Capital Structure And Cost Of Capital For Morrisons Finance Essay

It is very essential in today’s modern age to upgrade and promote business in such a way that functioning can take place smoothly. This assignment is about the capital structure and cost of capital for Morrisons PLC. Also in this project an analysis on if I was a project manager and had to design a new project for the company what all stages and things I would have to do; are mentioned. This study is based on facts taken from the company website and annual report of 2009/10. Other information is gathered from educational case studies, website and core textbooks on this topic.

Introduction

According to www.wisegeek.com [1] “Corporate finance is a broad term that is used to collectively identify the various financial dealings undertaken by a corporation”. In other words we can say that corporate finance is a division within a particular company that deals with financial operations of the company i.e. raising finances for various projects, analysis of various mergers and acquisitions etc. In the present world scenario, one of the most profitable sectors is retailing. Large scale retailers have become very powerful, in some ways even more powerful as companies than manufacturers. The British layman is highly dependent on these retailers like ASDA, Morrisons, Morrisons, Tesco etc so as to buy everyday use products and services. Even these retailers have broadened their scope of activity and have diversified into more than just everyday goods. One such retailer is WM Morrison Supermarkets PLC also referred to as Morrisons.

Morrisons was a company started at Bradford market by William Morrison in the year 1899. Today it is termed as the fourth largest chain of supermarkets in the United Kingdom. With almost 124,000 employees working in 403 stores across the nation, Morrisons has an operating income of £671 million in 2010. The different types of products that Morrisons has to offer are as below:-

Groceries

Consumer products

Fuel and Oil

Pharmaceuticals

Alcohol and beverages

These are the major areas of business for Morrisons but apart from these also certain services are offered at different locations which are store specific. Morrisons has not yet set up base outside the United Kingdom but according to the company website and also the annual reports, the business can be divided into 6 main regions, namely

Scotland with 51 stores

North UK with 72 stores

Midlands with 75 stores

South East including Gibraltar at 63 stores

South Central with 62 stores

South West with 51 stores

To discuss on the size of its business relative to its industry we can look at the report prepared by Edward Garner, 2008 [3] as shown below (certain areas deleted as appropriate):-

TOTAL TILL ROLL

Great Britain Consumer Spend

Includes all expenditure through main store tills and excludes petrol & instore concession

12 Weeks to 12 August 2007

12 Weeks to 10 August 2008

change

£000s

% **

£000s

% **

%

Total Till Roll

26,615,239

27,621,890

3.8 Total Grocers

18,733,701

100.0%

20,076,033

100.0%

7.2 Total Multiples

17,402,359

92.9%

18,719,527

93.2%

7.6

Tesco

5,962,922

31.8%

6,351,531

31.6%

6.5

Asda

3,142,151

16.8%

3,410,431

17.0%

8.5

Morrisons’s

3,016,586

16.1%

3,175,543

15.8%

5.3

Sainsbury

2,042,026

10.9%

2,233,137

11.1%

9.4

Total Coops

815,208

4.4%

846,405

4.2%

3.8 Total Independents

516,134

2.8%

510,101

2.5%

-1.2

Total Symbols

183,349

1.0%

181,137

0.9%

-1.2

Other Independents

332,785

1.8%

328,964

1.6%

-1.1

** = Percentage Share of Total Grocers

According to this report we can clearly say that in comparison with other supermarkets, Morrisons is ranked as #4 in this sector. The performance over the last few years can be summed in by the use of a table as shown below: – (all figures are in million £)

Year

Turnover

Profit or loss before tax

Profit or loss after tax

2009

14,528

655.0

460.0

2008

12,969

612.0

554.0

2007

12,462

369.0

247.6

2006

12,115

(312.9)

(250.3)

According to the figures shown in the table above we can say that although 2006 was a tough and bad year for the company, its recovery process was efficient and planned. Through 2007 the company improved methods so as to maximize profits. The entire tenure has shown an increase in turnover for the company but although the turnover in 2009 was at its peak the company failed to achieve a higher profit which might be due to a variety of reasons that will be discussed in the project ahead.

Morissons though been facing problems in 2006 & 2007 they have been winning awards and earning high percentage of profits with the production units of morissons as with special brewing, wines and bakery unit. they also have been The Oracle Retailer of the year 2009,The Oracle Retailer Week Awards, March 2009

Morissons have been pioneering in the retail sector comprising The Own Grocer Label awards, with gold and silver allocades among the retailers wining The Cloudy Apple Juice The Best Toffee Popcorn offering wide range of fresh farm products to freshly prepared breads and confectioneries within the nested units of morissons along with wide range of wine cellars and brewed beers and café outlets within

Financial structure

The financial structure of a company is known by the balance sheet of the company. In what areas changes are required and in what ways are all known through the balance sheet of the company. For a person to analyze the balance sheet appropriately one must understand the basic concepts of the balance sheet as a financial analyst. After going through the financial report (balance sheet as well as the annual report) for Morrisons, I have come to a point where a conclusion can be made on the financial structure with relevance to turnover and operating profits, capital expenditure, earning per share, tax payable, return to shareholders and dividend cover. All these factors will help to calculate the standing of Morrisons. A brief study is also done on the basis of the return on assets to compare Morrisons with other retailers.

Turnover and operating profit –

2008/09

2009/10

Changes

Turnover

£14528m

£15410m

6.07%

Operating profit

£671m

£907m

35.17%

Capital expenditure – the capital expenditure has increased by £228m and now is £906m. This is due to the recent buying of the new co-operative and Somerfield stores at a cost of £223m and a refurbishment cost of £102m. Apart from this we can see a fall in the previous made capital expenditure. This is a healthy growth projector.

Earnings per share – the earnings per share has increased from 17.4pence per share to 22.8 pence per share. This is mainly due to the increase in underlying profits. There have been no other significant factors that would affect the earning per share.

Tax payable – the tax paid during the year is £209m. In comparison to the tax paid in the previous year i.e. £104m there has been a vast increase, this is mainly due to the effective tax rate that was increased and made 30%.This represents 50% of the tax for the year ended 1 February 2009, as well as 50% of the expected tax for the year ended 31 January 2010, and repayments of previous years.

Return to shareholders – the final dividend paid during the year is 7.1pence which shows an increase of 2.1pence per share in comparison to last year. This makes the entire dividend paid during the year 8.2 pence and the dividend cover 2.5 times. The calculation is as shown below

Comparative study

According to a study by Biz/Ed [4] the following information can be gathered on the return to assets and profit margins. As we can clearly observe in the table underneath, Morrison has the highest return on assets in comparison to any other retailer of food and the profit margin is also comparative higher than any other retailer.

Company

Return on Assets

Profit margin

Marks and spencers

4.43%

3.91%

Morrisons

5.60%

3.61%

Morrison

12.93%

5.87%

Tesco

9.99%

5.72%

Working Average Cost of Capital

“An average representing the expected return on all of a company’s securities. Each source of capital, such as stocks, bonds, and other debt, is assigned a required rate of return, and then these required rates of return are weighted in proportion to the share each source of capital contributes to the company’s capital structure. The resulting rate is what the firm would use as a minimum for evaluating a capital project or investment.” According to www.investorwords.com [5] . The calculation for this is as shown below. All data is sourced from the annual report of 2009/10:-

Current share price = £277.50 (P1)

Previous year’s share price = £237.75 (P0)

Dividend for previous year = 5.80 (D-1)

Dividend for this year = 8.20 (D0)

Increase in dividends = 41.37%

The formula for calculating the cost of equity is as follows:

Re = D1/P0 +G

Therefore cost of Equity (Ke) = 10.6/326.25 + 41.37%

= 41.40%

Cost of debt (Kd) = Interest Paid/Average debt

= 260/924

= 28.13%

Therefore,

WACC = Ke*(proportion of equity) + Kd*(proportion of debt)

= 41.40*0.28 + 28.13*0.71

= 11.59+19.97%

= 31.56%

This shows that the average return that the company must pay to its investors is 31.56 %

Project analysis

If I were appointed as a project manager for the company, several roles would need to be fulfilled by me. For any new project to be successful the project manager is the key. The focus and aim success depends highly on the manager. The main functions for me in such a case according to Duncan Haughey [6] are as follows:-

Planning and Defining Scope

Activity Planning and Sequencing

Resource Planning

Developing Schedules

Time Estimating

Cost Estimating

Developing a Budget

Managing Risks and Issues

Creating Charts and Schedules

Risk Analysis

Morrison’s is a large retail firm which operates and sells almost all consumer goods. The latest expansion plan was too diverse into household furniture. The project being evaluated is the introduction of Morrison’s into the furniture segment. The aims of such a project would be to beat Morrisons that has already started into this sector. The final objective of beating the other retailers would almost be fulfilled in such a way.

Key determinants

Initial Investment – In order to conclude the early speculation for mounting into the manufacturing segment a careful research will be required on part of Morrisons. This would occupy looking at a business plan of a medium to large scale furniture producer. It will also involve hiring of an actuary to decide several costs. The recognition of accurate expenses necessary will involve hiring of engineers as well. An in depth study into the accessible furniture industry would be the best source of identifying the primary investment.

Annual Revenue – The quantity of cost to be incurred can be recognized with logical

accuracy, however, annual revenues cannot. This is because of the fact that revenues

are based upon demand for the product. Since Morrisons has been always selling

furniture its growth in the furniture production will have reasonable sales if the quality

is maintained. It can also be seen from the intensity of sales of Morrisons’s own range

of product labeled ‘Morrisons’s Basics’.

Annual Operating Costs – The present level of operations of Morrisons is based upon buying and reselling. This indicates that there is a low level of in service cost. In order to make out the correct level of operating cost an imminent into the financial statements of a furniture company will be mandatory. Additional transport costs will require to be assessed as Morrisons operates in a number of locations of UK. In order to reap the profit of economies of scale Morrisons will have to generate a central production facility. This will add to the set cost and help to reduce the operating costs.

Rates of Inflation – Rates of price rises straight affect retailers like Morrisons. Specific inflation of raw materials like wood will unfavorably affect the company directly. General inflation will also have an outcome as the price paid by consumers will reap lower value in the future. This has to be accounted for in the project assessment. The sources of inflation will be in print data provided by the government. These will include national financial plan and forecasts.

Rates of Taxation/ payment and Relief – Rates of taxation are significant elements of capital budgeting as they affect the cash flow. The tax rates are always particular by the government. So there are no problems identifying them. Other than taxes several allowances can be obtained when investing in a fresh project. There are special release programs that promote investors to invest rather than take dividends. Furthermore the fixed equipment bought is also eligible for capital allowance which is a taxation relief.

Risk

When any project needs to be taken up, an analysis on the risk involved needs to be done. Risk can be known as the possibility of making a loss. If we wish to analyse this in terms of money then, we can use the formulae:-

To manage the risk effectively I would carry out the following steps:-

Identify threats – the risk can be of various types i.e. overshooting costs, interest fluctuations, jobs taking too long etc.

Estimate risk – using the formulae given above, we can calculate the amount of risk for the proposed project.

Managing risk – you can manage risk by either utilizing the present assets or by creating new assets.

Review – testing systems and plans must be used effectively to check on the progress to manage risk.

Due to lack of data, the figures that are shown below are fictitious. The assumption that the project will function in the way of the product life cycle.

Year

2011

2012

2013

2014

Sales Revenue

1500

2000

2350

2550

Variable cost

620

680

720

860

Contribution

880

1320

1630

1790

Fixed Costs

500

Net Cash Flow

380

820

1130

1290

Taxation 30%

114

246

339

387

After Tax Cash Flow

266

574

791

903

8% Discount Factor

0.926

0.857

0.794

0.735

Present Value

246.31

491.91

628.05

663.70

Assumptions –

Initial investment is £3000

Fixed cost is £500

Variable cost is at 40% of sales

Discount factor is 8%

Tax rate is fixed at 30%

£

Sum of Present Values

2029.97

Written down Allowance

400.03

PV after 4 years

4000

Less: Initial Investment

3200

Net Present Value

3230

Quarterly report format

Following is the table assumed for the year with four quarters considering the assumed forecast for the year 2011

Year

Quarter 1

Quarter 2

Quarter 3

Quarter 4

Budget

Actual

Budget

Actual

Budget

Actual

Budget

Actual

Sales Revenue

Variable cost

Contribution

Fixed Costs

Profit

The per quarter report starting for the first month of year for a quarter will be as follows

Quarter 1

January

February

March

Budget

Actual

Budget

Actual

Budget

Actual

Sales Revenue

Variable cost

Contribution

Fixed Costs

Profit

The above comparative statement is for all 4 quarters of the financial year. Each quarter is divided into Budgeted and Actual. The report I would be sending to the directors if I were a manager the report would be in this format because it can be easily understood by the directors. If there is a difference between the budget and the actual amount in the statement then, this can be for a variety of reasons such as interpretation of budgets. If the difference is high then I would have to try and re-modify the budget for the next quarter and try and improve actual figures by all ways possible.

References

The role of a project manager; Duncan Haughey; 2009

“a snapshot of the UK grocery market”(2008); Edward Garner; TNS World-Panel

http://www.wisegeek.com/what-is-corporate-finance.htm

http://www.morrisons.co.uk/Corporate/About-Morrisons/Company-history1/

http://www.bized.co.uk/compfact/ratios/ror12.htm

http://www.investorwords.com/5849/WACC.html

Order Now