QUESTION
You need to consult annual reports pertaining to the most recent 2 years, information provided as part of investor briefings and other publicly available information in preparing your answers for questions 1, 2 and 3. It may also be useful for you to watch a webcast of an AGM of your chosen firm from the website of the chosen company. Please note webcasts of AGMs are not available for all companies and that you may require a broadband connection to access those that are available. Please cite appropriately all material consulted in your assignment.
Question 1
Select 2 firms – one from banking sector and one from retail or materials sector – listed on the ASX. Identify the organizational structure and board committees of the firms chosen. Comment on the independence of the board and board sub-committees and state in your view how well the interests of stakeholders are looked after. Examine the shareholding of directors and comment on their incentive structures. (6 Marks).
Question 2
Examine the cash flow statements of firms chosen in question 1 for the latest 2 years and comment on their net operating cash flows, net investing cash flows and net financing cash flows. What in your view are the major changes in cash flows over the 2 years and what do you think are the factors influencing these changes? (4 Marks).
Question 3
Estimate the free cash flow for the 2 selected firms. Comment on the appropriate level of free cash flow and discuss what might happen if a particular firm has a large amount of free cash flow. Please cite at least 5 references in your explanation and provide a list of references at the end of your answer to this question. (3 Marks).
Question 4
Your uncle has agreed to loan you $10,000 so you can go on holiday today. Because you are his favourite nephew, he has agreed to loan you the money at a below market interest rate of 6 percent per year. He has also agreed to a grace period of 2 years during which time no payments will be due. Your first payment is due exactly 3 years from today and you will have to make payments at the end of each year to repay the loan. The payments are all equal and there are 5 repayments in all. What is the size of each payment? (2 Marks)
Question 5
Your friend heard that you are studying managerial finance this semester. She has asked your advice on the dilemma she is facing. Your task is to consider her situation and provide her a financial advice.
Your friend’s situation: She has just celebrated her 30th birthday. She has two children. One will go to university overseas 15 years from now and requires four beginning-of-year payments for university expenses of $10,000, $11,000, $12,000 and $13,000. The second child will go to another overseas university in 20 years from now and require four beginning-of-year payments for university expenses of $15,000, $16,000, $17,000 and $18,000. In addition, your friend plans to retire in 30 years. She wants to be able to withdraw $50,000 per year (at the end of each year) from an account throughout her retirement. She expects to live 40 years beyond retirement. The first withdrawal will occur on her 61st birthday.
What equal, annual, end-of-year amount must your aunt save for each of the next years to meet these goals, if all savings earn a 12 percent annual rate of return? What if your aunt expects to receive a lump sum gift cheque on her 61st birthday for $400,000? (5 Marks)
SOLUTION
Answer 1
The two firms selected are Commonwealth Bank and Woolworths Limited (Retail).
The Membership of the Board and Committees of Commonwealth Bank is as follows:
There are currently 11 Directors of the bank and the details regarding their board membership, Position held, and Committee membership is as below:
1) D J Turner –Non Executive, Independent director, Group Chairman, Chairman of Board Performance and Renewal Committee and member of People and Remuneration, and Risk Committees.
2) R J Norris – Executive director, CEO, Member of Risk Committee.
3) J A Anderson – Non Executive, Independent director, member of Board Performance and Renewal and Risk Committees.
4) C R Galbraith – Non Executive, Independent director, member of Board Performance and Renewal, Audit, and Risk Committees.
5) J S Hemstritch – Non Executive, Independent director, Chairman of People and Remuneration Committee and member of Risk Committee.
6) S C H Kay – Non Executive, Independent director, Member of People and Remuneration, Audit, and Risk Committees.
7) A M Mohl – Non Executive, Independent director, Member of People and Remuneration, and Risk Committees.
8) F D Ryan – Non Executive, Independent director, Chairman of Audit committee and member of Risk committee.
9) H H Young – Non Executive, Independent director, Member of Audit committee and Chairman of Risk Committee.
10) B J Long – Non Executive, Independent director, Member of Audit and risk committees.
11) L K Inman – Non Executive, Independent director, Member of Risk committee.
Members of the board seem to be satisfactorily independent as each non executive director is free of management or business or any other relationship which could hinder fair judgement by such director. Also, details of related party transactions have been provided in cases where any director is involved with other companies having dealings with the bank. There seems to be adequate protection of shareholders interests as the selection procedure of directors and board members is fair, timely review of board’s performance and policies is done. In addition to the restrictions imposed by law, Board ensures very limited dealings by directors in the securities of the group. Other statutory procedures like audit and risk dealings also seem to be in place. Incentive structure for executives is based on financial and non financial objectives of the bank. Financial objectives are linked to cash NPAT and PACC and non financial objectives are related to customer satisfaction, reputation, talent and skill management. Bank follows a fair reimbursement policy to its top executives as half of the incentive is paid after annual results are declared and remaining half are deterred for an year, in case a CEO resigns in that year, such deterred amount is forfeited. LT incentives are paid in form of equity. All shares are acquired by Directors on normal conditions through Non-Executive Directors share plan as 20% of their fees is paid in form of shares with restrictions on trading. They hold around 150,000 shares out of the total 1,552,273,695 shares, as on 30th June 2011.
The constitution of Board of Directors of Woolworths Limited as follows:
Ten Non-Executive Directors: 1) JA Strong – Chairman
2) JF Astbury 3) JR Broadbent 4) RS Deane 5) DJ Grady 6) CJ Hrdlicka 7) LML Hullier 8) IJ Macfarlane 9) RG Waters 10) AM Watkins
Three executive directors namely:
1) MG Luscombe – MD and CEO
2) TW Pockett – Finance Director
3) GO’ Brien – Deputy CEO
All the aforementioned directors are members of various board committees of the company, details of which can be obtained form annual reports for the year 2011 published on company’s website. Company has employed ten non executive directors out of the total thirteen, who are considered to be independent and without any material relationship. They are selected by shareholders and are deemed to follow strict ethics that should be followed to protect shareholder’s interests. The maximum amount of director’s fees paid to each non executive director is $4,000,000 per annum. Remuneration of non executive directors is not based on performance objectives and the annual increment was less than recommended by external consultant but was in accordance with the overall salary increase in company.
Question 2
Examine the cash flow statements of firms chosen in question 1 for the latest 2 years and comment on their net operating cash flows, net investing cash flows and net financing cash flows. What in your view are the major changes in cash flows over the 2 years and what do you think are the factors influencing these changes? (4 Marks).
Answer 2
For Commonwealth Bank (As per company Annual report 2011): – On examining cash flow statements for the year 2011 and 2010, it is seen that cash flow from operating activities before changes assets and liabilities has increased from $2963 million to $7077 million. The major reason for this is decrease in asset through income statement which has gone from $(2466) million to $4452 million. Net cash provided by operating activities has increased drastically from $(26669) million to $17667 million. Major contributors are increase in deposits and public borrowings and realisations from loans, bills discounted and other receivables. Cash used in investing activities has increased due to purchase of property, plant and equipment over the last one year. Higher dividend payments and negative proceeds for debt issues have resulted in a huge fall in cash from investing activities.
For Woolworths Limited (As per company Annual report 2011): – Statement of cash flow changes for the year 2011 and 2010 depict no major variations in the cash flow patterns. Cash flow from operating activities has increased marginally by $200 million due to higher receipts from debtors. Proceeds from sale of property, plant and equipment has increased and so has payments for capital expenditure. Here also, Cash used in investing activities has increased marginally. Cash flow from financing activities also does not show huge changes except for payment for share buy back. Overall cash flow for Woolworths limited remained pretty consistent over the year.
Question 3
Estimate the free cash flow for the 2 selected firms. Comment on the appropriate level of free cash flow and discuss what might happen if a particular firm has a large amount of free cash flow. Please cite at least 5 references in your explanation and provide a list of references at the end of your answer to this question. (3 Marks).
Answer 3
Free cash flow is calculated by deducting capital expenditures from operating cash flow (Free cash flow, 2010). It is a measures amount of cash that a company generates after deducting cash required to pay for capital expenses.
Free cash flow for Commonwealth Bank as at June 30, 2011( Annual report, 2011):
Free cash flow = Net cash from operating activities- Capital expenditures
= $17,667 million – $ (443+533) million = $16,681 million
Free cash flow for Woolworths Limited as at December 31, 2011 (Annual report, 2011):
Free cash flow = $2,991.1 million – $2,138.5 million = $852.6 million
As seen from above calculations, free cash flow value for Woolworths limited is quite low than Commonwealth Bank. It is quite important to have adequate amount of free cash flow as it enables a company to pursue various productive activities like mergers and acquisitions, dividend payments, debt repayments, product development etc.
However, it is not necessary that lower or negative free cash flow is bad as it can also signify that company is expanding its asset base and is making capital investments. In the above case, Commonwealth Bank has a huge amount of free cash flow but it has made very less investments in its fixed asset.
Reference List:
- Free cash flow, 2010; accessed from: http://www.investopedia.com/terms/f/freecashflow.asp#ixzz1qKDpRsG0 on March 25th, 2011.
- Cash flow statement, 2011, Annual Report Commonwealth Bank, Pg 103.
- Cash flow statement, 2011, Annual Report Woolworths Limited, Pg 93.
Question 4
Your uncle has agreed to loan you $10,000 so you can go on holiday today. Because you are his favourite nephew, he has agreed to loan you the money at a below market interest rate of 6 percent per year. He has also agreed to a grace period of 2 years during which time no payments will be due. Your first payment is due exactly 3 years from today and you will have to make payments at the end of each year to repay the loan. The payments are all equal and there are 5 repayments in all. What is the size of each payment? (2 Marks)
Answer 4
Amount of loan = $ 10,000,
Grace period = 2 years,
Rate of interest, i = 6% per annum,
Amount of loan at the end of year 3, A =$11,910.16
Number of repayments = 5 starting from end of year 3.
Equal annual payments = (i x A)/[1-(1+i)^-n]
= (6% x 11910.16)/[1-(1+0.06)^-5] = $ 2,827.43
Question 5
Your friend heard that you are studying managerial finance this semester. She has asked your advice on the dilemma she is facing. Your task is to consider her situation and provide her a financial advice.
Your friend’s situation: She has just celebrated her 30th birthday. She has two children. One will go to university overseas 15 years from now and requires four beginning-of-year payments for university expenses of $10,000, $11,000, $12,000 and $13,000. The second child will go to another overseas university in 20 years from now and require four beginning-of-year payments for university expenses of $15,000, $16,000, $17,000 and $18,000. In addition, your friend plans to retire in 30 years. She wants to be able to withdraw $50,000 per year (at the end of each year) from an account throughout her retirement. She expects to live 40 years beyond retirement. The first withdrawal will occur on her 61st birthday.
What equal, annual, end-of-year amount must your aunt save for each of the next years to meet these goals, if all savings earn a 12 percent annual rate of return? What if your aunt expects to receive a lump sum gift cheque on her 61st birthday for $400,000? (5 Marks)
Answer 5
Retirement withdrawal per year for 40 years, p= $50,000
Rate of interest, i = 12%
Number of years, n = 40
Value of investment at the end of 30 years from now, A = p/i(1-(1+i)^-n)
A = 50,000/0.12(1-(1+0.12)^-40)
A = 412,188.8
Equal payments required for 30 years ,to attain investment goal of attaining $412,188,8
= iA/(1+i)^n-1
= (0.12×412188.8)/(1.12)^30-1
= $1650 per annum for 30 years starting from now
For children’s education:
Present value of requirement for first child, PV = 10,000+11,000/0.12(1-(1.12)^-1)+12,000/0.12(1-(1.12)^-1)+13,000/0.12(1-(1.12)^-1)
PV = 10,000+9,821.43+10,714.3+11,607.14
= 42,142.86
Value of annual investment for 15 years for first child = (0.12×42142.86)/(1.12)^15-1
= $923 per annum starting from now for 15 years.
Present value of requirement for second child, PV1 = 15000+16000/0.12(1-(1.12)^-1)+17000/0.12(1-(1.12)^-1)+18000/0.12(1-(1.12)^-1)
PV1 = 15000+14285.7+15178.6+16071 = $ 60535.71
Value of annual investment for 20 years for second child = (0.12×60535.71)/(1.12)^20-1
= $752 per annum for 20 years starting from now.
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