FINC2011 Major Assignment PDF

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Major assignment for FINC2011, finished version. ...

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FINC2011 MAJOR ASSIGNMENT

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EXECUTIVE SUMMARY This report was conducted to determine a possible share price using the constant dividend growth model for Information Technology Australia (ITA). Firstly, the report will focus on the approximation of a beta figure for ITA based on two other similar companies in NEXTDC Ltd. And Telstra Corp. Ltd. Secondly, the share price calculation will occur to give a recommended share price of $0.0048491 per share, based on the data given.

SELECTION AND JUSTIFICATION OF PROXY COMPANY Proxy companies chosen: NEXTDC and TELSTRA Two companies have been chosen to act as proxy representatives in order to calculate the share price of the company. This decision was based on the need to find a company that shared the same value of 2 billion AUD as well as show the effects of moving from the government sector to the public sector. NEXTDC Ltd. is a technology and infrastructure company listed on the ASX 200, valued at 2.23billion AUD. This company was selected due to it’s total value, nature of operations and the fact that it has been trading on the ASX since December 2010, and therefore has a strong amount of historical data. Additionally, Telstra Corp. Ltd. Will also be used in this assessment due to the similar government influence the firm faced during it’s initial sell-off. Both companies will be used to approximate the share price and Beta’s for ITA.

CALCULATION OF PROXY BETA’s See appendix 1 NEXTDC - 0.000412535 Telstra – 0.63

The Beta for NEXTDC Ltd. Was calculated in appendix 1 using the The Beta for Telstra Ltd. Was provided by Yahoo Finance 1 1 https://au.finance.yahoo.com/quote/tls.ax/ 2

β=

σi,m 2

σm

formula

In order to approximate the Beta with more accuracy, an average of these beta’s will be taken for the final proxy figure.

 Unleveraged Beta = 0.3152062675 = 0.32

As the market has a beta equivalent to 1, ITA falls short of that figure meaning that it will not respond as significantly to movements in the markets compared to its peers. ITA will still move in the same direction as the market, just not as significantly.

CALCULATION OF BETA FOR FOCUS COMPANY The calculated beta above needs to be adjusted for leverage. We are given an expected market debt to equity ratio of 0.67 and the current corporate tax rate is 30%2. The formula for calculating levered beta of a corporation: 1 = u [1 + (1 - t )] Where: βl = levered beta of a corporation βu = unlevered beta of a corporation tc = corporation tax rate Φ = debt/equity ratio = 0.67

 0.32 [ 1 + (1 – 30%) 0.67] = 0.47008 As the new levered beta is closer to 1, the adjustment for leverage reveals the firm will move closer to the market movements than previously thought. However the firm will still not move as significantly as the rest of the market.

CALCULATION OF CAPM RETURN

2 https://www.ato.gov.au/Rates/Changes-to-company-tax-rates/ 3

The CAPM states that the expected return on any investment is equal to the risk-free rate of return plus a risk premium proportional to the amount of market risk in the investment.

To find the CAPM return the following formula is used: E r i  rf  risk premium Risk free rate of return: Based on AUS government bonds. This is due to the widely accepted view that Australian government bonds are extremely unlikely to fail and therefore are “risk free”. An average of 5 year data was taken (see appendix 1) = $22.61763934

To calculate risk premium: Risk premium  quantity of risk  price of risk  p  E(rm  rf Market return = avg(market returns)*12 = 193.919922

 risk premium = 0.47008 * (193.919922 -22.61763934) = $80.52577703 Rf + risk premium = 22.61763934 + 80.52577703 = $103.1484164 CAPM return = $103.15

PRICE RECOMMENDATION Using the above data, this section will now provide a justification for a possible share price for ITA using the constant dividend growth model. The constant dividend growth model is as follows: p0 =

4

¿1 r−g Where: P0 = Present value of stock DIV1 = Estimated dividends for next year

r = Required rate of return g = Growth rate we are given the following information: DIV1 = 0.50 g = 4% Therefore the calculation will occur as such: P0 =

0.50 103.15 −0.04

= $0.0048491 per share This share price may be one possibility, however the figure appears to be on the lower end of the spectrum for possible share prices. One way an error could’ve been made is during the calculation of the CAPM return, wherein an incorrect figure there may have distorted the calculation in this latter section. This report would like to acknowledge that possibility in the need for full transparency.

CONCLUSION This report has detailed a possible share price based on the statistics given by NEXTDC Ltd. And Telstra Corp. Ltd. However, the report acknowledges the possibility of error during the CAPM return calculation, but stands by its selection of appropriate formula and figures.

REFERENCES 5

Analytics, I. (2019). Telstra Corp. Ltd.: Levered/Unlevered Beta (TLS | AUS | Fixed Line Telecommunications) - Infront Analytics. Retrieved from https://www.infrontanalytics.com/fe-en/21434AA/Telstra-Corp-Ltd-/Beta

Basel III: international regulatory framework for banks. (2019). Retrieved from https://www.bis.org/bcbs/basel3.htm

Changes to company tax rates. (2019). Retrieved from https://www.ato.gov.au/Rates/Changes-to-company-tax-rates/

Financial Concepts: Capital Asset Pricing Model (CAPM). (2019). Retrieved from https://www.investopedia.com/university/concepts/concepts8.asp

Our Company | NEXTDC. (2019). Retrieved from https://www.nextdc.com/ourcompany

Our History | NEXTDC. (2019). Retrieved from https://www.nextdc.com/ourcompany/history

Present Value of Stock with Constant Growth - Formula and Calculator. (2019). Retrieved from http://financeformulas.net/Present-Value-of-Stock-withConstant-Growth.html

Yahoo is now a part of Oath. (2019). Retrieved from https://au.finance.yahoo.com/quote/tls.ax/

APPENDIX 6

Appendix 1 - excel calculations for rm, rf, beta, CAPM

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