Financial Analysis of JB Hi-Fi Ltd

This finance assignment focuses on analyzing the company JB Hi-Fi Ltd. It utilizes the Discounted Cash Flow (DCF) model to determine the intrinsic value of its shares and compares it to the market price. Additionally, the assignment applies the Trade-Off Theory to provide recommendations regarding JB Hi-Fi's capital structure, considering the optimal balance between debt and equity financing.

Business Finance

TABLE OF CONTENTS
QUESTION 1..................................................................................................................................3
A Re-estimation of the cost of capital.........................................................................................3
B Cost of bond.............................................................................................................................3
QUESTION 2..................................................................................................................................6
A. Valuation of shares of JB Hi Fi Ltd..................................................................................6
b. Updating the valuation of JB Hi Fi Ltd...................................................................................7
c. Giving recommendations in relation to make investment in the company’s shares................9
QUESTION 3................................................................................................................................10
Giving recommendations to JB Hi Fi Ltd regarding capital structure by using trade-off theory
...................................................................................................................................................10
Table 1Current value of bond..........................................................................................................4
Table 2 Calculation of weighted average cost of capital.................................................................6
Table 3 Free cash flow and data of cash, debt and shares outstanding...........................................7
Table 4 Cost of equity......................................................................................................................7
Table 5Computation of enterprise value..........................................................................................8
Table 6Input for WACC..................................................................................................................8
Table 7Calculaiton of WACC.........................................................................................................8
Table 8Input table for valuation of shares.......................................................................................8
Table 9Second input sheet of valuation...........................................................................................9
Table 10 Calculation of fair value of shares....................................................................................9

QUESTION 1
A Re-estimation of the cost of capital
Cost of capital is the minimum required rate of return that is necessary for Val Ltd to earn
on their total invested or employed money so as to meet their financial obligation.
B Cost of bond
On the issue of bond, Val Ltd will be require to pay interest to the holders in return for
the money acquired, its cost has been computed here as under:
= Coupon rate/Market price*100(1-tax rate)
= ($1000*12.5%)/($1000*92%) * (1-30%)
= 9.51%
Table 1Current value of bond
Years to maturity 20
Principal amount 1000
Coupon rate 12%
Frequency 2
Market interest rate 15%
Periodic interest payment 60
Current value of bond $800.00
Cost of equity capital

Capital assets pricing model (CAPM) is the best model to value the cost of equity capital
through using following formula, mentioned below:
Cost of equity (Ke) = Rf + beta (Rm-Rf) /Risk free-rate + (Val Ltd’s beta*Risk premium)
Here, Rf - Risk-free rate
Rm – Market rate of return
Rm-Rf = Risk premium
Beta 1.6
Risk free rate (Treasury bonds) 3%
Market risk 10.0%
Risk premium (Rm-Rf) 7.00%
Thus, Ke = 3% + 1.6 (10%-3%)
= 3% + 1.6 (7%)
= 3% + 1.6 (7%)
= 3% + 11.2%
= 14.2%
Cost of preference share capital (Kp) – On preference share capital, Val Ltd has to pay
dividend at a decided or pre-determined rate to the share holders. Therefore, its cost can be
computed as follows:
Kp = Annual dividend per share/Market price *100
= 9/63*100
= 14.28%
Cost of debt: On the debt capital, VAL Ltd is liable to pay interest at a decided rate, on such
payment, tax benefits is available, henceforth, cost will be computed as follows:

= Interest/Market value *100 (1-Tax rate)
= (24m*12.5%/24m)*100(1-30%)
= 12.5% (70%)
= 8.75%
Table 2 Calculation of weighted average cost of capital
Source of
finance
Amount invested
(book value) Weight
cost of
capital
weight*cost
of capital
Bonds $20,000,000.00 0.12 9.51% 1.13%
Ordinary
shares $120,000,000.00 0.71 14.20% 10.14%
Preference
shares $4,000,000.00 0.02 14.28% 0.34%
Bank loans $24,000,000.00 0.14 8.75% 1.25%
$168,000,000.00 1.00 12.87%
Thus, as per the findings of the results, it can be seen that Val Ltd has to pay 12.87% to
their fund providers in return for the money invested. Thus, it will be used as a discounting factor
for the stock valuation purpose.
QUESTION 2
A. Valuation of shares of JB Hi Fi Ltd
Rf 7%
Rm 10%
Beta 0.56
CAPM or Ke 9%
P = D / K – G
D = dividend payout ratio
K = required rate of return according to CAPM model

G = Dividend growth rate
When dividend growth is 7.50%
P = .65 / .09 – 0.07
P = $32.5
When dividend growth is 8.75%
P = .65 / .09 – 0.08
= $65
b. Updating the valuation of JB Hi Fi Ltd
Table 3 Free cash flow and data of cash, debt and shares outstanding
2016
Sales 3874.9
Growth versus prior year 5%
EBIT 5% of sales 193.7
Less: Income tax 30% 58.1
Plus: Depreciation 0
Less: Capital expenditures 0
Less: Increase in NWC (20% change in
sales) 36.9
FCF 98.7
Cash 51884
Debt 494664
Shares outstanding 14.02290871
Table 4 Cost of equity
CAPM Assumptions
Ke 6.32%
RFR 8.0%
Beta 0.56
Rm 5%

Table 5Computation of enterprise value
Enterprise Value (EV)
Current Market Price 29
Diluted Shares 14
Market Capitalization 404
Long Term Liabilities 109
Less: Cash & Cash
Equivalents 51
Enterprise Value (in lacks) 462
Table 6Input for WACC
Debt Equity Weightage
E/(D+E) @ Enterprise Value 78.75%
D/(D+E) @ Enterprise Value 21.25%
Interest Rate (%) 13%
Tax Rate (@) 30%
Table 7Calculaiton of WACC
WACC Calculation
WACC 6.84%
Table 8Input table for valuation of shares
Terminal Value
Sum of PV of FCF for explicit forecast 92
WACC 6.84%
Long term growth in Revenues 7%
Present Value of terminal value 92

Table 9Second input sheet of valuation
Equity Value
Enterprise
Value 185
- Debt 109
+ Cash 51
Net Debt 160
Equity Value 345
Table 10 Calculation of fair value of shares
Intrinsic Value
Equity Value 345
Diluted Shares 14
Intrinsic Value 24.58609978
Interpretation
On updating of the data related to cash, debt and outstanding shares it is identified that
fair value of shares is 24.58AUD. Current share price in the market is 28.82 and on comparison
of same with the computed value it is identified that shares are overvalued by 4AUD. One must
not buy firm shares from the secondary market because it is not available at fair price. However,
difference is negligible and paying 4 AUD more for purchase of the relevant company shares is
not a loss making deal for the investor (Damodaran, 2016). Retail investor can also wait for
decline in the shares price. When market price will reduced to level of 24AUD investor can buy
shares from the stock exchange.
c. Giving recommendations in relation to make investment in the company’s shares
Two valuation methods are used to find out fair value of the firm shares. It can be
observed that from the method of dividend growth method that fair value of the firm shares is
32.5 and 35 AUD at rate of 7.50% and 8.50%. Contrary to this, in case of discounted cash flow
model it is identified that share real price is 24.58 AUD. Hence, on comparison it can be said that

there is not a big difference between the share prices that is computed by using both methods.
DCF method is assumed to be best method then dividend growth model. This is because in the
discounted cash flow model first of all cash flow is computed and present value of same is
computed (Shen, Firth and Poon, 2016). Thereafter, relevant cash flows are added and divided by
the issued shares. In this way intrinsic value of shares is computed. In this method overall
business performance and current capital structure is taken in to account. Thus, it can be said that
in the discounted cash flow model shares are valued in very systematic manner. On other hand,
in case of dividend discount model only cost of equity dividend growth rate are considered. Cash
flows are not taken in to account. Hence, DCF model is assumed better then growth model. On
30 June 2016 share price was 24.10 AUD which is almost equal to DCF model result 24.58AUD.
Hence, it is recommended that investment must be made in the firm shares.
QUESTION 3
Giving recommendations to JB Hi Fi Ltd regarding capital structure by using trade-off theory
 Debt: AU$110 (in millions)
 Shareholders’ equity: AU$405 (in millions)
Debt-equity ratio = Debt / equity
= 110 / 405
= .27
Hence, by considering the above ratio it has been analyzed that solvency position of Hi Fi
Ltd was not sound in the year of 2016. Moreover, in accounting period 2016, debt-equity ratio of
the firm was not sound because it is far from the ideal ratio. According to the ideal ratio
company needs to maintain the ratio of .5:1 for strengthening its liquidity position or
performance (Wilson, 2016). According to such aspect Hi Fi Ltd needs to make focus on issue 1
debt instrument in against to 2 equity shares. Trade off theory also helps in determining the fund
which business unit needs to enhance from debt and equity for making proper balance in the
financial structure. Hence, by considering such theoretical framework it can be said that in the

near future business unit needs to place emphasis on raising fund through the means of debt
instrument rather than equity shares.
By keeping all such aspects in mind it can be said company can make improvement in its
solvency aspect. Moreover, when business unit generates more funds from debt instruments then
it is obliged to make interest payment. This in turn imposes high financial burden in front of firm
and affects the profitability aspect in a negative manner (Jacob, Johan Schweizer and Zhan,
2016). Further, in the case of shares company offers dividend to the shareholders only when it
earns enough amount of profit margin. In this way, shares do not impose high financial burden in
front of firm. Hence, in accordance with trade off theory company needs to issue debt instrument
of AU$100 for enhancing fund. In this way, by raising fund through the means of debt Hi Fi Ltd
can make significant improvement in its liquidity position or aspects.

REFERENCES
Books and Journals
Damodaran, A., 2016. Damodaran on valuation: security analysis for investment and corporate
finance (Vol. 324). John Wiley & Sons.
Jacob, M. and et.al., 2016. Corporate finance and the governance implications of removing
government support programs.Journal of Banking & Finance, 63, pp.35-47.
Shen, J., Firth, M. and Poon, W.P., 2016. Credit Expansion, Corporate Finance and
Overinvestment:
Wilson, N., 2016. ESOPs: their role in corporate finance and performance. Springer.