# Corporate Finance and Financial Accounting Coursework

**Paper, Order, or Assignment Requirements**

Chosen Company: Ocado

Step 1 of Coursework

Now that you have chosen your target company and completed Lecture 1, as well as the tutorial for the lecture, you can start your coursework.

The first method that we will use in the valuation of our target company is called Valuation Multiples (or method of comparables or “comps”). An example of this method is the price earnings ratio. You may want to refer to the chapter in the recommended textbook on Valuing Stocks.

In line with the above, you will now need to choose benchmark companies in the same industry as your target company. These may be UK or foreign companies. For example, if I was valuing Royal Mails Plc I would probably use Deutsche Post (of Germany) as one of my benchmarks as I do not have a closely similar company listed on the London Stock Exchange. While you may decide to use all firms in the industry, it is acceptable to restrict the number of benchmarks to three. In extreme cases, a single benchmark may also be used. Note that I do not need to approve your choice of benchmarks. I will mark this in your report.

For all the companies (your target company and its benchmarks) you will need to calculate and discuss the following ratios:

• Price-earnings ratio price per share/ earnings per share

• Enterprise Value to Sales ratio

• Enterprise Value go EBITDA ratio

• EBITDA to Sales ratio

Step 2 of Coursework

Now that you have an idea of the value of your target company, by completing Step 1 of your coursework, our objective in Step 2 is to understand the company and its environment better. The purpose of this knowledge is to be able to improve and justify the valuation of the company.

Therefore, in Step 2, you will need to do a SWOT analysis (Strength, weakness, opportunities and threats) of the company. Issues that you may want to cover include:

• The companies market position (relative to its competitors)

• Business Model (how sound is it?)

• An assessment of the company’s sources of inputs and finance

• Risk management systems/corporate governance mechanisms in place (you may want to compare this with the requirements for listed companies on the London Stock Exchange, available on the Exchange’s website)

• Financial Performance (look at the liquidity/working capital position, profitability, gearing etc. What can you improve to generate synergy?

• Expansion potential

• Strong franchise value- this is the best source of growth. Does your target company have one it’s probably not maximising?

• Management team- poor management team is generally a motivation for takeover. There are ratios to calculate management efficiency.

You may want to discuss the above in about 1000-1500 words.

Other issues

Some of you have asked me if you need to show the formulas for your calculations. I need the figures used but not the formulas. You may want to send all formulas to the appendix (in which case I may not read them). Also, if you have used a spread sheet to complete your coursework, you may want to include this when submitting.

In addition, students have raised the question regarding the interpretation of derived figures. You will need to read materials on ratio analysis, a topic I believed you should have taken. You may also consult the relevant chapters of BD textbook.

Step 3 of Coursework

This step of your coursework carries 50% of the total marks (i.e. 50% of the 30% allocated to the coursework).

In this step you are required to come up with a business plan for your target company as well as a valuation of the company. In coming up with a business plan you should look at the operations, investments and capital structure of your target company with the aim of assessing any potential improvements and future growth. This plan must project the post-acquisition synergies – assume that these would be captured by the target company as you are not required to combine the financials of both the acquirer and the target in the coursework.

You will be coming up with a number of reasonable assumptions at this stage. These assumptions should be justified on the bases of past performance and position of the target company (strength and weaknesses of the income statements and the balance sheet).

In line with the BD textbook (Chapter 19- Valuation and Financial Modelling), please provide necessary calculations regarding operational improvements, capital expenditure and capital structure. You will then need to build a financial model of free cash flow. You need not forecast the balance sheet or the cash flow statement. You may also want to skip improvements in working capital management, as we have not treated this topic- the value of “increase in working capital” would be zero in this case.

It is important to note that your forecast of free cash flow should include two parts:

• Forecast over the short-term horizon (Year 1-5, where Year 0 is assumed to be 2014, the year for which the latest financial data is available) (5 Marks).

• The terminal value – assume that free cash flow at the end of Year 5 (2019) will grow at a constant from Year 6 (2020) to infinity (5 Marks).

• You will need to justify forecast of cash flows for the short horizon and the growth rate for the long horizon that you chose (5 Marks). Therefore, even though your Year 0 is 2014 you will need the accounting data for year -1 to say -5 (that is 2009-2013, 2009). You need not present the data for Years -1 to -5 in your report.

To be able to get the value of the target company, discount the free cash flows at the company’s cost of capital. You should derive the cost of debt (4 Marks) and the cost of equity (2 Marks). Please derive the cost of equity using CAPM. You can then use your results to calculate the weighted average cost of capital (4 Marks). To apply the CAPM you can take the easy path and simply use the beta value you have sourced (e.g. from Bloomberg or Financial Times). However, if you are able to run a regression to derive this value yourself and signal to me that you did this, I will credit you accordingly (4 Marks). You will need to source the risk free rate (use the yield UK Treasury Bond and justify). In line with empirical evidence and practice, please assume that the market risk premium is 5%. Calculate the cost of debt as interest payment divided by long-term debt (i.e. do not include short-term capital in your calculation). You can get the corporate tax rates in the UK by following this link: http://www.hmrc.gov.uk/rates/corp.htm.

It is important that you pay attention to the terminal value as it accounts for a significant proportion of the value of the company. To recount what I said in class, to get the terminal value at the end of Year 5 (which is the beginning of Year 6) use the formula for the present value of growing perpetuity. However, because we need the present value in Year 0, you will then need to discount back to Year 0, where “n” in your discounting formula equals 5 (5 Marks).

Therefore, the value of the target at Year 0 is the addition of the present value of cash flows (Year 1-5) and the present value of the terminal value. Assuming the firm has existing debt (before any new that you will introduce) you then need to subtract this from the value of the firm that you calculated to arrive at the value of equity. If you divide this by the number of shares in issue, you will get the intrinsic value per share based on the discounted cash flow method (5 Marks). Remember that we are evaluating the value of a company (its equity) and not a project. So you are not calculating the NPV. If you are, what is your initial investment? Many good students have made this mistake in the past.

Remember the value of equity you established in the Step 1? We need it in Step 3. To arrive at a value of the equity, we will need to find the weighted average of the value from Step 1 and the value from Step 3. In practice, we normally attach a greater weight to the value derived using the discounted cash flow method (Step 3). There are no hard rules about what weights you should allocate to the values. Just demonstrate to me that you know that the DCF method is significantly more important than the method of comparables. (4 Marks)

You can now compare your final value of the equity with what the market says (i.e. market price per share). Is your company undervalued? That is market price per share is lower than your calculated value of the company- a good justification to recommend a takeover (3 Marks).

Please allocate between 1000 words to the discussion of this part of your coursework (4 Marks). You may want to transfer all tables and calculations to the appendix section of your work.

Our final step will be the structure that I will require when presenting your report.

Please follow the guideline below in presenting your coursework report. (10marks)

1.1. Executive Summary

2.1. Review of UK and Global Economy (Re: Step 2 of Coursework)

2.2. Review of Target Company Sector (Re: Step 2 of Coursework)

2.3. Company Information (Re: Step 2 of Coursework)

3.1 Preliminary Valuation: Assumptions, Results, and Discussion (Re: Step 1 of Coursework)

3.2 Valuation: Assumptions, Results, and Discussion (Re: Step 3 of Coursework)

3.3 Sensitivity Analysis (Optional)

4.1 Recommendations and Conclusion

• Buy?

• At what price?

o e.g. average of results using the various valuation methods

o remember this is not an NPV coursework

• Any other issues

o e.g. limitations of your method

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