QUESTION 1: Weighted Average Cost of Capital (WACC) for MBS

For the successful completion of the project different topics such as estimation of WACC, NPV, DCF and IRR, such usefulness of PE, price to book, price to cash flow, EV to EBITDA and EV to sales ratio are covered. For the successful completion of the project different topics such as estimation of WACC, NPV, DCF and IRR, such usefulness of PE, price to book, price to cash flow, EV to EBITDA and EV to sales ratio are covered.

Corporate Finance

Table of Contents
INTRODUCTION...........................................................................................................................1
QUESTION 1...................................................................................................................................1
i. Weighted average cost of capital (WACC) for MBS:..............................................................1
ii. Calculation of Net Present Value (NPV) and Internal Rate of Return (IRR):.........................2
iii. Calculation of net present value (NPV) and internal rate of return (IRR) of the project is
delayed for 12 months:.................................................................................................................3
iv. Recommendation:...................................................................................................................4
QUESTION 2...................................................................................................................................4
PART A...........................................................................................................................................4
i. Usefulness of different ratios for Smart Software Plc..............................................................4
ii. Comments on market value of Smart Software Plc.................................................................5
iii. Explanation regarding reasonable equity value and enterprise value for Future Intelligence
if it is bought by Smart Software Plc:..........................................................................................6
PART B............................................................................................................................................7
i. Definition of economic value and the way in which adjusted book value approach to valuing
assets and liabilities moves book value nearer to economic value..............................................7
ii. Highlighting at the elements in the balance sheet that might require adjusting to arrive at an
economic value:...........................................................................................................................8
PART C............................................................................................................................................9
i. Calculation of EV / EBITDA ratio:..........................................................................................9
iii. Calculation of EV / Sales Ratio:...........................................................................................10
iii. Calculation of Price to earnings ratio...................................................................................10
iv. Calculation of price to cash flow ratio:.................................................................................10
v. Contrast and explanation of results of different market multiple ratios:...............................10
CONCLUSION..............................................................................................................................11
REFERNECES..............................................................................................................................13

INTRODUCTION
Corporate finance can be defined as the funds which are used by business entities for the
purpose of executing all the operational activities in a systematic manner. Main purpose of
utilising it in appropriate manner is to enhance value of the company for its stakeholders such as
shareholders, employees, customers, suppliers and investors (Damodaran, 2016). All the
activities which are related to it range between investment banking and capital investment
decisions. Main aim of this assignment is to develop understanding regarding regarding different
techniques which are used for effective management of corporate finance. This report is
segregated in two different parts. First one is based upon Mobile Battery Solutions Plc and
second section is based upon two companies. These are Smart Software Plc and AstraZeneca Plc.
For the successful completion of the project different topics such as estimation of WACC, NPV,
DCF and IRR, usefulness of PE, price to book, price to cash flow, EV to EBITDA and EV to
sales ratio are covered. Along with this, calculation of EV and different ratio for AstraZeneca Plc
are also aligned under this report.
QUESTION 1
i. Weighted average cost of capital (WACC) for MBS:
WACC regarded as average return rate that an corporation anticipate for compensating
to different investors. Weights used in assessing WACC are specific portion of organisation's
finance source. Typically, a firm is funded by combining borrowing or bonds with equity stocks
(Flannery and Hankins, 2013). Since a business can obtain more financing from one than
another, company measure a weighted average to figure out how costly it is for a business to
generate the resources required to purchase buildings, machinery, and stock. Here are following
steps to compute weighted average cost of capital, as follows:
Step 1:
Calculation of cost of equity:
Equity Beta = 1.2
Rm – Rf = 6.00%
Rf = 1.00%
Re = Rf + (Rm – Rf) = 1% + 6% x 1.2 = 8.20%
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Step 2:
Calculation of cost of debt:
Kd= Interest Rate ( 1 – tax rate) = 4 x (1 - .20) = 3.20%
Step 3:
WACC:
Proportion Cost (%)
Debt 0.4 3.2 1.28
Equity 0.6 8.2 4.92
WACC: 6.20%
ii. Calculation of Net Present Value (NPV) and Internal Rate of Return (IRR):
NPV: NPV is a easy yet significant instrument that demonstrates the distinction among
future cash-flows ' present value as well as total current investment figure. Through discounting
them at certain rate, present value of company's expected cash-flow is obtained. NPV is an
convenient-to-use and easy-to-understand instrument and is a common money budgeting method
used to assess investment and project appropriateness (Coles, Lemmon and Meschke, 2012). To
make rational investment choices, a thorough knowledge of this idea enables. In brief, NPV is
the substance acquired from the current cash-inflow amounts after deduction of the current
money outflow value. It is a extensive assessment method because the impact of period on cash-
flows is taken into consideration. In order to demonstrate its significance in current context, it
discounts potential future cash-flows.
IRR: Internal return-rate implies to interest rate which is benchmark where net present
value assessed using cash-flows includes positive as well as negative both in respect of any
project or proposal of investment is equal to zero. It is simply applied for evaluation of viability
or efficiency of any investment proposal (Ehrhardt and Brigham, 2016). Where IRR in respect of
any new project is above corporation's required return rate, than such project would be cost
efficient and beneficial for company. Where IRR is is lower than return rate required by
company then, it is advisable to reject such project.
Given Information:
Designing and developing Cost £15m
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Initial investment
in plant and equipment £150m
Total Initial Investment £165m
Working capital investment £12m
Corporation tax rate 20.00%
Selling Price £65
Sales volumes 1.5m and addition of 1.5m each year
Administration Costs £8m
Total incremental operating costs £15m in the first year of
operation and £20m per annum thereafter
Year 0 1 2 3 4
Initial Investment -165
Working Capital -12
Units 1.5 3 4.5 6
Sales 97.5 195 292.5 390
Less: Variable Costs 15 20 20 20
Less: Administration Costs 8 8 8 8
Less: Depreciation on Plant and
Machine 37.5 37.5 37.5 37.5
Profit Before Tax 37 129.5 227 324.5
Less: Tax @ 20% 7.4 25.9 45.4 64.9
Profit After Tax 29.6 103.6 181.6 259.6
Add: Recovery of Working
Capital 10.2
Net Cash Flow -177 29.6 103.6 181.6 269.8
PV Factor @ 6.20% 1 0.9416 0.8866 0.8349 0.7861
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PV of Cash Flow -177 27.87 91.86 151.62 212.10
NPV 306.45
IRR 40.07%
iii. Calculation of net present value (NPV) and internal rate of return (IRR) of the project is
delayed for 12 months:
Year 0 1 2 3 4 5
Initial Investment -165
Working Capital -12
Units 1.5 3 4.5 6 7.5
Sales 97.5 195 292.5 390 487.5
Less: Variable Costs 15 20 20 20 20
Less: Administration Costs 8 8 8 8 8
Less: Depreciation 30 30 30 30 30
Profit Before Tax 44.5 137 234.5 332 429.5
Less: Tax @ 20% 8.9 27.4 46.9 66.4 85.9
Profit After Tax 35.6 109.6 187.6 265.6 343.6
Add: Recovery of Working
Capital 10.2
Net Cash Flow -177 35.6 109.6 187.6 265.6 353.8
PV Factor @ 6.20% 1 0.9416 0.8866 0.8349 0.7861 0.7402
PV of Cash Flow -177 33.52 97.18 156.62 208.80 261.90
NPV 581.02
IRR 52.86%
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iv. Recommendation:
As per above calculations it has been analysed that NPV of original project is 306.45
where as IRR is 40.07% as NPV is positive so project is viable (Fracassi, 2016). If project is
delayed for 12 month than new NPV is 581.02 while IRR is 52.86%. In both cases NPV is
positive but if project is started one month delay NPV is more greater than original product's
NPV. In both cases IRR is greater than WACC, as per IRR perspective the given project and
option is viable. However, IRR in case project is delayed for 12 months is higher. Therefore
from overall analysis it has been analysed that project should be delayed for 12 months.
QUESTION 2
PART A
i. Usefulness of different ratios for Smart Software Plc
Ratios like Price-to-earnings ratio, Price-tobook ratio, and EV-to-EBITDA ratio are
market based ratio which defines organisation's present market situation. In this context
following is discussion on usefulness for Smart Software plc, as follows:
Price-to-earnings ratio: It is a ratio to assess value of corporation. It assesses current
share price comparative to EPS. The P / E Ratio exhibit connection between shares price of a
corporation and per-share earnings (EPS). It's a prevalent ratio which delivers a stronger sense in
respect of company's worth to shareholders. It represents market potentials and price which an
investor is required to pay per-unit of organisation's current earning. This ratio is useful for
company to evaluate whether securities of company is over or under valued (Cronqvist, Makhija
and Yonker, 2012). A company has high PE ratio is regarded as growth stock, which simply
implies high expectations of potential growth earning and favourable or positive aspect of
corporation's future performance.
Price-to book ratio: Corporations applies price-to-book ratio to make comparisons
market of a corporation with book value by dividing company's share price by book value per
share (BVPS). In company, asset's book-value is similar to amount of carrying value as stated in
balance sheet. It calculated by deducting amount of accumulated depreciation from asset's value.
Book value or net asset value of corporation measured aggregate amount of assets excluding
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intangible assets e.g. goodwill, copyright, patents etc. and all liabilities. Book value can be
net/gross of expenditures, like operating costs, taxes, or processing fees, in respect of initial
expenditures related to an investment (Baker and Wurgler, 2013). The price-to-book ratio
demonstrates whether or not asset value of a corporation is proportional to its share's market rate.
That's why it can be helpful in finding more realistic stocks value. This is particularly helpful in
valuing corporations which consist of mostly liquid assets like insurance, banking, finance and
investment firms.
EV-to-EBITDA ratio: It is a effective measure which is used to make comparison of
company's value, debt covered, to cash earnings excluding non-cash expenditures. Main use of
this ratio for company is to assess it's market position in industry. EBITDA is obtained deducting
interest amount, taxes and amount of depreciation from company's earnings. So this ratio furnish
more fair picture about corporation's financial performance (Cheng, Ioannou and Serafeim,
2014). Other element of such ratio is enterprise value which is aggregate sum of organisation's
equity value or amount of market capitalization including debt but excluding cash. This ratio is
also useful in addressing problems encountered in different traditional ratios such as PE ratio, so
mostly preferable over them.
ii. Comments on market value of Smart Software Plc
From the calculations of market multiple it has been analysed that price to earnings
ratio of Smart Software Plc is higher than Future intelligence Plc and lower than New Wave Plc.
It shows that the investor of the organisation can give second preference to make investment
within the company as it according to this ratio it has second rank. It affects it market value
because investors invest in such companies which may provide them high rate of interest on this
money (Ziegler, 2012).
Price to book value of the company is very high as compare to its competitors which
helps to enhance its market value. 1 is considered the ideal PB ratio and according to it Smart
Software Plc is the best company among all the three organisations. While making decision
regarding investment in business entities the investors will select it because the PB ratio of it is
very high (Amihud and Mendelson, 2012).
Price to cash flow ratio is an indicator which is mainly used for analysis of stock's price
relative to the operating cash flow of the company per share. This ratio of Smart Software Plc is
higher among all the competitors which shows that it is having the highest share value in the
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market. It can help the organisation to attract more and more investors because of the highest
ratio as compare to all the other enterprises. Main purpose of it is to determine profitability of an
organisation so that investors can make decision regarding making investment.
EV to EBITDA ratio is calculated for the purpose of comparing economic value of an
organisation with its earnings before different expenses such as amortization, depreciation,
interest, depreciation and taxes. Smart Software Plc is having the same ratio as New Wave Plc
which is one of its major competitor. As other ratios of the company are higher than its
competitors so it will not affect its market value.
EV to sales ratio is used by business entities to compare the total value of enterprise and
the sales which is generated in a specific financial year. With the help of it contribution of sales
in economic value of the organisation could be analysed. From the market measures calculations
it has been analysed that Smart Software Plc is having second highest EV to sales ratio. It shows
that investors of the company believes that the sales of the organisation will increase in
upcoming year.
iii. Explanation regarding reasonable equity value and enterprise value for Future Intelligence if
it is bought by Smart Software Plc:
Given Information
EBITDA £4 million
book equity £4 million
EV-to-EBITDA ratio 3.8
Price-to-book ratio 2.8
EV-to-EBITDA ratio = Enterprise Value / EBITDA
3.8 = Enterprise Value / £4 million
Enterprise Value = £4 million x 3.8 = 15.2 million
Price-to-book ratio = Price / Book Equity
2.8 = Price / £3 million
Price or Equity Value = £3 million x 2.8 = 8.4 million
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Explanation: As from above calculation it has been analysed that at given EBITDA and Book
Equity, Future Intelligence's Enterprise Value and Price would be 15.2 million and 8.4 million
respectively. From Price-to-book ratio company's share price is assessed while from EV-to-
EBITDA ratio company's enterprise value is determined. So above calculated figures are
appropriate for Smart Software Plc if company is deciding to acquire Future Intelligence.
PART B
i. Definition of economic value and the way in which adjusted book value approach to valuing
assets and liabilities moves book value nearer to economic value
Economic value: Term economic value is indeed a liability cash-flows and net present
value of asset cash-flows. It considers figures indicating value of implicit and explicit
alternatives integrated within organisation's assets and liabilities, whereas any gaps are not
considered here. Economic value implies to the £4 million highest possible sum of money that a
customer is ready to pay in respect of any good or service. Economic value shouldn't be puzzled
with term market value, which implies to lowest amount to be paid in respect of any product or
service by a buyer (Graham, Harvey and Puri, 2013). Consequently, economic value generally
exceeds market value. A specified population's choices decide economic value of any product or
service, as well as customer or buyer create trade-offs based on their respective resources.
Simply it is the fair amount which customer is willing to pay in respect of products or services.
Under Adjusted book value approach main aim is to assess actual fair value of
organisation's assets and liabilities. Also economic value can be defined as the process of
calculating profits which are generated by an asset and could be generated in future. Adjusted
book value and economic value both emphasises on fair and current value of different assets and
liabilities, which moves book values nearer to economic value (Constantinides, Harris and Stulz,
2013).
ii. Highlighting at the elements in the balance sheet that might require adjusting to arrive at an
economic value:
Economic value is also called as enterprise value as which provides fair value of
company by emphasising upon current share price. Here are key elements stated in balance sheet
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of AstraZeneca plc which require adjustment to compute economic or enterprise value, as
discussed below:
 Common equity: It is one of the key element in assessment of economic value. Here
common equity is taken at market value. So in order to assess the market value of
common equity, number of common stock outstanding is multiplied by current market
share price. As stated in balance sheet company's outstanding share are 1266 million so
by multiplying it from company's share's market price common equity could be found.
 Non-controlling Interest: It is also called as minority-interest, simply implies to
ownership status in which company own less than half of total outstanding-shares. Here
for calculation purpose non-controlling interest is also taken at book-value (Yu, 2013).
As stated in company's balance sheet, book value of non-controlling interest amount is
1682 million.
 Current interest-bearing loans and borrowings: In economic value only current loans
and borrowings on which company is paying fixed interest are considered. Book-value is
taken here for computation of economic value. Company has reported Current interest-
bearing loans and borrowings amounting 1397 million in year 2017.
 Non-current interest-bearing loans and borrowings: Here also non-current assets
bearing a interest rate is also added to arrive at figure of economic value. These figures
are taken at value shown in books. Company has reported in year 2017, Current interest-
bearing loans and borrowings amounting 1397 million.
 Cash and cash equivalents: Amount of cash and cash-equivalents is excluded while
calculating economic value. This amount is taken from balance sheet. Company has
stated 3,324 million of cash and cash-equivalent at year ended 2017.
PART C
i. Calculation of EV / EBITDA ratio:
Computation of Enterprise Value of AstraZeneca plc:
AstraZeneca PLC
Current share price (P) $34.70
No. shares of common stock outstanding 1266 million
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USD $ in millions
Common equity (market value) 43,935
Add: Non-controlling interests (per books)` 1,682
Total equity 45,617
Add: Current interest-bearing loans and borrowings (per books) 1,397
Add: Non-current interest-bearing loans and borrowings (per books) 15,197
Total equity and debt 62,211
Less: Other investments 2,387
Less: Cash and cash equivalents 3,324
Enterprise value (EV) 56,500
Calculation of EBITDA:
$ in millions
Reported Profit Before Tax 2227
Net Finance Expense 1395
Joint Ventures and Associates 55
Depreciation, Amortisation and Impairment 3036
EBITDA 6713
EV / EBITDA ratio :
EV 56500
EBITDA 6713
EV / EBITDA ratio 8.42
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iii. Calculation of EV / Sales Ratio:
EV 56500
Sales 22465
EV / Sales Ratio 2.52
iii. Calculation of Price to earnings ratio
Price per Share £4 million $34.70
Earning per Share $1.19
Price to earnings ratio 29.16
iv. Calculation of price to cash flow ratio:
Calculation of net operating cash-flow:
Particulars $m
Reported operating profit 3677
Depreciation 3036
(Increase)/decrease in working capital and short-term provisions -50
(Gains)/losses on disposal of intangible assets -1518
Fair value movement on contingent consideration arising from business
combinations 109
Non-cash and other movements -524
Interest paid -698
Tax paid -454
Net cash inflow from operating activities 3578
No. shares of common stock outstanding 1,26,6 million
£4 million Operating Cash-flow Per Share 2.83
Price per Share $34.70
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Operating Cash-flow Per Share $2.83
Price to cash flow ratio 12.26
v. Contrast and explanation of results of different market multiple ratios:
EV / EBITDA ratio: Normally a higher EV/EBITDA ratio reflects that company's
securities are possibly overvalued whereas higher figure of this ratio implies that securities are
potentially under-priced. Simply it can be understand as lower the ratio of EV/EBITDA reflects
that stock is more attractive. A ratio of EV/EBITDA lower than 10 is regarded more healthy.
However, such benchmark may change form one industry to other industry. Here AstraZeneca
plc's ratio is 8.42 which is less than 10 shows that company's stock is healthy.
EV / Sales Ratio: A case of higher EV / Sales ratio implies that corporation is costlier as
well as not favourable for shareholder or investors to make investment in company since they
would not get any instant benefit via this investment. While a lower EV / Sales indicates towards
crucial investment opportunity in perspective of investors because lower EV / Sales ratio shows
that company is undervalued so in case investors makes investment they will get benefit (Hann,
Ogneva and Ozbas, 2013). A EV/S ratio normally varies approx between 0.5 and 3 based on
industry profitability situation. A lower this EV/S ratio is better. Here AstraZeneca plc's
EV/Sales Ratio is 2.52 which favourable and indicating that company's position in market is
good so investors can invest in company's securities.
Price to earnings ratio: A PE or price to earnings ratio reflects expected price per share
based on corporation's aggregate earnings. A higher P/E ratio reflects an corporation's positive
performance in current and near future and also that investors can pay premium amount for
buying company’s shares. While a lower ratio, reflects that company's current as well as future
performance is weak. AstraZeneca plc's Price to earnings ratio is 29.16 that indicates that
company's position in market is strong.
Price to cash flow ratio: P/CF is most widely applied ratio in investment industry which
provides valuation of corporation while covering impact of cash company collected from
operations. Shares which are under-priced in context of cash-flows can be a reasonable
investment. AstraZeneca plc's price-to-cashflows ratio is 12.26 which indicates that company is
costlier and company's shares seems to be over-priced in relation to company's cash-flows.
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CONCLUSION
From above discussed study it has been articulated that taking financing decision in a
crucial task. Before accepting any financing and investment proposal company should consider
the effect of such proposal on company's current and future performance. Different ratio like EV
to EBITDA, EV to sales, PE ratio etc. contributes in assessment of company's actual market
position. Economic Value of entity is not only significant for company but also for investors as it
demonstrates actual real time position of company as on a particular date. Management should
adopt analysis of these ratio to enhance the accuracy of decisions and forecasts. Also
management adopt NPV and IRR to assess viability of two or more investments and projects
with different time-period.
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