FINANCIAL STRATEGY ASSIGNMENT 2

Programme Title: University of Derby Online Learning; Bachelor of Science (Honours) in

Management Accounting

Online Tutor: George Kofi Dei-Danquah

Prepared for: 6AG525

Prepared by: 100521203

Proposal#:
...the company has never attempted to determine its cost of capital, and Bob would
like you to perform the analysis. Since the company is privately owned, it is difficult
to determine the cost of equity for the company. Bob wants you to use the pure play
approach to estimating the cost of capital for Hubbard Computer LTD (HCL), and he
has chosen Harvey Norman as a representative company. The following steps will
allow you to calculate this estimate.

Due Date: 09/04/20

Word Count: 2500

TABLE OF CONTENTS

INTRODUCTION 4

BV OF DEBT AND EQUITY 5

ESTIMATION ON COST OF EQUITY 5

CALCULATION ON COST OF DEBT 6

CALCULATION ON THE WEIGHTED AVERAGE COST OF CAPITAL (WACC) 6

DISCUSSION ON THE POTENTIAL PROBLEMS OF USING HARVEY NORMAN

AS THE REPRESENTATIVE COMPANY 7

CONCLUSION 7

APPENDICES 8

Appendix 1 8

Appendix 2 9

Appendix 3 10

Appendix 4 11

Appendix 5 12

Appendix 6 13

Appendix 7 14

Appendix 8 15

Appendix 9 16

Appendix 10 16

Appendix 11 18

Appendix 12 19

REFERENCES 20
Introduction

Hubbard Computer LTD (HCL) = Main company

Harvey Norman (HVN) = similar business in the industry
Book Value (BV)

BV of Debt and Equity

The numerical values of debt and equity within HVN’s Ending 2019 Half Year Statement of
Financial Position will be employed to provide an analytical measurement for HCL. Atrill
(2017) declares that the insertion of relevant figures being long-term debts and non-current
assets, aids to present a transparent debt capacity, whereby with HVN in this context, enables
HCL to obtain a practical benchmark of industrial correlation. In this regard, HVN’s long
term debts present a total of $1,823,407,000 (See Appendix 1). However, for HCL to attain a
precise statistical representation of HVN’s debt the financial constituents of Provisions,
deferred income tax liabilities and other liabilities will be excluded, as such outflows are not
applicable in the operative spectrum of HCL (See Appendix 2). Therefore, the financial
inscriptions of Interest-bearing loans and borrowing and Lease liabilities, totalling
$1,485,029,000 will be the most valuable benchmark, which supports HCL’s comparison
purpose of debt (Atrill, 2017).
Moreover, the non-current assets displayed in HVN’s Ending 2019 Half Year Balance Sheet,
depicts a staggering result of $4,512,281,000 (See Appendix 3), indicative of a high volume
of collateral. Nonetheless, for HCL to obtain a realistic assumption of HVN’s equity, the
financial components of Trade and other receivables, Investments accounted for using equity
method, Other Financial assets and Deferred tax assets will be omitted, as these inflows can
be seen as HVN’s excess capitalisation, which have no comparison to HCL (See Appendix 4
and 5). Consequently, the necessary financial proceedings of Property, plant and equipment,
Property, plant and equipment: Right-of-use assets, Investment properties: Freehold,
Investment properties: Leasehold (Right-of-use assets) and Intangible assets, summing
$4,421,546,000, illustrates a sufficient threshold of equity, which aids HCL’s commercial
comparison (Atrill, 2014).

(284 words)
Estimation on Cost of Equity

The estimation of HVN’s cost of equity will be scrutinised through the myriad series of
financial instruments that contribute towards its capital structure. On this basis, the most
recent listed stock price of HVN depicts a value of 2.9000 in AUD (Australian Dollar) (See
Appendix 6). Furthermore, Appendix 6 exhibits HVN’s market capitalisation at 3.613
Billion, representative of the total cost to acquire HVN from the ASX market, which can be
straightforwardly measured via HVN’s per-share price alongside its total number of shares
outstanding (Little, 2019). Further to this, CFI (2020) eloquently affirm that HVN’s market
capitalisation has direct equivalence to the objective measurement of market value of equity,
as the two diverse proportions essentially present the same total of equity. In that connection,
Appendix 7 outlines the shares outstanding for HVN at an amount of 1.25 Billion,
demonstrative of the total stocks issued by HVN to its shareholders, which stems HVN’s
overall equity value at 3.613 Billion (AT, 2020).
Additionally, Appendix 8 and 9 illustrates HVN’s most recent annual dividend at a rate of
0.33, which specifies the forward stream of retained earnings per share that a shareholder of
HVN is expected to receive (Gordon, 1959). According to CFI (2020) the most predominant
mechanism that enables a shareholder to obtain an intrinsic value of payments from its share,
is the dividend discount model upon all future cash flows, which aids to reflect the PV of
shareholders’ entitlements, that suits HVN’s investors in this context. On this subject, when
determining the equity rate of return for HVN, the traditional view of dividends presents
23.3%, indicative of an optimistic growth in dividends from investments and a robust equity
value for HVN (See Appendix 10). McLaney et al (2004) postulates that the utilisation of the
traditional view on dividends aids to ascertain a meticulous estimation of HVN’s cost of
equity. But, McLaney (2017) declares that the traditional view on dividends lacks financial
logic in the estimation of retained earnings for investors, as it fails to include the potential
risk on firms’ operative activities: such as the COVID19. Likewise, Miller and Modigliani
(1961) classify the traditional view on dividends as a delusion that evaluates ‘random
variables ’to protrude a ‘probability distribution of possible returns’ for shareholders

For Harvey Norman:

beta
Yield on government debt
using historical market risk premium = Cost of Equity using CAPM

Calculation on Cost of Debt

Current business loan rates for each debt

Weighted Average cost of debt for BV and Market Value (MV)
Difference between BV and MV

Calculation on The Weighted Average Cost of Capital

(WACC)

WACC for BV
WACC for MV
Inclusion of 30% tax
Which one is more relevant?

Discussion on The Potential Problems of Using Harvey

Norman as The Representative Company

Conclusion
Appendices

Appendix 1

Source: ASX (2019, p.22)

Appendix 2

Source: ASX (2019, p.47)

Appendix 3

Source: ASX (2019, p.22)

Appendix 4

Source: ASX (2019, p.42)

Appendix 5

Source: ASX (2019, p.51)

Appendix 6

Source: Yahoo Finance (2020, Summary)

Appendix 7

Source: Yahoo Finance (2020, Statistics)

Appendix 8

Source: Yahoo Finance (2020, Statistics)

Appendix 9

Source: (SMH, 2020)

Appendix 10

Gordon’s Growth Model (The Traditional View of Dividend)

Formula:
Expected Return on share (E (Ri)) = Dividend expected in Yr1 on a share (D1) / Current
price of a share (Pi) + expected constant annual growth rate of share’s dividend (g)

Calculation:

Dividend expected in Yr1 = 0.33

Current Price of share = 2.9000
Expected annual dividend yield = 11.91%

Therefore:

E(Ri) = D1 / Pi + g

= 0.33 / 2.9000 + 11.91%

= 0.2328
= 0.2328 x 100
= 23.3%

E(Ri) = 23.3%
Appendix 11

Source: (SMH, 2020)

Appendix 12

References
AccountingTools (AT) (2020) Outstanding stock (Online) Available from:
https://www.accountingtools.com/articles/what-is-outstanding-stock.html (Accessed: 26th
March 2020)
ASX (2019) Half Yearly Report and Accounts – 28/02/2020 – 9:20 AM (Online) p.22, p.42
p.47, p.51, Available from: https://www.asx.com.au/asx/share-price-research/company/HVN
(Accessed: 17th March 2020)
Atrill, P. (2014) Financial Management for Decision Makers, 7th Edn, Pearson Education,
p.72-73
Atrill, P. (2017) Financial Management for Decision Makers, 8th Edn, Pearson Education,
p.86-89
Corporate Finance Institute (CFI) (2020) Dividend Discount Model (Online) Available from:
https://corporatefinanceinstitute.com/resources/knowledge/valuation/dividend-discount-
model/ (Accessed: 27th March 2020)
Corporate Finance Institute (CFI) (2020) Market Capitalization (Online) Available from:
https://corporatefinanceinstitute.com/resources/knowledge/finance/what-is-market-
capitalization/ (Accessed: 27th March 2020)
Gordon, M.J. (1959) Dividends, Earnings and Stock Prices, The Review of Economics and
Statistics, Vol.41 (2) p.101, Available from:
https://www-jstor-org.ezproxy.derby.ac.uk/stable/pdf/1927792.pdf?refreqid=excelsior
%3A91a0f58b4411387ac49192e1cfeeaa59 (Accessed: 26th March 2020)

Little, K. cited in the balance (2019) Why Per-Share Price Is Not as Important as Market Cap
(Online) Available from: https://www.thebalance.com/why-per-share-price-is-not-important-
3140791 (Accessed: 25th March 2020)
McLaney (2017) Business Finance: Theory and Practice, 11th Edn, Pearson Education, p.334
McLaney, E. Pointon, J. Thomas, M. Tucker, J. (2004) Practitioners’ perspectives on the UK
cost of capital, The European Journal of Finance, Vol.10 (2) p.125, Available from:
https://www-tandfonline-com.ezproxy.derby.ac.uk/doi/pdf/10.1080/1351847032000137401
(Accessed: 27th March 2020)
Miller, M. Modigliani, F. (1961) Dividend Policy, Growth, and the Valuation of Shares, The
Journal of Business, Vo.34 (4) p.426-427, Available from: https://www-jstor-
org.ezproxy.derby.ac.uk/stable/2351143?seq=1#metadata_info_tab_contents (Accessed: 28th
March 2020)
The Sunday Morning Herald (SMH) (2020) Harvey Norman Holdings Limited (Online)
Available from: https://www.smh.com.au/business/investments/harvey-norman-holdings-limited/
hvn/shares-news (Accessed: 26th March 2020)

Yahoo Finance (2020) Harvey Norman Holdings Limited (HVN.AX) (Online) Statistics,
Available from: https://au.finance.yahoo.com/quote/HVN.AX/key-statistics?p=HVN.AX
(Accessed: 26th March 2020)
Yahoo Finance (2020) Harvey Norman Holdings Limited (HVN.AX) (Online) Summary,
Available from: https://au.finance.yahoo.com/quote/HVN.AX?p=HVN.AX (Accessed: 26th
March 2020)