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1. Prepare a brief description of the companies, outlining the core activities, the markets they operate within and any factors in the companies’ history which you consider help to present a “picture” of those companies.
2. Calculate the following key ratios for BOTH of your selected companies for the past 4 years (show all workings):
i) Return on Assets (EBIT / Total Assets)
Return on Owners Equity (Net Profit After Tax / Owners Equity)
Gearing Ratio Total Liabilities / Total Assets
EBIT x NPAT x TA = NPAT
TA EBIT OE OE
Be sure that you have “proven” the above equation.
ii) Present the above ROA and ROE results in the form of a clear and useful graph for each company.
iii) Explain what phenomenon is being “captured” by the variable TA/OE, and how it is impacting on the relationship between Return on Assets and Return on Owners Equity.
Be sure to explain why the ROE is significantly greater than or less than the ROA.
3. i) By use of the Australian Stock Exchange website, www.asx.com.au prepare a graph / chart for movements in the monthly share price over the last 5 years for both of the companies that you are investigating. Plot them against movements in the All Ordinaries Index.
ii) Write a report which compares movements in the companies’ share price index to the All Ords Index. For instance, how closely correlated were the two lines with the All Ords Index. Above or below? More or less volatile?
iii) From research via the internet or financial/business publications, note any significant announcements which may have influenced the share price of each company. These factors could include merger activities, divestitures, changes in management’s earnings forecasts, changes in analysts’ forecasts, unusual writeoffs or abnormal items, macroeconomic factors, industry wide factors, significant management changes, changes in the focus of the company, impact of competitors, law suits etc. (Restrict the number of announcements to 5 for each company)
iv) Graph and compare the trends in the accounting profitability ratios (ROA and ROE) in part 2i) above with the behaviour of your companies’ share price movements.
How strong is the correlation between these variables?
In light of your observations above, what is your conclusion about the relationship between annual accounting profitability results and share prices? To what extent do ROA and ROE results “drive” share price movements? 2 + 2 + 4 = 8 marks
v) Are you able to identify any changes in the share price which may have resulted from the announcements identified in point iv) above.
4. Go on-line to http://www.reuters.com/finance/stocks/ and type in the code for your company into the Search Stocks field and click on the magnifying glass button.
i) What is the beta for your two companies? 2 marks
ii) What is the current risk free rate? Justify your answer by referencing from a professional /academic source. 3 marks
iii) What is the current Market Risk Premium (using the Capital Asset Pricing Model definition). Justify your answer by referencing from a professional /academic source. 3 marks
iv) Using the three values above, calculate the required rate of return for each of your two companies’ shares. 2 marks
v) Which of these companies is the more “conservative” investment? Explain your answer. 1mark
5. Consider the gearing ratios for your two companies over the past five years:
i) Do they appear to be working towards the maintenance of a preferred optimal capital structure? Explain your answer.
ii) What have they done to adjust / amend their gearing ratio? Increase or repay borrowings? Issue or buy back shares? Has the Director’s Report given any information as to why they have made any adjustments?
It will help to prepare a bar graph using information from the Financing activities section of their Statement of Cash Flows for both companies, showing the major inflows and outflows of cash to Shareholders and Long-Term Liabilities.
iii) Is there any significant difference in the average gearing ratios of these two companies? If so, what factors may help to explain this difference? 3 marks
6. Weighted Average Cost of Capital (WACC)
i) Using information from the latest company report for each company, and the estimated cost of equity capital calculated in part 4 iv) above, calculate the WACC for each of your companies.
ii) Explain the implications that a higher WACC has on management’s evaluation on prospective investment projects.
7. Dividend policy
i) Calculate and graph the following ratios for each of the past 4 years for both companies :
• Earnings Per Share
• Dividends Per Share
• Dividend Payout Ratio
ii) Discuss what the dividend policy of the management of each of these companies appears to be. Explain fully.
8. Based on your analysis above, write a letter of recommendation to your client, providing an explanation as to which (if any) of the two companies that you would like to include in their investment portfolio.
Please refer to the ratio results calculated earlier and any other trends or factors that you believe to be important.
You must also state any limitations that you would place on your professional indemnity for the advice given to your client.