BUS5IAF Introduction to Accounting and Finance Management

The purpose of these questions is to require you to demonstrate your ability to conduct research into real companies, their operations and events affecting those companies. You should demonstrate your ability to interpret data, summaries your findings and to communicate your views in a report. The emphasis is on explaining the financial management of the company, as revealed in the accounting reports, and also to place those reports within the wider economic context.

(I) Debt Valuation (20%)

What are the short-term and long-term debts used by your firm?

Is your company’s debt structure consistent with the industry?

How does the industry your company operates in influence the proportion of short-term to long-term debts of your company?

What is your company’s the cost of debt?

(II) Share Valuation

What is your company’s cost of equity?

Evaluate and discuss your company’s revenue, earnings, EPS, dividends and growth expectations. Use the most recent reported earnings results from the annual report you submitted in PART A for your analysis.

Value your company’s stock using comparables approach (ie. P/E) and constant dividend growth rate model. What are the factors that influence your company’s stock price and how are they captured in these models?

Which of the values in question 3 appear most reasonable compared to the market price of your company’s stock? 5. What additional data and information would you prefer for valuing your company’s stocks? Explain your reason(s).

(III) Cost of Capital

Calculate the weighted average cost of capital (WACC) of your company?

Explain the company’s tax rate in the calculation of WACC?

Why is there a difference in the cost of debt and the cost of equity?

Should current liabilities be included in the cost of capital calculation? What are the pros and cons?

What is the major value of the WACC calculation for your company and how is it applied in investment decision-making?

Provide examples of how your company might have recently used WACC in its investment decision-making with reference to two projects recently undertaken by your company. You may need to synthesize information from your readings (ie. Annual reports, GPFS etc.) to identify the projects.

Define and explain capital structure of your company. Discuss whether it is consistent with the industry and why or why not.

What is the optimal capital structure and what economic circumstances will likely cause a change in it?

(IV) Market Analysis

Comment on your chosen company’s financial performance relative to its industry. You will have to investigate your company’s industry using sources such as Bureau of Statistics, industry journals/publications, analysis in financial press, IBISWorld etc.

Conduct a literature search on your company. Summarise and explain how your company is being viewed by financial analysts and others in the press (or has been viewed over recent years, as appropriate to your company). Do you agree with the comments?Why/why not? Explain.

Comment on any other item that is important or different about your company (that is relevant to the topics in this course).

Answer:

Debt Valuation:

Short term debts means any financial obligation which is either due within a 12- month period or within current financial year. It forms part of current liabilities on company’s balance sheet. (Investopedia, n.d.)

Long term debts, also called as long term loans, refer to those financial obligations which become due in a more than 12-month period. (Investopedia, n.d.)

Observing the company’s balance sheet, it has been seen that the company does not have any short term or long term debts.

The industry peers of the company are CSL, Sirtex Medical, Mesoblast etc.

As on 30^th June, 2016, CSL has both long term ($3081.0) and short term debts ($62.3). Similarly, the other industry peers of LCT has either short term or long term or both short term and long term debts. Therefore, the debt structure of LCT is not consistent with that of industry.

As discussed already above that LCT does not have any short term or long term debt so the industry which LCT operates in does not influence the proportion of short term and long term debts of the company.

Cost of Debt refers to the interest at a fixed rate of interest paid by the firm on its debt. It basically provides an idea that how much a firm is required t

o pay as interest for using the debt. Debt includes loans, bonds, term loans, etc.(Investopedia, n.d.)

Observing the company’s balance sheet, it has been seen that the company does not have debt, so there is no cost of debt to the company.

Share Valuation:

The cost of equity refers to the return on the investment which is made by the stakeholders in the firm. However, the return on investment is not fixed as there is no fixed rate of interest, but the firm is required to pay the return on the investment to the stakeholders as they expect some return on their investment.

Cost of equity = D1 P0

Where, D1= dividend to be paid by company

P0= current market price of company D1= nil

Since there is nil dividend so there is no cost of equity to the company.

As on 30/06/2017,

Revenue = $841,447

Earnings = $(3,123,208)

EPS:-

Basic EPS (cents) = (0.69)

Diluted EPS (cents) = (0.69)

Dividends = Nil

The loss of the company has been reduced from $(7043402) in the year ended 30^th June, 2015 as the previous year loss include 50% of the loss of 50% owned joint venture company Diatranz Otsuka Limited(DOL).

Revenue and other income has decreased from $ 1044639 because of the reduced level of services required by DOL.

Valuation of Stock:

Comparables Approach i.e. P/E

Share Price (in cents) 0.07

Earnings per share (cents per share) (0.69)

= 0.07/(0.69)

= (10.14)cents

Dividend growth rate model: P=D/k-g
Where: P=security's price

D=dividend payout ratio

k=required rate of return

Stock can not be valued using this method as there is no dividend to be paid by company.

Stock price of the company is affected by thedividend pay out ratio, growth rate of the company, changes in economic policy, changes in interest rates etc.

Market price of share as on 30^thJune, 2016 = 0.07 cents

Comparables approach gives negative value of stock which is not feasible. Stock cannot be valued using dividend growth rate model as there is no dividend payout of the company.

Therefore it is not possible to compare the values and comment on the reasonability of price.

The required rate of return for the company, the dividend payout ratio, growth expectations of company are required to calculate the value of the stock as stock valuation is not possible without these elements.

Cost Of Capital:

Weighted Average Cost of Capital (WACC):

Weighted average cost of capital can be used to ascertain the company’s position, and to evaluate the company’s capital structure for any change in weights. To calculate weighted average cost of capital relative proportions of different sources of finance should be used. (Investopedia, n.d.)

Weights are used with the Cost of debt and Cost of equity to determine the Weighted Average cost of capital. Weights are on the basis of Book Value as well as market Value. Market Value Weights are more reliable for calculating the Weighted Average Cost of Capital.

Since, there is no cost of equity and no cost of debt to the company, WACC cannot be calculated for the company.

WACC is calculated using the following formula :

WACC = WACC = x Re + x Rd x (1 – Tc)

Where:

Re = cost of equity

Rd = cost of debt

E = market value of the firm’s equity

D = market value of the firm’s debt

V = E + D

E/V = percentage of financing that is equity

D/V = percentage of financing that is debt

Tc = corporate tax rate

As there is a tax shield associated with the interest cost of the company, the debt side of the WACC formula is considered after taking tax effect.

Since there is losses to the company for the period ended 30/06/2017, no tax rate is applied for the company.

Cost of Debt means the interest at the fixed rate of interest paid by the company on its debt. In the case of debts, which we generally classified as bonds, debentures, the rate of interest is fixed and known in general cases to the investors.(Investopedia, n.d.)

The cost of equity means the return on the investment which is made by the shareholders in the company. Generally cost of capital is high as compare to other source of financing as expectation of the shareholders is high. (Investopedia, n.d.)

There is a difference between cost of debt and cost of equity as cost of debt is calculated for the financing which is done by means of debt while cost of equity is calculated for the financing which is done by means of internal funds of the business.

Current liabilities should not be included in the calculation of cost of capital. Capital means the funds generally used by the company to finance its long term requirements which include equity (and preference shares) and long term debts. Current liabilities are generally for short term and used by company to meet its working capital requirements. These are not classified under capital or long term debts. Therefore , current liabilities are not used while calculating cost of capital as overall cost of capital of a company considers cost of equity, cost of preference stock and cost of long term debts.

As we have already discussed in detail as how to calculate the Weighted Average Cost of Capital, we need cost of debt and cost of equity to calculate WACC. Since there is no cost of debt and cost of equity to the company, WACC for the company cannot be calculated.

Weighted average cost of capital is used to ascertain the company’s position, and to evaluate the company’s capital structure for any change in weights. To calculate weighted average cost of capital relative proportions of different sources of finance should be used.

Investors generally use WACC as a tool to decide whether to invest or not in the company as investors invest in a company in expectation of some return.A investor can decide by by comparing return on assets produced by the company with company’s WACC. If return on assets is higher than WACC than investors can put their hard earned money in the company otherwise investors should put their money elsewhere. This is how WACC is used in investment-decision making.

The LCT has entered into joint venture with Diatranz Otsuka Limited (DOL) in partnership with Otsuka Pharmaceutical Factory (OPF) Inc for development of DIABCELL. DOL has licenced OPF to use DIABCELL in US and commercialise the US product in rest of the world. Here, LCT can use WACC to decide the investment in it.

LCT is investigating application of NTCELL for Parkinson’s disease and other neurodegenerative conditions like Alzheimer’s, motor neurone diseases. LCT can use WACC in taking decision as if the expected return from this research is more than WACC then it should take the research ahead otherwise not.

Capital structure refers to the different sources of funds used by the company to finance its overall operations and growth. The capital structure of a company mainly consists of debt and equity.(Investopedia, n.d.)

Capital structure of LCT consists of only equity of $5676660 which includes issued capital of $68406383, reserves of $3981761 and accumulated losses of $ 66711484.

The capital structure of Living Cell Technologies is not consistent with the industry as its industry peers like CSL, Mesoblast, Sirtex Medical etc. have a capital structure which is constituted of mixture of debt and equity but the LCT capital structure consists of only equity.

Optimal capital structure refers to the best ratio of debt and equity for a firm which maximizes the firm’s value. It balances between the ideal debt to equity range and minimizes the cost of capital of a company. (Investopedia, n.d.)

Economic circumstances like change in interest rate, change in tax rate, change in government policies will likely cause a change in optimal capital structure of a company.

If the interest rate increases, the cost of debt gets increased and consequently, it increases the cost of capital. So the level of interest rates affects the cost of debt and cost of capital. And it changes the portion of debt in overall capital structure.

If the tax rates increase, it decreases the cost of debt to the company and consequently cost of capital gets decreased. It is likely to affect the capital structure of the company.

Similarly, government policies related to the business of firm affects the portion of debt and equity in the capital structure of the company.

Market Analysis:

The company has reported loss of $(3123208) for the period ended 30^thJune, 2016. Its industry peer Sirtex Medical ahs reported profit of $54046000, CSL has reported profit of $ 1043.6 million. Similarly other peers have also reported profit so LCT has not performed financially well relative to its industry peers.

The LCT has been in the news for making progress in treatment of Parkinson’s disease by implanting pigs brain cells into brains of Parkinson’s affected people. I agree with the comments as the facts show that LCT is successful in treating Parkinson’s disease as NTCELL has proved to be and effective and safe option for treating Parkinson’s. As the news reported that the effectiveness of NTCELL implantation was measured with the Unified Parkinson’s Disease Rating Scale (UPDRS) after 130 weeks of treating patients.

LCT’s product pipeline consists of cell therapies developed from cells sourced from a unique herd of designated pathogen-free pigs bred from stock originally discovered in the remote sub-Antarctic Auckland Islands.

LCT’s proprietary technology, IMMUPEL™, coats cells with protective capsules that prevent them from being attacked by the patient’s immune system. This allows the use of cell therapies without the need for co-treatment with drugs that suppress the immune system, which often have negative side effects.

References:

Living Cell Technologies, n.d., Annual Reports, Viewed on 13/10/2017 <https://www.lctglobal.com/investor-centre/key-financial-reports>
CSL, n.d., Annual Reports, Viewed on 13/10/2017 <https://www.csl.com.au/investors/financial-reports.htm>
Sirtex Medical, n.d., Annual Reports, Viewed on 13/10/2017 <https://www.sirtex.com/media/112608/sirtex_annual_report_2016.pdf>
Investopedia, n.d., Cost of Equity, Viewed on 13/10/2017 <https://www.investopedia.com/terms/c/costofequity.asp>
Investopedia, n.d., Cost of Debt, Viewed on 13/10/2017 <https://www.investopedia.com/terms/c/costofdebt.asp>
Investopedia, n.d., Weighted Average Cost Of Capital – WACC, Viewed on 13/10/2017<https://www.investopedia.com/terms/w/wacc.asp>
Investopedia, n.d.,Optimal Capital Structure, Viewed on 13/10/2017<https://www.investopedia.com/terms/o/optimal-capital-structure.asp>
Singhal D K, 2017, Financial Management,Viewed on 13/10/2017
Parkinson’s News Today, NTCELL shows promise as cell therapy for Parkinson’s patients, Viewed on 13/10/2017 <https://parkinsonsnewstoday.com/2017/06/21/living-cell-technologies-ntcell-therapy-trial-parkinsons/>

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