Financial Statement Analysis and Cash Flow

This assignment involves analyzing financial statements to determine the operating free cash flows (OFCF) for a company over several years. It requires calculating net profit before depreciation but after tax, adjusting for changes in fixed assets and working capital, and finally discounting future cash flows to their present value. The analysis aims to understand the company's ability to generate cash from its operations and the value of those future cash flows.

15058285_P58836_assignment 3
ACCOUNTING AND FINANCE
RESEARCH PROJECT
Student number: 15058285
Submission date: 30th September 2016
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EXECUTIVE SUMMARY
After globalisation, companies carry out operations at international level as they operate in different countries across globe.
Thus, in order to sustain in the competitive age, they need huge amount of capital that is collected from debt and equity capital. The
composition of fixed and fluctuating capital that companies use is called capital structure. TUI Group is world’s leading tour company
that provides superior quality services to the global consumers to attain success. It is listed on London Stock Exchange (LSE) and
constutitents of FTSE index and regulated market of the Frankfurt Stock Exchange. This assignment report will lay emphasizes upon
the application of different corporate finance theories like capital structure theory in contxt to TUI Group. Moreover, shareholders
value analysis will be done in order to measures TUI Group’s worth to shareholders. Along with this, sensitivity analysis will be done
to assess the potential change in business performance with the market uncertainties.
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Table of Contents
INTRODUCTION........................................................................................................................................................................................3
1.TUI’s capital structure under the light of finance models.....................................................................................................................3
2. TUI’s market evaluation.....................................................................................................................................................................10
A. Weighted Average Cost of Capital for TUI.......................................................................................................................................10
B. Shareholder Value Analysis Model...................................................................................................................................................14
C. Value Drivers.....................................................................................................................................................................................17
D. Practically Application Difficulties of SVA......................................................................................................................................19
E. Market Value of TUI..........................................................................................................................................................................22
3. Impacts of modifications of key assumptions of the model...............................................................................................................23
CONCLUSION..........................................................................................................................................................................................26
REFERENCES...........................................................................................................................................................................................27
APPENDIX................................................................................................................................................................................................29
Appendix 1. DCF model.........................................................................................................................................................................29
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INTRODUCTION
In the volatile market era and tough competitive age, companies are require to make evaluation of their performance and
market valuation as well. TUI Group is one of the top or leading tourism organization that has more than 1800 travel agencies, six
airlines, 130 aircraft, 300 hotels and 13 cruises around the globe.The present project report aims at developing an understanding of the
different capital structure theories in the light of finance models. Moreover, the report will also make market value analysis by
estimating weighted average cost of capital of TUI Group. Apart from this, Shareholders value analysis (SVA) refers to the process of
analysing that how operations of a firm affects the value of net present value (NPV) to the investors. In other words, it helps to
measure the ability of organizations to generate excessive earnings than the cost of capital. The assignment report will apply the SVA
model for TUI Group to analyse its earnings capability. Along with this, the report will also describe the difficulties associated with the
model in real corporate practice.This report will guide the management to take necessary steps and suitable and necessary decisions for
the better functioning, expansion and performance of the organization.
1.TUI’s capital structure under the light of finance models
For understanding the capital structure of the company, first of all an understanding is needed to be established for the ways of selecting their
capital structure and its formation by any of the organizations. There is a relationship exists between capital structure of the company and the
value of the firm (GmbH, 2016). The capital structure formations are different with respect to the nature of the organization and the region of
location of the organization. This basic theory by Modigliani and Miller (1958) was proposed in a seminal research paper which is named as
“The cost of capital, corporation finance, and the theory of investment”. This paper explained that the factors like taxation remedies on interest
payment and transaction cost are absent, credit of corporations and people takes place with similar rateand the value of the organization is
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termed as independent from its capital structure.This proposed prototype is ideal for the organizations which exist in the environment of perfect
competition and product markets.Apart from this basic model of capital structure, other three models for the structuring the base for theoretical
considerations for the organization are discussed subsequently (Hammes y.n.d).
Miller and Modigliani(1958), developed two prepositions to describe the capital structure one is in the absence of capital structure and another
is with the absence of taxation liabilities that are enumerated underneath:
Preposition: 1. In the absence of taxation
In this preposition, it has been believed that changes in capital structure do not influence net value and weighted average cost of capital of
the firm. In other words, change in leverage and mix of debt and equity will not have any effect on firm’s value and cost of capital, thus, capital
structure is irrelevant. As per the theory, TUI can gathered funds either from the use of debt or equity capital each has different benefits and
shortcoming as well and each of the investors in the market have a same access to buy or sell their holdings.
Preposition: 2. With the presence of taxation (Trade-off theory)
The earlier preposition believe that there are no taxes, however, in the real corporate world, companies are require to pay taxes on their
earnings. This theory is termed as trade-off theory, in which, it has been discovered that debt is a cheaper financial source relatively to the cost
of equity. The reason behind this is interest paid on borrowed money is tax deductible, therefore, it provides tax benefits to the TUI Group.
However, such kind of benefits will not be available on equity financing as dividend on equity capital will not give tax advantage to the
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company. Thus, on the basis of this theory, TUI Group must make use of debt capital to a threshold point in their capital structure so as to
reduce the overall cost of capital and rise firm’s value. However, beyond a threshold point, if debt are increase then it gives rises to the equity
capital risk, which in turn, result in higher cost. Therefore, in accordance with the theory, TUI Group must makes use of debt capital to a
specified point in order to reduce WACC and maximize value.
The mode of debt financing is not a straight forward process but annexed with a lot of costs along with the benefits.The firm needs to make a
fine balance between costs and benefits by equalizing both the debt and capital sources through the application of trade off method. Something
is forgone to achieve other thing but the thing that is permitted to forgo should not be in higher value than the benefits so the marginal
difference is the profit that is enjoyed by the company. Hence for the purpose of effective capital structure through the suitable mix of debt and
equity financing, a cost and benefit analysis is also required to maintain for trading off the costs for the benefits and to determine the level of
credit that is manageable by the firm for maximizing the value. If factors like rate of corporate tax, rate of personal tax on equity earning, if
mark-up rates on debt are under level, positive sentiments of market towards debt financing, knowledge from signs of quality of firm, signs
from aggressive competition, accessibility to capital markets at fair value, expense of excess financing, costs of transaction, rights of the
financers, the control mechanism and better skills of negotiations are signals of the benefits of the debt and these factors take the debt to higher
best possible stage. There are other factors which work in opposite direction like personal rate of tax on net revenue, direct financial distress
cost and otherwise, the high rate of mark up on debt, negative sentiments of market toward debt financing, flexibility in knowledge,
accessibility to capital markets at fair price, costs of underfinancing, transaction costs, rights of creditor and competitiveness of the market.
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These factors show themselves as the cost of debt and they are contributing factor in declining the best possible stage (Serveas and Tofano
2006)
Pecking Order Theory
According to this theory, the organization does not set any particular amount of debt in conscious but relies solely on the outcome of
profitability of the organization. This theory suggests that companies can raise money from three sources, that are retained profit, equity
financing and debt financing (Serveas and Tofano 2006). It is one of the most influential theory of corporate leverage that demonstrates that
availability of asymmetric information to the managers affects the selection of internal and external financing. It believes that retained earnings
is the most effective source of finance because it is available at nil financial cost and have no adverse impact. While, if they need to raise money
through external finance, then debt gains preference over equity because share capital is more riskier and costlier because of higher premium.
The reason behind this is debt interest is fixed and also give tax benefits, whereas, external investors need higher return in return for the risk
undertaken. Thus, it can be said that firms often prefer internal financing, if require more funds, then debt will be issued first and then rest of the
funds will be collected by equity capital (Serveas and Tofano 2006).
Agency costs
Agency costs theories of finance takes their origination from basic principle of partnership and agent-principal relation. Principal under this
scenario is shareholder and members of management work as agents of the principal to function in the favour of shareholder and organization
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by conduct of best practices. However, due to occurrence of asymmetric and imperfect level of comprehension and medium of transfer that
knowledge, the control of outcome and resultant factors are beyond the capacity of the management sometimes same is the case with decisions
which are taken by the management. As per agency cost theory, shareholders do not necessarily desire a high level of variation and hence they
raise the debt level of the company. Therefore, they reduce the FCFF (Free cash flow for the firm) which is available to managers who are self-
motivatedfor fund provision in variation programs which are not profitable(Jstor.org, 2016).
This theory says that agency costs arises when managers of the firm owns a proportion of total share capital. As a result, they can work in
the interest of stakeholders. This theory proposes that indebtedness can be considered as a way to resolve conflicts between both the managers
and shareholders. The theory indicates that indebtedness gives rises to three type of costs that are control and justification, higher risk and
bankruptcy as well. Thus optimal capital structure gives huge assistance to the firm to minimize agency cost and to appeal for external funds to
meet out long-term capital requirement.
TUI’s Structure of Capital
The capital structure of TUI is dependent on several factors namely size of the firm, CVA, earnings volatility, profitability, growth
opportunities, energy extremity, framework of ownership, rated vs. non-rated, less cost against service and leasing characteristics. With respect
to size of the firm, TUI is considered as one of the greatest because of the widespread huge size and number of employees as well as area of
management. The greater the size, theless capacities and abilities ofearnings due to meeting up the mass administrative and operational cost. As
per Wessel and Titman (1988) the size of the company stimulates the revenue capacity of that company. TUI Group follows trade-off theory, in
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which, it makes use of both equity as well as debt capital to meet out their long-term capital. Debt is utilized by the firm to get taxation benefits
and trading on equity so as to maximize their return for the investors (TUI’s annual financial reports, 2015)
). Moreover, another reason for debt utilization is it does not transfer rights to the debt holders, however, equity holders have right to control
decisions. On the basis of it, it can be said that Trade off theory is following by TUI Company. But still, it must be noted that the proportion of
debt in TUI’s long-term capital is still less than equity because it brings excessive financial burden to the firm as they are legally liable to pay
fixed interest obligations as per debt covenants. Optimum mix of debt and equity assists TUI group to manage their financial risk and solvency
position as well to repay long-term liabilities on right time.
The All other variables by keeping under consideration can be stated the Trade-off theory is appropriate for application and development
the capital structure of TUI Company. trade-off theory is applicable here because the size has played a significant role in the development and
expansion of the company worldwide. If we evaluate other afore mentioned factors as well under the light of trade off theory, we get results as
positive relationship with CVA, positive relationship with level of profitability, negative relationship with revenue volatility, negative
relationship with growth opportunities, negative relationship with energy extremity, positive relationship with structure of ownership, positive
relationship with rated vs. non-rated, positive as well as negative relationship with less cost vs. service and positive relationship with leasing.
The same connections and states of relationships have been observed in the case of TUI Company
TUI Group’s capital structure or gearing
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2015 (GBP
million)
2016 (GBP
million) % increase/decrease
Long-term debt 1218.33 1300.62 6.75%
Shareholders equity 1781.33 2810.08 57.75%
Debt to equity 0.68 0.46
(Source: TUI financials at LSE, 2017)
2015 (GBP million) 2016 (GBP million)
0
500
1000
1500
2000
2500
3000
Debt and equity
Debt and equity (In GB P million)
Chart prepared in MS spreadsheet (ExceL)
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Important highlights:
Taking into consideration the results, it can be seen that in 2016, TUI Group enhanced its debt from 1218.33 to 1300.62 GBP million
by 6.75%. However, excessive additional capital requirement has been fulfilled by issuing more share capital. As in 2016, it has been increased
from 1781.33 to 2810.08 by 57.75% resulted in declined gearing or leverage from 0.68:1 to 0.46:1 indicates lower financial risk. But still, it is
a little bit far away from the ideal ratio of debt to equity of 0.5:1 (TUI financials at LSE, 2017). Thus, on the basis of this, it can be suggested
to the firm to raise additional money through taking external borrowings via debt capital to get more tax benefits and improved solvency.
Moreover, it will also drive benefits of Trading On Equity (TOE), under this TUI Group can use debt to raise earnings for the equity
shareholders and satisfy them.
2. TUI’s market evaluation
A. Weighted Average Cost of Capital for TUI
The economic goal of the company as a market driven securities based organization is to make certain a sustainable and balanced
rise in the worth of the group as a whole.The standardized and benchmark level administration system has been formulated for
implementation of value- recognized management over the venture as a complete as well as separate sectors of the ventures. WACC
refers to the rate which TUI Group will be require to pay to their fund providers to finance their assets, also termed as cost of capital
(Tripathi, 2017). It is calculated by taking into account both the cost of debt as well as equity capital by using following formulas:
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WACC = (equity/value*Ke) + [Debt/value*Kd(1-Tax rates)
Higher the WACC gives rises to the risk and decrease in corporate value or vice-versa.
The company uses ROIC and absolute value added approaches for value analysis of the project. The company compares
ROIC with sector specific cost of capital. The company applies EBITA approach for monitor of the economic performance along
with various variables of the Group. The company has achieved a sustainability in fuel consumption and carbon emission as far as
their air craft segment of the venture is considered.
Calculation of cost of equity as per dividend growth model:
Cost of equity is the required rate of return that TUI Trvael group will be require to pay to their equity investors as a monetary
return for the risk borne. As per dividend growth model, cost of equity can be computed by taking into accont the dividend rate and
market price of the share plus expected rate of growth in dividend (Heinrichs and et.al., 2013). Henceforth, it can be writeen as
follows:
Cost of equity (Ke) = (Current dividend/market price)+Growth rate in dividend
Where;
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ke stands for cost of equity
P0 means share market price
d0 denotes constant dividend
The current share market price of TUI group has been reported to 1163.00 extracted from London Stock Exchange. However, on
the other hand, current dividend per share 41.59 pence to satisfy stakeholders by delivering them fair return on their holdings.
As per the findings, cost of equity (Ke) of TUI Trvel Group is computed here as under:
ke = Dividend/market price per share
ke = (41.59 pence/1163.00) (TUI financials at LSE, 2017.)
ke = 3.58%
Note: Growth rate of dividend has not been taken into consideration because TUI Travel Group did not distributed any dividend
from 2012 to 2015 and distributed return to the investors in the year 2016 only to 41.59p ( TUI financials at LSE, 2017). Thus, as
per the calculation derived, it is clear that cost of equity is 3.58% per annum.
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Cost of debt: Cost of debt refers to the interest rate which TUI group is liable to pay to their respective debt holders as financial
return. It can be computed using following formula, given below:
Cost of debt (Kd) = (Interest / Debt )*100(1-t)
t – Corporation tax rate
Here, taxation rates has been taken into account because interest paid on debt resources is considered as tax deductible expenses,
and HMRC provide tax benfits to the company. With reference to TUI Group, it is calculated here as under:
Kd = (134.89/1300.62)*100(1-0.20%)
= 10.30%(1-20%)
= 8.30%
In UK, taxation rate is 20% per annum, according to this, companies have to pay 20% annually on their coporate earnings.
Weighted average cost of capital assign weight to each source of capital, such as debt and equity to the total capital and
multiply it to the cost of capital of each source to find out overall cost (Heinrichs and et.al., 2013.). In other words, it can be said
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that it takes into account all the long-term financial source to compute the overall cost of capital. For TUI Travel Group, it is
computed here as under:
Source of finance 2016 Weight Cost of capital WACC
Long-term debt 1300.62 0.32 3.58% 1.13%
Shareholder's equity 2810.08 0.68 8.30% 5.67%
Total capital 4110.7 1 6.81%
(Source: TUI’s annual financial reports. 2015)
Taking into account the results, it can be seen that WACC for the TUI Group is 6.81%. It means that it is essential for the TUI
Travel Group to generate minimum earnings at that rate so as to reapy their capital suppliers, especially shareholders and debt
holders.
B. Shareholder Value Analysis Model
Shareholder value analysis, shortened to SVA refers to the process of examining and forecasting the affect of business
decisions over net present value (NPV) to the shareholders. In corporate world, this analysis is often used by the firms to measure their
ability to earn excessive over the cost of capital (WACC) (DeFusco and et.al., 2015). Thus, it provides a framework to the firms for
analusing options so as to drive improvement in the shareholders value.. In short, it can be said that it is a forecasting tool that enable
companies to forecast their future through the projection of free cash flows and discounted it at an appropriate discounting rate. It can
aid towards major decisions such as capital investment, acquisition and so on (Mousavi and et.al., 2013). With the help of this tool,
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business managers can set policies in relation to brigning improvements in their performance in the future period and drive success as
well.
According to the model of SVA, enterprise value can be computed using following formula, mentioned here as under:
Shareholders value/Market value of equity = Total business value – Long-term debt
Total business value – Present value/discounted value of estimated future cash flows + Terminal value
Here, discounted values of cash flows will be measured through multiplying discounted factor (WACC) to the future projected
cash flows. With reference to TUI Group, SVA has been done here as under:
Summary
Calculations of Enterprise value /Summary
Total discounted cash flows (DCF attached in Appendix 1) 22734.54
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Add: Terminal value (see working note 3) 15259.35668
Total 37993.89
Less: Market value of debt 1300.62
Market value of equity 36693.27
(Source: TUI financials at LSE, 2017)
Looking to the table, it becomes clear that market value of equity capital for TUI Group is 36693.27.
Discounted cash flow model: DCF model is considered highly suitable to estimate future cash flows by taking into account
only cash based expenditures and revenues (Tripathi, 2017). Moreover, it also take into account changes in working capital and fixed
assets and discount projected cash flows with an appropriate discounting factor that is WACC.
Regards to TUI Travel Group, the model is applied and attached in Appendix 1.
Working note: 1.
Incremental fixed assets
sales
13884.43
253
14337.0
6503
14804.4
5335
15287.0
7853
15785.4
3729
16300.0
4255
16831.4
2394
17380.1
2836
17946.7
2054
18531.7
8363
Net book value of
fixed assets
6985.258
008
7212.97
7419
7448.12
0483
7690.92
9211
7941.65
3503
8200.55
1407
8467.88
9383
8743.94
2577
9028.99
5105
9323.34
0345
Increase/decrease in
fixed assets
-
914.8419
921
227.719
4111
235.143
0639
242.808
7277
250.724
2923
258.897
9042
267.337
9759
276.053
1939
285.052
528
294.345
2404
Working note: 2.
Increase/decrease in working capital
Sales
13884.4
3253
14337.0
6503
14804.4
5335
15287.0
7853
15785.4
3729
16300.0
4255
16831.4
2394
17380.1
2836
17946.7
2054
18531.7
8363
Working capital 2029.90 2096.07 2164.41 2234.97 2307.83 2383.06 2460.75 2540.97 2623.81 2709.34
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4036 8908 108 0882 0932 6221 418 4766 0543 6767
Increase/decrease in
working capital 391.19 66.17 68.33 70.56 72.86 75.24 77.69 80.22 82.84 85.54
Working note: 3.
Terminal value
2017E 2018E 2019E 2020E 2021E 2022E 2023E 2024E 2025E 2026E
Discounted cash flows (DCF)
1965.4
7
2631.7
3
2544.2
6
2459.6
9
2377.9
4
2298.9
1
2222.5
0
2148.6
3
2077.2
2
2008.1
8
Discounted value of 1 GBP @
6.81% 0.9362 0.8765 0.8207 0.7683 0.7194 0.6735 0.6305 0.5903 0.5527 0.5175
7.085
7
Terminal value 7.5986
15259.
36
C. Value Drivers
SVA analysis is used by corporations to maximize their shareholders value and in order to fulfil these aim, companies are
required to measure their key value drivers (Pandey and Arora, 2013). Most importantly, business have to quantify the expected
growth in revenues (sales), operating profit, taxes, fixed assets, increase in working capital and so on (Grant, 2016). With reference
to TUI Travel, the following key value drivers have been taken into consideration and applied in DCF model.
1 Sales growth (last year % change) 3.26% per year
2 Operating profit margin (5 year average) 3.89 % of sales per annum
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3 Taxes (5 year average) 20.46% of operating profit
per annum
4 Depreciation (5 year average) 31.40% of fixed assets
5 Fixed capital investment (5 years average) 50.31% of sales per year
6 Incremental working capital investment (5 year
average)
14.62% of sales per year
7 The planning horizon 10 years
8 The required rate of return (WACC calculated
above)
6.81% per annum
Justifications of the assumptions
2012 2013 2014 2015 2016 Average
Revenues 15096.57 15514.32 15229.41 13021.2 13446.09
% increase -13.64% 2.77% -1.84% -14.50% 3.26% 3.26%
Operating profit 449.76 421.41 604.68 590.64 708.67
Operating profit margin as % of sales 2.98% 2.72% 3.97% 4.54% 5.27% 3.89%
Taxes 91.25 121.68 174.58 43.27 120.03
Taxes as % of operating profit 20.29% 28.87% 28.87% 7.33% 16.94% 20.46%
Net book value of fixed assets 6905.83 7217.76 7026.26 7084.65 7900.1
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NBV of fixed assets as % of sales 45.74% 46.52% 46.14% 54.41% 58.75% 50.31%
Current assets 3620.46 4014.28 3918.58 3295.83 4607.72
Current liabilities 5873.81 6344.78 5852.56 5673.47 6246.43
Working capital -2253.35 -2330.5 -1933.98 -2377.64 -1638.71
Working capital investment as % of
sales -14.93% -15.02% -12.70% -18.26% -12.19% -14.62%
Depreciation 2454 2063 2208 2391 2190
Depreciation % on NBV of assets 35.54% 28.58% 31.42% 33.75% 27.72% 31.40%
(Source: TUI financials at LSE, 2017)
With regards to the sales, in 2016, TUI Travel Group’s turnover has been enhanced from 13021.2 Pound million to 13446.09
pound million by 3.26% per annum. In such respect, last year’s % change in sales revenues has been taken into account for
revenues forecasting because in the last 5 year, TUI’s sales shows a fluctuating trend, and in 2012 and 2015, it has been decreased
by 13.64% and 14.50%, so, if we use average of 5 years, then average growth rate is identified negative to 4.79%, however, it
seems not significant for the firm to expect that company will generate less sales revenues in upcoming period ( Larivière and et.al.,
2016). Due to this reason, last year % growth in turnover @ 3.26% has been taken intop consideration. However, on the other side,
for the estimation of WC, fixed capital investment, taxes, depreciation and operating profit, 5 year average has been used,
mentioned above.
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D. Practically Application Difficulties of SVA
Supporters of SVA model comment that the SVA model is comparatively the most prominent and admirable model for
analysing the financial repercussions of strategies and mark it as the key input to the corporate planning of the decade. Global giant
companies including Dexter, Trinova, Westinghouse and Signode are having a sound round of success with it as it delivers the
perfect analysis of the financial consequences.
Apart from these valuable advantages, staticians and economists also comment on the difficulties that arise in the application of the
model in practice. Managers applying the model in TUI Group are not so much supportive to this model as the complex calculations
involved along with obstructive assumptions make it a challenge for them (Yang and et.al., 2017). In addition to this, the situation
becomes more difficult for the TUI’s managers, when accounting and reporting systems are unable to provide costing data and the
balance sheet figures required to carry out the analysis.
In practical, the users of the model also comment on the susceptibility of the model towards manipulation. The manipulations in the
reported data in TUI’s annual report can turn the analysis in to the favours for some thereby resulting in the undervalue to the
corporation.
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Other difficulties include the selection of the figures for the analysis i.e. planning span, discount rate and forecasted cash flows
which are based on the judgment of the analysts. A slight mistake in the figures might render the whole of the analysis of no use.
Also most of the values as measured by SVA lie in terminal or residual values of the close of the planning period. It increases the
difficulties as these numbers are also not certain (Wessel and Titman, 1988).
There are also complains regarding the calculation of values and subjecting the results to extensive sensitivity analysis overturns
strategic process of thinking (Steenkamp, 2017). Further, the model is also not recommended for the analysis of innovative
strategies which opens the markets for which the probabilities are unknown for instance the next age group of receivers of
televisions.
Although eh technique is the prominent one in analysis, however it has some severe difficulties also while its application. For most
of the time, TUI Group may be unable to connect the figures of the SVA model to the best possible strategic thinking process of the
company. As a result, there is absence of imagination element and rigor in the strategic thinking process. Although the SVA model
is implemented in the various sections of the organization and the analysts are also vulnerable to human limitations including
limited thinking, errors and over optimism, the aforesaid problems in the application of the SVA model are understandable but not
admirable.
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Although there are certain difficulties in eh application of SVA model, however, still his model is highly recommended by the
supreme economists and analysts. They recommend this because the results are highly applicable to current position of the TUI
Group.
Apart from this, SVA model does not pay attention to the employment, ethical business practices of TUI group and other
qualitative factors which is also a shortcoming of this method. Moreover, company may find difficulties in making necessary
assumptions so as to predict future cash flows (Verma and Sharma, 2017). Thus, it can lead to take misleading strategic decisions
which can affect performance adversely. In addition to this, it requires too much time and efforts of the managers to make an
accurate prediction for shareholders value analysis framework that is also a limitation of this method.
E. Market Value of TUI
Shareholder value analysis (SVA) measures the company’s financial worth by taking into consideration the overall returns that the
shareholder get from the company. The Shareholder value analysis (SVA) has been developed on the concept that the directors of
the company have the foremost objective of the maximization of their shareholdervalue (Serveas and Tofano 2006).
Shareholder value added (SVA) reveals the worth of the company to the stock holders taking aside the liabilities in addition to
capital costs of the company (TUI’s annual financial reports. 2015).
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The factors taking into consideration for the analysis of SVA model includes the average Sales growth for the last year 2016,
which is 3.26% per year. The Operating profit margin on average for the last 3 year is 3.89% of sales. Taxes are estimated to be
20.46% of operating profit, Incremental fixed capital investment are projected at 50.31% of sales and Incremental working capital
investment are estimated at 14.62% of sales (Steenkamp, 2017). However, the rate of depreciation on fixed assets is estimated to
31.40% per annum. It is because, in the DCF model, companies make use of only the cash flows and avoid non-cash expenditures
which does not bring in cash inflows and will not result in cash outflow. Depreciation is a non-cash expenditures therefore, it
should be added back to the net profit after taxes so as to estimate the operating free cash flows.
On the basis of applied DCF, present value of cash flows for the future 10 years is identified to 22734.54 whilst terminale value
worth 15259.36 is added thereon to find out the enterprise value (EV) and in the given scenario, it is computed to 37993.89 (Pandey
and Arora, 2013). This value consists of both the debt and equity, therefore, in order to derive the market value of equity capital,
current long-term debt capital of TUI Group worth 1300.62 GBP has been subtracted. As a result, market value of equity capital,
also called shareholders value is computed to 36693.27 GBP.
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15058285_P58836_assignment 3
3. Impacts of modifications of key assumptions of the model
Sensitivity analysis is often used by the business organizations to measure the changes in business performance by taking into
account change in underlying assumptions used for the model (Tripathi, 2017). For the given scenario, TUI’s performance has been
evaluated here by making varied assumptions from the earlier stated, presented here as under:
Estimate change in sales @ 5% per year
Sensitivity analysis for the change in sales
Items 2017E 2018E 2019E 2020E 2021E 2022E 2023E 2024E 2025E 2026E
Revenues
14118.3
9
14824.3
1
15565.5
3
16343.8
1
17161.0
0
18019.0
5
18920.0
0
19866.0
0
20859.3
0
21902.2
6
% increase
Net operating profit before
taxation 549.21 576.67 605.50 635.77 667.56 700.94 735.99 772.79 811.43 852.00
Taxes 112.37 117.99 123.89 130.08 136.58 143.41 150.58 158.11 166.02 174.32
Net profit after taxation 436.84 458.68 481.61 505.69 530.98 557.53 585.40 614.68 645.41 677.68
Add: Depreciation
@31.40% 4433.18 4654.83 4887.58 5131.96 5388.55 5657.98 5940.88 6237.92 6549.82 6877.31
Net profit before
depreciation but after tax 4870.01 5113.51 5369.19 5637.65 5919.53 6215.51 6526.28 6852.60 7195.23 7554.99
Add/less: Increase/Decrease
In fixed assets value -797.14 355.15 372.91 391.55 411.13 431.68 453.27 475.93 499.73 524.72
Add/less: Increase/Decrease
In working capital 425.40 103.21 108.37 113.78 119.47 125.45 131.72 138.31 145.22 152.48
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15058285_P58836_assignment 3
Operating free cash flows
(OFCF) 4498.28 5571.87 5850.46 6142.98 6450.13 6772.64 7111.27 7466.84 7840.18 8232.19
Discounted value of 1 GBP
@ 6.81% 0.9362 0.8765 0.8207 0.7683 0.7194 0.6735 0.6305 0.5903 0.5527 0.5175
Present value of
OFCF/Disconted cash
flows 4211.48 4884.02 4801.25 4719.89 4639.91 4561.28 4483.98 4408.00 4333.30 4259.87
Total of present value of
future cash flows 45302.96
Calculations of shareholders value
Total discounted cash flows (DCF) 45302.96
Add: Terminal value 32369.04
Total 77672.00
Less: Market value of debt 1300.62
Market value of equity 76371.38
Incremental fixed assets
sales 14118.39 14824.31
15565.5
3 16343.81 17161.00 18019.05 18920.00 19866.00
20859.3
0 21902.26
Net book value of
fixed assets 7102.96427 7458.112
7831.01
8 8222.569 8633.697 9065.382 9518.651 9994.584
10494.3
1 11019.03
Increase/decrease in
fixed assets -797.135727 355.1482
372.905
6 391.5509 411.1285 431.6849 453.2691 475.9326
499.729
2 524.7157
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15058285_P58836_assignment 3
Increase/decrease in working capital
Sales 14118.39 14824.31
15565.5
3 16343.81 17161 18019.05 18920 19866 20859.3 21902.26
Working capital 2064.10928 2167.315 2275.68 2389.465 2508.938 2634.385 2766.104 2904.409
3049.62
9 3202.111
Increase/decrease in
working capital 425.40 103.21 108.37 113.78 119.47 125.45 131.72 138.31 145.22 152.48
As per the table, presented below, it can be seen that if TUI Group’s revenues goes up by 5% on an annual basis, then it will
results in higher profitability and as a result, discounted value of FCF will be increase to 45302.96 ( TUI’s annual financial report,.
2015). Moreover, terminal value is expected to be 15669.41, which in turn, total capital of the firm goes up by 77672.00. It is
subtracted from the long-term debt of the firm worth 1300.62 and shareholder value is measured at 76371.38 higher than computed
market value of equity of earlier as it was valued at 36693.27.
CONCLUSION
After a detailed analysis of the applicable finance theories, weighted average cost of capital and SVA model implications, it can be concluded
that the Shareholder value analysis provides a perfect measure the company is maximizing the economic wealth of shareholder. The weighted
average cost of capital also revealed sound results and the company, in the recent annual report has estimated the weighted average cost of
capital to grow at a rate of 10% per annum. It has also been established that there are certain difficulties in the practical application of
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15058285_P58836_assignment 3
Shareholder value analysis model. However, still the giant multinationals are using it to further strengthen the global positioning of their
companies.
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15058285_P58836_assignment 3
REFERENCES
Books and Journals
DeFusco, R. A. and et.al., 2015. Quantitative investment analysis. John Wiley & Sons.
Grant, R.M., 2016. Contemporary strategy analysis: Text and cases edition. John Wiley & Sons.
Hammes, K. (y.n.d) Essays on Capital Structure and Debt Fianncing.
Heinrichs, N. and et.al., 2013. Extended dividend, cash flow, and residual income valuation models: accounting for deviations from
ideal conditions. Contemporary Accounting Research. 30(1). pp. 42-79.
Larivière, B. and et.al., 2016. Modeling Heterogeneity in the Satisfaction, Loyalty Intention, and Shareholder Value Linkage: A
Cross-Industry Analysis at the Customer and Firm Levels. Journal of Marketing Research. 53(1). pp. 91-109.
Modigliani, F. and Miller, M. (1958). The cost of capital, corporation finance and the theory of investment. [S.l.].
Mousavi, S.M. and et.al., 2013. Optimizing multi-item multi-period inventory control system with discounted cash flow and
inflation: two calibrated meta-heuristic algorithms. Applied Mathematical Modelling. 37(4). pp. 2241-2256.
Servaes, H. Tufano,P. (2006) Corporate Capital Structure Deutsche Bank, Accessed from: London.edu/serveas
Steenkamp, J.B., 2017. Global Brands and Shareholder Value. In Global Brand Strategy. Palgrave Macmillan UK. 5(2). pp. 275-289.
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TITMAN, S. and WESSELS, R. (1988). The Determinants of Capital Structure Choice. The Journal of Finance. 43(1). pp.1-19.
Tripathi, R.P., 2017. Optimal ordering policy under two stage trade credits financing for deteriorating items using discounted cash
flow approach.International Journal of Process Management and Benchmarking. 7(1). pp. 120-140.
Verma, N. and Sharma, R., 2017. Creating shareholders' value utilising capital in post-merger and acquisition scenario: a study of
Indian Telecom Industry. International Journal of Management Practice. 10(1). pp. 75-92.
Yang, M. and et.al., 2017. Value uncaptured perspective for sustainable business model innovation. Journal of Cleaner Production.
140(15). pp. 1794-1804.
Online
Cbsnews.com. (2016). Implementing Shareholder Value Analysis. [Online] Available
at:http://www.cbsnews.com/news/implementing-shareholder-value-analysis/ [Accessed: 27th September 2016].
GmbH, G. (2016). GRIN - Does capital structure influence firms value?. [Online] Available at:
http://www.grin.com/en/e-book/48170/does-capital-structure-influence-firms-value [Accessed: 29th September. 2016].
Investinganswers.com. (2016). Shareholder Value Added (SVA) Definition & Example | Investing Answers. [Online] Available at:
http://www.investinganswers.com/financial-dictionary/stock-market/shareholder-value-added-sva-1860 [Accessed: 27th
September. 2016].
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Jstor.org. (2016). Agency Costs of Free Cash Flow, Corporate Finance, and Takeovers on JSTOR. [Online] Available at:
https://www.jstor.org/stable/1818789 [Accessed: 29th September 2016].
Pandey, M and Arora, D., 2013. Shareholders Value Analysis: A Review. [PDF]. Available through:
http://www.ijsr.net/archive/v4i5/SUB154598.pdf. [Accessed on 14th January 2016].
TUI financials at LSE. 2017. [Online]. Available through: http://www.londonstockexchange.com/exchange/prices/stocks/summary/
fundamentals.html?fourWayKey=DE000TUAG000GBGBXSET1. [Accessed on 2nd January 2017].
TUI’s annual financial reports. 2015. [PDF]. Available through :<
https://www.tuigroup.com/damfiles/default/tuigroup-15/en/investors/6_Reports-and-presentations/Reports/2015/
TUI_AR_2014_15.pdf-5fc3533700b336f9aa822a767588d0ac.pdf>. [Accessed on 14th January 2016].
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15058285_P58836_assignment 3
APPENDIX
Appendix 1. DCF model
2017E 2018E 2019E 2020E 2021E 2022E
2023
E
2024
E
2025
E 2026E
Revenues
13884.
43
14337.0
7
14804.4
5
15287.
08
15785.
44
16300.0
4
16831
.42
17380
.13
17946
.72
18531.7
8
% increase
Net operating profit before
taxation 540.10 557.71 575.89 594.67 614.05 634.07
654.7
4
676.0
9
698.1
3 720.89
Taxes 110.51 114.11 117.83 121.67 125.64 129.73
133.9
6
138.3
3
142.8
4 147.49
Net profit after taxation 429.60 443.60 458.07 473.00 488.42 504.34
520.7
8
537.7
6
555.2
9 573.39
Add: Depreciation @31.40%
2193.3
7 2264.87 2338.71
2414.9
5
2493.6
8 2574.97
2658.
92
2745.
60
2835.
10 2927.53
Net profit before depreciation
but after tax
2622.9
7 2708.48 2796.78
2887.9
5
2982.1
0 3079.31
3179.
70
3283.
36
3390.
40 3500.92
Add/less: Increase/Decrease In
fixed assets value (See working
note 1.)
-
914.84 227.72 235.14 242.81 250.72 258.90
267.3
4
276.0
5
285.0
5 294.35
Add/less: Increase/Decrease In
working capital (see working
note 2) 391.19 66.17 68.33 70.56 72.86 75.24 77.69 80.22 82.84 85.54
Operating free cash flows
(OFCF)
2099.3
2 3002.37 3100.25
3201.3
2
3305.6
8 3413.45
3524.
73
3639.
63
3758.
28 3880.80
Discounted value of 1 GBP @
6.81% 0.9362 0.8765 0.8207 0.7683 0.7194 0.6735
0.630
5
0.590
3
0.552
7 0.5175
Present value of 1965.4 2631.73 2544.26 2459.6 2377.9 2298.91 2222. 2148. 2077. 2008.18
31