FNCE3000 Corporate Finance

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3.3 DGM calculations

All information needed to calculate Rd using the DGM can be found in the annual report; income statement and balance sheet section.

Use the following formulas:

Dl is the sum of the dividends (payment date) for the reporting period. Do not include any special dividends as it is a one-off occurrence.

Do not include franking credits.

Dividend in the formula of 'g' is DI.

PO is the beginning price of the share of the reporting period. Use profit after tax for net income.

Include the page number of the annual report where you have obtained the figures

Always use numbers from the main Income Statement and Statement of Financial Position.

Use statutory not underlying, and do not use adjusted figures.

If your company has many divisions/operations, you have to use the numbers of the main group.

You may use the calculated basic EPS from the annual report, but check if they have used adjusted figures and note in your report what they have adjusted for. Your EPS cannot be negative.
If your g is negative, you will have to take averages for the variables used in the formula. The choice of which variable to apply an average will depend on the company's history.

Make a note in your report that as the payments are 6 months apart, the numbers do not fit the DGM formula well.

Selection of Re calculation

Identify if there had been major events that occurred that may have caused a huge fluctuation in volatility: this will affect Re through CAPM.

3.4 Calculation of Rd

Identify all long-term borrowings used for CAPEX purposes. These are usually loans, bonds, notes or leases.

You will need to use the publicly available information as an estimation for the rate and add appropriate margin. This added margin is to account for the terms or risks included in the loan contract.

To decide on the suitable margin, you need to identify investigate the maturity, security and variability of the loan instrument.

Maturity - you will need to identify all the ones 1 year or less. These are to be ignored. We are only identifying the long-term debts. Typically, these would be in the borrowings section. You will have to read the notes to the items. Longer term loans would attract a lower margin.

Security – you need to identify if the borrowings are secured or not. The stronger the security, the lower the margin.

Variability – you need to identify if the various instruments are fixed or variable loans. Variable loans are riskier and therefore would attract a higher margin.

Rate - you cannot use the interest repayments to ‘reverse’ engineer the rate. You are to follow the steps below to calculate your weighted average cost of debt:

Establish your base rate - Investigate the current bank bill swap rate (BBSW)
+ credit rating (follow lecture 4 recording)
Apply a suitable margin to each loan instrument:
Rank all your loan instruments in order of risk
Apply a margin for each loan instrument
Research publicly available loan rates to ensure that your margins are reasonable

Review the annual report to verify if there are any mandates or restrictions to the amount to debt. Significantly high levels of debt would attract a higher margin.

You still have to go through the above steps and include a margin on each instrument even if a rate is provided in the annual report. However, you can use that rate to justify your margin applied.

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