Sources Of Finance For Marks And Spencers
Marks & Spencer is one of the leading retailers in UK with average 21 million customers visiting per week in stores. They provide with quality clothing, home products and food which is supplied by approximately 2000 suppliers all over the world. The company has 75,839 employees as evaluated in 2008 and has about 700 stores in UK. The 49% of the sales is occupied by clothing and home products while 51% is occupied by food products. Outside UK the company operates in approximately 40 other countries which include India, China and Indonesia etc. The companies 90% business comes from sales in UK while rest comes from overseas sales. Marks & Spencer values Quality, Value, Service, Innovation and Trust.
The company generated an overall revenue of £9062.1 million as on 28th March, 2009. The overall profit was £768.9 million of which £652.8 million was generated from operations in UK and £116.1 million from operations overseas.
The case study takes into consideration the analysis of financial reports of Marks and Spencer and relates the academic principles of Corporate Finance with the analysis of the report.
2. SOURCES OF FINANCE
2.1 SHORT & MEDIUM TERM FINANCE
Trade Credit
“Trade Credit is finance obtained from suppliers of goods and services over the period between delivery of goods and the subsequent settlement of the account by the recipient.”
(Pike & Neale, 2006)
It is sometimes also called spontaneous finance as the company can enjoy the goods or benefit from the service provided without having to pay up.
Common way of expressing the credit term is- ‘2/10 : net 30’
This implies that the supplier will provide 2% discount if the money is payed back in 10 days otherwise the company has to pay full payment in 30 days.
The length of the trade credit depends on certain factors like industry custom and practice, relative bargaining power and type of products.
Factoring- Sometimes the suppliers need payment earlier than expected. Institutions called factors help by offering to purchase a firm’s debtors for cash. Factoring involves raising immediate cash based on the security of the company’s debtors, thus accelerating payments from customers.
Bank Credit
Bank lending to companies is predominantly short term, although now it is also a valuable source of medium term finance.
Overdrafts
Overdrafts specify the amount that a company may withdraw either in forms of cash or cheques. Interest is charged on a daily basis depending on how much the company is overdrawn each day. Bank generally takes security which can be fixed charge (where overdraft is secured against specific asset) or floating charge (which offers security over all of the company’s assets)
Short Term Loans
Short term loans are generally provided for more than 1 year. The bank can charge variable or fixed rate of interest. Usually fixed rate of interest is quite high. Variable rate of interest can be also in various forms:
Bullet Loans Balloon Loans
Revolvers
It allows the borrowers to borrow, repay and re-borrow over the life of loan facility.
Securitisation
This is the practice whereby instead of lending money to customers, banks raise finance for them by arranging and selling to customers their securities like commercial papers often allowing lower interest rates.
Bill Finance
Bill allows the company to pay out a specific amount after a specific period of time.
Bills of Exchange
Trader purchasing goods from suppliers draws up a bill stating a promise to pay at some future date and it’s up to the supplier to keep the bill or sell it in the market at a discount if he needs the money earlier.
Acceptance Credit
It is a tie up between the company and the bank. The bank issues a bill for the company and company can use it at a later date. The bank can sell the bill in the market at a discounted price. If it does then the company collects the money from the company which bought the bill from the bank.
Hire Purchase
It may be simply defined as “hiring with the option to purchase”. On payments of final installment ownership of the asset passes to the customer. The inland revenues will generally permit the customer to claim and retain capital allowances provided that the option to purchase fee is less than the market value at the end of the contract term.
Leasing
“A leasing transaction is a commercial arrangement whereby an equipment owner conveys the right to use the equipment in return for payment by equipment user of a specified rental over a pre-agreed period of time.”
(Pike & Neale, 2006)
2.2 LONG TERM FINANCE
Equity
Shares are described as permanent capital because the funds supplied for their acquisitions are non-returnable in most circumstances other than in the event of a liquidation. Shares are issued at nominal value and are sold at the market price. Shareholders have a share in ownership of company and also have voting rights. Dividends are payed as a percentage return on their nominal value. A company can receive equity finance from various sources like
Business Angels: Private equity investor with spare funds to invest who wishes to gamble on the future prospects of young companies.
Venture Capital: Sale of equity to a specialist institution that may also provide management assistance. For e.g. 3i.
Obtaining a Quotation (IPO)
Preference Shares
Preference shares are entitled to a fixed percentage dividend, which is paid before any profits are distributed to ordinary shareholders. Participating preference shares may be entitled to some extra dividend, over and above their fixed dividend entitlement. Convertible preference shares can be converted to ordinary shares. Cumulative preference shares have unpaid dividends that are carried forward and must be paid before dividends are paid to ordinary shareholders. Preference share holders do not qualify for tax relief.
Debt
Debentures
Debentures are basically loan secured on company assets with floating or fixed interest rate. It is a multiple loan to the company in the sense that it is contributed by several people opposed to just one individual. Debenture holders are creditors but not members of the company. Loan Stock is a kind of debenture that is issued at face value. It is not secured on assets but effectively secured on firm’s earning power, thus more risky and lower ranking of payment. Debentures issued at large discounts and redeemable at par or above are known as Deep Discount Bonds. They are generally issued at low rate of interest but have cost of redemption.
Mortgages
It is a form of secured loan placing the title deeds of property with a lender as security for a cash loan. The interest is payable on the amount borrowed.
Warrants
They are rights given to investors allowing them to buy new shares in a company at a future date, at affixed given price. They are generally issued alongside unsecured debt as a bribe to potential investors.
2.3 SOURCES OF FINANCE IN MARKS & SPENCER
2.3.1 Current & Non-Current Liabilities
Current liabilities are the one M&S needs to pay within 1 year time whereas non-current liabilities are the one M&S can pay any time after 1 year. As per the annual report for M&S,
Current Liability
M&S has short term loans in the form of Bank Loans and overdrafts worth £147.9 millions.
Syndicated Bank Facility worth £781.2 million which relates to a £1.2 bn committed bank revolving credit facility set to mature on 26 March, 2013.
Finance Lease liability worth £13.7 million. The average lease term for the equipment is 6 years and 125 years for property. Interest rates are fixed.
Non-Current Liability
Bank Loans worth £11.2 million.
Finance lease liabilities worth £88.2 million.
Medium-term notes worth £ 2018.5 million.
2.3.2 Net Assets
Equity
Ordinary Share Capital
Shares
£m
Allotted, called up and fully paid ordinary shares of 25p each
At start of year
1,586,478,423
396.6
Shares issued on exercise of share options
2,217,763
0.5
Share purchased in buy-back
(10,901,267)
(2.7)
At end of year
1,577,794,919
394.4
2,217,763 ordinary shares having nominal value were allotted during the year under two schemes namely Save As You Earn (SAYE) Share Option scheme and Executive Share Option Scheme. In SAYE, the board may offer options to purchase ordinary shares in the company once in each financial year to those employees who enter into an HM Revenue & Customs approved (SAYE) savings contract. In terms of Executive Share Option Scheme, the Board may offer options to purchase ordinary shares in the company to executive directors and senior managers at the market price on a date to be determined prior to the date of the offer.
10.9 million shares having a nominal value of £2.7m were bought back and subsequently cancelled during the year in accordance with the authority granted by the share holders at the Annual General Meeting in July 2007.
Share Premium Account
“A reserve setup to account for the issue of new shares at a price above their par value.”
(Pike & Neale, 2006)
In M&S, Share Premium Account had £ 236.2 m as on 28th March, 2009 out of which £ 231.4 m were carried forward from previous year and £ 4.8 m was from share issued on exercise of employee share options.
Capital Redemption Reserve
It is a reserve established when the firm buys its own shares in a scenario that result in loss of share capital. In M&S it was worth £ 2202.6 m. As discussed earlier £ 2.7 m worth were purchased in buy back, thus added to the capital redemption reserve.
Hedging Reserve
Hedging is an attempt to minimize the risk of loss stemming from exposure to adverse foreign exchange rate movements. M&S as on 28th March,2009 had £ 62.6 m in Hedging Reserve.
2.3.3 Net Debt
Cash & Cash Equivalents
It includes short term deposits with banks and other financial institutions, with an initial maturity of three months or less and credit card payment received within 48 hours. It was worth £ 422.9 m for M&S.
Financial Assets
M&S has current and non-current assets worth £ 53.1 m that includes unlisted investments and Listed UK Securities.
Bank Loans & Overdraft
M&S has current and non-current loans & overdrafts that include £ 4.0 m loan from the Hedge End Park Limited joint venture.
Syndicated Bank Facility
It relates to a £ 1.2 bn committed bank revolving credit facility set to mature on 26 March 2013 and is worth £ 781.2 m.
Medium Term Notes
These are notes that actually retire in 5 to 10 years. A corporate note continuously offered by a company to investors through a dealer. Investors can choose from differing maturities, ranging from nine months to 30 years.
(Forbes Digital)
In M&S these notes are issued under M&S plc’s £ 3bn European Medium Term Note Program and all pay interest annually. The medium term notes are worth £1848.1 m.
Finance Leases
It is group’s policy to lease certain of its properties and equipments under finance leases and is worth £ 101.9 m.
3. COST OF CAPITAL
3.1 Weighted Average Cost of Capital
3.2 Weighted Average Cost of Capital for M&S
As seen earlier M&S has capital in the form of debt and equity. To evaluate the Weighted Average Cost of Capital, we need to evaluate
Cost of Debt ( Kd)
Cost of Equity ( Ke)
Weight or proportion of debt & equity
Cost of Debt (Kd)
To evaluate Kd, we need to find
I = Interest paid for the debt
MV(Market Value) = Total current Market Value of the Debt
T = Corporate Tax if any
As Kd = [I(1-T)] / MV X 100
Looking at the Annual Report we can see in Cash flows from financing activities that :
I = £ 197.1 m which is approximately 7.9%
In Taxation Charges
T = 28%
In net Debt
MV = £ 2490.8 m
Thus we can calculate Kd by putting in the values as:
Kd = [ 197.1 m(1-.28)]/ 2490.8m X 100
= (141.912/2490.8) X 100
= 4.7
Cost of Equity
To evaluate Ke, we need to evaluate
D = Dividend on ordinary share capital
MV = Market value of equity
As Ke = (D/MV) X 100
Looking at the report we can find
Net dividend = 22.5 p per share
The total no. of shares at the end of the year = 1,577,794,919
The total Dividend D = .225 X 1,577,794,919 = £ 355 m approx
Market Value MV= .25 X 1,557,794,919 = £ 394.4 m
Therefore Ke = (D/MV) X 100
= (355/394.4) X 100
= 90
Weighted Average Cost of Capital (WACC)
Weighted Average Cost of Capital can be calculated by formula
WACC = Ke[ E/(E+D) ] + Kd [ D/(E+D) ]
Where E = Market Value of Company’s Equity
D = Market Value of Company’s Debt
Therefore WACC = 90[394.4/(394.4 + 2490.8)] + 4.7[2490.8/(394.4 + 2490.8)]
= (90 X 0.135) + (4.7 X .86)
= 12.15 + 4.902
= 17.052 %
3.3 Gearing Indicators for M&S
To be done
Capital Gearing
Capital Gearing =
4. INVESTMENT APPRAISAL TECHNIQUES
“An investment project is a series of cash inflows and outflows, typically starting with cash outflows (the initial investment outlay) followed by cash inflows and/or cash inflows in later periods.”
(Gotze, Northcott, & Schuster, 2008)
The financial manager needs to employ appraisal techniques in order to decide which projects to accept and which to reject because these decisions largely shapes the future of the business and its ability to manage its future operations. The project accepted must meet the financial criteria of the company, generally it’s a return greater than the cost of capital needed to finance it.
4.1 Return on Investment (Accounting Rate of Return)
This approach expresses the profit before tax arising from an investment as a percentage of the total outlay on the investment. When using the return on investment approach the project which gives the highest ARR is the one that should be accepted. Difficulties arise with the method when the duration of the investment extends for more than one year, as it then becomes necessary to determine some representative profit and investment value for the duration of the project. Other problem is that profits are the results of receipts and outgoings and they do not represent cash transactions and the cash flow arising is not taken into account during the term of the investment.
4.2 Return on Investment (ARR) related to M&S
As per the annual reports of M&S from year 2006 to 2009, M&S has invested on property. The investment, depreciation & Net Profit are described in the annual report related to property. The tax & budgeted profits are assumed accordingly.
Year 2006 2007 2008 2009
Investment £ 38.5 m £ 24.1 m £ 24.3 m £ 24.3 m
Budgeted Profits £ 4 m £ 4 m £ 32 m £ 8 m
Less Depreciation (£ .1 m) (£ .2 m) (£.3 m) (£ .5 m)
Tax (£ 9.6 m) (£ 1.9 m) (£ 4.7m) (£ 1.1m)
Net Profit (£ 4.7 m) £ 1.9 m £ 27 m £ 6.4 m
The average profit for the four years would be:
Average Profit = [ (4.7) + 1.9 + 27 + 6.4] / 4
= 29.6 / 4
= £ 7.4 m
We can compare this with the original investment made in four years:
Average investment = [ 38.5 + 24.1 + 24.3 + 24.3] /4
= £ 28.55 m
By comparing, Avg Profit/ Investment= (7.4/28.55) X 100 = 24.91 %
Thus the company can decide on whether the investment is good or not.
4.3 Payback
This method refers to how quickly the incremental benefits that accrues to a company from an investment project ‘payback’ the initial capital invested. When faced with a straight accept or reject decision it can provide a rule where projects are accepted if they payback the initial investment outlay within a certain predetermined time. In addition, the payback method can provide a rule when a comparison is required of the relative desirability of several mutually exclusive investments (Lumby, 1988).
This method simply measures the time period taken until the profits generated from the investment equal the initial cost of investment. The advantage of Payback is that it focuses on risks in considering the period during which the investment remains outstanding. The drawback is that the method takes no account of cash inflows after payback, neither is there any attempt to consider reinvestment possibilities for incoming funds during the period prior to payback.
4.4 Payback related to M &S
With relation to M&S, we again take the project of investment in property, plant & equipment.
We take the 2 investments made in 2008 and 2009 and compare them with assumptions made for returns in the following years.
2009 2008
Investment Outflow Year 0 (£ 540. 8 m) (£ 958.4 m)
Cash Inflows Year 1 £ 58.3 m £ 91.6 m
Year 2 £ 142.6 m £ 400.4 m
Year 3 £ 222.4 m £ 300.2 m
Year 4 £ 100.4 m £ 286.7 m
Year 5 £ 143.7 m £ 123.2 m
Total cash Inflow £ 667.1 m £ 1202.1 m
Now comparing the two projects of 2008 & 2009 we can see that payback for 2009 is 5 years and payback for project in 2008 is 4 years. Thus project that M&S invested is 2008 is better in terms of investment.
4.5 Net Present Value
“Net Present Value is the net monetary gain (or loss) from a project, computed by discounting all present and future cash inflows and outflows related to the project.”
(Gotze, Northcott, & Schuster, 2008)
Using the NPV method, all future cash flows related to investment project are discounted back to time 0. In order to establish the cash flows arising from a project into their present values, it is necessary to establish the cash inflows and outflows arising from it, and what cost of capital should be used to evaluate such projects.
In order to determine the NPV of a project, we need to list all the cashflows related to the project. The net cash flows are then discounted at the cost of capital using the formulae:
Discount factor = 1/ (1+i) n
where n represents the number of periods and
i represents the cost of capital per period
The general rule is that if NPV is positive, the project is accepted else it is rejected.
4.6 Net Present Value related to M&S
We assume the example that taken in the pay back technique for the year 2009 and we assume the cost of capital to be 10 %.
Year Net Cash Flows Formula Disc. Factor NPV
£ £
2009 (£ 540.8 m) – 1 – £ 540.8 m
2010 £ 58.3 m 1/(1+.1)1 .909 £ 52.99 m
2011 £ 142.6 m 1/(1+.1)2 .826 £ 117.78 m
2012 £ 222.4 m 1/(1+.1)3 .751 £ 167.02 m
2013 £ 100.4 m 1/(1+.1)4 .683 £ 68.57 m
2014 £ 143.7 m 1/(1+.1)5 .621 £ 89.094 m
£ 126.3 m (£ 44.35 m)
As we can see above the NPV for the project is negative thus this project should be rejected.
4.7 Internal Rate of Return (IRR)
Internal Rate of Return of a Project is that cost of capital which makes the net present value of a project equal to zero. If the cost of capital required to reduce the future cash flows to zero is greater than the company’s cost of capital, then the project will be accepted because it gives a positive return for the business.
4.8 Internal Rate of Return related to M&S
In internal rate of return we need to assume cost of capital so that NPV nears 0. Thus we assume the cost of capital as 9% first.
Year Net Cash Flows Formula Disc. Factor NPV
£ £
2009 (£ 540.8 m) – 1 – £ 540.8 m
2010 £ 58.3 m 1/(1+.09)1 .917 £ 53.46 m
2011 £ 142.6 m 1/(1+.09)2 .842 £ 120.06 m
2012 £ 222.4 m 1/(1+.09)3 .772 £ 171.69 m
2013 £ 100.4 m 1/(1+.09)4 .708 £ 71.08 m
2014 £ 143.7 m 1/(1+.09)5 .650 £ 93.40 m
£ 126.3 m (£ 31.10 m)
Now we try with cost of capital as 7 %
Year Net Cash Flows Formula Disc. Factor NPV
£ £
2009 (£ 540.8 m) – 1 – £ 540.8 m
2010 £ 58.3 m 1/(1+.07)1 .935 £ 54.51 m
2011 £ 142.6 m 1/(1+.07)2 .873 £ 124.48 m
2012 £ 222.4 m 1/(1+.07)3 .816 £ 181.48 m
2013 £ 100.4 m 1/(1+.07)4 .763 £ 76.6 m
2014 £ 143.7 m 1/(1+.07)5 .713 £ 102.45 m
£ 126.3 m (£ 1.7 m)
As we can see that with cost of capital as 9% the NPV is – £ 31.10 m and with cost of capital 7% the NPV is – £ 1.7 m, thus it shows that NPV will be zero between 6 and 7 % cost of capital. As the company’s cost of capital is 10 % and the cost of capital to make the NPV zero is between 6 & 7 %, thus this project can’t be accepted as its less than the company’s cost of capital.
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