Study On The Valuation Of Debenhams Finance Essay

Experts in the field agree in rule that, concern value is derived from the watercourse of discounted future benefits to the proprietors. The difference among the assorted rating theoretical accounts is attributable to the method in which those benefits are estimated. Opinions differ among rating practicians, faculty members and experts as to which methods are most appropriate. The construct of rating has become an of import issue, particularly sing their impact on affairs such as estate revenue enhancement liability, concern acquisitions, contracts understandings, and other non concern affair such as heritage and divorce. Research on the theory and application of rating methods frequently outputs assorted consequences, which merely exacerbates the argument ( Jenkins, 2006 ) . Butinvestors need to understand equity and house rating in order to

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-Be able to find the factors that create value for the house,

-Understand the causes of alterations in the house ‘s stock monetary value from period to period and

Directors besides need to understand rating in order to

-make investing funding and dividend determinations that create value and

-Determine the value of the stock or stock options that they own

BACKGROUND INFORMATION OF THE COMPANY

Debenhams is a prima section shops group. They have a strong presence in cardinal merchandise classs including adult females swear, menswear, place wares, wellness and beauty, accoutrements, intimate apparel and kids wear. A alone mix of sole ain trade names, including Interior designers at Debenhams, and third-party trade names helps differentiate Debenhams from its rivals.

Debenhams has 157 shops including 13 Desire by Debenhams shops, across the UK and Ireland with about 10.9 million square pess of trading infinite and about 24,000 employees.

In add-on Debenhams has 51 international franchise shops in 18 states outside the UK and Ireland. Debenhams is besides widening its client range by doing direct gross revenues through its cyberspace web site.

As at stopping point of trading on 8th of April, 2010, its portion monetary value was ?76.45p and portions in issues was 1,672,848,189, portion capital of ?1milion and equity of ?425.3million

Scope OF THE REPORT

This study effort to discourse Debenhams and its public presentation with peculiar accent on the rating, utilizing specific rating theoretical accounts such as monetary value net incomes ratio, discounted hard currency flow, dividend rating theoretical account, market capitalization, economic Added value, Net Asset Value, Modigliani and Miller Model of capital construction.

The general troubles and restrictions with any rating project and the differentiations among rating constructs are compared and nomenclatures will besides be defined.

DEFINATIONS

The construct of value is the bosom of fiscal direction ( Pike and Neale, 2003, p. 113 ) . Valuing portions or so any other plus is non a precise scientific discipline. It ‘s more of an art. ‘Pike and Neale define Value ‘ as ‘whatever the highest bidder is prepared to pay ‘ .

Pricing information efficiency is the extent to which available information is built into the construction of portion monetary values ( Pike and Neale, 2003, p. 46 ) . They argued that if information relevant for measuring a company ‘s future net incomes chances ( including both past information and relevant information associating hereafter expected events ) is widely and cheaply available, so this will be integrated into portion monetary values by an efficient market.

Harmonizing to them, the finding of just market value of assets ( physical, securities, intangible ) depends on the prevailing fortunes. The market monetary value of an plus can be trusted as a just appraisal of its value, so long as the market is moderately efficient ‘ .

Efficient market – is a fiscal market in which current monetary values to the full reflect all available relevant information, both private ( i.e. information known merely to insiders ) and public ( Pike and Neale, 2003, pp. 112-113 ) . This is the highest degree ( strong signifier ) of market efficiency. The other two degrees are the weak-form efficiency ( where current monetary values reflect the historical sequence of monetary values ) and semi strong-form efficiency ( where current monetary values to the full reflect all publically available information, including such things as one-year studies and intelligence point.

DISTINCTIONS AMONG VALUATION CONCEPTS

The term value can intend different things to different people.

Liquidation value is the sum of money that could be realised if an plus or a group of assets ( e.g. , a house ) is sold individually from its operating administration. This value is in contrast to the going-concern value of a house, which is the sum the house could be sold for as a go oning operating concern ( Van Horne J.C. and Wachowicz J.M. jr. , 2005, p. 72 ) . If there were an at hand bankruptcy, the house ‘s settlement value will hold a major function. For illustration the portion monetary value of Debenhams as at 8th of April, 2010, was ?77.5p. If there came up return over rumors, such monetary value would close up like wise it will fall if the company faces settlement.

The book value of an plus is the accounting value of the plus – the plus ‘s cost minus its accrued depreciation. The book value of a house, on the other manus, is equal to the ‘dollar ‘ difference between the house ‘s entire assets and its liabilities and preferable stock ( discriminatory portions ) as listed on its balance sheet. Book value is based on historical values and hence, may bear small relationship to an plus ‘s or house ‘s market value.

For illustration the book value of Debenhams as at 29th August 2009 was ?425.3m ( 2009 study ) whiles its market value base on market capitalisation theoretical account was ?132,991.431m ( refer to market rating theoretical account ) .

In general, the market value of an plus is merely the market monetary value at which the plus ( or a similar plus ) trades in an unfastened market place. The market value of a house is frequently viewed as being the higher of the house ‘s settlement or going-concern value ( Brealey and Myers, 2000 ) contend that, in good functioning capital markets the market value of the house is the amount of the present value of all assets ( touchable and intangible assets ) held by the house, the whole peers the amount of the parts ( Brealey, Myers, 2000, p. 541 ) .

Van Horne and Washowicz province that: ‘the intrinsic value of security or portion is what the monetary value of the security or portion should be if decently based on all factors bearing on rating ( assets, net incomes, future chances, direction etc ) . In short the intrinsic value is its economic value ‘ . They further argue that ‘if markets are moderately efficient and informed, the current market monetary value of a security should fluctuate closely around its intrinsic value ‘ ( Van Horne J.C. and Wachowicz J.M. jr. , 2005, p. 73 )

VALUATION MODEL ONE – Monetary value EARNING RATIO

The monetary value to net incomes ratio ( P/E ) is the most widely quoted figure when investors attempt to set a value on a portion. The P/E ratio is a much-used public presentation index. It is a step of the market ‘s assurance in peculiar company or industry. It is the portion monetary value divided by the current net incomes per portion ( Pike and Neale, 2003, pp. 60-61 ) .

A P/E Ratio measures the monetary value that the market attaches to each lb of company net incomes and is hence a kind of pay-back period ( Lakshmi, 2010 ) .

The ratio seeks to project how many times the current dividend per portion can do up the current portion value.

The market monetary value of Debenhams portions as at 8 April 2010 was 77.55p. Expressway and Neale, ( 2003 ) argue that ; if there is an active and efficient market, a company ‘s portion, information provide a dependable indicant of its value. The markets closed the trading on the monetary value of ?77.55p. The net incomes per portion as of 2009 Accounts was 10p

The Price Net incomes Ratio ( P/E Ratio ) is merely the market monetary value of a portion divided by the last reported net incomes per portion. Thus the P/E Ratio for Debenhams is 77.55 [ i.e. 77.55/ 10 ]

By multiplying this P/E ratio by the net income, the value for the concern could be determined ( Ventura, 2005 ) . The net income as at 2009 was ?95.1million ( Debenhams, 2009, p. 56 ) Therefore the value of Debenhams April 2010 harmonizing to the P/E ratio rating theoretical account is ?7,375.005m [ i.e. 77.55*95.1 ] .

P/E ration suggest how many old ages the markets is prepared to wait to cover the portion monetary value.

The reading of the P/E ratio is capable to predominating circumstance about the company, a rival or industry. For this ground, a rivals P/E ratio is used to function as a control to supply alternate rating to cut down the prejudice hitherto could be so obvious [ Next plc is selected whose monetary value on 9 April was 2271p and 2009 basic gaining per portion was ?156.0p so P/E ratio is 2271/156 = 14.56

Therefore the value of Debenhams utilizing a rival ‘s P/E ratio is 14.56 * 95.1 = ?1,384.66m. This is how subjective this rating can be.

On its ain, each P/E ratio is meaningless. The P/E points us to optimism or pessimism. The P/E ratio of 77.55 is really high. This does non intend that the company has done good, but suggests that the company is expected to make good in the hereafter ( Pike and Neale, 2003, p. 123 ) .

There are some factors that can hold consequence on the P/E ratio. These include: if the company was up for settlement – the monetary value would fall well ; if there is extremely rumoured take-over, the monetary value will hit up, if the industry is fighting. A company in hurt may hold a low P/E ratio if compared to the industry ( Moffat, 2003 ) .

The P/E ratios need to be compared to the industry figures and like-for-like companies to be meaningful.

One of the major jobs with utilizing P/E ratios to value concerns is that ‘it relies on accounting net incomes instead than the expected hard currency flows which confer value on any point. Using P/E ratio to observe under or over-valuation implies that markets are slow or inefficient processors of information.

Another lack in valuing a company by the P/E/ ratio method is that it does non see hazard and growing, instead depends on historical earning. It can besides be confounding ( Arnold, 2005, p. 923 ) .

VALUATION MODEL TWO – DISCOUNTED CASH FLOW- DCF

This theoretical account of concern rating takes into history the clip value of money. The of import variables that determine a DCF theoretical account are the free hard currency flows and the price reduction rate. Discount rate is the rate of return used to dismiss hard currency flows received in future old ages. It is the chance cost given the hazard category of the hereafter hard currency flows ( Arnold, 2005 ) . The price reduction rate has impact on DCF theoretical account because the higher the price reduction rate the lower the net present value.

DCF works best when sing mature companies as they tend to hold predictable steady net incomes watercourse. DCF would non be the most appropriate tool for valuing fast turning, new or immature companies as they barely generate much in the manner of free hard currency and even if they do, be given to plow back into the concern.

Debenhams equity funding was linked to the predominating LIBOR rate which is tantamount to chance cost. In August 2008 they secured funding of ?950miilion and the LIBOR rate for 12 months at the clip was 3.2364 % .this rate was usage as the Leaden Average Cost of Capital ( WACC ) .Debenhams ain WACC= divided/equity =

The company free hard currency flow from amalgamate hard currency flow statement was use. This is because of difference in calculation as amortization which is non hard currency point like depreciations are omitted. Again others sentiment that, accumulations and increase in defer revenue enhancement should be taken into consideration, for these ground the company hard currency flows are use. Alternatively the prescribe method of ciphering FCF= Revenue -operating cost+ depreciation + investing outgos. others methods includes hard currency flow from runing activities+ hard currency flow from funding activities -cash flow from puting activities

hard currency and hard currency equivalent from Debenhams fiscal statement

2005

2006

2007

2008

2009

2010

64

0.3

79.3

-2.9

188.2

% alteration

-99.7

-20.7

-102.9

88.2

Continuing Value

354.2

354.2= 1.882*188.2 i.e. 88.2 % +1

Debenhams ‘s five old ages hard currency flow has been inconsistent with varied per centum alterations as in the above tabular array. The 2008 flow was in the negative as they were severely hit by the economic meltdown and the recession ; nevertheless they bounced back in 2009 even when the recession was non over yet and the president was optimistic about better public presentation in 2010. Therefore in gauging the go oning value, the premise that, FCF growing is changeless after the prognosis skyline was made. Other methods includes convergence attack and terminal value

Horizon, 5 old ages WACC= 1.032364 ( 12 months LIBOR rate August 2008 )

Time

year1

twelvemonth 2

twelvemonth 3

twelvemonth 4

twelvemonth 5

Free Cash Flow ( ?m )

64

0.3

79.3

-2.9

188.2

Continuing value

354.2

value of Asset

64

0.3

79.3

-2.9

542.4

Ke

1.032364

1.0323642

1.0323643

1.0323644

1.0323645

64

0.3

79.3

-2.9

542.1

1.032364

1.065775

1.100268

1.1358773

1.1358773

=

61.99364

0.281485

72.07334

-2.553093

477.25227

609.047635

PV = ?609.05

utilizing the expression

DCF is cardinal rating tool that less likely to be manipulated by aggressive accounting patterns, such as depreciation and stock rating methods. It besides gives investors a good image of cardinal drivers of the portion value of the company and expected growing rate in operating net incomes

The DCF attack to rating removes the job of restricting investing funding to keepings as in the dividend growing theoretical account.

However developing a DCF demands a batch more work than others. It is simply a mechanical tool which makes it capable to the proverb ‘garbage in refuse out ‘ . Furthermore, little alterations in input can ensue in big alterations in the value of the company.

There are troubles in measuring growing chances and their funding demands in future old ages ( Arnold, 2005 ) .

VALUATION MODEL THREE – DIVIDEND VALUATION

The dividend rating theoretical accounts ( DVM ) province that, the value of a portion is the amount of watercourse of future discounted dividends plus the value of the portion as and when it is sold in the future twelvemonth. That is, it is based on the premiss that, the market value of a portion represents the amount of the expected future dividend flows, to eternity, discounted to show value ( Arnold, 2005, p. 914 ) .

This theoretical account assume that the company would go on to run in sempiternity

Five twelvemonth 2005-2009 Divided payment, EPS, cost of capital and figure of portions in issues

Item

Description

2005

2006

2007

2008

2009

Dividend per portion

0

2.4

6.2

3.0

0

portions in issue

472.3 m

588.8 m

847.7 m

1,288.5m

1,672.85m

cost of capital

2.30 %

4.31 %

5.45 %

5.19 %

3.24 %

net incomes per portion

26.2

7.4

9.3

9

10

Analysiss from the tabular array above indicate different value at certain clip in the five-year period ( 2005-2009 ) with the highest value in 2007 and zero values in 2005 and 2009 as no dividend were paid in those periods.

The cost of equity capital has been calculated on the premise that: the portion monetary value represents the investor ‘s chief, and the dividend per portion represents the involvement.

The cost of capital is an chance cost to alternative investing and LIBBOR 12 months August rate was used to warrant the fact that Debenhams fiscal twelvemonth is at the 30 of August, hence 2004 August 12 months rate was used for 2005 fiscal twelvemonth to buttress the point that investor ‘s capital might hold been used for a full twelvemonth to anticipate a return. The uncertainness and the incompatibility of Debenhams dividend payment, makes it trouble to foretell its future payment and its rate of growing.

It is hence assumed that the 2008 dividend will be maintained till eternity for the intents of valuing this company. Harmonizing to the cardinal theory of value, the value of a fiscal plus at any point in clip peers the present value of all future dividends. The future dividends collectible yearly is set at 3.0p. If all future dividends are the same, the present value of the dividend watercourse constitutes sempiternity. Therefore if Debenhams is expected to pay dividends of 3.0p per twelvemonth to eternity and the rate of return on a portion of this hazard is 5.19 % ( LIBBOR Rate August2008 ) so:

P0 =d1 /ke ( Arnold, 2005, p. 915 )

P0 is amount of the watercourse of future discounted dividends plus the value of the portion as and when sold in some future twelvemonth, where D1 is the dividend and ke is the cost of equity

= 3 / 5.19 %

= 3 / 0.0519

= 57.80p per portion

Number of portions available in 2008 is 1,288.5m.

Therefore, the value of the company by the dividend rating theoretical account is ?74,475.3m ( i.e. ?57.8p * 1,288.5m ) .

Dividend rating theoretical accounts have its drawbacks. First, they are extremely sensitivity to the premises ; secondly, the quality of input informations is frequently hapless ; and thirdly, if the growing rate exceeds the cost of equity capital a absurd consequence occurs ( Arnold, 2005 ) .in a period where dividends are non paid the company can non be valued or its value is zero like in 2005 and 2009 where dividends were non paid. Manager can act upon the value of a company by declaring higher dividend to force the value of the company up.

VALUATION MODEL FOUR – Market Capitalization

This method of rating is applicable for quoted companies merely. Market capitalization is the market value of a house ‘s equity ( Pike and Neale, 2003, p. 854 ) . The market value is determined by multiplying the quoted portion monetary value of the company by the figure of issued portions ( Ventura, 2005 ) .

There is a correlativity between the Efficient Market Hypothesis ( EMH ) and the market capitalization rating theoretical account. Lakshmi ( 2010 ) argue that ‘If EMH holds and single monetary values reflect directors ‘ actions so the market capitalization of the company which peers portion monetary value multiplied by the figure of portions issued should reflect the value of the company. Directors could act upon this theoretical account by unnaturally increase the portion monetary values like in the instance of Enron and WorldCom. Others contended that ‘there are jobs with this attack as it may be hard to trust on the market as it can frequently be biased due to investors ‘ outlooks. There are several unfavorable judgments sing the cogency of the EMH and inquiry how efficient are the markets as the market all over the universe are non perfect.

The company had 1,672,848,189 portions in issue as at 29th August, 2009 ( 2009 one-year study ) with matching market value per portion of ?79.5p By market capitalization rating method, the market value of Debenhams as at August 2009 was ?132,991.431m ( i.e. ?79.75*1672848 ) . Compared with 2008 when 1,288.5m portions were in issue with the market value per portion at ?49.75p.The market value of Debenhams as at August 2008 was ?64,102.875 million ( i.e. 1, 2588.5m * ?49.75 ) .

Whereas the book value ( stockholders equity ) stood at ?125.3m as at 30 August 2008, its market value was ?64,105.875million. The ratio of market value to book value is 511.60 ( 64,102.875/125.3 ) . This is an indicant of how bias this rating can be as originative accounting could adversely impact on the market value like in the instance of Enron and WorldCom which lead to the collapsed of hitherto successful companies in the eyes of the markets. The book value is based on historical value of its assets less liabilities. The market value for the company is based on what investors are willing to pay. This includes the creativeness of its greatest assets – people, the successful trading schemes, the profitable trade names etc. Another job with this rating is that unquoted companies can non be valued.

Net ASSET VALUE METHOD

Net plus value ( NAV ) is a term used to depict the value of an entity ‘s plus less its liabilities. The term is most normally used in relation to common financess due to the fact that portions of such financess are redeemed at their net plus value. The term is besides use to mention book or equity value of a concern. Net plus value may stand for the value of the entire equity, or it may be divided by the figure of portions outstanding to arrive net plus value per portion.

There is no general accepted method of ciphering net plus value and the standards used for the rating will depend upon the fortunes, the intents of the rating and any ordinances that may use. The NAV of Debenhams as per 2009 study was ?425,300,000m whiles its market capitalisation was ?132,991.431m. This is against the averment that most quoted companies have NAV less than their market value ( Lakshmi, 2010 ) . NAV would normally be below the market monetary value for the undermentioned grounds:

NAV describes the company ‘s current plus and liability place. Investors might believe that, the company has important growing chances, in which instance they would be prepared to pay more for the company than its NAV.

The current value of a company ‘s assets may be higher than its historical cost used in the NAV computation. Intangible assets, like good will are largely non included on a balance sheet and so will non look in an NAV computation.

Therefore, a company ‘s market value will non ever be greater than its NAV. This rating is earnestly subjective and unfastened to use of balance sheet figures.

Problems:

Fixed plus values are normally out of day of the month

Stock values are non dependable as different methods yield different consequence

Debtors ‘ figures are leery

The bases of valuing intangible plus like good will are non realistic.

ECONOMIC VALUE ADDED ( EVA )

Economic Value Added ( EVA ) is non a valuing theoretical account per sey, it more of a fiscal public presentation tool to cipher the true economic net income of a corporation. EVA can be calculated as net operating net income after revenue enhancements minus a charge for chance cost of capital invested.

EVA=NOPAT- ( k X Net assets )

NOPAT is the net operating net income after revenue enhancement ; K is the cost of capital and net assets is the book value of the assets adjusted for accounting deformations

Debenhams NOPAT FOR 2009 ?95.1 one twelvemonth LIBBOR Rate for August 2009 is 6.7 % .this is used as the cost of capital and net plus of ?425.3m

EVA= 95.1- ( 0.067*425.3 ) = ?66.6049m

Unlike Market-based steps, EVA can be calculated at divisional ( Strategic Business Unit ) degree. It is a flow and can be used for public presentation rating over clip.

Contrast to accounting net income, such as EBIT, Net Income and EPS, EVA is Economic and is based on the thought that a concern must cover both the operating costs and the capital costs.

EVA can be used for the undermentioned intents:

Puting organisational ends, public presentation measuring, finding fillips, communicating with stockholders and investors, motive of directors, capital budgeting, corporate rating, analysing equity securities etc

MODIGLIANI AND MILLER MODEL OF CAPITAL STRUCTURE

The basic theorem provinces that, under a certain market conditions such as the absence of revenue enhancements, bankruptcy and in an efficient market, the value of a house is unchanged irrespective of how the house is financed. In other words it does non count if the house ‘s capital is raised by equity or debt. Their dividend policies notwithstanding the value of that house will the same. Therefore M & A ; M 1 says the construction of debt and equity in corporation is irrelevant. The value of the house is determined by Real Assets and non its capital construction

M & A ; M Proposition II states that, the value of the house depends on three things:

Required rate of return on the house ‘s assets ( Ra )

2 ) Cost of debt of the house ( Rd )

3 ) Debt/Equity ratio of the house ( D/E )

Part B

FIVE Year MONTHLY RETURNS OF THE COMPANY TO THE FSTE100 INDEX

Investors hold on securities with the hope of return ( capital additions & A ; dividend ) and the return of a company is normally given by the expression

R= ( P1-P0+D ) /P0

Where p1 is the current monetary value of a security p0 is the old monetary value, D is the dividend paid and R is the return.

In the instance of Debenhams, historical monetary values were non available in 2005 and in that twelvemonth and 2009 no divided were paid. This could non allow five old ages historical FSTE100 to be calculated. Therefore three old ages was conducted

As it can seen from the chart below, Debenhams have about negative returns, though it has really high portion monetary values, it appears to propose that it is overvalued but investors may still maintain religion with them because of high dividend payment which makes them the industry favourites. Note: Restriction its 3 twelvemonth chart and non 5years.

BETA OF DEBENHAMS

Betas ( I? ) of a portion or portfolio refer to the relation of its return to the whole market.

An plus with a beta of 0 agencies that its monetary value is non correlated with the market. A positive beta means that the plus correlates to the market. A negative beta indicates the plus reciprocally correlate to the market. High beta does non vouch high returns. But the beta coefficient is a cardinal variable in the capital plus pricing theoretical account ( CAPM ) and it measures the portion of the plus ‘s systematic hazard that can non be mitigated by the variegation, because it is correlated to the return of the other assets in that portfolio. Rational investors are merely rewarded for bearing systematic hazard, since this hazard indicates the extent to which the expected return varies with the overall market Pike and Neale, 2003 ) . Beta is a step of the volatility or the sensitiveness of plus return in footings of the market hazard. A company beta is an indicant of its volatility or the liquidness in the market.

Debenhams Beta ( I? ) of 0.4 from the computation indicates that, the stock move in proportion with the market. Yahoo finance mark Debenhams correlativity at 0.4127.This buttress the point that, its portions are sensitive to the motion of the markets. Unlike Yahoo finance beta of 0.7821whisch is normally over a drawn-out period of clip, the 0.4 from the computation is with obvious restriction of base on merely 3 old ages of informations. Therefore the differences

THE CAPM MODEL

CAMP suggest that merely systematic hazard is relevant in measuring the required hazard premium for a security and concludes that when an efficient capital market is in equilibrium, i.e. all securities are right priced, the relationship between hazard and returns is given by the market security line ( SML ) which province that, the needed return on a portion is made up of the return on hazard free plus plus a premium for hazard related to the market ‘s ain hazard premium but varies with Beta of the portion in inquiry.

Rs= Rf + { I? ten ( Rm-Rf ) }

[ Rs ] The expected return from single security

[ I? ] The beta factor for single security

[ Rf ] the hazard free rate of return ( 3 months authorities stock -T-bills )

[ Rm ] The expected rate of return of the market

[ Rm-Rf ] the market hazard premium

No plus is risk free even authoritiess default on loans and defer involvement payment, nevertheless in a stable political and economic environment authorities stock is near hazard free. Pike and Neale suggest that Rf is usually 3 months Treasury measure rate which was 0.48 and agrees with Barclay ‘s capital that market hazard premium ( Rm-Rf ) is normally 5 % -6 % . Using the beta from Yahoo finance, Rs= 0.48+0.7821*0.06 =52.7 % , utilizing ain beta output 50.4 % . This is really high return and could explicate why Debenhams have really high portion monetary values.

Unlike DGM model CAPM does non necessitate growing projections nor does it depend on instantaneous efficient markets but nevertheless work on legion premises 11 of them

HISTORICAL VARIANCE FOR THE COMPANY

The discrepancy is a step of dispersion/ variableness ; it measures divergences from the

Mean. It is the amount of single return minus the mean all square divided by the entire figure of the return as

x

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