Financial Performance & Capital Cost Analysis (2007-2008)
Financial Performance & Capital Cost Analysis (2007-2008)
Fundamental Concepts in Capital Cost
This section clarifies common misconceptions regarding financial concepts.
The Cost of Capital
FALSE. The cost of capital is not always the same. It represents the return investors require on a company's securities (shares and bonds) to be willing to invest. It therefore includes the cost of equity and the cost of debt.
Book Value of Shares
FALSE. The book value of shares, as recorded in the balance sheet (nominal value + premiums + reserves), does not necessarily coincide with the market price of the shares.
The Beta Coefficient
FALSE. Beta is a measure of overall market risk (economic and financial) that is non-diversifiable. It also depends on the company's level of indebtedness, reflecting its financial risk.
Financial Ratio Analysis: 2007 and 2008
a) Price-to-Earnings (P/E) Ratio Calculation
The P/E ratio is calculated as: Market Price Per Share / Earnings Per Share. In this context, it's represented as Money Market Shares / Net Profit.
- 2008: 47,328 / 809 = 58.50
- 2007: 48,960 / 1,336 = 36.65
This indicates that for every dollar of profit, investors were willing to pay $36.65 in 2007. Interpreted as a payback period, investors would take approximately 36 years to recover their investment through profits in 2007.
b) Cost of Equity (Kp) using the P/E Ratio Model
The cost of equity (Kp) can be estimated as the inverse of the P/E ratio (1/PER).
- Kp 2007: 1 / 36.65 = 2.73%
- Kp 2008: 1 / 58.50 = 1.71%
The inverse of the P/E ratio provides the annual return investors would obtain. The cost of equity capital decreased in 2008, likely as a result of decreased earnings.
c) Payout Ratio, Retention Rate, and Return on Equity (ROE)
These metrics are crucial for understanding a company's dividend policy and internal growth capacity. The sustainable growth rate (g) is the rate at which profits and dividends can grow without changing financial leverage.
- Return on Equity (ROE) (rf): Net Income / Equity
- 2007: 1,336 / 24,506 = 5.45%
- 2008: 809 / 24,394 = 3.32%
- Payout Ratio (a): Total Dividends / Net Profit
(Assuming Dividends = 0.1 * Number of Shares)
- 2007: (0.1 * 5,440) / 1,336 = 544 / 1,336 = 40.72%
- 2008: (0.1 * 5,440) / 809 = 544 / 809 = 67.24%
- Retention Rate (b): 1 - Payout Ratio (a)
- 2007: 1 - 0.4072 = 0.5928 = 59.28%
- 2008: 1 - 0.6724 = 0.3276 = 32.76%
- Sustainable Growth Rate (g): Retention Rate (b) * Return on Equity (rf)
- 2007: 0.0545 * 0.5928 = 3.23%
- 2008: 0.0332 * 0.3276 = 1.09% (rounded from 1.087%)
d) Cost of Equity (Kp) using the Gordon-Shapiro Model
The Gordon-Shapiro Dividend Discount Model calculates the cost of equity as: Kp = (Dividend per Share / Current Share Price) + Sustainable Growth Rate (g).
- Kp 2007: (0.1 / 9) + 0.0323 = 0.0111 + 0.0323 = 4.34%
- Kp 2008: (0.1 / 8.70) + 0.0109 = 0.0115 + 0.0109 = 2.24% (rounded from 2.236%)
As observed, the cost of equity (Kp) calculated using the Gordon-Shapiro model for 2008 significantly decreased, almost by half, from 4.34% to 2.24% compared to the previous year.
e) Key Differences: P/E Ratio vs. Gordon-Shapiro Models
The fundamental difference between the P/E ratio model (when used to derive Kp as 1/PER) and the Gordon-Shapiro model lies in their assumptions about growth and dividend distribution.
- The P/E ratio model, when inverted to estimate Kp, implicitly assumes that the company distributes all its profits as dividends, or at least doesn't explicitly account for growth from retained earnings.
- The Gordon-Shapiro model explicitly considers the growth of company profits and dividends. It assumes that a portion of profits is retained, and this retention of earnings allows for a sustainable growth rate (g), which is a key component of the model.
Cost of Debt Capital Calculation
The cost of debt (Ki) is calculated as: Interest Expense / Total Debt (Financial Liabilities).
- Ki 2007: 1,011 / 21,452 = 4.71%
- Ki 2008: 1,137 / 21,767 = 5.22%