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ACC515 Accounting and Finance

Published : 08-Sep,2021  |  Views : 10

Question:

APN Outdoor Group (APO) is an ASX Listed firm which specialises in offering advertising services including digital billboards, static roadside billboards, transit advertising, rail advertising and airport advertising throughout Australia and New Zealand (Reuters, 2017). In 2016, the firm's sales exceeded AUD$300 million.

Being part of the finance team of APN Outdoor Group, you have been tasked with reviewing and preparing a report on the capital structure of the firm and critique whether the firm has been  successful in maximising wealth generation for shareholders. An excelloent source for information specifically on the APN Outdoor Group is the analysis provided by the Wall Street Journal at

http://quotes.wsj.com/AU/XASX/APO (Note: this site opens at an overview of APO.AX and historical financial data and ratios for the firm can be accessed by clicking on the link to 'All Sections' on the right).

  • Assume that for the 2016 year the firm APO.AU has a Beta of 1.3, that return on the ASX market was 7%, and that the yield on Australian Government bonds was 2.4%.
  • Using data from the firm's 2016 annual report:
  • Categorise the firm's current capital structure into debt and equity.
  • Calculate the firm's after-tax Weighted Average Cost of Capital.
  • Compare the firm's capital structure with at least one other firm operating within their industry.
  • Critically analyse other key financial ratios for APN.
  • Outline any significant changes to have occurred to the firm's capital structure during the past three years.
  • Critically evaluate the extent to which the firm has been successful in maximising wealth for shareholders in the past three years.
  • Discuss why it is important for the firm to minimise their cost of capital.

Answer:

APN Outdoor group Limited (APO) is one of the greatest outdoor advertising operator in Australia and in New Zealand. It is an ASX listed company which offers many advertising services. These advertising includes digital billboards, static roadside billboards, advertisement of rails and advertisement of airport in Australia and New Zealand. This study aims to demonstrate the capital structure of APN outdoor group and its wealth maximization strategy, with the help of different financial instruments like financial ratios and comparative analysis. The researchers have also aimed to recommend the company for lowering its cost of capital.

Discussing the capital structure of APN Outdoor Group

Every business raises funds for financing its projects. It may raise funds either internally or externally. If a firm raises funds internally it may use reserves and surpluses, retained earnings or it may have to sell its assets. However, if the company needs huge funds, it has to raise funds by issuing either equity shares or preference shares. Moreover, it may also borrow funds from financial institutions or banks (Hope & Myllylahti, 2013). Thus, the capital structure is said to be the mixture of short-term and long-term debt or equity.

  1. a) Comparing the bonds of the company with government bonds

According to Wayne Castle, the CFO of APN Outdoor Group, the bonds of the company distributed in the market proved to be the beneficial factor for the business. The rate of the bonds was low as compared to the government, but the return on such bonds were reasonable. Thus, in the year 2014, the company sold bonds in large distribution. This not only helped the parent company to grow their business, but it's subsidiaries like iOM Pty Ltd, has largely gained benefit in promoting them in the international market. On the counterpart, government bonds took dominating position since 2015, due to its low risk, regular income and easy to buy and sell factor (www.quotes.wsj.com, 2017).

  1. b) Categorizing and calculating current capital structure and after tax weighted average cost of capital

From the annual report of 2016, it has been found that the company APN outdoor group limited has taken more borrowings in the year 2016 for its current project. It has been found that company has not raised its funds from internal sources but it has raised its funds from external sources like borrowings of $ 102,677 from bank and issued equity shares to the public, which is fully paid up (Becker & Ivashina, 2015). The structure of equity debts is described below.

Number of issued capital is 166,614,509 and the paid-up capital is $ 222,334

Basic earnings per share is 0.29*166,614,509= $48,318,208

Dividend paid is $29,158.

Computation of after tax weighted average cost of capital

APO issued 166,6144,509 shares of common stock @ $7.50 per share. The shares are currently trading at $ 9.90 per share. Current risk-free rate is 2.4%, market risk premium is 7% and the company has a beta coefficient of 1.3 (www.au.finance.yahoo.com, 2017).

The tax rate is 28.5%.

Current Market Value of Equity = 1666144509 × $9.90 = $16494820640

Current Market Value of Debt = 1666144509 × $25 = $41653612725

Total Market Value of Debt and Equity = $ 58148433365

Weight of Equity = $16494820640/ $41653612725= 39.59%

Weight of Debt = $41653612725/ $58148433365= 71.63%, or

Weight of Debt = 100% minus cost of equity = 100% − 39.59% = 61.41%

Cost of Equity = Risk Free Rate + Beta × Market Risk Premium = 2.4% + 1.3× 7% = 11.5%

After-tax cost of debt is 7.586% [= 10.61% * (1 – 28.5%)].

WACC = (weight of equity * cost of equity) + (weight of debt * after tax cost of debt)

WACC = (39.59% * 11.5%) + (61.41% * 7.586%) = 9.317%

  1. c) Comparing firm’s capital structure with Investa Office Funds

Capital structure of APO includes long-term borrowings, issued capital, reserves and surpluses and retained earnings. Similarly, the capital structure of IOF also includes borrowings, issued capital, reserves and surplus, but IOF also has issued debentures at the rate of 8%. Based on the comparison of financial statements of both the companies for the year 2016, it can be said that APO has issued more equity capital as compared to equities issued by IOF. However, there is an interesting fact in the comparison of issued capital between both the companies (Baur & Miyakawa, 2014). APO at one hand had similar pattern of issuing equities and IOF on the other hand had issued different number of equities in different years. This indicates that IOF is relatively dependent on the equities to raise funds for its business projects.

  1. d) Outlining significant changes in the capital structure of the firm in the past three years

Based on the review of annual reports of past three years, it can be seen that the APO has not gone through a big rollercoaster in its capital structure. Its long-term borrowings had increased over three years, but issued and paid up capital remained unchanged. In addition, retained earnings had significantly rose in every consecutive year, along with the considerable rise in the reserves and surpluses (Robb & Robinson, 2014). This indicates that the company is wisely applying wealth maximization strategies. However, the most eye-catching change can be seen, the company had paid dividend in the year 2016 amounted to $ 29,158, which is more than twice of previous year that is $ 9,164.

Critically analyzing the wealth maximization strategy of APN Outdoor Group

In every business shareholder value maximization plays a pivotal role in creating profit. Therefore, wealth maximization balances the interest of shareholders and stakeholders. Similarly, it becomes necessary to wisely chose the appropriate wealth maximization strategies. Building credit, wisely investing, building wealth through retained earnings, and boosting stock prices are the best ways to maximize wealth or shareholders value.

  1. a) Critically evaluating key financial ratios of APN Outdoor Group

Financial ratios of APN Outdoor Group for the year 2016 and 2015

Rate of return on net sales

Operating profit / net sales

69527/330938

59026/300820

Rate of return on equity

Net profit / total equity

49860/269199

40919/248095

Earnings per share

given in the annual report

29.98 cents

24.61 cents

Particulars

2017

2016 $

2015 $

Working capital

Current assets-current liabilities

94467 - 49625

84760 - 44567

Current ratio

Current assets/current liabilities

94467 / 49625

84760 / 44567

Accounts receivable turnover

Net credit sales/Average receivables

((330938/(69213+62777)/2))

((300820/(62777 + 67525)/2))

Debt ratio

Total liabilities/total assets

182171 / 451370

141143 / 389238

Debt to equity ratio

Total liabilities/total equity

182171 / 269199

141143 / 248095

Assets turnover ratios

Net sales / average total assets

((330938/(451370 + 389238)/2))

((300820/(389238 + 403589)/2))

Table 1: Key financial ratios

(Source: self-created)

  1. b) Understanding the way company is maximizing its wealth in the past three years

Wealth maximization means maximizing the wealth of shareholder. Shareholder’s wealth maximizes when net worth of a firm maximizes. Wealth maximization is based on cash flows, which is a wider concept. On the other hand, profit maximization only focuses on earning profit, but in case of wealth maximization, overall growth of the business is focused (Jones & Felps, 2013). It includes, generating efficient revenue, taking proper business decision for countering the future losses and unwanted expenses. Therefore, it can be said that wealth maximization is a good practice. However, the possible ways, in which APO can maximize its wealth are discussed below.

In this case, the company has generated huge revenue as compared to the previous year, which is the first step of wealth maximization. The company APN outdoor group invested in a project and get more internal rate of return and its net present value also increased, in this way shareholder’s wealth increased (Grant, 2016). This company motivated its employee for the purpose of maximizing its wealth.

The company’s total equity in the year 2016, 2015 and 2014 are $ 269,199, $ 248,095 and $ 216274 respectively. However, total debt for the three consecutive years include borrowings, amounted to $ 102,677, $ 65,926 and $ 85,121. On the other hand, issued and paid up capital were remained unchanged. Thus, it can be said that the company is not completely dependent on the raising funds from public. Whatever the funds required, it raises from borrowings.

  1. c) Discussing the importance of minimizing cost of capital

Since cost of capital is that required of return, which is used for capital budgeting project, it becomes important to minimize cost of capital, because high cost of capital will tend to increase cost of capital budgeting like rise in cost of making plants, buildings, etc. (Dhaliwal et al. 2014). However, lower cost of capital will allow only required cost of budgeting, unnecessary cost will be abandoned. Thus, it is very important to minimize cost of capital. The importance is described below.

Due to minimizing cost of capital, required rate of return will increase and internal rate of return will also increase. But due to reduction in the value of 1 dollar every year, rate of dividend will remain same but net present value will increase in future. For example,

  1. d) Recommending the firm, the ways in which it can lower its cost of capital and adopt alternative capital structure

There are many ways for minimizing cost of capital

Level of interest rates: The level of interest rate affects the cost of capital because if interest rates increase, the cost of capital will also increase so the company APN outdoor group should borrow loan at very low interest which minimizes the cost of capital.

Capital structure policy: The company APN outdoor group must have control over its capital structure. If it raises huge funds by issuing preference shares or by borrowing loans, it must pay dividend if the company earns profit. However, if the company earns losses, it must pay interest. Thus, the company must make correct decision before raise funds from these sources.

Tax rates: If tax rates increase, cost of capital will also increase. So, for minimizing cost of capital, company should decrease cost of production.

Investment policy: APN Outdoor group should invest practically, for example, if APO invest in low cost project, it may save investment cost, but the return will not be satisfactory. On the other hand, the investment in superior project may attract higher investment cost, but it will give higher rate of return.

Conclusion

It has been found from above discussion that the company APN outdoor group has taken borrowing in the year 2016 for its current project. APN Outdoor group Limited(APO) is one of the greatest outdoor advertising operator in Australia and in New Zealand. Company is performing well in the last five years. This company mainly focuses on wealth maximization tools. According to the annual report of 2016, 2015 and 2014 it has been found that, APN outdoor group has increased its internal rate of return and got positive net present value.

 References

APO.AU Stock Price & News - APN Outdoor Group Ltd. - Wall Street Journal. (2017). Quotes.wsj.com. Retrieved on 17 September 2017, from http://quotes.wsj.com/AU/XASX/APO

APO.AX: Summary for APNOUTDOOR FPO - Yahoo Finance. (2017). Au.finance.yahoo.com. Retrieved 17 September 2017, from https://au.finance.yahoo.com/quote/APO.AX?p=APO.AX

Baur, D. G., & Miyakawa, I. (2014). No puzzle: The foreign exchange exposure of Australian firms. International Review of Financial Analysis, 32, 13-22.

Becker, B., & Ivashina, V. (2015). Reaching for yield in the bond market. The Journal of Finance, 70(5), 1863-1902.

Dhaliwal, D., Li, O. Z., Tsang, A., & Yang, Y. G. (2014). Corporate social responsibility disclosure and the cost of equity capital: The roles of stakeholder orientation and financial transparency. Journal of Accounting and Public Policy, 33(4), 328-355.

Grant, R. M. (2016). Contemporary Strategy Analysis Text Only. John Wiley & Sons.

Hope, W., & Myllylahti, M. (2013). Financialisation of media ownership in New Zealand. New Zealand Sociology, 28(3), 192.

Jones, T. M., & Felps, W. (2013). Shareholder wealth maximization and social welfare: A utilitarian critique. Business Ethics Quarterly, 23(2), 207-238.

Robb, A. M., & Robinson, D. T. (2014). The capital structure decisions of new firms. The Review of Financial Studies, 27(1), 153-179.

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