) |
(146.02) |
(150.38) |
(103.27) |
|
13,510.00 |
14,154.30 |
14,831.99 |
15,391.34 |
15,920.78 |
16,319.12 |
(Brooks 2015)
|
Year |
1 |
2 |
3 |
4 |
5 |
|
Sales |
45,000.00 |
46,800.00 |
48,672.00 |
50,132.16 |
51,636.00 |
|
Variable cost |
(20,250.00) |
(21,060.00) |
(21,902.40) |
(22,559.47) |
(23,236.20) |
|
Fixed cost |
(4,050.00) |
(4,131.00) |
(4,213.62) |
(4,297.89) |
(4,383.85) |
|
Depreciation |
(2,000.00) |
(2,050.00) |
(2,100.00) |
(2,150.00) |
(2,200.00) |
|
Operating income |
18,700.00 |
19,559.00 |
20,455.98 |
21,124.80 |
21,815.95 |
|
Tax (30%) |
(5,610.00) |
5,867.70 |
6,136.79 |
6,337.44 |
6,544.78 |
|
Net income |
13,090.00 |
13,691.30 |
14,319.19 |
14,787.36 |
15,271.16 |
|
Depreciation |
2,000.00 |
2,050.00 |
2,100.00 |
2,150.00 |
2,200.00 |
|
Operating cash flow |
15,090.00 |
15,741.30 |
16,419.19 |
16,937.36 |
17,471.16 |
|
Investment in fixed assets |
(1,400.00) |
(1,400.00) |
(1,400.00) |
(1,400.00) |
(1,400.00) |
|
Investment in working capital |
(180.00) |
(187.00) |
(187.20) |
(146.02) |
(150.38) |
|
Free cash flow |
13,510.00 |
14,154.30 |
14,831.99 |
15,391.34 |
15,920.78 |
|
Present value [email protected] 7.875% per annum (Tax Adjusted) |
0.93 |
0.86 |
0.80 |
0.74 |
0.68 |
|
Present value of free cash flows |
12,523.75 |
12,163.17 |
11,815.09 |
11,365.62 |
10,898.34 |
|
Terminal value |
Amount ($) |
|
Present value of free cash flows in five years |
58,765.97 |
|
Add: Long-term growth |
138,391.59 |
|
Terminal Value ($) |
197,157.56 |
|
Year |
Expansion |
Discounted Value @10.35% per annum |
|
t=1 |
(4,000.00) |
(4,000.00) |
|
t=2 |
1,000.00 |
906.21 |
|
t=3 |
2,000.00 |
1,642.42 |
|
t=4 |
3,000.00 |
2,232.57 |
|
t=5 |
6,000.00 |
4,046.34 |
|
NPV |
4,827.53 |
|
After-tax cash flow projections for ‘Expansion’ next year ($’000) |
|
|
Year |
Expansion |
|
t=1 |
-4000 |
|
t=2 |
1000 |
|
t=3 |
2000 |
|
t=4 |
3000 |
|
t=5 |
6000 |
|
Value of the option at year 0 |
8000 |
|
Value of abandonment |
Amount($’000) |
|
Proceed at the beginning of year 2 |
120,000.00 |
|
Present value @10.35% Pa |
108,744.90 |
|
Less: Investment |
4,000.00 |
|
|
104,744.90 |
|
Add: Present value of year 1 cash inflow |
906.21 |
|
Value of abandonment |
105,651.11 |
|
Particulars |
Amount ($) |
|
Free cash flow in 2017 |
48,100,000.00 |
|
Less: Free cash flow in year 1 |
13,510,000.00 |
|
Economic depreciation |
34,590,000.00 |
The shareholders would mostly be concerned with the decline in Earnings per share (EPS) and dividend per share. As can be seen from the brief financial statement of the organization that compare to 2016 when the EPS and dividend were 198 cents and 80 cents respectively both hjave reduced substantially in the year 2017 with 116 cents and 35 cents respectively (Rossi 2015).
The worst feature of long term incentives on Botanica would be the excessive operating costs and resultant cash outflow which could have major impact on the profitability of the organization as well as on its liquidity position in the future (Motta and Ferraz 2015).
|
Calculation of weighted Average Cost of Capital (WACC) of CFTP |
|||
|
Sources |
Cost (%) |
Weightage (%) |
Proportionate cost (%) |
|
Cost of equity |
11.25 |
0.60 |
6.75 |
|
Cost of debt |
4.45 |
0.40 |
1.79 |
|
Weighted Average Cost of Capital |
8.54 |
CFTP would use retained earnings in which the company has an unutilized balance of $23168000.00 to finance the expansion strategy requiring $4000000.00.
The final dividend should not be exceeded 35 cents per share at any cost. This is because of the expansion strategy that the company has in front of it which require an additional $4000000.00 to materialize thus, the cash outflow should be as low as possible to arrange the funds required for expansion project (Borenstein 2017).
Implied dividend on the basis of the share price at the end of 2017 after taking into consideration cost of equity and assumed growth rate is as followed:
|
Growth rate |
2.50% |
|
Cost of equity |
4.78% |
|
Share price ($) |
7.27 |
|
Implied dividend ($) |
0.17 |
Yes, the amount of implied dividend is very much achievable.
In order attract re-investment often companies increase discount on DRPs however, in this case CFTP should not increase DRPs on its dividend for 2017 as the company does not require huge amount of re-investment for its expansion project.
Frank, M.Z. and Shen, T., 2016. Investment and the weighted average cost of capital. Journal of Financial Economics, 119(2), pp.300-315.
Bodie, Z., 2013. Investments. McGraw-Hill.
Baker, M. and Wurgler, J., 2015. Do strict capital requirements raise the cost of capital? Bank regulation, capital structure, and the low-risk anomaly. The American Economic Review, 105(5), pp.315-320.
Brooks, R., 2015. Financial management: core concepts. Pearson.
Brotherson, W.T., Eades, K.M., Harris, R.S. and Higgins, R.C., 2015. ‘Best Practices’ in Estimating the Cost of Capital: An Update.
Franks, D.M., Davis, R., Bebbington, A.J., Ali, S.H., Kemp, D. and Scurrah, M., 2014. Conflict translates environmental and social risk into business costs. Proceedings of the National Academy of Sciences, 111(21), pp.7576-7581.
Hull, J.C., 2014. The evaluation of risk in business investment. Elsevier.
Huikku, J., Mouritsen, J. and Silvola, H., 2017. Relative reliability and the recognisable firm: Calculating goodwill impairment value. Accounting, Organizations and Society, 56, pp.68-83.
vom Brocke, J. and Sonnenberg, C., 2015. Value-orientation in business process management. In Handbook on Business Process Management 2 (pp. 101-132). Springer Berlin Heidelberg.
Larson, E.W. and Gray, C., 2013. Project Management: The Managerial Process with MS Project. McGraw-Hill.
Crill, R., Hanchar, J., Gooch, C. and Richard, S., 2014. Net Present Value Economic Analysis Model for Adoption of Photoperiod Manipulation in Lactating Cow Barns.
Rossi, M., 2015. The use of capital budgeting techniques: an outlook from Italy. International Journal of Management Practice, 8(1), pp.43-56.
Stiglitz, J.E. and Rosengard, J.K., 2015. Economics of the Public Sector: Fourth International Student Edition. WW Norton & Company.
Borenstein, S., 2017. Private Net Benefits of Residential Solar PV: The Role of Electricity Tariffs, Tax Incentives, and Rebates. Journal of the Association of Environmental and Resource Economists, 4(S1), pp.S85-S122.
Anderson, V., 2014. Alternative Economic Indicators (Routledge Revivals). Routledge.
Motta, R.S.D. and Ferraz, C., 2015. Estimating timber depreciation in the Brazilian Amazon.
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