Analysis of JB Hi-Fi: Debt Valuation, Share Valuation, Cost of Capital

This report provides a comprehensive financial analysis of JB Hi-Fi Limited, a major Australian and New Zealand retailer. It begins with an examination of the company's debt valuation, comparing short-term and long-term liabilities and assessing the impact of Amazon's market entry. The report then delves into share valuation, utilizing both the dividend discount model and a comparables approach, while also identifying factors influencing stock price. The analysis continues with a detailed look at the cost of capital, including the calculation of the Weighted Average Cost of Capital (WACC), the rationale behind the cost of equity versus debt, and the application of WACC in project evaluations. Finally, the report concludes with a market analysis, focusing on the influence of Amazon and segment-wise classifications of the business. Appendices include supporting calculations and data. The report utilizes information from JB Hi-Fi's annual reports and other financial resources.

Running head: INTRODUCTION TO ACCOUNTING AND FINANCE
Introduction to Accounting and Finance
Name of the Student:
Name of the University:
Author’s Note:
Course ID:

1INTRODUCTION TO ACCOUNTING AND FINANCE
Table of Contents
(I) Debt valuation:............................................................................................................................3
Answer to Question 1:.................................................................................................................3
Answer to Question 2:.................................................................................................................3
Answer to Question 3:.................................................................................................................3
Answer to Question 4:.................................................................................................................4
(II) Share valuation:.........................................................................................................................4
Answer to Question 1:.................................................................................................................4
Answer to Question 2:.................................................................................................................6
Answer to Question 3:.................................................................................................................7
Answer to Question 4:.................................................................................................................9
Answer to Question 5:.................................................................................................................9
(III) Cost of capital:.........................................................................................................................9
Answer to Question 1:.................................................................................................................9
Answer to Question 2:...............................................................................................................10
Answer to Question 3:...............................................................................................................10
Answer to Question 4:...............................................................................................................11
Answer to Question 5:...............................................................................................................11
Answer to Question 6:...............................................................................................................11

2INTRODUCTION TO ACCOUNTING AND FINANCE
Answer to Question 7:...............................................................................................................11
Answer to Question 8:...............................................................................................................12
(IV) Market analysis:.....................................................................................................................12
Answer to Question 1:...............................................................................................................12
Answer to Question 2:...............................................................................................................13
Answer to Question 3:...............................................................................................................13
References:....................................................................................................................................15
Appendices:...................................................................................................................................17

3INTRODUCTION TO ACCOUNTING AND FINANCE
The organisation selected to fit the purpose of this report is JB Hi-Fi Limited, which is
one of the largest retailers of consumers in Australia and New Zealand.
(I) Debt valuation:
Answer to Question 1:
According to the annual report of JB Hi-Fi in 2017, the short-term debt of the
organisation has $885.8 million from $446.8 million in 2016. On the other hand, the long-term
debt of the organisation has been $713 million in 2017, which has increased from $140.8 million
in 2016 (Jbhifi.com.au 2017).
Answer to Question 2:
As identified above, the short-term debt of JB Hi-Fi is higher in contrast to the short-term
debt. However, according to the industry trend, the long-term liabilities are nearly 2.5 times in
contrast to the short-term debt. However, in case of JB Hi-Fi, the organisation has more short-
term liabilities due to large amount of trade and other payables. However, this has helped in
increasing the cash base of the organisation in contrast to the other organisations in the industry.
Answer to Question 3:
The entry of Amazon in the market of Australia and New Zealand would have broad-
reaching influence on the debt structure of JB Hi-Fi Limited. This is because the organisation is
expected to lose earnings by 23% coupled with a fall in sales percentage by 2% by 2022. In case,
there is a fall in sales margin, the net income is expected to fall sharply, which, in turn would
reduce the dividend payout of the organisation. Due to this, the shareholders of JB Hi-Fi Limited
might not be willing to invest in the shares of the organisation. As a result, the organisation
needs to rely on long-term bank loans for carrying out its daily operations. Under such

4INTRODUCTION TO ACCOUNTING AND FINANCE
circumstances, the long-term debt of the organisation would increase with a fall in current
liabilities, as the creditors might not be willing to extend their credit terms (Beaumont 2015).
Answer to Question 4:
The cost of debt for Harvey Norman in the year 2017 has been depicted briefly as
follows:
Particulars Details Amount (in million $)
Operating
income A 269.9
Interest expense B 10.7
Interest rate C=A/B 3.96%
Profit before tax D 259.2
Tax expense E 86.8
Tax rate F=E/D 33.49%
Cost of debt C*(1-F) 2.64%
(II) Share valuation:
Answer to Question 1:
The cost of equity of JB Hi-Fi in 2017 has been represented in the form of a table as
follows:
Particulars Details Units
Beta A 0.52

5INTRODUCTION TO ACCOUNTING AND FINANCE
Risk-free rate B 2.78%
Annual return of S&P 500 C 12.47%
Cost of equity
B+A(C*B
) 7.86%
For arriving at the cost of equity, certain calculations have been made, which are
represented in the form of tables (Refer to Appendices, Appendix 1 and Appendix 2).

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Answer to Question 2:

7INTRODUCTION TO ACCOUNTING AND FINANCE
According to the above figure, it could be stated that JB Hi-Fi has experienced a
considerable growth in revenue, earnings, EPS and dividend. This is because the organisation has
focused on enhancing its product quality while minimising the prices that has increased the sales
massively in 2017. As a result, the earnings of the organisation have increased massively in the
same year, which has increased the trust of the investors. Due to this, the EPS of the organisation
has risen in 2017, which has helped in meeting its growth expectations (Loughran and McDonald
2016).
Answer to Question 3:
Value of Shares under Dividend Discount
Model:
Particulars Amount
Current Dividend per Share $0.46
Dividend Growth Rate 14.17%
Required Rate of Return 4.20%
Expected Value of Shares -$5.27
Stock Valuation under Comparables Approach:
Particulars Amount
Stock Price of Harvey Norman on 31st
$3.82

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June,2017
EPS of Harvey Norman on 2017 $0.40
P/E Ratio of Harvey Norman 9.467
EPS of JB Hi-Fi on 2017 $0.00
Stock Value of JB Hi-Fi $0.00
For arriving at the stock value using two different approaches, certain calculations have
been made, which are represented in the form of tables (Refer to Appendices, Appendix 3 and
Appendix 4).
There are certain factors that influence the stock price of JB Hi-Fi Limited and they are
represented briefly as follows:
 News releases on earnings and securing a big contract
 Accounting scandals due to change in management
 Rise in interest rate leading to fall in net income and dividend to the shareholders (Floyd
and List 2016)
 Expansion of economy leading to rise in stock price
 Inflationary conditions leading to higher prices resulting in fall in share price
 Changes in economic policy, which might increase or decrease the stock price of the
organisation (Cordis and Kirby 2016)

9INTRODUCTION TO ACCOUNTING AND FINANCE
Answer to Question 4:
Between the dividend discount model and comparables approach, the latter is superior, as
it compares the stock of JB H-Fi to the other stocks of the index. In addition, this type of
fundamental analysis is beneficial, since it evaluates the value of the stock over the long-term.
Furthermore, it uses ratios and metrics for grasping the stock value and whether the same is a
sell, purchase or hold. On the other hand, dividend discount model concentrates on the dividend
factor only and it fails to consider the buybacks (Benson, Faff and Smith 2014).
Answer to Question 5:
The additional data that need to be taken into consideration for valuing the stock of JB
Hi-Fi Limited include the following:
 Operating cash flows
 Capital expenditures
 Free cash flow
(III) Cost of capital:
Answer to Question 1:
Particulars Details Units
Market value of equity A
$853.5
0
Market value of debt B
$713.0
0
Cost of equity C 7.86%

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Cost of debt D 2.64%
Tax rate E 33.49%
Total market value of debt and
equity F=A+B 1566.5
WACC
(A/F*C)+(B/F*D)*(1-
E) 5.08%
Answer to Question 2:
The tax rate of JB Hi-Fi has been computed by obtaining the figures from its income
statement. In order to compute the tax rate of JB Hi-fi, the figure for profit before tax and the
taxable amount have been considered. After that, the taxable amount has been divided by the
profit before tax amount to arrive at the tax rate. If the tax rate of the organisation, the WACC of
JB Hi-Fi falls down, since a larger tax rate produces a greater tax shield and vice-versa.
However, as the profit of the organisation has grown over the years, it has resulted in higher tax
rate leading to fall in WACC (Jin, Kanagaretnam and Lobo 2016).
Answer to Question 3:
The cost of equity for an organisation is always greater than the cost of debt, since debt is
to be repaid to the lenders first, if the business liquidates, as mandatory by the Australian
regulations. However, the investors carry greater amount of risk, since in case of business
liquidation, the organisation needs to clear off its debt obligations firstly and the remaining
amount would be distributed equally to the investors (Gerrans, Faff and Hartnett 2015). Hence,
there exists a difference between the cost of debt and cost of equity of JB Hi-Fi.

11INTRODUCTION TO ACCOUNTING AND FINANCE
Answer to Question 4:
Capital primarily refers to the fund used for funding the long-term needs, Short-term
loans are used to finance short-term needs; thus, it is not possible to classify such liabilities under
capital. Hence, including short-term loans in WACC calculation would result in inaccurate
projections.
Answer to Question 5:
The major value of WACC computation for JB Hi-Fi Limited is depicted as follows:
 Easy to understand, as the manager of the organisation could apply weights of each
source finances with its cost along with aggregating the outcome
 As a single hurdle rate is inherent, there would be no change in the proposed capital
structure, which would help in evaluating projects for making better investment decisions
Answer to Question 6:
Focus Shopfit and Project Cars 2 are the two projects, in which JB Hi-Fi has used the
WACC to evaluate the same. In order to use WACC, the organisation has applied weights of
each source finances with its cost along with aggregating the outcome. As it has used a single
hurdle rate for both the projects, it has helped in undertaking quick decisions through which it
has grabbed new opportunities.
Answer to Question 7:
In order to assess the capital structure of JB Hi-Fi, the debt-to-equity ratio has been taken
into consideration and its calculation is depicted as follows:
Particulars Details Amount (in million $)
Total debt A 713