Reference no: EM133152060

Introduction

Put yourself in the following situation as a member of the Financial Services Team of XYZ plc, which is a UK conglomerate. Itowns companies across different industries, such as - car manufacturing, consumer goods, leisure etc.

You have been requested to provide meaningful financial analysis and information for decision making concerningfinancing, performance, capital investment, constrain in production,budgeting, and sensitivity analysis.Accordingly, you are required to write a report (3,000 words in total) providing information about these areas.

Please use the Harvard referencing where relevant, do notuse lecture slides or any Pedia (such as Wikipedia or Investopedia) as reference. You should report your calculations and supplementary information in Appendix.Don't forget to mention your assumptions and the limitations of your analysis.

Financial analysis related to Investment Strategy:

Because of the climate change target of the UK (the road to net-zero target),the company's newly appointed investment manager Ms Madison came up with a new investment strategy - closing five of the company's existing brand and focusing more on the company's most popular electronic vehicle brand in the UK. According to her assessment, this closing decision will generate around £100 million free cash flow, which the company could reinvest to expand its popular brand - ‘eXi Drive'. Madison suggests that the market survey indicates this is one of the most popular brands in England, and demand is increasing. The year-to-year sales of the ‘eXi Drive' brand have gone up by 25% (5,000 units in 2021 compared to 2020), which was higher than all of those five brands together.

Moreover, she has indicated that the expansion decision will reduce the overall cost while improvingquality. This cost-quality dynamic will help the company face competition and achieve a larger market share. However, this expansion will cost £150 million for the company, which require rigorous strategic assessment, including financial viability. Now, she has approached you to evaluate this possible restructuring decision, whether it is a financially viable strategy or not. She also has suggested that this expansion project will run for the next five years, and after that, the company will enter into a new strategic cycle.

You have collected the following information from her to do the financial analysis for meaningful decisions.
The expansion is expected to increase the sales of ‘eXi Drive' by the following units.

8,000 units in 2022
8,000 units in 2023
10,000 units in 2024
11,000 units in 2025
12,000 units in 2026

In 2021 the market price of this brand was £45,000, but the company wants to reduce it by £5,000 in 2022 and then will increase/decrease with the pace of the economy and purchasing power of the consumers. KPMG has projected that the Bank of England's bank rate will remain 0.50 per cent for the next couple of years, which will allow the post-Brexit-and-Covid expansion of the economy. In line with this economic assessment, your company has decided not to increase the price for the next three years (i.e., till 2024), but from the fourth year, a contingency plan is in place to increase the unit price by £2,000.

The production cost is £20,000 per unit, which will increase in the line of inflation and other materialscost over the project's life at a rate of 10% each year starting from year two. The production involves fixed overhead expenditure of £20 million in 2022 and 2023, £15 million in 2024 and £10 million in 2025 and 2026. The project requiresa working capital investment of £850,000 at the beginning, 50 per cent of which the company will recover at the end of project life. The cost of promotion and R&D will be £5 million, respectively, over the five years. Assumethat there is no other cost involved in this investment. The company is currently following the straight-line depreciation method, and historically 10% of the cost price of such investment is recovered in the final year.

Financing choices: (the Board of Directors have agreed)
The Board of Directors disapprovedreinvesting the £100 million free cash flow from closing the existing five brands. Instead, they want to keep this fund reserve for future uncertainty. For this expansion project recommended by Ms Madison, the Board has recommended raising capital from alternatives financing from external sources.

The company has three choices for financing this expansion: issuing new equity, issuing a bond, or issuing preference shares.
The equity of XYZplc is currently trading in London Stock Exchange (LSE) with a face value of £10. The market price of each share is as follows:

 

Date	Closing Price
04.11.20	£34.50
03.12.20	£36.20
06.01.21	£33.55
03.02.21	£35.10
To date	£ 34.80

 

In the last fiscal year, the company had declared a £1.2 per share dividend (DPS). The company's investment banker KPMG always charges an issuing (i.e. flotation) cost of 20% on the face value to issue new common stock in the market. Historically, the company's earnings per share are as follows:

 

Year	EPS (Earning Per Share
2017	22p
2018	26p
2019	17p
2020	22p
2021	25p

 

The company has also assessed the possibility of issuing a bond in the market. Currently, bonds of similar companies are selling at £110, slightly over the face value (i.e. £100) with a coupon rate of 10% and maturity of 5 years. The company's third financing option is to issue preferred stock in the LSE. The industry average preferred dividend and the current market price of preference shares of similar companies are £10 and £108, respectively.

You have also collected additional data on the UK financial market and the company. Currently, the yield of the 3-month UK Gilt is 3.0%, the FTSE 100 index has an average yearly return of 10%, and the average corporate tax rate in the UK is 30%. In addition, the beta of XYZ plc is 1.5, which is slightly higher than the market beta of 1.

The company wants to maintain its existing capital structure policy of 50% debt, 10% preferred equity and 40% common equity for this new investment.

Ms Madison has requested you to make a report based on the following queries so that she can present it at the next board meeting.

Question 1. What will be the cost for each source of financing? Consider both DDM (i.e. Dividend Discount Model) and CAPM (i.e. Capital Asset Pricing Model) method for common equity. Please provide your comments on the assumptions of each approach and their merits and limitations.

Question 2. Determine the optimum cost of capital using the Weighted Average Cost of Capital (WACC) approach for target capital structure. (Hints: Ms Madison would prefer to use CAPM over DDM).

Question 3. Evaluate the total value addition (i.e. total NPV) and breakeven rate (i.e. IRR) of this possible restructuring decision. (Hints: Use the WACC as your discount rate to evaluate the investment projects)

Question 4. Assume that the product lifecycle of five years is viewed as a safe bet, but the scale of demand for the product is highly uncertain, mainly due to possible BREXIT and COVID-19. Analyse the sensitivity of the projected NPV to the unit sales and the cost of capital.

Question 5. Explain how the BREXIT could affect the UK automobile manufacturing sector and the possible strategic changes required in this industry to cope with the risk?