DCF models for decision-making and using accounting income for evaluating project performance

Case Study:

3. Synthesize and apply both theory and empirical information to the solution of to a range of investment-decision problems.

4. Reconcile conflict between DCF models for decision-making and using accounting income for evaluating project performance.

You work in the corporate finance department of a major investment bank. One of your clients has expressed an interest in buying Marks and Spencer (M&S). As an investment advisor you wish to value the company so have collected the following information:

Balance sheet as at:

31 Mar 2012 2 April 2011

Non-current assets £m £m

Intangible assets 584 528

Property plant and equipment 4,790 4,662

Trade and other receivables 270 276

Other 169 236

5,813 5,702

Current assets

Inventories 682 685

Trade and other receivables 253 250

Other current assets 329 237

Cash at bank 196 470


1,460 1,642

Current liabilities

Trade and other payables 1,449 1,348

Borrowings and overdrafts 328 602

Current tax liabilities 88 115

Other current liabilities 140 145

2,005 2,210

Net current assets (545) (568)

Non-current liabilities

Borrowings and others non current liabilities 2,489 2,457

Net assets 2,779 2,677


Share capital (25p shares) 400 396

Share premium account 295 255

Capital redemption reserve 2,203 2,203

Other reserves (6,110) (6,049)

Retained earnings 5,991 5,872

Total equity 2,779 2,677

Other information:

Share price Div/share1 EPS2

31 Mar 2012 376 17.0 32.5

2 Apr 2011 336 15.7 38.4

Share price at 11 January 2013: 363p

1 This includes the interim dividend paid during the financial year and the final dividend declared but not paid at the year end.

2 This is the fully diluted EPS which is the better measure as it takes into account any new shares that have been issued during the year.


Asset valuations

The intangible assets have recently valued and it is thought that they are overstated by £50m

The property plant and equipment have recently been valued and it is thought they are understated by £28m

There may be £7m of debtors (trade receivables) that cannot be collected

The Capital Asset Pricing Model.

Assume the risk free rate of return is 3% and the average return on the market is 5% per cent. Beta for M&S is 0.75

Non Current liabilities

The non-current liabilities pay a coupon of 5%. They are currently being traded at £125 per £100. You should consider these ˜irredeemable’ They are shown in the balance sheet at their par value.

The share price over the last 12 months is shown below: (courtesy of London stock exchange)

Task 1 Valuation of M&S plc.

(Use only the information contained above for task 1)

a) Net asset value

Calculate the Net asset value per share for M&S and comment on your answer.

b) Cost of capital

i. Calculate the cost of equity capital for M&S plc. using the Capital Asset Pricing Model.

ii. Calculate the cost of debt capital (ignore taxation).

iii. Calculate the weighted average cost of capital WACC.

(use the share price as at 31 March 2012 for the value of equity)

c) The dividend growth model

Use the dividend growth model to:

a) Calculate the theoretical price of a share under the following assumptions: (i) g = 0 (ii) g = 2

b) Comment on your answers in relation to the current share price of 363p

d) Value per share using the price earnings (p/e) ratio

Calculate the price earnings ratio using the share prices as at 31 March 2012 (376p) and 11 January 2013 (363p) and the EPS figure for 2012.

Comment on your answers if the retail industry sector containing M&S has an average p/e ratio of 8.5.

Task 2 Advise your client

Discuss whether you would advise your client to purchase part or all of this company, given that a rival may be about to offer 380p per share

Base your advice on relevant theories and include references to academic literature on the valuation of companies.

You should use the information contained in this case study.

Task 3 Share price tracking

Critically analyse the movement of your chosen share during the period it was being tracked.

Refer to relevant theories and academic literature.