ASSIGNMENT FRONT SHEET BUS687 RESIT
Certification : I certify that the whole of this work is the result of my individual effort and that all quotations from books, periodicals etc. have been acknowledged.
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Programme: Business Undergraduate Year/Level: 3/6
Academic Year: 2021/22 Trimester: 1
Module title: Financial Strategy Assignment no.: 2
Module code: BUS687 Word guide: 2,000 – 2,500
Percentage Weighting of this assignment for the module: 70%
Issue date: 28th March 2022 Return date: 4th May 2022
Lecturer: Ken Chua Second marker: Ms Jesse Tan
Notes for students :
1. Electronic copy of assignment must be submitted through the Turnitin software.
2. This assignment will be marked electronically and results available online through Grademark in Turnitin within 3 weeks of the submission date.
3. 10% of marks are awarded for satisfactory use of language and/or good presentation.
4. 5% of marks are awarded for satisfactory referencing and/or presentation of a bibliography where either is required. Note that all referenced work should be obtained from credible sources.
5. Students should ensure that they comply with Glyndwr University’s plagiarism policy.
6. Students should make correct use of the Harvard referencing method.
Learning Outcomes Tested in this Assignment:
Assess and apply various business performance measurements, conduct financial analysis and control activities
Assess and apply various business performance measurements, conduct financial analysis and control activities
Critically discuss the functions and value of business finance
Critically evaluate and apply business valuation models
Would students please note that achievement of the learning outcomes for this assessment is demonstrated against the assessment criteria shown below (which are not necessarily weighted equally). All marks/grades remain indicative until they have been considered and confirmed by the Assessment Board
Assessment Criteria Marks Awarded Marks Available
1 Identify suitable source of finance and calculate net present value of a given project
Relationship between company capital structure and its corporate strategy 60
3 Wide ranging references with the correct use of the Harvard system 5
4 Quality of the written work. Clear structure to the work and correct spelling was used throughout.
Additional Comments from Second marker or External Examiner (if required) :
Grading and marking Criteria
Grading & Marking Criteria for BA Programmes
80 + Outstanding work of exceptional merit which is original in content or approach allowing a novel perspective, going beyond what is available in the literature.
70 – 79 Work, which is clearly articulated and well substantiated, based on extensive reading, and demonstrates an authoritative grasp of the concepts, methodology and content appropriate to the subject and to the assessed task. There is clear evidence of originality and insight and an ability to sustain an argument, to think analytically and/or critically and to synthesize material effectively.
60 – 69 Work which demonstrates a very good level of understanding of the concepts, methodology and content appropriate to the subject and which draws on a wide range of properly referenced sources. There is clear evidence of critical judgement in selecting, ordering and analyzing content. The work demonstrates some ability to synthesize material and to construct responses which reveal insight and may offer some occasional originality.
50 – 59 Work derived from a solid basis of reading and which demonstrates a grasp of relevant material and key concepts and an ability to structure and organize arguments. The performance may be rather routine, but the work will be accurate, clearly written and include some critical analysis and a modest degree of original insight. There will be no serious omissions or irrelevancies.
40 – 49 Competent and suitably organized work which demonstrates a reasonable level of understanding with minimal analysis and interpretation. It covers the basic subject matter adequately but is too descriptive and insufficiently analytical. There may be some misunderstanding of key concepts and limitations in the ability to select relevant material so that the work may be flawed by some omissions and irrelevancies. There will be some evidence of appropriate reading, but it may be too narrowly focused.
30 – 39 Work lacks evidence of knowledge relevant to the topic and/or significantly misuses terminology. There is either no evidence of literature being consulted or irrelevant to the assignment set. Inaccurate or inappropriate choice of theory. Unsubstantiated/invalid conclusions based on anecdote and generalization only, or no conclusions at all. Lacks critical thought, analysis, and reference to theory.
0 – 29 Insufficient level of understanding and knowledge base unacceptably weak. No evidence of logical structure and poorly presented. Referencing is unsystematic or absent.
The Chief Executive Officer, Simon Steeler of Snack Food Limited has never enjoyed working with analysts. However, after his last analyst call, he was asked about the company’s cash holdings, capital structure and their overall performance measures. One analyst complained at their growing cash position and lack of use of debt finance. The analyst noted that their large equity balance made it difficult for the snack company to earn a high return on equity. The analysts suggested that Simon should take a more aggressive capital structure. Simon Steeler is expecting to retire in 2-years. Simon accepts he may not fully understand capital structure theory. However, Simon dislikes debt, he dislikes it so much that Snack food limited has zero debt. At the end of 2020, Snack Food Limited has zero debt, and held total cash equal to 18% of total assets (total assets in 2020 was valued to be £890million.
Snack Food Limited is based in Wales, and distribute a wide range of crisps, pancakes, waffles, cakes, and popcorn. They sell their produce to thousands of customers every day in a wide range of stores and distribution outlets. The company’s growth is driven by its efficient operations and due to their strong position in Wales and England. They have even taken note of the recent trends in ESG and made healthier versions of their products to satisfy consumer demand.
Snack Food Limited is a well-managed company and it followed a singular philosophy; maximise shareholder value. This singular philosophy came directly from Simon. This philosophy is engrained at all levels of the company and new recruits spend six-weeks being trained on this philosophy to ensure they fully understand it. The management own approximately one-sixth of the 33.9million shares outstanding. Simon believes management owning shares helps reduce agency theory.
Snack Food Limited works in a competitive landscape. They compete with large brands such as Walkers Chips Limited and smaller brands such as Bruce Cakes Limited. Snack Food Limited is very efficient in their operating and capital budgets, and Simon Steeler has had an active role in setting and managing their budgets. If costs change too much, they are always brought back into line with savvy techniques.
Snack Food Limited have a cautious approach and are seen to be risk averse. The company invested in new capacity and new products when attractive opportunities arose. They don’t take high-risk bets, and see growth as a long-run incremental process of smalls steps in product design and make small acquisitions when needed. This has led to positive operating profits. This risk aversion has meant Simon Steeler prefers equity finance and is against debt finance, and Snack Foods Limited follows consistently to Simon beliefs. Consequently, Snack Food Limited has a large cash balance, that improves safety and flexibility. Some of the analysts and his investment committee don’t agree with Simon’s beliefs. However, Simon never listens to them.
Snack Food Limited is looking at taking on debt. In particular, they are analysing if their debt-to-capital ratio should be 20%, 40%, or 60% compared to 0 they currently have. Table 1 shows their financial information for each capital structure.
Table 1. Note all values quotes are in millions of pounds, except per share data and financial ratios.
20% Debt-to-Capital 40% Debt-to Capital 60% Debt-to-Capital
Sales £1,364.6 £1,364.6 £1,364.6 £1,364.6
Operating income (EBIT) £151.3 £151.3 £151.3 £151.3
Interest expense 0 £4.1 £12.8 £33.5
Income before income taxes £151.3 £147.2 £138.5 £117.8
Income Taxes £53.7 £52.3 £49.2 £41.8
Net income £97.6 £94.9 £89.3 £76.0
Dividend paid to stockholders £28.8 £28.5 £26.8 £22.8
Common shares outstanding 33,883,400 29,709,777 26,983,400 24,476,604
Earning per share £0.85 £0.96 £0.99 £0.93
Interest Coverage Ratio (times) N/a 36.90 11.82 4.52
Debt 0 £145.0 £290.0 £435.0
Owners equity (book value) £780.1 £580.1 £435.1 £290.1
The current market figures were recently reported to be. The current return on the market is 8%, the current beta of Snack Food Limited stock is 1.2. If Snack Food Limited increases their leverage to 20%, Beta will rise to 1.3. If they increase their leverage to 40%, their beta will rise to 1.5, and to 60% it will rise to 1.8.
Snack Food Limited acquisition team recently identified a project they could invest in. It will pay £180,000 in 4 years. Since it’s a risky project for Snack Food Limited, their discount rate applicable to this project is only 30%.
Table 2. Current Interest Rates and Bond ratings Information
Yield To maturity of 10-year U.K. Treasury Bond 1.8%
Corporate Bond Rating AAA AA A BBB BB B
Corporate bond 10-year yield to maturity 2.5% 3.2% 3.8% 4.4% 6.1% 7.7%
Benchmark bond Debt-to-capital ratio 13.8% 29.6% 33.8% 40.4% 47% 62.3%
Benchmark Interest Coverage 64.7 15.8 9.6 4.1 2.4 1.3
The corporate tax rate for Snack Food limited is 35.5%. They have a dividend payout ratio of 30%. The quality of the debt issued by Snack Food Limited decreases and the interest rate rises. Analytics provided by Moody’s, noted the current credit rating of Snack Food Limited is “AAA”. A 20% debt-to-capital, the credit rating will most likely reduce to “A”, if debt-to-capital changes to 40%, the credit rating will reduce to “BBB”, and if the debt-capital ratio becomes 60%, the credit rating will lower to a “B”.
If Food Snack Limited decides to repurchase shares to the market price of £41.67 per share, the premium increases linearly based on the size of the repurchase. Consequently, when the debt-to-capital ratio is changed to 20%, the premium required to repurchases shares increases to 15%, at 40% debt-to-capital ratio the premium rises by 25%, and at 60% debt-to-capital ratio, the premium rises to 30%.
1) For the risky investment Snack Food limited is considering to invest in, what would the investment be worth today? (5 marks)
2) For Snack food limited, what would the optimal capital structure be? In your answer, provide reasonings as to why this would be your optimal capital structure? (45 marks)
3) If Snack food limited were to repurchase shares, what would the cost be for the following scenarios, 0% debt-to-capital ratio, 20% debt-to-capital ratio, 40% debt-to-capital ratio, 60% debt-to-capital ratio. (15 marks)
4) Based on the qualitative and quantitative information provided, if you were the investment advisor to the CEO (Simon), describe and explain what recommendations you would give to Simon on the suitable sources of finance Snack Food Limited could utilize to raise debt? (20 marks)
(i) a wide-ranging reference with the correct use of the Harvard system
(ii) quality of the written work with clear structure to the work and correct spelling was used throughout.
(Total 100 marks)