Financial Analysis, Valuation and Capital Structure of BAE Systems

This report presents a comprehensive financial analysis of BAE Systems Plc. It begins with an introduction to financial analysis and its importance, followed by a detailed examination of various financial ratios, including net profit margin, gross profit ratio, current ratio, debt-equity ratio, and return on equity, comparing BAE Systems to General Dynamics Corp. The report then explores the limitations of ratio analysis. The core of the report focuses on company valuation, employing asset-based valuation, dividend valuation model, and price-to-earnings ratio methods. The report also delves into capital structure, calculating the cost of debt and equity, and discussing the weighted average cost of capital (WACC) along with the difficulties associated with its calculation. The analysis provides insights into BAE Systems' financial performance and valuation, offering a comprehensive overview of its financial health.

Finance

Table of Contents
INTRODUCTION...........................................................................................................................1
MAIN BODY...................................................................................................................................1
2.1 ...............................................................................................................................................1
(a)Financial Analysis..................................................................................................................1
(b) Limitations on the usefulness of ratio analysis......................................................................3
2.2 Company Valuation..............................................................................................................3
2.3 Capital Structure....................................................................................................................8
CONCLUSION..............................................................................................................................10
REFERENCES..............................................................................................................................11

INTRODUCTION
Finance is termed as one of the most important element for each business organisation in
order to perform all the required activities so that operations can be conducted in well defined
manner. Financial performance of business organisation is an important tool used to access
success of business in measurable terms. Financial statements are prepared so that financial
performance can be measured and assessment for financial needs can be identified (Knorr Cetina
and Preda, 2012). This project report is based on financial analysis of BAE Systems Plc which is
listed in London stock exchange. The project report includes financial analysis, company
valuation and analysis of capital structure of business organisation so that financial calculations
can be made in appropriate manner.
MAIN BODY
2.1
(a)Financial Analysis
Financial Analysis is a process through which businesses, projects and budgets are
evaluated in order to determine performance as per set targets. In the process of Financial
Analysis number of financial documents needs to be prepared so that performance can be
analysed appropriately. Ratio analysis is one of the tool which helps in financial analysis as it is
purely based on formulas and leads to generation of best results for business organisations.
Comparison for financial performance is made on the basis of industrial standards so that actual
performance can be analysed and most productive results can be generated (Ayub, 2013). In
order to access financial performance of BAE Systems Plc and one of its competitor ratio
analysis needs to be performed which is as follows-
Net-profit Margin:
Year – 2018 BAE Systems General Dynamics Corp
Net Profit Margin ( % ) 5.94% 9.24%
This ratio represents the net profitability situation of business by showing proportion of
net profit and turnover. GD corporation and BAE system has net profit ratio of 5.94% and 9.24%
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respectively. Which shows that BAE has lower efficiency to generate return as in comparison to
General Dynamics Corporation.
Gross Profit Ratio:
Year-2018 BAE Systems General Dynamics Corp
Gross Profit Ratio (%) 65.16% 18.55%
Interpreting this ratio reflects how effectively a business can provide gross profits before
considering indirect expenses. As above table shows BAE System Plc 's gross-margin is 65.16%
while General Dynamics Corporation's gross-margin is just 18.55%. It means that BAE is more
competent to generate gross profits than its competitor.
Current Ratio:
Year-2018 BAE Systems General Dynamics Corp
Current Ratio 1.0289 1.23
This ratio presents liquidity position of company in short-term. This evaluates
corporation's proportionate of current liabilities and current assets (McLean and Zhao, 2014).
Table containing current ratio of companies shows that current ratio of BAE is 1.03 and of
General Dynamics Corporation is 1.23. This shows that General Dynamics Corporation's short
run liquidity position is much better than BAE.
Debt-equity Ratio:
Year-2018 BAE Systems General Dynamics Corp
Debt-equity Ratio 3.46 0.98
It reflects level of total debts in company as in comparison to shareholders' equity. BAE
system has reported debt-equity ratio of 3.46 while its competitor General Dynamics Corporation
has reported debt-equity ratio of 0.98. This means that in company BAE systems debt level is
higher than total equity funds. While in General Dynamics Corporation debts are lower than in
proportion to shareholders' funds.
Return on Equity:
Year-2018 BAE Systems General Dynamics Corp
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Return on Equity 18.03% 28.88%
This ratio is denoted as percentage return company is providing to its shareholders. BAE
has reported 18.03% return on equity in year 2018 while its competitor has provided 28.88%
return on equity. This major difference in comparative analysis of both company shows that
General Dynamics Corporation is able to provide more return to shareholders than its competitor.
Overall evaluations and analysis of different ratios of BAE and General Dynamics
Corporation indicates that BAE is required to make improvement in aggregate operational and
financial performance. In each measure except gross margin BAE has performed poor as in
comparison with General Dynamics Corporation.
(b) Limitations on the usefulness of ratio analysis
Ratio analysis helps in analysing financial performance of a business organisation and is
available with number of benefits but together with this certain amount of limitations are
available to ratio analysis and which is as follows-
Historical data usage: All the information which is used to calculate and analyse ratio is
actually derived form historical results. Past results does not provide certainty that same results
will generate in future and this leads to inconsistency for the analysis made in terms of financial
analysis through ratios (Besley and Brigham, 2013).
Operational changes: A company leads to change in its operational structure over a
period of time and ratios that are calculated before such change when compared with new
structure performance provides misleading information. For example- organisations policy to
invest in fixed assets may changed and this leads to difference is ratios.
Business conditions: Ratio analysis needs to be done in the context of general business
environment and change in the business conditions may leads to manipulation of required
information. For example- change in debtors collection period may leads to generation of
difference in ratios.
Point of time: Some of the ratios are calculated on the basis of information generated
through balance sheet. When there is a unusual decline in the account balance on the last day of
the reporting period then it leads to generation a negative effect on ratio analysis which is not
completely true.
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2.2 Company Valuation
Business valuation is a general process of determining the economic value of a whole
business or company unit. In order to calculated value of BAE Systems Plc some of the methods
are used as follows-
Asset Based Valuation: In this form of valuation in a business all the focus is made on
the value of all the assets of the company on the basis of fair market value of the total assets.
These assets will be calculated on the basis of their net value after deducting their net liabilities.
Assets are evaluated and their net market value is obtained (Frieden, 2015).
Asset Based Valuation of BAE System Plc
Year-2018 (GBP in
millions)
Assets
Current assets
Cash and cash equivalents 3232
Receivables 1427
Inventories 774
Other current assets 4143
Total current assets 9576
Non-current assets
Net property, plant and equipment 2365
Goodwill 10239
Intangible assets 419
Deferred income taxes 702
Prepaid pension benefit 308
Other long-term assets 1137
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Total non-current assets 15170
Total assets 24746
Liabilities
Current liabilities
Short-term debt 785
Accounts payable 911
Taxes payable 334
Other current liabilities 7277
Total current liabilities 9307
Non-current liabilities
Long-term debt 3514
Accrued liabilities 534
Deferred revenues 560
Pensions and other benefits 4573
Minority interest 72
Other long-term liabilities 640
Total non-current liabilities 9893
Total liabilities 19200
Net Assets of BAE System 5546
Thus, corporation's value as per assets based valuation is GPB 5546 millions
Cross Check:
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Stockholders' equity
Common stock 87
Additional paid-in capital 1249
Retained earnings -2271
Accumulated other comprehensive income 6481
Total stockholders' equity 5546
Analysis: The above analysis provides that on the basis of asset valuation method of
BAE System Plc organisation is available with a net value of 5546 millions. The aggregate asset
is available with a value of 24746 million and total external liabilities are of 19200 millions
which will be deducted from the amount of total assets so that accurate value of assets can be
calculated.
Dividend Valuation Model: It is a method through which stock price of organisation
based on the theory that stock is worth the sum of all its future dividend payments discounted
back to their present value is calculated. It is a method which is used to value stocks based on the
net present value of the future dividends (De Mooij, 2012). Value as per this model is calculated
and evaluated on the basis of formula as follows-
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Analysis: On the above method of calculation it has been analysed that value of stocks
possessed by BAE System Plc organisation is 24814.9071 millions. This specifies that amount of
stock is quite good and represents fair market conditions.
Price to Earning Ratio: This is a valuation method through which business
organisations evaluate its current price relative to its per-share earnings. Through this ratio it is
evaluated by business organisations regarding what amount general public is willing to pay in to
acquire shares of the organisation. PE is determined using market price of shares and multiplied
by companies net-income available for shareholders.
Valuation of BAE through PE Method
Pounds in millions 2018
Sales Receipts 16821
Cost of goods sold 5860
Gross-profit 10961
Operating-expenditures
Other operating expenditures 3602
Aggregate operating expenses 3602
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Operating incomes 7359
Interest Expenditure 307
Other miscellaneous income/(expense) -5828
PBT 1224
Provision for income-taxes 191
Net-income from continuing operations 1033
Other-incomes -33
Net-income 1000
Net-income available to common shareholders 1000
Earnings per share
Basic 1.25
P/E Method = Market Share Price / Earning Per Share 462.30/1.25
=369.84
Business Value = PE Ratio * Net income = 369.84 * 1000 million 369840 Million
Analysis: From the above valuation method it is evaluated that through PE ratio
organisation value is evaluated with an amount of 369840 million. While as per asset valuation
companies value is 5546 million and as per dividend valuation method it is 24814.91 million.
Among all calculations PE ratio generates maximum value of the organisation.
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2.3 Capital Structure
(a) Cost of debt of the convertible bonds for Absolute plc
Tax rate on convertible bond: 8.00%
Rate of tax: 19.00%
8% convertible bond: 750000
Cost of debt formula= Interset payable * (1- tax rate)
= 8% * (1-19%)
= 8% * (0.81)
= 6.48 percent
Cost of debt in amount= 750000 * 6.48 %
= 48600
(b) Cost of equity
It is the amount that an investor requires on an investment made in equity finds. When a
business organisation make a investment in a project then in that case it is the amount which a
business organisation is planning to recover or earn form that investment (Prasad, 2015). Cost of
equity for BAE System Plc organisation is as follows-
Paid dividend: £0.28 for each
share
Dividend rate per share for next year: £0.30 for
each share
Market price (ordinary share): £3.16 for each
share
Growth rate (G): 6.00%
Cost of equity= (Dividend per share / Market price of ordinary share) + g%
= (0.30 / 3.16) + 6 %
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= 9.49 + 6 %
= 15.49 %
(c)Weighted average cost of capital
It is the rate that a company is expected to pay on an average to all its security holders to
finance its assets. It is referred as the cost of capital that an organisation needs to pay in order to
generate and employ required finances in the business organisation. The cost incurred for the
capital is dictated by the external environment and not on the basis of management of business
organisation (Richards, 2012).
(d)Difficulties in calculating WACC
 Estimation of cost of equity is performed through different methods and models and in
each model different issues are involved in relation to estimation. Difference in the rate
of assumption leads to generation of difficulties in the process of calculating WACC.
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