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Requirements
Question:
1- Write a note on Corporate Finance in approx 2000 words with references to Harvard.
Solution:
Introduction
The report is prepared to study the financial performance of a company that has been listed in the major stock exchanges like London, New York, Tokyo and Mumbai. For the purpose of this report, ABB Ltd. has been considered as the company whose financial performance and position will be evaluated based on its annual reports.
ABB ltd is main technology provider in transport and infrastructure industry. Headquarter of company is in Switzerland. Company can be said global leader in Electrification products, Robotic and Motions and Power Grind. It is operating more than 100 countries mainly in America, Europe, Asia, Middle East and Africa. In the year 2017, they are more focused on automation and sustainable development (McKinsey & Company, 2010). They are also investing in consumer related service and products so business risk can be reduced. ABB Ltd is currently listed in following five stock exchanges. We have currently taken NASDAQ base for calculation of various financial aspects.
The report shall analyze the financial performance of the company and shall bring before the factors which influence the growth of the company and its decision making process. The evaluation of the financial performance of the company shall be done in three stages starting with EVA analysis, then the shareholder value analysis and at the end equity analysis of the company’s financial information taking into account the financial statements over a period of five years i.e., 2013 to 2017.
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Place Your OrderEconomic Value Added (EVA) Analysis of ABB Ltd
EVA is measured on the basis of the residual income. It shows the profitability of project accepted by the company. As per EVA if company is providing good return to its shareholders than only company is generating profit. EVA considers investment as heavy measure. How much return is earned on invested asset is more important for EVA (Michael Rago,2008).
EVA = NOPAT- (WACC* Capital Invested)
NOPAT = Net Operating Profit after Tax (PBIT Less Interest Less Tax)
WACC = Weighted Average Cost of Capital
WACC= Cost of Equity*Equity/Equity+Debt +
Cost of Debt (1-Tax Rate)*Debt/Equity+Debt
Capital Invested = Equity+ Long Term Debt at Beginning of the period
One of the technique which is used in evaluating the economic profit in financial management of a company is termed as Economic Value Added. The calculation of EVA is done by deducting the net income after tax from the cost of capital. The benchmark used in this process is to look that the company has the ability to meet its operating as well as capital costs (Florian Steiger, 2008). The evaluation of financial performance of ABB Ltd. is done using the EVA method in following ways:
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Total shareholder Return Analysis of ABB Ltd: Total Shareholder return is calculated for measuring performance of company’s share over the specific period. It includes appreciation done in share prices and dividend provided by the company for that particular period. Comparison between various companies becomes possible as it includes dividend and share price both. There can be possibility of uneven trend in share prices and dividend policies between the various companies hence, it is easy to compare with total shareholder return. This shows how much premium return is held by shareholders in the company. Total Shareholder Return = (Ending Price of Stock – Beginning Price of Stock) + Dividend Received during the period/Beginning Price of Stock
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Valuation of Equity of ABB Ltd: Equity Valuation defines value of firm in the market. It shows true value of shareholder in the company (Marco Madeira 2013). There are two concepts for valuing equity one is relative valuation and another is absolute valuation. In relative valuation stock is compared with the another company and with the help of market rate and ratio analysis, where in absolute valuation dividend discount model, Discounted Cash flow model or other model is used where growth can be estimated (Nguyen and Vu Linh 2013). External factor always impact on the growth of the company, one model which can be useful for one company cannot be use full for another hence it is depend on investor for which model he wants to go for.
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Net Asset value Method: NAV is calculated by deducting total liabilities from total assets of the company and id divided by the total number of outstanding shares i.e. Net Asset Value = Assets – Liabilities / Total Number of Outstanding Shares. The NAV is used to measure the financial performance of the company by the investors. The investors use this method to assess the performance of the company based on the NAV, if the NAV is high that the value of assets is more than that of its liabilities then the investors invest more on the shares of the company to get better returns. On the other hand, if the NAV of the company is low then the investors move to other sectors or other company who has a higher NAV for investment.
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Discounted Free Cash Flow: Discounted Free cash flow is a method of valuation which is used to estimate the value of investment on the basis of future cash flow. The analysis of the DCF helps in finding the value of future cash flow without using a discount rate. The value of future cash flow is used to evaluate the potential investment. The main purpose of analyzing the DCF is to estimate the amount an investor will receive from investment in the company (Dechow et al 2014). The evaluation of DCF includes the following:
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Free Cash Flow: The free cash flow is used to represent the generation of cash after deduction the cash out flows of the company which is used to support the operations of the company.
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Terminal Value: Terminal value is used to determine the company’s future cash flows through an asset valuation model.
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Final Output: This is the final result after calculating all the units in the discounted free cash flow system. This shows the actual cash flow of the company in the present scenario.
Conclusion
ABB Ltd is generating higher profits from the limited resources. Company has better ratios in valuation in compare to big companies in the market. Company has multi divisions plus company is planning to invest into FMCG sector as per announcement done in 2017, hence company is planning expansion from retained profits. Strict dividend policy and Re Investment from retained earnings is company’s main policy. As per relative approach company has Intrinsic Value of $20.34 and as per absolute approach it has intrinsic value of $31.48. Market value of Share currently is $26.82. Hence, as per free cash flow model market is undervalued whereas per relative approach it is overvalued. Difference in valuation can be arise because of different methods can be used for publishing value of equity under relative approach and assumptions of investor to carry out calculation of equity. Relative approach considered cash plus non-cash items while absolute approach considers only cash items hence, there are chances of difference in prices of both the method. As company has different divisions in different countries there are many external factor which affects the company environment, hence exact estimation of cash flow is not possible it can be overestimated or underestimated, hence value of equity should be considered more appropriate from relative approach.
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References
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Annual Reports (2018), Annual Reports of the ABB Ltd, retrieved from: http://www.annualreports.com/Company/abb-ltd
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Chandra, P. (2017). Investment analysis and portfolio management. McGraw-Hill Education. https://books.google.co.in/books?hl=en&lr=&id=nS1HDwAAQBAJ&oi=fnd&pg=PT37&dq=Chandra,+P.,+2017.+Investment+analysis+and+portfolio+management.+McGraw-Hill+Education.&ots=IZXABJtuOL&sig=LolMfAyflnyEjVwY0HpFjcLO3l4
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Dechow, P. M., Sloan, R. G., & Zha, J. (2014). Stock prices and earnings: A history of research. Annu. Rev. Financ. Econ., 6(1), 343-363. https://www.annualreviews.org/doi/abs/10.1146/annurev-financial-110613-034522
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Florian Steiger (2008), the validity of company valuation using discounted cash flow method retrieved from: https://arxiv.org/ftp/arxiv/papers/1003/1003.4881.pdf
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Jensen, M. C. (2017). Value maximisation, stakeholder theory and the corporate objective function. In Unfolding stakeholder thinking (pp. 65-84). Routledge. https://www.taylorfrancis.com/books/e/9781351281874/chapters/10.4324/9781351281881-4
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Marco Madeira (2013), Equity Valuation, retrieved from: https://repositorio.ucp.pt/bitstream/10400.14/16783/1/Thesis%20Equity%20Valuation%20-%20Marco%20Madeira%20152111148.pdf
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McKinsey & Company (2010), Valuation: Measuring and managing the value of company Page (797-813), retrieved from: https://books.google.co.in/books?hl=en&lr=&id=iI3J4b2hWlwC&oi=fnd&pg=PT9&dq=related:RxlLBNAMT44J:scholar.google.com/&ots=IJ4DrGgC0n&sig=bo1rL8VkO8c1adt7bLGUs7W2s4M#v=onepage&q&f=false
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Michael Rago (2008), an analysis of Economic Value Added, retrieved from: https://pdfs.semanticscholar.org/0709/df4a9b4f30fc430e6eb1ef64208e77dda4aa.pdf
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Nguyen and Vu Linh (2013), Discounted Cash flow and Economic Value added methods in corporate valuation, retired from: https://www.theseus.fi/bitstream/handle/10024/57094/Nguyen_Vu_Thuy_Linh.pdf;sequence=2
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Richard A. Brealey, Stewart C. Myers, Franklin Allen and Pitabas Mohanty(2012), Principles of Corporate Finance (Page 510-543), retrieved from: https://books.google.co.in/books?hl=en&lr=&id=XMGjAgAAQBAJ&oi=fnd&pg=PR1&dq=related:RxlLBNAMT44J:scholar.google.com/&ots=rkWZjo7UAQ&sig=DaSpe2SeV_u6J_xNDVGGrwS5RUY#v=onepage&q&f=false
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Yahoo Finance (2018), ABB Ltd Summary and Analysis, retrieved from: https://finance.yahoo.com/quote/ABB/
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Yahoo Finance (2018), IBM Ltd Summary and Analysis, retrieved from: https://in.finance.yahoo.com/quote/IBM/
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