FINA6000 Managing Finance: Capital Structure & WACC Analysis Report

This case study provides a comprehensive financial analysis of Woolworths Limited and BHP Billiton Limited, focusing on their capital structure, weighted average cost of capital (WACC), and valuation. The analysis evaluates the changes in the capital structure of both companies over the past five years, highlighting the debt-to-equity proportions and their alignment with industry trends and financial theories like the trade-off theory. WACC is calculated for both companies, considering the cost of debt and equity, and the impact of taxation on WACC is explored. Furthermore, the intrinsic value of each company is determined using dividend growth and P/E valuation models, leading to an investment decision recommendation based on the comparison of intrinsic and market values. The study concludes that both companies are undervalued, presenting investment opportunities, with a nuanced consideration of other factors like market position and industry growth rates influencing the final decision. Desklib offers a wealth of similar solved assignments and past papers to aid students in their studies.

Running Head: Managing Finance
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Project Report: Managing Finance

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Contents
Introduction.......................................................................................................................3
Company overview...........................................................................................................3
Capital structure................................................................................................................3
WACC..............................................................................................................................5
Tax influence on WACC..................................................................................................5
Valuation analysis.............................................................................................................6
Analysis on investment decision......................................................................................6
Other factors.....................................................................................................................7
Standard risk.....................................................................................................................7
References.........................................................................................................................9
Appendix.........................................................................................................................10

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Introduction:
Financial management focuses on the equity, debt and ratios of an organization in
order to evaluate the performance, financial position and other financial facts about the
business. Financial management involves a proper planning directing, organizing and
controlling the financial activities such as utilization and procurement of organization’s
funds. Procurement of funds and management of funds are the primary activity in the
financial management (Gibson, 2011). In case of management of funds, the assets and the
resources of the business is managed to ensure the adequate and regular supply of funds, to
ensure the utilization of optimal funds of the business etc.
In this report, the study has been done on Woolworths limited and BHP Billiton
limited to identify the performance of both the companies in the market in order to invest in
the company. The capital structure, WACC, intrinsic value etc. of both the companies has
been determined to measure the overall performance of the business so that the better
investment decision could be made.
Company overview:
Woolworths limited:
Woolworths limited is an Australian company which operates its operation under the
Australian retail industry. The main area of operations of the company is Australia and New
Zealand market. This company is recognized as the second largest Australian company in
terms of revenue generation. In the year of 2018, 205000 people are working in the company
in order to meet the mission, vision and strategic objectives of the business (Home (b) (a),
2018).
BHP Billiton:
BHP Billiton limited is an Australian company which operates its operation under the
Australian mining industry. The main products and operations of the company are in mining,
metals, petroleum etc. The main area of operations of the company is worldwide. This
company is recognized as the largest mining company in terms of market capitalization
(Home (a), 2018). In the year of 2018, 62,000 people are working in the company in order to
meet the mission, vision and strategic objectives of the business.
Capital structure:

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Capital structure is a position of funds of an organization. It evaluates the long term
debt and total equity of the business against the total available capital of the business.
Evaluation on the capital structure level of the business is crucial for the investors as it
defines about the total associated risk with the business (Higgins, 2012). In this report, the
capital structure of BHP Billiton and Woolworths limited has been identified to measure the
associated risk with the companies.
In case of Woolworths, it has been found that the capital structure of the company has
been changed a lot in last 5 years. At initial stage, the debt equity proportion of the company
was 0.62:0.38 which has been led to 0.73:0.27 (Annual report, 2018). It represents that the
company has improved the equity level to fund the resources of the business which has
reduced the risk of the business. Mainly, the capital structure level of the business has been
changed because of the industry factors and the need of the business to set an optimal capital
structure. Through evaluation on the retail industry, it has been found that the changes are
quite similar to the industry and these changes have taken by the business because of the
market demand. Woolworths is following the trade off theory in order to manage the tax
shield of the business through improving the funds through debt and equity funds (Lemmon
& Zender, 2010).
Calculation of capital structure of Woolworths limited
2014 2015 2016 2017 2018
Total ordinary share 10252500 10834200 8470600 9526000 10481000
Total long term debt 6394500 5334000 6038900 4565600 3881000
Total 16647000 16168200 14509500 14091600 14362000
Ordinary share proportion 61.59% 67.01% 58.38% 67.60% 72.98%
Long term debt proportion 38.41% 32.99% 41.62% 32.40% 27.02%
(Morningstar, 2018)
Further, in case of BHP Billiton, the calculations represents that various changes have
occurred into the capital structure position of BHP as well. But these changes are not huge
and represent that almost similar proportion of equity and debt is managed by the company so
that the associated risk and cost level of the business could be managed. The current debt and
equity proportion of the business is 0.57:0.43 (Morningstar, 2018). Through evaluation on the
mining industry, it has been found that the debt and equity level of industry has also not been
changed a lot. BHP is following the trade off theory in order to manage the tax shield of the
business through improving the funds through debt and equity funds (Frank & Goyal, 2009).

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Calculation of capital structure of BHP Billiton
2014 2015 2016 2017 2018
Total ordinary share 79143000 64768000 54290000 57258000
5559200
0
Total long term debt 54206000 46959000 52323000 48382000
4241200
0
Total
13334900
0
11172700
0
10661300
0
10564000
0
9800400
0
Ordinary share
proportion 59.35% 57.97% 50.92% 54.20% 56.72%
Long term debt
proportion 40.65% 42.03% 49.08% 45.80% 43.28%
(Morningstar, 2018)
WACC:
After the evaluation on the capital structure level of the business, WACC of the
companies have been calculated to identify the total associated cost of the business. WACC
represents the total cost of debt, equity and other sources of funds which must be paid by the
company against the total investment and borrowings in the business.
The WACC calculations of Woolworths represents that the total cost of debt of the
business is 2.80% and the 8.35% is the total cost of equity of the business. Further, the debt
and capital ratio of the business is 0.27:0.73. It leads to the conclusion that the total cost of
capital of Woolworths limited is 6.85% (Morningstar, 2018). Company has to pay 6.85% to
the debt holders and equity holders from the profit to maintain the resources in the business.
Further, the study has been done on BHP Billiton and it has been found that the total
cost of debt of the business is 1.75% and the 10.62% is the total cost of equity of the
business. Further, the debt and capital ratio of the business is 0.43:0.57 (Morningstar, 2018).
It leads to the conclusion that the total cost of capital of BHP Billion is 6.78%. Company has
to pay 6.78% to the debt holders and equity holders from the profit to maintain the resources
in the business.
It represents that the cost of BHP is lower than the Woolworths and the associated
risk of BHP is higher than Woolworths. The difference in the total cost is not much higher
and it has taken place because of lower cost of debt of the business.
Tax influence on WACC:

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In order to calculate the WACC, cost of debt, cost of equity, cost of preference share
and cost of other sources are required to be determined. The cost of debt, cost of preference
share etc are tax free for the business and thus it is determined after deducting the taxation %
from the total cost (Brigham & Daves, 2012). If the tax rate of the country would be reduced
or eliminated than the total cost of debt or preference share would be improved and it would
lead to the higher weighted average cost of capital in the business.
The impact of taxation on WACC could be recognized through the below equation:
The formula of WACC is as follows:
1 - T x D V x r d + P V x r p + E V x r e
But if the taxation factor is eliminated from the business than the formula of WACC
would be as follows:
D V x r d + P V x r p + E V x r (Chandra, 2011)
It defines that the elimination of taxation directly eliminated the fact which helps the
business to reduce the total cost of the business and thus the total cost of the business get
increased.
In case of Woolworths and BHP Billiton, the tax rate has been eliminated to identify
the impact of taxation rate on WACC level of the business and it has been determined that the
weighted average cost of capital of Woolworths and BHP Billiton has been improved from
6.85% to 7.17% and 6.78% to 7.10% because of the improvement in the cost of debt level of
the business.
Valuation analysis:
It is quite important for the investors and the financial analyst to recognize the
intrinsic value of the business. Intrinsic value stands for the fair value of the stock of an
organization. In valuation analysis, the important factors of an organization are considered to
recognize the fair value of the stock.
The valuation analysis study on both the companies has been done in the attached
spreadsheet.
Analysis on investment decision:

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In case of Woolworths limited, in order to recognize the intrinsic value of the
business, the dividend growth model and PE valuation model has been applied on the
company so that it could be measured that whether the investment into the company would
offer the return to the investors or not. The dividend growth model explains that the intrinsic
value of the company is $ 57.05 on the basis of the dividend growth rate model whereas the
P/E valuation model explains that the intrinsic value of the company is $ 39.58. The market
value of the stock is $ 29.98 which explains that the stock price of the company is
undervalued in the market and the investment into the company would offer huge return to
the investors (Yahoo finance (b), 2018). This is the right time to purchase the stock of
Woolworths limited.
In case of BHP Billiton, in order to recognize the intrinsic value of the business, the
same valuation model has been applied on the company so that it could be measured that
whether the investment into the company would offer the return to the investors or not. The
dividend growth model explains that the intrinsic value of the company is $ 38.09 on the
basis of the dividend growth rate model whereas the P/E valuation model explains that the
intrinsic value of the company is $ 45.88. The market value of the stock is $ 33.01 which
explains that the stock price of the company is undervalued in the market and the investment
into the company would offer huge return to the investors (Yahoo finance (a), 2018). This is
the right time to purchase the stock of BHP Billiton.
On the basis of the study, I found that P/E valuation model is more reliable as it
directly focuses on the earnings of the business. Through the evaluation, it has been
concluded that the performance of both the comapny is better, however, Woolworths limited
is performing better than BHP Billiton in terms of the associated risk and the return from the
business.
Other factors:
If the other factors of the business such as the projects, market position, demand of
the products, industry growth rate etc of the companies are measured than it could manipulate
the decisions. As the BHP’s growth rate is quite better than the Woolworths limited and the
market performance and competitive level of BHP is also better in the market (Haney, 2009).
An investor is required to evaluate on all the related factors in order to measure the overall
performance and position of the business.

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Standard risk:
Risk of an organization could be calculated through various measurement bases such
as probability distribution, standard risk and coefficient of variation. All of these methods
take the concern on different factors to determine the performance of the stock. Through the
study on all the factors, it has been determined that the standard deviation method is one of
the best and common method to measure the performance.
Beta level represents about the volatility in the stock price of an organization. Beta of
Woolworths and BHP Billiton has been calculated through regression model to measure that
how much the stock price gets fluctuated against the index price. On the basis of the study it
has been found that the volatility level of Woolworths and BHP is 0.96 and 1.34 which
explains that the Woolworths fluctuations are lower than market index and the fluctuations in
the BHP stock is higher than the market index. It represents that the portfolio of both the
stock would be better as it would compensate the associated risk of the investment.
Conclusion and recommendation:
On the basis of the study, it is recommended to the investors to invest in the stock of
Woolworths to get higher return and increase the market value of stock as the associated risk
with the Woolworths stock are quite average and the return from the stock are higher. Along
with that, the valuation method also explains that the intrinsic value of the stock is higher
than the market value of the company.

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References:
Annual report. (2018). Woolworths limited. (online). Retrieved from:
http://www.wesfarmers.com.au/util/news-media/article/2018/08/14/wesfarmers-2018-
full-year-results
Brigham, E., & Daves, P. (2012). Intermediate financial management. Nelson Education.
Chandra, P. (2011). Financial management. Tata McGraw-Hill Education.
Frank, M. Z., & Goyal, V. K. (2009). Capital structure decisions: which factors are reliably
important?. Financial management, 38(1), 1-37.
Gibson, C. H. (2011). Financial reporting and analysis. South-Western Cengage Learning.
Haney, L. H. (2009). Business Organization and Combination. BiblioBazaar, LLC.
Higgins, R. C. (2012). Analysis for financial management. McGraw-Hill/Irwin.
Home (A). (2018). BHP Billiton limited. (online). Retrieved from https://www.bhp.com/
Home (B). (2018). Woolworths limited. (online). Retrieved from:
https://www.woolworthsgroup.com.au/
Lemmon, M. L., & Zender, J. F. (2010). Debt capacity and tests of capital structure
theories. Journal of Financial and Quantitative Analysis, 45(5), 1161-1187.
Morningstar. (2018). BHP Billiton limited. (online). Retrieved from
https://financials.morningstar.com/income-statement/is.html?
t=0P000000NF&culture=en&ops=clear
Morningstar. (2018). Woolworths limited. (online). Retrieved from:
http://financials.morningstar.com/cash-flow/cf.html?t=WOW&region=aus&culture=en-
US
Yahoo Finance (A). (2018). BHP Billiton limited. (online). Retrieved from:
https://au.finance.yahoo.com/quote/BHP.AX/history?p=BHP.AX&.tsrc=fin-srch-v1
Yahoo Finance (B). (2018). Woolworths limited. (online). Retrieved from:
https://au.finance.yahoo.com/quote/WOW.AX/history?
period1=1372617000&period2=1530297000&interval=div
%7Csplit&filter=div&frequency=1mo

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Appendix:

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