In the economy of today, it becomes mandatory to follow right set of strategies to take an ad hoc advantage of the rapidly changing situation of the market. This competitive scenario demands the right set of skills in order to obtain success and stand against the competitive market (Olawale et al., 2010). Thus, the investment decisions come into play. Analyzing the importance of investment decision is crucial to lead to the right outcomes. In case an organization makes wrong investment decision, the loss is bear by the organization.
Investment has always been an important point of consideration in the corporate life. Similar is the case here. For Helical Bar, there is the opportunity of investment, to development a scheme to build an Office Block of 15,000 square metres usable space at the University of Reading. The remaining staff of Henley Management College would move from their current site in Henley on Thames to this building. On looking at the costing, the purchase price for this investment would be at around £7.5 million. This price includes all the legal expenses and other expenses. Thus, hereon we would consider the total purchase price as £7.5 million.
For any valuation decision, it becomes important to aggregate the information for correct valuation (Albagli, 2009). Thus, for this report we would use wide range of information about the financial position of Helical Bar. Based on the information collected, various financial models will be used. These financial models would use calculations to come up to some findings about the financial position of the company. The results would be compared with the offer at hand, for the investment in project at hand. This would finally help us to know whether it is beneficial for Helical Bar to invest in the building project or not.
Statistical Calculations
The companies most commonly make use of traditional techniques of cost benefit analysis for any investment project they have at hand (Willcocks & Lester, 1996; Hinton & Kaye, 1996; Ballantine & Stray, 1998). These techniques help the organization in making the right decision at various instances. There are certain situations, in which the organization has to make certain decisions. Under such situations, the organizations use various valuation techniques to find out the expected rate of return from the project at hand. Based on the results found from the situation at hand, the organizations make investment decisions.
These techniques help the organization attain the right decisions for their growth. There are number of financial techniques available at hand such as Internal Rate of Return, Return on Investments, Capital Asset Pricing Model, Helican Bar method etc (Apostolopoulos and Pramataris, 1997). Depending on the project's importance, the duration of investment, the cost and many other factors, it is required to adopt the right technique for analyzing the results. For the case of investment opportunity here available for Helical Bar, we have made use of the techniques to reach to certain outcomes for investment decision.
Below table 1 describes monthly and annual return of the Helical Bar. From these results, we can see that the rate of return for the company is .31% considering all the shares. However, looking at the returns of share from Real Estate, we can see that the returns are just .11%. Overall, the returns of Helical Bar are .89% on monthly basis. Thus, we can see that the returns are quite high for the company for the overall. However, the returns from real estate are not much as compared to that of the total. Higher returns from the company are thus expected overall. It is suggested from these results that it would not be a good decision to invest on the project at hand. The company could earn better revenues by investment on some other opportunities, which it might get anytime in the future, which is not related to real estate.
Date
Returns (FTSE-All Share)
Returns (FTSE-Real Estate Off.)
Returns (Helical Bar)
Monthly Return
0.3137%
0.1153%
0.8875%
Annual Return
3.8306%
1.3927%
11.1853%
Table 1: Monthly and annual return of the Helical Bar
Below table 2 describes the return on equity for all FTSE shares and for Real Estate Official FTSE shares
Return on equity (FTSE-AS)
4.09%
Return on equity (FTSE-RE)
3.70%
Table 2: Return on equity for all FTSE shares and for Real Estate Official FTSE shares
Return on equity, an important financial parameter, is of concern while making calculations (1999). Thus, hereon we calculated the value to get results. From the above table, we can see that the returns on equity for the real estate official are 3.70%; while for the company as a whole, the returns are 4.09%. Thus, again we get the results, which show that it is not a good idea to invest on the project offer at hand. The returns can even be higher from investment in other business opportunities of the organization, as compared to the investments made in this project for the office block.
Cov(H;FTSE-AS)
0.001187
Cov(H;FTSE-RE)
0.001083
Table 3: Covariance
Looking at the covariance of the two options available at hand, we can see that its value is 0.001187 for the returns that the company gets from it is all the shares, whereas, for the real estate official investments, the company's covariance is 0.001083. Thus, there is not much difference in the covariance of the return of the prices of both the share types.
Var(FTSE-AS)
0.00192
Var((FTSE-RE)
0.005206
Table 4: Variance
From the calculations, we found that the variances of the two options available at hand are quite dissimilar. We can see that its value is 0.00192 for the returns that the company gets from all of its shares, whereas, for the real estate official investments, the company's variance is 0.005206. Thus, there is not much difference in the variation of the return of the prices of both the share types.
Beta (FTSE-AS)
0.618047
Beta (FTSE-RE)
0.208049
Table 5: Beta
Beta value for FTSE all shares is found to be three times to that of the real estate official investments. Thus, the point stands against the idea of company investing in the project.
Mkt return (FTSE-AS)
4.1510%
Mkt return(FTSE-RE)
2.5772%
Table 6: Market Return
The market returns from all the investments of Helical Bar, an important tool of financial analysis (Bhandar, 2003) are found to be double to the market return from official investments of them. Thus, again here it concludes that the company shall not invest in this official project of building.
Risk-free interest rate
4.00%
Table 7: Risk free interest rate
The value of risk free interest rate is noted as 4%. Thus, on comparing this figure with the values of table 6, we can see that the returns from investments of the company are higher then the risk free interest rate. However, the returns from official real estate projects are even less then the returns from risk free interest rate. Thus, it is better for the organization to invest in projects other then the investments on official real estate projects.
Cov
0.054961623
Var
0.077217404
Beta (levered)
0.711777662
Market return
0.031665645
Table 8: Calculations based on the past records of Helical Bar
The past performance of the organization shows that, Helical Bar had done quite well in operations. The return from market is also 3.1%, which is quite notable. The organization shall thus make use of its right set of skills and grow further with time. They should also focus on their strength areas in a focused manner to ensure that they are growing with the passage of time.
Beta (unlevered)
0.399662835
Beta(levered)
1.096545831
Cost of Equity (CAPM)
0.0309
Table 9: Calculations based on the old records of Helical Bar
If an organization has the value of its CAPM (Capital Asset Pricing Model) greater then zero, it has higher rate of return along with higher risks, and in case it is lower then 1, then it has lower rate of return and lower risks; as compared to the total market (Fabozzi et al., 2006). Hereon, the performance of the organization as per the old records shows that, Helical Bar had done quite well in operations. The beta leveraged is 1.1, which is quite notable. The value of CAPM was noted as 0.03. Thus, the expected rate of return is 3.09% for the company. The company would thus give return of 3.09% for the investments made in it. The beta value obtained is 1.1 (leveraged) which shows that the company's shares have higher returns from the higher risks involved. Thus, the investors can earn higher returns by investing in the company, and at the same time, they are at higher risk. Whereas, on considering the results of beta (unleveraged) the outcomes are opposite. Here the returns are lesser from lesser risks by investing in the company.
Beta (unlevered)
0.646211809
Beta (levered)
1.187109147
Cost of Equity (CAPM)
0.0301
Table 10: Calculations based on the new records of Helical bar
The value of CAPM was noted as 0.03, based on new records of the company. Thus, the expected rate of return is 3.01% for the company. The company would thus give return of 3.01% for the investments made in it. The beta value obtained is 1.18 (leveraged) which shows that the company's shares have higher returns from the higher risks involved. Thus, the investors can earn higher returns by investing in the company, and at the same time, they are at higher risk. Whereas, on considering the results of beta (unleveraged) the outcomes are opposite. Here the returns are lesser from lesser risks by investing in the company.
Overall, the returns expected from the company are expected to be high with somewhat higher risks involved by investment in the company, as compared to that of the share market. Average debt from year 1999 to the year 2010 was calculated as 42.98%.
Fixed rate borrowings:
Rate (in %)
Amount
Weighted rate (in %)
Cost of debt (in %)
- fixed
- swap rate plus bank margin Jun 2011
5.33%
4,316.00
0.0025
- swap rate plus bank margin Nov 2010
5.65%
5,200.00
0.0032
- swap rate plus bank margin Oct 2012
7.15%
28,500.00
0.0220
- swap rate plus bank margin Oct 2014
8.29%
6,690.00
0.0060
- swap rate plus bank Dec 2013
6.24%
10,120.00
0.0068
- swap rate plus bank margin Jan 2011
6.04%
4,200.00
0.0027
- swap rate plus bank margin Mar 2012
5.29%
3,570.00
0.0020
- swap rate plus bank margin Aug 2013
6.55%
9,912.00
0.0070
- swap rate plus bank margin Oct 2010
6.27%
14,652.00
0.0099
- swap rate plus bank margin June 2011
3.55%
5,400.00
0.0021
Weighted fixed borrowings
6.036%
92,560.00
6.428%
2.441%
floating borrowings
2.321%
151,146.00
2.321%
1.439%
total borrowing
243,706.00
3.881%
Table 11: Cost of Debt calculations
It is true that finding out exact cost of debt is near to impossible initially, but we can find the estimated value of it (Brigham et al., 2008). On looking at the figures of cost of debt, we can see that weighted fixed borrowings' cost of debt is 2.44%. The figures are 1.44% for the floating borrowings of the company. On having an eye on the total borrowings, the cost of debt stands to 3.88%. Thus, the company pays the returns on debt at 3.88%. The borrowers are thus able to get lesser returns from the company for the borrowings made to the company, as compared to the market rate of return for the company (as we can see from table 6).
Year
Total liabilities
Net assets
Year 2010
203000000
242607000
Year 2009
224700000
237066000
Year 2008
205500000
268650000
Year 2007
134000000
282186000
Year 2006
112700000
230097000
Table 12: Liabilities and Assets
The assets and liabilities are displayed in the above table. We can see that both its assets and liabilities are increasing with the passage of time. The company is thus into the expansion phase in this competitive market.
The debt of x percent means that the x% of the total amount is considered as long term investment from the investment made by any investor (Rachlin & Sweeny, 1996; Gibson, 2008).
Chart 1: Debt vs/ Equity
The above chart demonstrates the debt and equity of Helical Bar from the year 2006 to the year 2010. The value of their net assets was noted to increase in the year 2007. Then, it fell for the next two years followed by a slight increase in the year 2010. However, the total liabilities of the company regularly increased from the year 2006 to the year 2009. This value was found to fall to a considerable amount for the next year.
Item (2010)
Amount
Perecentage
Debt amount
203,000,000.00
46%
Equity amount
242,607,000.00
54%
Total value
445,607,000.00
100%
Table 13: Debt Equity
The table above clearly describes the debt equity position of the company for the year 2010. The ratio of debt to equity was noted as 0.425. This shows that the ratio is quite good for the company as per the financial norms. The company shall however try to increase its debt a bit more, or decrease a bit more of its liabilities. This way, the debt equity ratio would be able to reach to the standard value of .5. The company is however operating well at present.
R(e-as)
4.09%
R(d)
4.75%
R(e-re)
5.06%
T ©
53%
R(d) (new)
6.67%
Table 14: Weighted average cost of capital
The weighted average cost of capital for the company are found to be appropriate with the market standards.
WACC (Target)
WACC (Net)
FTSE-RE
0.037719087
0.035225215
FTSE-AS
0.033119761
D/E (old)
0.836744199
D/E (target)
0.753842519
Debt (target)
0.42982338
Equity (target)
0.57017662
Tax shield
0.933314311
Debt(new)
0.472805718
Equity (new)
0.527194282
D/E (new)
0.896833925
Table 15: WACC Target/ Net
The WACC (Weighted average cost of Capital) consists of the average cost that an organization bears for each dollar of finance it takes to purchase its assets (Besley & Brigham, 2008; Ross et al., 2008).
The net WACC was found to be 0.035 for the company. Thus, the company shall have a return of 0.035 on its investments. This ratio is of quite help for the organization to understand its returns. The company is however, seem to be doing well and shall explore further. There are though risks associated with investment made. The debt equity ratio for the company was found to be .84, which is quite high. It is recommended that they should expand further in their operations to handle the business. They should make investment in more and more projects, and raise funds from financial sources. The higher debt equity ratio would further help the organization to receive funds from various sources. The new debt equity ratio on the other hand was found to be .90. This is quite high value. The organization should thus get involved in making more and more investments in various projects (such as that offered at hand at present). This way, they would be able to have a balanced ratio, which would be of help for them to grow further. Cost of equity was calculated as 0.0301 for them.
Sensitivity analysis
Sensitivity analysis demands that the output of certain decision is found (Saltelli, 2004). This tool can help in finding risk associated with the project (Besley & Brigham, 2007).
Variables
Value
Controllable input
Unit Price
7500000
Uncontrollable input
units
1
Variable cost
750000
Fixed cost
7500000
Performance measure
Net Cash Flow
7500000
expected value
8,250,000.00
Table 16: Sensitivity Analysis
Target value
8,250,000.00
Current value
7500000
Table 16: Sensitivity Analysis results
Conclusion
For the provided situation, after thorough analysis we have found that Helical Bar is doing well in its operations at present. The organization is growing with the passage of time. However, there are some business opportunities left for the organization. At present, the organization has to choose whether it has to invest, for developing a scheme to build an Office Block of 15,000 square metres usable space at the University of Reading. After the completion of the project, the remaining staff of Henley Management College would move from their current site in Henley on Thames to this building.
After making use of various financial techniques, we have found that returns for the organization suggest that the organization should not invest in the project at hand. After the calculations, we have found that the organization is doing well since last few decades. There is no need for the organization to migrate towards the riskier investment. The organization is not gaining well from these sort of investments. It would just reduce the liquidity of the organization, and the present liquidity of the organization would go into long- term investment. This investment is expected not to give any return for the organization. The results from the market return too give us the same conclusion that the organization shall drop the plan of investing in this project. The suit is further followed by the calculations obtained for CAPM.
However, the debt to equity ratio for the organization is quite high. Thus, it is recommended that the organization shall make more investments in the market, to reduce its debt. The liabilities on the other hand are the legal obligations that the organization has to get rid of. These are quite less at present. The organization shall take investment decisions by borrowing from the financial institutions and making use of the liquidity to make right investment decisions for growth. Thus, the organization shall make investment in good projects.
Overall, it is recommended that the organization shall drop the idea of investing in the project at hand, and shall prefer investing in the projects, which offer good rate of return. This way, the organization would be able to stand well for the longer period, and grow with the passage of time.
References
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