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CORPORATE FINANCIAL

STRATEGY

STRATEGY

Table of Contents

INTRODUCTION...........................................................................................................................1

(A) DISCOUNT RATES AND CAPITAL STRUCTURE.............................................................1

(i) Calculation of cost of debt (Kd), cost of equity (Ke) and weighted average cost of capital1

Cost of debt.............................................................................................................................1

Cost of equity.........................................................................................................................2

Wweighted average cost of capital.........................................................................................2

(ii) Critical assessment of capital structure & its repayment ability......................................3

(B) DIVIDEND POLICY................................................................................................................4

(i) Change in dividend over 5 historical years........................................................................5

(ii) Critical assessment of dividend pay-outs.........................................................................5

(iii) Critical analysis of dividend consistency........................................................................6

(C) VALUATION............................................................................................................................7

Static valuation multiples.......................................................................................................7

Absolute valuation method.....................................................................................................7

(D) DEBANHAMS POSITION IN THE CORPORATE LIFE CYCLE........................................8

(i) Revenue and profit growth................................................................................................8

(ii) Financing........................................................................................................................10

(iii) Free cash flow................................................................................................................10

(iv) Dividend payout ratio....................................................................................................11

(E) SHAREHOLDER VALUE PERFORMANCE.......................................................................12

Reapport Analysis................................................................................................................12

Revenue growth...............................................................................................................12

EBITDA margin..............................................................................................................12

Cash tax rate....................................................................................................................13

Working capital investment.............................................................................................13

INTRODUCTION...........................................................................................................................1

(A) DISCOUNT RATES AND CAPITAL STRUCTURE.............................................................1

(i) Calculation of cost of debt (Kd), cost of equity (Ke) and weighted average cost of capital1

Cost of debt.............................................................................................................................1

Cost of equity.........................................................................................................................2

Wweighted average cost of capital.........................................................................................2

(ii) Critical assessment of capital structure & its repayment ability......................................3

(B) DIVIDEND POLICY................................................................................................................4

(i) Change in dividend over 5 historical years........................................................................5

(ii) Critical assessment of dividend pay-outs.........................................................................5

(iii) Critical analysis of dividend consistency........................................................................6

(C) VALUATION............................................................................................................................7

Static valuation multiples.......................................................................................................7

Absolute valuation method.....................................................................................................7

(D) DEBANHAMS POSITION IN THE CORPORATE LIFE CYCLE........................................8

(i) Revenue and profit growth................................................................................................8

(ii) Financing........................................................................................................................10

(iii) Free cash flow................................................................................................................10

(iv) Dividend payout ratio....................................................................................................11

(E) SHAREHOLDER VALUE PERFORMANCE.......................................................................12

Reapport Analysis................................................................................................................12

Revenue growth...............................................................................................................12

EBITDA margin..............................................................................................................12

Cash tax rate....................................................................................................................13

Working capital investment.............................................................................................13

Fixed capital investment..................................................................................................13

Cost of capital..................................................................................................................14

Value/Growth/Duration/Terminal...................................................................................14

CONCLUSION..............................................................................................................................14

REFERENCES..............................................................................................................................16

APPENDIX....................................................................................................................................18

Appendix 1...........................................................................................................................18

Appendix 2...........................................................................................................................18

Appendix 3...........................................................................................................................18

Appendix 4...........................................................................................................................19

Appendix 5...........................................................................................................................19

Cost of capital..................................................................................................................14

Value/Growth/Duration/Terminal...................................................................................14

CONCLUSION..............................................................................................................................14

REFERENCES..............................................................................................................................16

APPENDIX....................................................................................................................................18

Appendix 1...........................................................................................................................18

Appendix 2...........................................................................................................................18

Appendix 3...........................................................................................................................18

Appendix 4...........................................................................................................................19

Appendix 5...........................................................................................................................19

Index of Tables

Table 1 Calculation of cost of debt (Kd)..........................................................................................1

Table 2 Calculation of cost of equity (Ke).......................................................................................2

Table 3 Calculation of weighted average cost of capital (WACC).................................................2

Table 4 Debt to equity ratio and interest coverage ratio..................................................................3

Table 5 Dividend per share and total cash dividend........................................................................5

Table 6 Dividend pay-out ratio of Debanhams................................................................................6

Table 7 Required rate of return table for M&S...............................................................................8

Table 8 Equity value by using Gordon model.................................................................................8

Table 9 Percentage change in revenue and profit over last 5 years.................................................8

Table 10 Calculation of Debt and equity proportion in total capital.............................................10

Table 11 Calculation of FCF in last 5 year....................................................................................10

Table 12 Dividend payout ratio from FY2012 to FY2016............................................................11

Table 13 Calculation of Terminal value and enterprise value.......................................................14

Table 14 Revenue growth of Debanhams and Marks and Spencer...............................................18

Table 15 EBITDA growth and EBITDA margin of Debanhams and M&S..................................18

Table 16 Working capital of Debanhams Plc from 2012 to 2016.................................................18

Table 17 Fixed assets turnover ratio of Debanhams and M&S.....................................................19

Table 18 WACC and ROCE analysis............................................................................................19

Index of Figures

Figure 1 Debt to equity ratio for 5 years..........................................................................................4

Figure 2 Debanhams dividend per share from FY2013 to FY2017................................................5

Figure 3 Debanham revenue and profitability from 2012 to 2016.................................................9

Figure 4 Debt and equity composition of Debanhams..................................................................10

Figure 5 Debanhams and Marks and Spencer' sales performance.................................................12

Table 1 Calculation of cost of debt (Kd)..........................................................................................1

Table 2 Calculation of cost of equity (Ke).......................................................................................2

Table 3 Calculation of weighted average cost of capital (WACC).................................................2

Table 4 Debt to equity ratio and interest coverage ratio..................................................................3

Table 5 Dividend per share and total cash dividend........................................................................5

Table 6 Dividend pay-out ratio of Debanhams................................................................................6

Table 7 Required rate of return table for M&S...............................................................................8

Table 8 Equity value by using Gordon model.................................................................................8

Table 9 Percentage change in revenue and profit over last 5 years.................................................8

Table 10 Calculation of Debt and equity proportion in total capital.............................................10

Table 11 Calculation of FCF in last 5 year....................................................................................10

Table 12 Dividend payout ratio from FY2012 to FY2016............................................................11

Table 13 Calculation of Terminal value and enterprise value.......................................................14

Table 14 Revenue growth of Debanhams and Marks and Spencer...............................................18

Table 15 EBITDA growth and EBITDA margin of Debanhams and M&S..................................18

Table 16 Working capital of Debanhams Plc from 2012 to 2016.................................................18

Table 17 Fixed assets turnover ratio of Debanhams and M&S.....................................................19

Table 18 WACC and ROCE analysis............................................................................................19

Index of Figures

Figure 1 Debt to equity ratio for 5 years..........................................................................................4

Figure 2 Debanhams dividend per share from FY2013 to FY2017................................................5

Figure 3 Debanham revenue and profitability from 2012 to 2016.................................................9

Figure 4 Debt and equity composition of Debanhams..................................................................10

Figure 5 Debanhams and Marks and Spencer' sales performance.................................................12

INTRODUCTION

In today’s era, establishments are facing number of financial challenges due to volatile

external market conditions. Funds are the key requirement for every enterprises regardless their

size and nature of business because none of the entity can run their daily activities without

enough financial resources. Therefore, in every organization, Certified Financial Officer (CFO)

is responsible to handle, monitor and administrate financial functions. They make policies &

plans to procure required capital to finance their operations and put control over its use for

paying off their monetary obligations and financial commitment. Debanhams is a UK-based

multinational retailer which is operating in the fashion industry. Its product portfolio covers

designer cloth, accessories, cosmetics, home & furniture products, electrical equipments and

gifts & toys. The report here purposes at examining its corporate financial strategy through the

analysis of weighted average cost of capital and capital structure. Moreover, dividend policy and

stock valuation will be made using valuation multiples and absolute valuation technique. Lastly,

it will make evaluation of its position under the corporate life cycle i.e. start-up, growth, maturity

and decline through revenue & profit, financing structure, free cash flow and dividend decisions.

(A) DISCOUNT RATES AND CAPITAL STRUCTURE

(i) Calculation of cost of debt (Kd), cost of equity (Ke) and weighted average cost of capital

Cost of debt

On debt capital, Debanhams is liable to pay financial costs in the terms of interest to the

lenders, called cost of debt (Kd) (Benito, Guillamón and Bastida, 2016). On such payment, tax

shield benefits are available to the company because in UK, tax authority, Her Majesty Revenue

& Custom (HMRC) provide tax deductions to the amount of interest paid on loan. Hence, cost of

debt is calculated using below mentioned formula:

Cost of debt (Kd) = Interest/Net debt*(1-tax rate)

Table 1 Calculation of cost of debt (Kd)

2012 2013 2014 2015 2016

Interest (In GBP million) 12 13 13 17 14

Net debt (in GBP million) 249 236 224 197 200

Tax rate (%) 20% 20% 20% 20% 20%

Cost of debt (Kd) 3.86% 4.41% 4.64% 6.90% 5.60%

1

In today’s era, establishments are facing number of financial challenges due to volatile

external market conditions. Funds are the key requirement for every enterprises regardless their

size and nature of business because none of the entity can run their daily activities without

enough financial resources. Therefore, in every organization, Certified Financial Officer (CFO)

is responsible to handle, monitor and administrate financial functions. They make policies &

plans to procure required capital to finance their operations and put control over its use for

paying off their monetary obligations and financial commitment. Debanhams is a UK-based

multinational retailer which is operating in the fashion industry. Its product portfolio covers

designer cloth, accessories, cosmetics, home & furniture products, electrical equipments and

gifts & toys. The report here purposes at examining its corporate financial strategy through the

analysis of weighted average cost of capital and capital structure. Moreover, dividend policy and

stock valuation will be made using valuation multiples and absolute valuation technique. Lastly,

it will make evaluation of its position under the corporate life cycle i.e. start-up, growth, maturity

and decline through revenue & profit, financing structure, free cash flow and dividend decisions.

(A) DISCOUNT RATES AND CAPITAL STRUCTURE

(i) Calculation of cost of debt (Kd), cost of equity (Ke) and weighted average cost of capital

Cost of debt

On debt capital, Debanhams is liable to pay financial costs in the terms of interest to the

lenders, called cost of debt (Kd) (Benito, Guillamón and Bastida, 2016). On such payment, tax

shield benefits are available to the company because in UK, tax authority, Her Majesty Revenue

& Custom (HMRC) provide tax deductions to the amount of interest paid on loan. Hence, cost of

debt is calculated using below mentioned formula:

Cost of debt (Kd) = Interest/Net debt*(1-tax rate)

Table 1 Calculation of cost of debt (Kd)

2012 2013 2014 2015 2016

Interest (In GBP million) 12 13 13 17 14

Net debt (in GBP million) 249 236 224 197 200

Tax rate (%) 20% 20% 20% 20% 20%

Cost of debt (Kd) 3.86% 4.41% 4.64% 6.90% 5.60%

1

In UK, corporate tax rate is 20% as per which, Debanhams is accountable to pay 20% tax

on their pre-tax profit every year. From the results drawn above, it is seen that from FY 2012 to

FY 2015, cost of debt shows an increasing trend as it was 3.86% increased to 4.41%, 4.64% and

6.90% respectively. Over the period, interest payment shows a declining trend because of

reduction in debt through repayment to the lenders. However, in 2016, it dropped down to 5.60%

due to cut in interest rates charged by Bank of England (BOE) from 0.25% to 0.50% so as to

avoid possible recession due to Brexit (separation of UK from European Union) (UK Interest

rates cut to 0.25%, 2016).

Cost of equity

Unlike debt, there is no liability for the Debanhams to pay a fixed or certain rate of

dividend regularly to the shareholders in return for the capital they provided to the entity.

Moreover, tax deductions are also unavailable on dividend payment (Goldmann, 2017).

Cost of equity (Ke) = Risk free rate + beta (market return-risk free return)

Table 2 Calculation of cost of equity (Ke)

2012 2013 2014 2015 2016

Risk free return (Rf) 3.95% 3.95% 3.95% 3.95% 3.95%

Beta 0.59 0.62 0.67 0.68 0.72

Market return (Rm) 12.01% 15.44% 2.57% 0.77% 7.76%

Risk premium 8.06% 11.49% -1.38% -3.18% 3.81%

Cost of equity (Ke) 8.70% 11.07% 3.03% 1.78% 6.71%

As per the results, it can be seen that in 2013, Ke grown to 11.07% due to increase in beta

and market return to 15.44%. However, afterwards in 2014 and 2015, it dropped to 3.03% and

1.78% due to declined market return on FTSE 350 Index whilst in next year, it grown up to

6.71% because of high return expectations of investors as they demanded more dividend on their

capital.

Wweighted average cost of capital

WACC = Debt/(debt +Equity)*Kd + Equity/(debt + Equity)*(Ke)

Table 3 Calculation of weighted average cost of capital (WACC)

2012 2013 2014 2015 2016

Long-term debt 249 236 224 197 200

2

on their pre-tax profit every year. From the results drawn above, it is seen that from FY 2012 to

FY 2015, cost of debt shows an increasing trend as it was 3.86% increased to 4.41%, 4.64% and

6.90% respectively. Over the period, interest payment shows a declining trend because of

reduction in debt through repayment to the lenders. However, in 2016, it dropped down to 5.60%

due to cut in interest rates charged by Bank of England (BOE) from 0.25% to 0.50% so as to

avoid possible recession due to Brexit (separation of UK from European Union) (UK Interest

rates cut to 0.25%, 2016).

Cost of equity

Unlike debt, there is no liability for the Debanhams to pay a fixed or certain rate of

dividend regularly to the shareholders in return for the capital they provided to the entity.

Moreover, tax deductions are also unavailable on dividend payment (Goldmann, 2017).

Cost of equity (Ke) = Risk free rate + beta (market return-risk free return)

Table 2 Calculation of cost of equity (Ke)

2012 2013 2014 2015 2016

Risk free return (Rf) 3.95% 3.95% 3.95% 3.95% 3.95%

Beta 0.59 0.62 0.67 0.68 0.72

Market return (Rm) 12.01% 15.44% 2.57% 0.77% 7.76%

Risk premium 8.06% 11.49% -1.38% -3.18% 3.81%

Cost of equity (Ke) 8.70% 11.07% 3.03% 1.78% 6.71%

As per the results, it can be seen that in 2013, Ke grown to 11.07% due to increase in beta

and market return to 15.44%. However, afterwards in 2014 and 2015, it dropped to 3.03% and

1.78% due to declined market return on FTSE 350 Index whilst in next year, it grown up to

6.71% because of high return expectations of investors as they demanded more dividend on their

capital.

Wweighted average cost of capital

WACC = Debt/(debt +Equity)*Kd + Equity/(debt + Equity)*(Ke)

Table 3 Calculation of weighted average cost of capital (WACC)

2012 2013 2014 2015 2016

Long-term debt 249 236 224 197 200

2

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