RaDrones Plc (RaDrones) is an Irish-listed company which manufactures and retails drones at its stores throughout Ireland. RaDrones drones are popular with surveying companies, farmers and hobbyists. The company has experienced high growth rates since it commenced trading in 2010. Since it commenced trading, the company has experienced average annual growth rates of 10% per annum.
However, due to a number of well-publicised cases of drone operators flying recklessly, the Irish airspace regulator introduced mandatory licences for drone operators in December 2017. The process for obtaining a drone pilot licence is estimated to take 12-18 months to complete. RaDrone expects the new regulations will have a significant negative impact on its business.
The company expects its growth rate will drop significantly in 2018 and will gradually recover over a period of 5 years. However, it does not anticipate the growth rate will ever fully recover to the high growth rates experienced during the pre-regulation period. The share price of RaDrones had fallen to €32.50 per share by the end of December 2017.
Additional information for year ended / at the 31st December 2017: Earnings before interest and taxes (EBIT) for 2017: €50 million Capital expenditure for 2017: €20 million Depreciation for 2017: €2 million Revenues for 2017: €120 million Working capital as a percentage of revenues: 10%. Tax rate: 12.5%. Current market value of RaDrones debt: €150 million The risk free rate is 3% and the market risk premium is 5%. The firm has 10 million outstanding shares in issue.
Expected financial information for next 5 year growth-recovery period: Length of growth recovery period: 5 years Expected growth rate for 2018: 1% (increasing by 1% per annum over the next 5 years) Financing details: o Beta during recovery phase: 2.2 o Cost of Debt during recovery phase: 5% (pre-tax) o Debt Ratio during recovery phase: 60%
Expected financial information after 5 recovery period: Expected stable growth rate in FCFF: 6%. Tax Rate: 15% Financing details: o Beta during stable growth phase: 2 o Cost of debt during stable growth phase: 7% (pre-tax) o Debt ratio during stable growth phase: 40% …Question 1 continues over the page.
You may assume that the growth rate affects sales revenue, earnings before interest & taxes (EBIT), capital expenditure and depreciation.
Required:
(a) Use a Free Cash Flow to Firm (FCFF) model, at the end of December 2017, to estimate the value per share of RaDrones shares. (34 marks)
(b) Discuss other valuation methods that could be used to value RaDrones and outline when they might be suitable. (6 marks)
(TOTAL: 40 MARKS)
Question 2 – Bonds
Soze & Sons Shipping Plc (SSS) is a company listed on the Irish Stock Exchange. The company was founded by William Soze in 1902. The company was run and owned entirely by the family until 2015, when it became a listed company. The Soze family still own a combined 20% of the share capital of the company. The Managing Director of SSS is Peter Soze, a descendant of the founder. Peter’s business philosophy was heavily influenced by the opinions of his grandfather; he believes the company should remain entirely equity financed. The company has never, throughout its history, been financed with debt.
When the company was listed on the Irish Stock Exchange in 2015, the Soze family was forced to make significant changes to the company’s board of directors. As a consequence, you were appointed as the company’s Finance Director in late 2015.
In December 2017, Peter calls you into his office to discuss the financial affairs of the company. During this meeting, Peter claims, “Our advisors keeping talking about bonds! They want me to buy them and they want me to sell them. I need your advice.”
Firstly, SSS’s financial advisors have proposed that SSS consider investing any future excess cash by purchasing other companies’ bonds. The advisors produced a report which contains the yield curve below. Peter states during the meeting, “The longer the bond term, the higher the yield. Of course I’m going to invest in the longer term bonds.” Secondly, SSS needs to raise an additional €11 million in capital in order to finance its operations in 2018. During the meeting, Peter states, “I don’t want the company to issue bonds; debt is a very expensive way to finance a company. The 9% rate on the bonds exceeds our current cost of capital.” SSS’s current cost of capital is 8%. You may ignore costs associated with bond issues. The company’s financial advisors have proposed the company undertakes a bond issue; the details of the proposed bonds are listed below: Number of Bonds: 10,000 Bond Face Value: €1,000 Coupon Rate: 9% Maturity Term: 3 years Current Market Value: €1,100 Tax Rate: 12.5%
…Question 2 continues over the page.
Required:
(a) Explain to Peter why investors may prefer to purchase bonds with shorter terms until maturity. (5 marks)
(b) Calculate and explain the financial implications of SSS undertaking the bond issue for the company’s cost of capital. You are required to show all workings. (15 marks)
(c) Explain the benefits and disadvantages of financing a business with equity versus debt. (10 marks)
(TOTAL: 30 MARKS) of 9
Question 3 – Financial Statement Analysis
You are a financial analyst working for a company called Five Worlds Chemicals Ltd (FWC). FWC manufacture and export various chemical products. The directors of FWC feel the company will grow rapidly over the next three years and are focused on increasing the company’s manufacturing capacity to facilitate this future growth. In the recent past, FWC completed a successful share issue and loan application which allowed the company to raise much needed finance. The company now wishes to apply to their bank for a further long-term loan facility. You have been tasked with analysing the business for the purpose of making a loan application and identifying areas of the business which could be improved in order to ensure the loan application is successful. The following extracts from the financial statements of FWC for the year ended 31st December have been made available to you:
Statement of Comprehensive Income / Income Statement 2017 2016 €'000 €'000 Revenue 1,200 810 Cost of Sales (496) (323) Gross Profit 704 487 Administrative Expense (180) (200) Depreciation Expense (50) (44) Operating Expenses (158) (106) Profit Before Tax 316 137 Finance Costs (100) (36) Income Tax Expense (40) (19) Profit from Continuing Operations 176 82
Current Liabilities Trade Payables 250 300 Taxation 100 120 Total Equity and Liabilities 10,105 7,970
Required:
(a) Using financial ratios and the available financial information, analyse the following aspects of FWC’s performance: Profitability Efficiency Leverage Liquidity (24 marks)
(b) Explain the advantages and limitations of the Economic Valued Added (EVA) measure. (6 marks)
'Modigliani and Miller conclude that, in a perfect world, dividend policy should not matter to the value of the firm. Given the world is imperfect relative to the one analysed by Modigliani and Miller, which imperfections suggest that their conclusion might not hold in the world that actually exists? How might these imperfections affect company dividend policy?' (15 marks)
Part (b) Big Ten Four Ltd (BTF) is a listed company which owns and operates fuel stations around Europe. The Managing Director of BTF is Daniel O’Leary. BTF is generates significant cash from operations each year from its existing asset base. However, the company has experienced a lack of available, profitable, investment opportunities over the last number of years. O’Leary is considering using BTF’s excess cash reserves to purchase a large renewable energy company which operates wind farms around Western Europe. O’Leary believes the acquisition will boost BTF’s earnings per share and will diversify the company’s asset base, thereby reducing risk.
Discuss the potential benefits and drawbacks of O’Leary’s acquisition plan.