Apex Tannery Limited

Equity Valuation Project

Financial Analysis & Control

FIN-4207

Submitted To:
Md. Hashibul Hassan
Assistant Professor
Department of Finance
Jagannath University

Submitted By:

GROUP-12

Serial No. Name ID No.

1 Lamia Akter B-120203036
2 Md. Tarek Mia B-120203038
3 RomanaAkterPria B-120203059
4 Asif Al Saif B-120203139

Date of Submission: 29th January, 2017

Table of Contents
I. Executive Summary ............................................................................................................................... 1
II. Business and Industry Overview ........................................................................................................... 2
a) Business Overview ............................................................................................................................ 2
b) PEST Analysis ..................................................................................................................................... 3
c) SWOT Analysis................................................................................................................................... 4
d) Industry Overview ............................................................................................................................. 5
e) Five Forces Model ............................................................................................................................. 6
III. Accounting Policies ........................................................................................................................... 8
a) Potential Red Flags ............................................................................................................................ 8
IV. Financial Analysis .............................................................................................................................. 8
a) Ratio Analysis .................................................................................................................................... 8
b) Horizontal Analysis .......................................................................................................................... 10
c) Vertical Analysis .............................................................................................................................. 10
d) Z- Score ........................................................................................................................................... 11
V. Valuation Analysis ............................................................................................................................... 13
a) Assumptions .................................................................................................................................... 13
b) Cost of Equity .................................................................................................................................. 14
c) Cost of Debt .................................................................................................................................... 14
d) Weighted Average Cost of Capital .................................................................................................. 14
e) Unlevered Free Cash Flow .............................................................................................................. 14
f) Present value of free cash flow ....................................................................................................... 15
g) Terminal Value ................................................................................................................................ 15
h) Enterprise value and Implied Share Price ....................................................................................... 15
i) Sensitivity Analysis .......................................................................................................................... 15
j) Monte Carlo Simulation .................................................................................................................. 16
k) Valuation Findings ........................................................................................................................... 16
VI. Appendices
VII. References

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 I. Executive Summary

Analysis of Apex Tannery Limited

Investment Recommendation – Over-Valued (Sell) January 1, 2017

Valuation Predictions
MV Per Share at DSE (29/12/2016) Tk. 135.60
Actual Current Price Tk. 135.60 (December
Revenue (FY 2015-16) Tk. 2,158.363.000 29, 2016)

Market Capitalization Tk. 152,400,000 DCF Valuation Tk. 24.40

Shares Outstanding 15,240,000 Unlevered Beta 1.13

Dividend Yield 2.88% Cost of Debt (Kd) 8.1%

Net Asset Value per Share Tk. 74.72 Cost of Equity (Ke) 14.5%

Return on Equity 8.30% WACC 14.43%

Return on Assets 4.81%

Apex Tannery Limited is Bangladesh’s leading manufacturer and exporter of finished and crust
leather to major leather product manufacturers in China, Japan and Italy. ATL pioneered the
export of value-added crust and finished leather from Bangladesh and now comprises almost
19% of Bangladesh’s total leather export earnings at USD 110 million in 2014-15. They are
currently a nationally recognized brandname. Over the years, the company tries to add value,
reduce costs, and provide innovative thinking for improvement of their product quality, with
world class compliance and working standards. ATL’s competition includes some national
companies like Samata Tannery, Karim Leather etc. as well as the foreign companies of India;
Myanmar etc as it is an export based company.

ATL normally purchase huge quantities of raw hides and skins during the Eid-Ul-Azha festival, so
that their production is not adversely affected due to low supply during the rest of the year. ATL
performed business activities in very challenging circumstances like negative impact of
continuing recession in Europe. Despite the unfavorable environments, the management took
measures to control costs, explored China to improve export. The main contributing factor of
cost reduction was low cost of raw hides and skins.

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Once the past reports were analyzed we were able to forecast the financial statements for the
next five years. We were able to make assumptions andderive the balance sheet from the
forecasted income statement and the cash flows fromeach of the aforementioned statements.

With the forecasted information, we were able to calculate a value for the firmusing the
discounted free cash flow method. This wasdone using the CAPM and the weighted average
cost of capital each of which werefigured using a calculated beta. After valuing the company
using this method and comparing it to the price per share that Apex Tannery Ltd
currentlytrades for on the stock market, we felt that the price per share is currently highly
overstated. Assuming that no more than 4% growth was attainable which we felt was fairly low
compared to past and potential growth. ATL’s stocks should be sold at this time.

II. Business and Industry Overview

a) Business Overview

Apex Tannery Limited produces and sells leather primarily in Bangladesh. It offers goat and cow
crust and finished leathers for shoes and leather goods. The company also exports its products
to Europe, China, South America, and internationally. Apex Tannery Ltd. was incorporated in
1976 and is headquartered in Dhaka, Bangladesh .The leading manufacturer and exporter of
finished and crust leather from Bangladesh to major leather product exports in China, Japan
and Italy with annual export revenues of USD 110 million in 2014-2015, comprising almost 19%
of the total export earnings from leather of Bangladesh. ATL pioneered the export of value
added crust and finished leather from Bangladesh as well as accessing capital markets for
growth. ATL introduced the first convertible debenture in Bangladesh and has been publicly
traded since 1986. ATL currently employs 955 persons, is professionally managed and is fully
compliant with Corporate Governance Compliance Report under Section 2CC of the Securities &
Exchange Commission Notification Order. ATL is also the first tannery in Bangladesh to be ISO
9001-2000 certified.

ATL’s vision is to attain 100% customer satisfaction worldwide through continual quality
improvement of their products. They always try to understand and satisfy customer’s wants
and needs. They are committed to provide best quality product and timely delivery, meet the
requirements of customers with competitive price and up to date fashion trends. ATL normally
purchase huge quantities of raw hides and skins during the Eid-Ul-Azha festival, so that their
production is not adversely affected due to low supply during the rest of the year. ATL
performed business activities in very challenging circumstances like negative impact of
continuing recession in Europe. Despite the unfavorable environments, the management took
measures to control costs, explored China to improve export. The main contributing factor of
cost reduction was low cost of raw hides and skins.

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 b) PEST Analysis

Political – this refers to the ways in which the government can intervene in an economy in
terms of environmental and labor laws, tariffs, trade restrictions and tax policies. It also shows
how a government can influence education and health and how it will affect the infrastructure
of a country. The political factors for the tanning industry are given below:

 The political environment is highly volatile with frequent strikes and clashes
between the major political crises.
 The government policies are highly favorable with the sector being declared a
“Thrust sector”, whereby enjoying 7% interest loan for loans, bonded warehouse
facility, cash incentives etc.
 Trade policies fixed by the government have always been favorable to businesses
though bureaucratic red tape has always hindered the smooth operation of
business.
 The government has set highly attractive incentives for the foreign investors to lure
in FDI, including 100% foreign ownership, 100% profit transfer to country of origin
and that too without prior permission from the central bank.

Economic – this refers to how exchange rates, inflation rates, interest rates and economic
growth will impact on a business and how it can grow, develop and make various decisions. For
example if a business exports goods these operations can be greatly affected by exchange rates
and these are factors that need to be included in a business’s strategic management plan if they
are to succeed. The effects of economic forces for tanning industry are given below:

 The economy has been growing at over 5% over the last decade and is set to
continue this trend for years. This has increased the number of middle to high
income group in the economy who can afford leather goods with higher than
average disposable.
 Interest rates have been set at minimum possible level by the government whereby
ensuring cheap source of capital for the business.
 Exchange rates are heavily monitored by the central bank, and are always favorable
to the exporters. However, the relatively devalued local currency makes imports of
chemicals used in the processing of raw hides and machineries used in the
production process expensive.
 While the economy sees high level of food inflation level has been quite consistent
over the last few years at less than 8 percent showing a downward trend

Social – these factors refer to how a society behaviors culturally, how the population rate will
grow, how health-conscious people in a country are, how its range is distributed in a country
and the various attitudes that people have towards their careers. When social trends change it
can greatly affect the need for a business’s products or services. Similarly if a society has an
older population the cost of labor will increase and a business will need to change their
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management strategies in order to cope with these changes. The effects of social factors for
tanning industry are in the following:

 Social factors like the acceptability of leather goods by the vast majority of the
population help the sector gain popularity.
 The trend of the present generation to lean towards fashionable and expensive
products like leather belts, side bags, jackets etc., increased the prospect of the
sector.

Technological – this refers to how technology can change and looks at automation, R&D activity
and technological incentives that are available. Technology can also have a great impact on
efficient production levels and influence decisions on outsourcing. In addition to this there are
some changes in technology that can affect the costs that a business needs to meet and can
improve the quality of a product or service that a business offers. The effects of technological
factors for tanning industry are in the following:

 The local companies are lacking behind major international brands in terms of
innovation and quality.
 The small firms in the local market are overshadowed by the bigwigs producing in large
scale allowing for them to be able to afford expensive technologies.

c) SWOT Analysis

 Strengths

Apex Tannery Ltd provides best quality product and timely delivery. They always try to add
value, reduces cost and provide innovative thinking for improvement of their product quality,
with world class compliance working standards. With these strengths, ATLholds a leading edge
in the existing market and can maintain a wide demographic spread within the market. ATL has
good brand image as it’s the only ISO 9001-2000 Certified Company and the continuously last
five times National Export Trophy winner of Bangladesh. It has strong linkage and coordination
among its suppliers and buyers. ATL has the strong access of getting all available market
information. It has also strong laboratory facilities to modify the raw hides and also to preserve
the modified hides.

 Weakness

ATL has some weaknesses in the systems of collecting the raw hides. Sometimes they collect
hides from the inefficient suppliers which reduce the quality of those hides.

 Opportunities

ATL has huge opportunities to expand their export business in the international market because
for tannery industry there is a huge untapped international market. The skins of cows and goats
of Bangladesh has fine grain structure and tensile strength, as they are grown up naturally, so in
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the world market their demand is too high. ATL has the scope of expanding forward linkage
business. It can also grab the opportunity of product differentiation.

 Threats

ATL’s Threats include emergence of alternative sources both in national and international
market. In national market the other tannery companies like Samata Leather, Karim Leather
are doing well and in international market India’s companies was our main competitor but
nowadays Myanmar is raising the livestock’s commercially and they try to grab the
international leather market.

There are some social threats are also rising for tannery as some people are now becoming
against the use of animal skin to make any kinds of product as they think that it is a very
inhuman work. The raw hides/skins are exported illegally which is a barrier for this industry.
The continuous recession in European market is now the main threat because of that many
companies have to face the difficult situation like continuously facing the loss, reduces the
selling amount drastically.

d) Industry Overview

At present, there are about 220 tannery units in Bangladesh and they use locally available raw
hides and skins. Of them 114 are large and medium units (by local standards) and are registered
with the Directorate of Industries. Others are mostly of small and cottage type and are not on
the register of the government. About 150 tannery units are located at Hazaribagh of Dhaka in
only 50 acres of land popularly known as tannery estate. According to the records of the
Bangladesh Tanners Association, about 3,000 workers are employed in the tanning industry.
Besides, there are about 100 qualified technologists including foreign nationals who are
working in different tanneries. Total capital invested in the tannery industry is estimated at Tk
2.5 billion, of which government/bank finance is about Tk. 1.2 billion. About 1,500 persons are
involved in the process of collecting raw hides and skins and making them available at tannery
units. About 100 organizations import chemicals for use in tannery industry. Bangladesh
produces approximately 100-150 million sq feet of raw hides and skins, about 85% of which is
exported in crust and finished form. Exports of leather and leather goods crossed $1 billion for
the second year in fiscal 2014-15, according to data from the Export Promotion Bureau. In
2014-15, Bangladesh exported leather and leather goods worth $1.13 billion, compared with
$1.12 billion in the previous fiscal year, making it the second highest contributor to national
exports after garment.

Traditionally, the market for leather has always been in Europe, mainly Italy. The recession in
Europe is still continuing but it is hoped for improvement in the near future. Accordingly, the
leather industry in Bangladesh diverted most of their exports from Europe to China. The
economy of China continues to be strong and the local demand for goods and services shows
an upward trend due to the rise of the middle class. Purchasing power has increased, resulting

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in increased domestic consumption of all kinds of goods, shoes being one of them.
Consequently, the demand for leather has increased amongst the local shoe industry.
Bangladesh leather industry has taken advantage of this favorable situation in China, which
resulted in higher exports. Current demand of leather, leather product and footwear in the
world are nearly $21500 core. Bangladesh exports roughly $50 Core. About $1.50 Core square
foot leather is produced in Bangladesh. So, contribution of leather in world market is bellow
one percent. As a result we have a huge possibility to grab the market with our highest level of
efficiency and proper strategic planning. For this it has been a crying need to shift the tanneries
to Savar Tannery Estate. According to the related professionals more profit can be gained by
proper strategic planning, market monitoring, and quick preservation of raw leather,
transportation and proper processing of leather. The largest market for leather is China where
labor wage has been increased. Recently Bangladeshi manufacturers are seeing bright
prospects for the leather sector after the readymade garment industry because of a policy
change in China, the world’s largest economy. Moreover anti damping tax has been introduced
for leather and leather product of China. .They expect Bangladesh to be an attractive
destination for leather sector entrepreneurs as China, the world’s largest footwear
manufacturer, is shifting focus away from this sector. The manufacturers believe Bangladesh’s
annual $550-million footwear industry may grow to a $15-billion sector within a few years, if
the opportunity is seized.

e) Five Forces Model

 Bargaining power of buyers

Bargaining power of the customer is moderately high in tanning industry. The local handicraft
dealers, the exporters have high bargaining power.In the tanning industry buyers are
concentrated and buy in high volume. On the other hand the leather products are
undifferentiated so that the buyers have access to buy products from anyone. In this industry
buyers can easily switch from one to other because here switching costs are low. As the Buyers
have the knowledge about the production cost they can easily bargain with the sellers while
they buy the products.

 Bargaining power of suppliers

In tanning industry suppliers have moderately low bargaining power. In the tannery industry
there are many suppliers and few dominant buyers. Most of the buyers are price sensitive and
they purchase large volumes of standardized products, so the suppliers have little bargaining
power. In the tannery industry there is a little threat that the suppliers can integrate forward in
to the industry.

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  Threat of substitute products

The threat of substitute products is moderately high in this industry.Buyer’s willingness to

substitute products is increasing .For example: we can see the shoes and other footwear’s are
made of rubber, cloth, plastic. In manufacturing Wallet, ladies bag, belt etc. use of plastic and
rubber are increasing day by day. Increasing use of synthetic, rubber and plastic products is a
problem for leather products and tanning industry. The synthetic products can also satisfy the
same set of customer needs.
The relative price and performance of substitute products are also good. For example: The Price
of substitutes like rubber and plastic is very low-compared to leather. These products are also
very long lasting, convenient and safe from effect of water.
Although the above threats exist in this industry, we think these are moderately high threats
because all the customers are not willing to use plastic, rubber or synthetic products over
leather products

 Threat of New Entrants

The threat of new entrants largely depends on the barriers to entry. In tanning industry it is
easy to enter, so the threat of new entrants is quite high. The threat of new entrants in tanning
industry is high because economies of scale are low.The capital requirement required to enter
in tanning industry is very low. Proprietary technology is not an issue for this industry. In
tanning industry the customer switching costs are low. The industry’s distribution channel is
easily accessible so it is very much easy for any new companies to start this business.

 Rivalry among existing companies

The rivalry among the firms is moderately low in tanning industry. The structure of competition
- for example, rivalry is more intense where there are many small or equally sized competitors;
rivalry is less when an industry has a clear market leader. In tanning industry there are few large
firms are controlling the whole market, so there is low level of competition in the industry.
This is a fast growing industry so the existing firms are not concerned with the strong rivalry
among them. According to the Export Promotion Bureau export earnings from this sector
increased by 11.21% from July-Sep 2015 to July-Sep 2016. And according to Bangladesh Bank’s
Statistics Division Leather products and Footwear’s export amount also increased by 8.16%
during this period.

Exit barriers - when barriers to leave an industry are high (e.g. the cost of closing down
factories) - then competitors tend to exhibit greater rivalry. But the exit barrier’s conditions are
very low for tanning industry, so the rivalry among existing companies of tanning industry is
also low.

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 III. Accounting Policies

a) Potential Red Flags

After reviewing ATL’s financial Statements we have identified the following red flags

In 2014, the company’s other comprehensive income increased abnormally rather than the
previous and the subsequent years. It was incurred from the fair valuation of Investment of
Apex Footwear Limited. The share price of this company was suddenly increased at a very
higher rate in 2014. The share price was volatile through 2012 to 2016 but the rate was too
high in 2014. In 2012 the price was Tk266.60 , in 2013 it was Tk 251.40, in 2014 it was Tk
338.30, in 2015 it was 334.20 and in 2016 it was Tk 319.40.We can see that after and before the
increased the price was less volatile, but what was the reason of this abnormal increase of
share price in 2014 the company did not give any explanation in their financial statements
especially in their notes segment. We think that company has done it by realizing income from
invested share, but they are not actually selling their share. So, showing realizing income
without selling share, may indicate that the company has tried to manipulate their net income.

IV. Financial Analysis

a) Ratio Analysis

In analyzing ATL’s financial reports it is important to gather past

information in order to predict what the future of the firm may be. First, we assessed the
firm by using financial ratio analysis. We used ratios to perform a liquidity analysis, a
profitability analysis, and a capital structure analysis. The liquidity ratios are used in
order to determine how liquid a company’s assets are. Liquidity is important in
“evaluating the risk related to a firm’s current liabilities”. If a firm does not possess the assets
required to repaytheir liabilities, they may be considered an investment risk but, on the other
hand if theratios are too high, then the company may not be imploring enough debt to reach its
fullgrowth potential. The profitability ratios indicate how profitable a company is using its
current business methods. The ROE measures Net Income to Shareholders equity which
is very important to let a shareholder know how efficiently their investment is being
utilized. The ROA can tell “how much profit a company is able to generate for each
dollar of assets invested”. The capital structure ratios are useful in analyzing
investment strategy because it employs the use of debt and interest in computing the
ratios.

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Profitability

In the profitability aspect of Apex Tannery Ltd, they remain volatile with the industry average
on Return on Assets, Return on Equity, and Asset Turnover. The decreasing rate of ROE and
ROA are indicating that managers are slightly less efficient to invest the shareholders’ fund and
to use the company’s assets for generating profit. But the fluctuating rate of Gross profit
margin , NOPAT margin, Net income margin indicate that the overall operating performance or
profit generating power is not consistent; sometimes it is satisfactory and sometimes it is
below average.

Asset Management

Apex Tannery Ltd has better asset utilization ratios throughout this periods except 2015-16.
The company was able to invest effectively in its operating working capital by taking full
advantage of trade credit from its vendor and by delaying payment of some of its operating
expenses. It is also managing its inventory more efficiently. So that the company has
significantly lower capital tied up in its stores. The company’s long term assets has good sales
generating power what we can observe by the good turnover rate of long term and fixed
assets. In 2016-16 because of the recession in European market and the declining demand of
leather in China’s market company’s performance was not satisfactory.

Liquidity

In the liquidity phase of ATL’s financials we see the current and quick ratiotend to remain
around the industry average for the respective years.The company has good current, quick and
cash ratios which indicates that the company’s ability to repay its current liabilities is very high.
The company has enough power to repay its current liabilities. But the ability of the firm’s
operations to generate the resources needed to repay its current liabilities is not satisfactory
which we can see from the poor Operating cash flow ratio of Apex Tannery Ltd.

Debt & Coverage

Apex Tannery has very low liabilities-to-equity , debt-to-equity, net-debt-to-equity, debt-to-

capital ratios which implies that the company has lower dependency on the debt to collect their
total fund in comparison to shareholders’ fund specially long-term debt . We can say the
company is primarily relying non-interest-bearing liabilities such as accounts payable and
accrued expenses to finance its operations. Its interest coverage ratios are comfortable which
implies that the company has enough power to cover its interest expense through its operating
activities. This insures they are managing their credit wisely and can cover their debt.

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Sustainable Growth Rate

Sustainable growth rate is the rate at which a firm can grow while keeping its profitability and
financial policies are unchanged. From the above we can see that the company has a lower ROE
and a higher dividend payout ratio which leads to a significantlylower sustainable growth rate.
So the company should change their several policies like payout policies, financial leverages
policies etc.We feel ATL needs to sustain a higher growth rate than its current SGR in order to
compete in the highly competitive markets of the industry

b) Horizontal Analysis

For Horizontal Analysis we have taken Year 2011-12 as base year for. First we common size all
year data using 2011-12 data as base year. For this we use this formula:
Year 2012−13 (Actual Year)
For year 2012-13 = year 2011−12(Base Year)

For common sizing every year data, we divided individual year’s data by the base year data.

After common sizing 2011-12 to 2015-16 income statement and balance sheet, we calculated
the increase/ decrease from year to year. For this we use this formula:
This year data
For calculating difference = Previous year data – 1

From horizontal analysis in income statement, we can see sales from 2011-12 to 2015-16
decreasing significantly. Other accounts like cost of goods sold and operating expenses
decreasing as same percentage like sales. It indicates our efficiency in collecting raw materials
and managing operating expenses same as before. For this reason in 2015-16, profit from
operation became 78.57% than 100% in 2011-12. When market will start to boom again, ATL
will get more profit as before.

From horizontal analysis in balance sheet, we can see ATL had made significant amount of
investment in its fixed assets throughout these five years. It also reflects that with investing in
new technology, they can reduce their production cost and get efficiency in production. Trade
& others payable were increased drastically in 2014-15 but again got into the reasonable level
in 2015-16. The increasing rate indicates us the inability of paying the receivables payment of
this company.

c) Vertical Analysis

Vertical analysis is known as common size analysis. Vertical analysis is the proportional analysis
of a financial statement, where each line item on a financial statement is listed as a percentage
of a base item.

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To conduct a vertical analysis of balance sheet, the total of assets and the total of liabilities and
stockholders’ equity are generally used as base figures. All individual assets are shown as a
percentage of total assets. The current liabilities, long term debts and equities are shown as a
percentage of the total liabilities and stockholders’ equity.

To conduct a vertical analysis of income statement, sales figure is generally used as the base
and all other components of income statement like cost of sales, gross profit, operating
expenses, income tax, and net income etc. are shown as a percentage of sales.

In a vertical analysis the percentage is computed by using the following formula:

Amount of individual item
Percentage of base = ∗ 100
Amount of base

From vertical analysis of income statement, we see there are no significant variances from the
base item (sales) in year 2011-12 to 2015-16. Which indicate if we increase the sales, the profit
will also increase at same percentage.

From vertical analysis of balance sheet, we see ATL is investing more in fixed assets than
current assets. There are also significant decreases in inventories, which reflect the company is
gaining efficiency in inventory management from year to year.

d) Z- Score

The Altman Z- Score model, weights five variables to compute a bankruptcy score. The formula
can be used to predict the probability that a firm will go into bankruptcy within two years. Z-
scores are used to predict corporate defaults and an easy-to-calculate control measure for the
financial distress status of companies. The Z-score uses multiple corporate income and balance
sheet values to measure the financial health of a company.

The model is as follows: Z= 1.2 (X1 ) + 1.4 (X2 ) +3.3(X 3 ) + 0.6 (X4 ) + 1.0 (X5 )

Where,

X1 = Net working capital/ Total assets

X2 = Retained earnings/ Total assets

X3 = EBIT/ Total assets

X4 = Market value of equity/ Book value of total liabilities

X5 = Sales/ Total sales

The model predicts bankruptcy when Z<1.81. The range between 1.81 and 2.67 is labeled the
“gray area”. The model predicts safe zone when Z > 2.99.

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For Apex Tannery Ltd:

X1 = Net working capital/ Total assets

= 341.00/1879.00

= 0.1815

X2 = Retained earnings/ Total assets

=474.00/1879.00

=0.2523

X3 = EBIT/ Total assets

=143.65/1879.00

=0.0765

X4 = Market value of equity/ Book value of total liabilities

=1571.244/774.831

=2.028

X5 = Sales/ Total assets

=2158.00/1879.00

=1.148

So, Z-Score for Monno ceramic: Z= 1.2 (X1 ) + 1.4 (X 2 ) +3.3(X3 ) + 0.6 (X4 ) + 1.0 (X5 )

=1.2*0.1815+1.4*0.2523+3.3*0.0765+0.6*2.028+1.0*1.148

=3.188

This observation of Apex Tannery Limited’s Z-score predicts that it is in the safe area. The
reason for ATL’s apparent strong financial performance and high market valuation is due to the
positive numbers in all variables of the equation. In the first component, one can see that there
is no deepening trouble with regard to repeated operating losses which would show a
reduction in working capital relative to total assets. The second component shows the
company’s history in its ability to reinvest earnings in itself. This is most likely due to the fact
that ATL is doing business in many years and has created an advantage to younger companies.
The third component, which makes adjustments for variable tax rates and leverage due to
borrowings, gives a plus to ATL in its utilization of assets. The fourth component is a good
indicator of the extent to which the company’s assets can decline before debts may exceed
assets. The final component points out the profitability of ATL’s assets relative to the amount of
sales generated per asset. ATL’s cost of debt is estimated to be 8.1% which is a fairly low rate.

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Comparatively, the z-score matches up with the low cost of debt. Because ATL has
such a safe z-score, they should have the ability to borrow money at low cost.

V. Valuation Analysis

In valuing Apex Tannery Limited a combination of historical and forecasted data are used to
predict the firm’s overall value. We used DCF (Discounted Cash Flow) method to valuing the
company. Discounted cash flow (DCF) is a valuation method used to estimate the
attractiveness of an investment opportunity. DCF analysis uses future free cash flow projections
and discounts them to arrive at a present value, which is then used to evaluate the potential for
investment. Valuing the price of the firm is important to shareholders as well as potential
shareholder so they are able to determine if the company is worth what they are paying for it. If
a company is overvalued then it is a good time to sell shares as well as vice versa, when it is
undervalued it is a good time to buy shares. This is important to the company as well because
they may be willing to buy back shares when the price is low.

a) Assumptions

For doing our valuation using the DCF model we have taken some assumptions of many items
of income statement, balance sheet like the sales growth, percentage of cost of goods sold, tax
rate, percentage of current assets, fixed assets etc. From our taken assumptions first we have
made the Pro-forma Income Statement and Balance Sheet. Then using that pro-forma
statement we have completed our DCF model’s required computation. The key assumptions
are in the following:

 In DCF Model we have taken our forecasted sales growth will be 4% for the next
five years. Though our company’s amount of sales was decreasing for the last
two years but our industry’s prospect is good and as a market leader of this
industry we are hoping that our company will attain this sales growth in the next
five years.

 We have assumed that our cost of sales will be 94% which was the average of
actual years cost of sales.

 The company’s average EBIT was 5% but we have taken 6% as the EBIT of the last
financial year was 7%. So we have taken the middle number of 5% to 7% and
hoped that the company will fulfill this target.

 We have taken Depreciation and Amortization’s percentage is 0.19%; it is our

calculated average rate.

 We have taken the perpetuity growth rate is 3.53% which was calculated by the
GDP rate which is 7.05% divided by 2.

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  We have assumed that the market size premium will be 2.00%.

 The market risk premium is 4.00% which was taken from the Bangladesh Bank
interest rate spread.

 We have taken the before tax Cost of debt is 12% from the available rate of 10-
20 years bond’s interest rate.

b) Cost of Equity

Apex Tannery Limited has an estimated cost of equity of 14.50%. This figure was generated by
using a risk free rate of 7.94%, which is the rate on the twenty year treasury bonds. There are
also a market risk premium of 4.00%, levered beta 1.13 and size premium 2%. The market risk
premium is collected from Bangladesh bank interest spread table. The beta used was calculated
using market closing price and DSEX index of July, 2015 to June, 2016. The cost of equity was
calculated as follows:

Cost of equity = Risk free rate of return + (Market risk premium * Levered beta) + Size premium

c) Cost of Debt

ATL’s cost of debt is estimated to be 8.1%; this figure was calculated using 10-20 years bond
rate of 12% and tax rate of 32.5%. The cost of debt was calculated as follows:

After tax Cost of debt= Cost of debt (1-Tax rate)

d) Weighted Average Cost of Capital

ATL’s Weighted Average Cost of Capital (WACC) is estimated to be 14.43%, in making these
calculations it was determined that ATL is comprised of 0% debt and 100 % equity. ATL has no
debt to total capitalization, which frees it from having to worry much about debt covenants and
interest payments. WACC was calculated as follows:

WACC= (Debt to total capitalization * After tax cost of debt) + (Equity to total capitalization *
Cost of equity)

e) Unlevered Free Cash Flow

ATL’s unlevered free cash flow is the gross free cash flow generated by ATL; it is the free cash
flow available to pay all stakeholders. The unlevered free cash flow computed as follows:

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Unlevered Free Cash Flow = EBITDA - CAPEX - Working Capital – Taxes

f) Present value of free cash flow

After we calculated unlevered free cash flow for forecasted years 2016-17 to 2020-21. We
discounted that future cash flow to get the present value of free cash flow. Free cash flow
computed as follows:
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Present value of free cash flow = Unlevered future free cash flow * (1+WACC) ^discount period

g) Terminal Value

ATL’s terminal value calculated applying Gordon growth model. The terminal value of ATL is the
present value of all future cash flows where we expect stable growth rate forever. Terminal
value calculated as follows:
Terminal year free cash flow∗(1+Perpetuity Growth Rate)
Terminal value = (WACC−Perpetuity Growth Rate)

Then terminal value discounted using discount factor to get the present value of terminal value.
Here terminal year free cash flow was 104.36 million, WACC was 14.43% and Perpetuity growth
3.53%.

h) Enterprise value and Implied Share Price

ATL’s enterprise value is 721.82 million, which is computed with Present value of free cash
flows from 2016-17 to 2020-21 plus Present value of terminal value.

After we calculated enterprise value, we calculated implied equity value. Implied equity value is
calculated using this formula.

Implied equity value = (Enterprise value – Total debt + Cash and cash equivalent)

ATL’s implied equity value is 371 million with outstanding shares of 15.20 million. Then we
calculated implied share price using this formula:

Implied share price = (Implied equity value / Outstanding shares)

ATL’s implied share price is 24.40 taka per share..

i) Sensitivity Analysis

From the sensitivity analysis between Perpetuity growth and WACC, we see that Perpetuity
growth is more sensitive than WACC. If WACC is 14.43% enterprise value will be 721.1255
million, a 1% increase in WACC decrease 9.72% enterprise value. WACC is used in DCF to
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discount the future values, so any increase in WACC will decrease the amount of enterprise
value. On the other hand Perpetuity growth is used to forecast future growth in terminal value,
so any increase in perpetuity growth will increase the amount of enterprise value. The
relationship between Perpetuity growth and WACC is negative.

From the sensitivity analysis between Annual sales growth and WACC, we see sales growth is
more sensitive than WACC. There are negative relationship between Annual sales growth and
WACC.

From this two analysis we can conclude that we must increase sales to increase the enterprise
value, with current financial position.

j) Monte Carlo Simulation

Monte Carlo simulation is a computerized mathematical technique that allows people to

account for risk in quantitative analysis and decision making. The technique is used by
professionals in such widely disparate fields as finance, project management, energy,
manufacturing, engineering, research and development, insurance, oil & gas, transportation,
and the environment.

By doing the Monte Carlo simulation we have found that our calculated enterprise value’s
certainty rate is 57.7% so we can say the assumption we have taken for the Monte Carlo
simulation is justified.

k) Valuation Findings

Apex Tannery Ltd.’s current share price in share market is 135.60 taka per share. According to
DCF valuation share price is 24.40 taka per share, which is far less than market value of per
share.

So, according to our valuation ATL’s share price is highly overvalued in market. For this reason if
one has ATL’s share now he should sell the share before the price fall.

Our evaluation process might have some limitation due to some key assumption. But still we
can say the share price is overvalued. We saw sales were decreased in the last two financial
years. There are also increasing competition in both local and international market. There are
also possibilities to do well because the financial condition of EU is improving and the China’s
market is flourishing. If ATL can capture those new markets, they will be in good position in
future. We make our recommendation using actual data and some assumption based on actual
data so DCF may not be predicted future exactly. But still we think the share price is overvalued
in respect to their financial position

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