Investment

However, according to Hu and Plant (2001) cited in Sam Lubbe, discovered that there was no increase in the level of financial performance. Rather, it is the other way round – increased financial performance lead to increased IT investment. However, the study conducted by Emre Berk, Kamran Moinzadeh, Kar Yan Tam on the impact of IT capital on business performance of four newly-industrialized economies (NIEs) during the period 1983 and 1991 and found that the following observations- ‘first, IT investment is not correlated with shareholder’s return.

Second, there is little evidence that the level of computerization is valued by the market in developed and newly-developed countries. Third, there is no consistent measurement of IT investment as indicated by the mixed results across different performance ratios. ” The organization may face a sudden raise of need for new investment, which in many cases is very vaguely calculated in terms of money, as the IT interment involves multiple factors to consider. The Costing models of IT projects vary and show different outputs and hence the figures are not always constant.

There are additional costing emerges from time to like, infrastructure and training costs that emerge very quickly than other segments due to high depreciation, innovation and high attrition rates in IT sector. However the following two examples shows a value improvement and direct ROI as a result of IT investment. Eg – 1: “Mitre Corporation, in 1995, launched a collaborative component to their intranet, called Mitre Information Infrastructure.

To date, Mitre has invested $7. 2 million in the MII, netting an ROI of $62.1 million in reduced operating costs and improved productivity. ” (Source: usabilityfirst. com) Eg-2: “Diamond Bullet, a Foraker company, redesigned the architecture of a state government portal site that increased users’ success at finding information from 72% to 95%, reduced their time in finding information by 62%, and resulted in significantly higher user satisfaction ratings. This led to an estimated savings of at least $1. 2 million per year for the citizens of the state and increased revenue for the state estimated to be at least $552,000.”

(Source: usabilityfirst. com) Importance of infrastructure: The performance gain from the investment in IT is measured in the quantifiable terms like ROI. But ROI of IT depends on infrastructure which includes human resource, capital availability, telecommunication network and power supply. According to Mike Martin, most of the IT budget goes on to applications which merely keep the organization in line with the rest of the industry, or offer a temporary, but easily replicable advantage.

Related to this article: 

 which of the following best describes the purpose of angel capital

The maintenance of the applications requires infrastructure. The presence of satisfactory infrastructure is related to the ROI in IT because the adoption of IT requires supporting network of electricity, telecommunications and skilled people. In the field of information technology, infrastructure is a very crucial component. Implementing a cost effective IT Infrastructure that aligns with organization’s business strategy is essential to ensure the success of the Information Technology (Peter Weill, 1992).

An investor is usually expected to buy stocks that are projected to appreciate as well as stocks with high expected earnings. The performance of Polaroid stock over recent past has oscillated from a low of $ 49 in November 2007 to high of $ 57 in December to the current price of $ 53. This indicates that this stock is volatile and is not a good buy when one’s wealth has declined. Moreover the stock has not significantly appreciated over the past year. b) Expect to appreciate in value

A stock’s price is expected to appreciate if the company releases better earnings forecasts or news of an event like an acquisition/merger that is expected to add value to the company. The earnings are expected to rise to $ 3. 85 up from last years $ 3. 41 according to Market Watch analyst predictions. The strong reported earnings is also expected to boost the price therefore buying this stock now is advisable also due to projected improved 2008 earnings (Market Watch) c) Bond market becomes more liquid The bond market liquidity and stock market liquidity are linked and movement in either liquidity affect both.

The stock and bond market are also affected by volatility in either market. Increased bond market liquidity leads to a reduction in the liquidity of the market and vice versa. (Guyenko, Ruslan 2005) Liquidity is the ability of investor to acquire and dispose large quantities of an asset quickly and at a minimal transaction cost. Therefore increased bond liquidity leads to the stock market being less liquid and thus not advisable to buy the stock. d) Appreciation of gold The general down turn of the economy and the depreciation of dollar has been the main factor for gold appreciation in the recent past.

Economic downturn leads to companies making less profit and therefore the stocks decline on the fact that the companies are earning less. As long as the gold keeps on appreciating then it would be advisable to invest in gold and not stocks e) Bond market prices become volatile As seen earlier, the bond market and the stock market are linked in two ways i. e. the liquidity of the market and the volatility of the markets. The volatility can have an impact on the liquidity of the markets by changing the stock risks undertaken by the market making agents. An increase in volatility of the bond market reduces the liquidity of the stock market.

A reduction in the liquidity consequently makes the stock market less attractive for investments. (Guyenko, Ruslan 2005) 2 bond effects on interest rates The money supply in an economy can be increased or decreased by the use of expansionary or concretionary policies. Expansionary policies. It can be achieved by using either open market operations, lowering rates while the decline in reserve requirement leads to lenders having more money to invest. These investments can be in bonds and therefore the prices will increase thereby reducing the interest rates.

(Moffat, Mike 2008) The increase in bond prices will make them unattractive therefore making the investors to sell the bonds and buy foreign bonds Contractionary policy The supply money in the economy can be reduced by selling bonds (open market operations), raising federal discount rate and raising reserve requirements. This works in opposite way of expansionary policies. From the above graph, it is clear that an increase in the supply of the bond leads to an increase in the price of the bond while at higher bond price, the demand for the bond is lower.

From the previous analysis, it is worthwhile to remember that the higher the price of the bond the lower the interest rate. Federal deficit on interest rates There has been no statistically proven relationship between the level of federal deficit/surplus and the current real interest rates. The research that has been done shows that the effect is minimal. Crowding out theory states that if the government increases its level of debt by borrowing then supply of funds available to other borrowers’ decline hence increasing real interest rates.

However, this theory can be avoided in an open market economy where money can flow in from foreign economies thereby offsetting the crowding effect. Research on this theory indicates that the effect of the deficit on real long-term interest is minimal. Rircadian equivalence theory states that individuals increase in bond investments due to increase in deficits are increase in their wealth because this increase will require new taxes in the future and thereby one should increase his savings to cater for future tax.

This theory established that the addition savings offset the extra debt issued thereby having no effect on real interest rates (Joint Economic Study- US Congress. December 2003) 5) Riskiness of bonds and interest rates. The effect of the bond price and the level of interest rates have an inverse relationship. This means that an increase in the price of the bond leads to a decrease in the rate of interest and vice versa. This is due to the fact that the new investors demand the effective rate of interest. (Financial Guide 2008).

6) Interest rates and inflation Inflation is the genera increase in commodity prices following in the decline of purchasing power of money. In an economy, the interest rate can be real or nominal. Nominal interest rates are that have not been adjusted for inflation while real rate are rates already adjusted for inflation. Real rate= nominal rate- inflation rate. The higher the inflation rate the higher the nominal rate and vice versa. The announcement by the president that the inflation will be reduced will result in to lower nominal rates.

7) Market interest rate on bond yields The Feds declaration that the interest rates will rise sharply next year will cause the newly issued bonds to increase their yields so that they remain competitive thereby rendering the current bonds in the market less attractive. This is because the investors will want to buy the new bonds offering higher yields rather than existing bonds with low yields. The longer the maturity of the bond the higher the yield demanded by the investors because inflation will rise and thus lower the price of the bond.

(Fidelity Investments 2008) 8) Interest rates and increase in stock prices. The changes in interest rates will affect the risk of any investment be it stocks or shares. An increase in the interest rate increases the risk of investments thereby reducing the value of the investments. Therefore the interest rates will decline if the investors believe that the stock prices will increase. A decline in the interest rates means that the cost of doing business is less. Thereby more returns to companies hence affecting the stock prices.

Financial markets refer to mechanisms that allow individuals to trade on financial securities such as bonds and stocks with the sole aim of facilitating the growth of business investors to increase their incomes and wealth (Madura, 2008, p. 26). In a much broader perspective, they are known to be the markets used by business investors for exchange of credit and capital throughout the business ventures. The financial markets can be classified into the capital market that deals with long term debt instruments and the money market that deal with short term debt market.

In the present world economies the financial markets are basically the bond market, the commodities market, stock market, and the foreign exchange market (Jaffee & Dwight, 1999). Financial intermediaries are the financial institutions that act as the middlemen between the financial lenders and the financial borrowers, such institutions are for example; the brokerage companies, insurance companies, banks, finance companies, and credit unions among others (Bhole & Mahakud, 2009, p. 5).

These institutions get money from the investors and give loans to the borrowers thus availing a link between the people looking for credit and those looking for earnings. The two sectors, financial markets and financial intermediaries play a critical role in the business industry because of their major roles played to the investors and entrepreneurs in the whole economy. It is important therefore to determine the roles played by the two sectors to the investors and the economy and also the relationship created between them and finally their importance in the financial world (Bhole & Mahakud, 2009, p.

11). It is important to understand that in the marketplace the main question that is dealt with is how to sufficiently supply a given commodity and meet a particular demand for the good or service. In the financial markets, supply comes from businesses and investors while the demand mainly comes from the government and the substantial companies with large financing requirements. This relationship is better practiced in the financial markets as a platform for the interplay of these parties in the transaction of business (Allen & Gale, 2003).

The financial markets provide a place and platform where the money which is the most important element is made available to make business transactions active and circulate throughout the economy (Levine, 1995, p. 25). Banks have a role of transforming the short term resources which are the current accounts into long term and medium term resources that is the bank loans. Therefore, the banks provide a very important link between the businesses and the households thus acting as an important role in the financing of the business sector and the economy as a whole.

The banks play a role of distributing all the monies that are being deposited by the customers on their current accounts and then avail loans to the interested borrowers. This means that the banks exist with a major aim of creating money sand making it available for lending. In addition to that, large companies and even the government cannot really rely on the loans for their operations (Levine, 1995, p. 18). Therefore, they have to find out mechanisms that they obtain their long term financing options, the debts with long maturities; these can be obtained outside the bank into the financial market.

The financial market extends to the institutional investors who are responsible to draining the public savings and investing them in more profitable activities. Some of these institutional investors include the insurance companies, retirement funds, pension funds, and the fund managers among many others. They have a major role to play in the economy and the financial markets by availing the money deposited as savings by the customers who are basically the public into incentives that are most profitable.

The institutional investors contribute to the existence of the financial markets by buying securities from companies that are in need of financing. Among the securities issued include the long term borrowing bonds and the equity capital (Levine, 1995, p. 21). This means that money is being made available to those in need of funding from the savers and thus facilitating the circulation of money in the whole economy, one of the main goals of the financial institutions. The investors in the business market are in need of someone who acts as a broker in the business transactions being carried out.

This therefore, means that they need a broker in certain transactions such as buying of securities in the stock market (Allen & Gale, 2003). The brokers are the financial intermediaries in the financial market who provide a link between the entrepreneur and the source of funding who are the financial institutions. Some of the activities being carried out by these brokers are for example; trading directly in the financial market and the stock exchange market since they have a direct link with these institutions that an individual investor.

This makes it easier for the investor to trade effectively and incurring fewer costs as compared to when he would have traded directly with these institutions in the financial market (Levine, 1995, p. 26). In additional to the above, the brokers are beneficial to any individual investor since they have the ability to participate in the financial markets and are able to oversee each transaction, that is from placement to execution, and also provide the individual investors with relevant information and advice in better decision making about their investments.

There are a number of important functions that are being carried out by the financial market to the individuals, companies and the government as a whole. It is evident that the financial markets are necessary platforms needed by the banks and other financial institutions in implementing their monetary policy decisions. This is because they provide information necessary for the implementation of such decisions such as the marginal lending, and the management of equity in the market operations (Jalan, 2006).

This information among many others is essential for the financial institutions and the banks thus making the existence of the financial market a very important element in the economy and the existence to be strong and effective (Jaffee & Dwight, 1999). The financial markets act as the funding agents of the government. This is affected by the government involving itself in the treasury and bond transactions and participating in the implementation of the debt management strategies and also in the control over the dealers in the bond market.

The government also takes the financial market as a platform for management of the investments portfolio in the whole economy and also the corporations for the public deposits. In addition to the above, the financial markets are of importance to the government as they provide information about the market and to assist the government in the implementation and reinforcement of the important decisions in about the whole economy performance (Mayer & Vives, 1993, p. 156). It also provides services of custody and settlement availed to the government and banks in carrying out their activities.

The financial markets act as the financial intermediaries in any growing or developed economy. The funds that are in surplus are transferred from the savers in excess to those in need of money through the financial markets. This is because those who save are not the ones that have the important investment opportunities and ideas (Mayer & Vives, 1993, p. 156). Therefore, the financial markets take the role of intermediation of the two parties and enhance trade to be carried out more effectively.

The existence of the financial markets and intermediaries provide the investors with lower trading costs as compared to when they were non existing. Involvement in these markets will help the investors to manage their own financial wellbeing in the most appropriate way (Jalan, 2006). This has led to the increase in the preference of many individuals in the financial market and thus facilitating their existence further. In addition to the above, the investors are being awarded the opportunity to diversified and wide business opportunities in the financial market.

This is as a result if the competition being provided in the financial markets which leads to a wider variety of investment choices that better fit the investors’ needs. This makes many individuals to actively get involved in the financial market and thus facilitating its growth. Finally, the financial markets provide the potential investors with a greater accessibility to the credit facilities. This makes it possible for these investors to get an attraction to participate in the market and thus facilitating its growth (Bhole & Mahakud, 2009, p.

45). The financial markets and intermediaries also have participated a lot in the business world and incentives. First, it provides business incentives with greater accessibility to a wide range of capital opportunities at the lowest cost. Such capital opportunities are for example, the bonds, stocks, and mutual funds. This range of capital is according to the reach, taste and preference of a business individual thus influencing their active involvement in the financial market.

These markets also provide the investors and business incentives with maximum amount of information which gives them the ability to give better approximation and accuracy of the set prices. This is due to the increased transparency and improved price discovery which is provided in the financial markets (Mayer & Vives, 1993, p. 158). To the side of the government and the economy as a whole, the financial markets provide much improved benefits. These markets are increasingly popularising and many companies and investors are turning to them for better financial needs.

This however, from another point of view provides increased employment opportunities and the growth of the economy. This is because they allow for small and medium sized firms to expand and provide room for more employment (Jalan, 2006). This is why most governments prefer the financial markets and financial intermediaries because of such treasons. One of the major reasons for the existence of the financial markets is because of the government intervention. The government intervenes in the financial markets through many ways.

For example a government may decide to select good firms in an industry and on the other hand force other firms out of the business industry; these are those with unlawful operations. The government can implement policies and regulations that otherwise maintain better operation of the business entities in the industry (Madura, 2008, p. 21). Fines are imposed for the financial institutions and also other business entities that throughout the economy and also the financial sectors. The government therefore involves itself in adequate regulation of the participants in the financial markets.

This is to overcome the problems that may arise from bad participators and thus enhancing the consumer confidence in the financial markets and also reducing the moral hazard effects by improving the consumer knowledge on the financial markets. This type of regulation by the government in the financial markets has not only improved the consumer confidence but also it has strengthened the existence of the financial markets and financial intermediaries in the present time and also from the past (Jalan, 2006).

Therefore, from the above descriptions, it has been noted that the financial markets have so far been essential for the operation of many sectors of the economy that is the individuals, business incentives, companies, and even the government as a whole. This improved relationship has led to an increase in the rate of participation of these sectors in the financial markets thus facilitating their survival in the economy. Financial intermediaries also as part of the financial market are seen to have a direct impact on relatively every sector in the economy.

Their role as the main bridge between the lenders and borrowers is the most important reason as to why every sector of the economy participates in this platform. The associated advantages advanced to potential investors, companies, and the individuals have led to the increased goodwill of these financial markets and financial institutions thus increasing the participation of the various sectors. Finally, due to the government intervention and involvement in the operation of the financial markets and the financial intermediaries has improved the confidence of participants and hence strengthening its existence in the economy.

Bibliography: Allen, Franklin & Gale, Douglas, 2003. Financial intermediaries and markets. Retrieved August 19th, 2010, from: http://finance. wharton. upenn. edu/~allenf/download/Vita/finintermed. pdf Bhole, L M & Mahakud, Jitendra, 2009. Financial Institutions and Markets. New Delhi: Tata McGraw-Hill. Jaffee, Dwight & Russell, Thomas 1999. Financial markets and financial intermediaries: the case of Catastrophe Insurance. Retrieved August 19th, 2010 from, http://faculty. haas. berkeley. edu/jaffee/papers/nber99.

pdf Jalan, Karna, 2006. Role of financial intermediaries in the 21st Century. Retrieved August 19th 2010 from, http://www. indianmba. com/occasional_papers/op125/op125. html Levine, Ross, 1995. Stock market development and financial intermediaries: stylized facts. London: World Bank Madura, Jeff, 2008. Financial markets and institutions. Mason, OH: Thomson Higher Education Mayer, Colin & Vives, Xavier 1993. Capital markets and financial intermediate. New York, NY: Cambridge University Press.

Every company needs to raise funds or capital for financing its projects. The cost of capital represents the maximum return that a company must earn on its investments so that the market value of company’s stock or equity does not decrease. In other words, a firm must earn a return on the investments that are financed by the shareholders, at a rate which is equal or more than the rate of return required by equity holders of the firm. Otherwise, if a certain project fails to earn an expected rate of return, there will be a fall in the market value of company’s shares and will also result in reduction of shareholder’s wealth.

Therefore, we can say that a firm’s cost of capital is the required rate of return required by a firm from a certain investment so that it can increase the market value of the firm(Scribd. com , n. d. ). A firm’s cost of capital represents the minimum rate of return required of the investment in order to maintain if not increase the market value of its equity. The cost of capital comprises of two components; cost of equity and cost of debt. However, it may include only cost of equity for a firm which is un-geared or has no debt liability in its capital structure. 1.

Cost of equity – The cost of equity capital for a firm is the rate of return required on an investment by the shareholders of the firm. This required return comprises of both dividend payments and capital gains in terms of increase in share price. These returns are not historical returns but rather the expected future returns by the ordinary shareholders. The cost of equity varies from company to company depending upon the financial and business risk of the companies. The cost of equity is calculated by the following formula: Ke (Cost of equity) = Dividend per share (for next year)/Current market value of shares +

Dividends growth rate (Brigham & Houston, 2009). The cost of equity reflects the opportunity cost of shareholders of a firm for their investment in the firm’s equity. The above formula calculates the cost of equity based on the firm’s current rate of return. A higher cost of equity means a higher risk for the investment and therefore the required return demanded by shareholders will be higher as well. 2. Cost of debt – The cost of debt is an effective rate that the company pays as interest payments on its debt. The cost of debt is a part of capital structure that forms the cost of capital of a firm along with the cost of equity.

As interest expense is a tax deductible expense so the after-tax cost of debt is usually taken. The cost of debt can be calculated by the following formula: kd (Cost of debt) = Interest expense ? (1 – tax rate)/ Total debt amount Once we know the cost of equity and cost of debt of a firm, we can find out the real cost of capital of a firm through its weighted average cost of capital (wacc) formula. In this formula, each category of firm’s cost of capital is to be proportionately weighted. A higher WACC reflects a higher business and financial risk of a firm and therefore a higher return for investment.

WACC is calculated by the following formula: WACC: E/V ? ke + D/V ? kd (1- tax rate) Where: E = market value of firm’s equity V = Total value of a firm (Equity + Debt) Ke= Cost of equity D = market value of firm’s debt E/V= percentage of debt financing in a total capital financing of a firm D/V= percentage of debt financing in a total capital financing of a firm (Brigham & Houston, 2009). 2. How do market rates and the company’s perceived market risk influence its cost of capital, and how does the company’s debt to equity mix impact this cost of capital?

When a firm raises finances, the return it pays to the investors reflects the cost of getting the required capital, whether it is in the form of interest payments or dividends to shareholders. The return on investment required by investors is derived from the market’s assessment of adequate return to compensate for the certain risk level and the risk perceived by the company. The required return increases according the increase in risk(Gitman,2000). The company’s debt to equity mix is a main determinant of company’s total cost of capital.

The higher the company is geared, the higher will be its cost of capital because the higher gearing or debt level will increase the financial risk of the company. Therefore, investors will demand the higher returns on their investment with the higher risk profile of a firm thus increasing the overall cost of capital of a firm (Investopedia,n. d. ). 3. What is market risk, and how is it measured? Market risk is the risk that the value of an investment will decrease because of the change in value of the market risk factors. These market risk factors include share prices, foreign exchange rates, interest rate risk and etc.

Market risk is usually measured by an approach called Value at Risk. This approach takes various assumptions for measuring risk. One of the assumptions it uses is that the certain portfolio of an investment stays the same over a certain period of mode. Such an assumption however, can be useful for short time horizons but for the longer time horizons, it is not considered too useful (Brigham & Houston, 2009). 4. Don mentioned using standard deviation and the coefficient of variation to measure risk. What does that mean? The standard deviation is sometimes used by analysts and investors to measure the portfolio of investment or a stock.

The main reason being that the standard deviation is a useful measure of volatility, the more an investment’s returns vary from the average returns, the more risky it will be considered. The coefficient of variation represents the ratio of standard deviation to mean and it is a useful tool to compare a degree of variation from one data series to another. For investors, it helps them to determine the amount of volatility or risk they are assuming in comparison to the expected return from an investment. The lower ratio means the investment is favorable for investors in terms of a better risk-return tradeoff.

Reference: Brigham, E. F. &Houston, J. F. (2009). Fundamentals of Financial Management (with Thomson ONE – Business School Edition) Gitman, L. J. ( 2000). Principles of managerial finance. McGraw-Hill Investopedia. (n. d. ). Weighted Average Cost of Capital. Retrieved July 23, 2010, from http://www. investopedia. com/terms/w/wacc. asp Scribd. com. (n. d. ). Cost of Capital. Retrieved July 23,2010, from http://www. scribd. com/doc/9675052/Cost-of-Capital Thismatter (n. d. ) Single Asset Risk Retrieved July 23,2010, from http://thismatter. com/money/investments/single-asset-risk. htm

1. Introduction

       The first part of this paper will critically evaluate the Financial Management policies and practices of Kingfisher for the five-year period 2004 through 2008 by looking how the company has kept its stock prices attractive to investors in relation to the measurable revenue growth and profitability. This will also look into the liquidity position and solvency position as well as the company’s efficiency in the management of company resources.  The second part will determine whether or not the current share prices of Kingfisher plc represent a “fair value” by conducting stock valuation using the company’s estimate of cost of capital.    The first part will include an analysis on the financial ratios of Kingfisher for the years 2004 through 2008 as basis of knowing how the company performed financially and the results of the analysis will used as proofs or in evaluating the company’s financial policies and practices.

2. and 3. Analysis and Discussion with Conclusion

First Part

2.1 How has the company’s stocks performed?

       The best evidence of well performing company is the stock price of the company. Increasing stock price is the evidence of a growing and well performing company since a company will always logically aim to have higher stock price.  The stockholders are first and foremost interested in the maximization of their wealth and they desire to have higher stock prices. There is thus a need to compare current prices with their old price and if the former is higher, the same would point to increased wealth after adjustment for inflationary effects. Increasing wealth is the dream of every stockholder since each stockholder has other options with their money other investing with Kingfisher.

     Using the stock price as basis to evaluate the company’s financial performance, Kingfisher exhibited a continued decline in stock price for one year. See Figure 1 below.

Figure 1.   Graph of Kingfisher stock for one year

Source: MSN, 2008a

    The declining stock price appears to be more disastrous for the company considering that the company appears to have shown only a increase in revenues from 2007 to 2008 after suffering a continued decline in revenues for the years 2004 through 2007.  This means that company has not impressed investors by the increase in its revenues for 2008 in terms of increasing stock prices in the stock market. See Figure 2 below.

Figure 2.: Revenues for the last five years., Source MSN, 2008b

2.2. How has the company performed financially?

      Looking at the company financial performance is best attained by understanding its revenue and profitability growth. This portion will therefore analyze the company’s gross margin, operating, and net profit margins on whether they are growing in the normal course of events. This will also look into other measures of profitability like return on assets and return on equity and relate the same with the margin ratios.

       Sales revenues showed continued decline for the past four years from 2004 through 2007.  The company managed to have caused a revenue increase in 2008 but the increase was not even able to reach the 2004 level of revenues, the fall started.  Sales revenues in 2004 got recorded at £9.3 billion. This amount decreased to £8.6 billion in 2005, further went down £8.0 billion 2006 and still not enough for it went down further to £7.6 billion. Fortunately, the 2008 revenues showed an increase to $8.8 billion but it still lower than the 2004 revenue level of £9.3. See Figure 2 above. Moreover, the increase in 2008 was not reflected in the stock price behaviour from 2007 to 2008 because of the latter’s decline for the same period.  As to why the increase in revenues countered the decrease in stock price may be appreciated by studying further the company’s profitability. Although increase in revenues is an important goal of every business, Kingfisher was sacrificing or giving up profitability in exchange.

         Gross margins exhibited to some extent an increasing trend for the years 2004 through 2007 within the range of 34 to 37% and in 2008 a remarkable rate was reflected at 50%. When viewed in the context of decreasing sales revenues for the years 2004 through 2007, the growing trend in gross margins can be considered a favourable development. But the increasing gross margins will still have to be verified if the said sign of positive development is sustained in terms operating margins and net margins.  See Figure 3 below.

     Net operating margin for Kingfisher started at 5% in 2004, slightly increased to 6% in 2005 and then went down to 3% in 2006.  A fluctuating trend was therefore notable with the net profit margin since after the decrease in 2006, it went up again to 9% in 2007 but only to fall again to 6% in 2008. It could be further observed that the increase in gross margin in 2008 was not matched by the decrease in operating margin for the same period.  See Figure 3 below. Kingfisher’s net profit margin may further provide explanation on whether the increase in gross in margin in 2008 has in fact contributed to the profitability or not of the company.

 Figure 3. Gross Margin, Net Operating Margin, Net Profit Margin Analysis, Source MSN, 2008b

       The company’s net profit margins have behaved almost similarly as that of the net operating margins.  In addition, the profitability of the company was further made lower if net profit margins are compared with net operating profit margins. The fact that net profit margins are lower than net operating margins, is an indication that the company has no other non-operating income that could have increased its income from operations. The company was spending additional expenses for interest expenses due to loans made with creditors. If assessed at this point whether the company is growing, it can be stated that there has been poor growth in revenues and low profitability. There are other ways of verifying the truth of this preliminary assessment using other profitability ratios.

       The company’s return on assets (ROA) is one way of confirming or denying the preliminary finding as to low profitability of Kingfisher.   The company reflected a 3% ROA in 2004 and that it was able to increase the same to 4% in 2005 but only to allow it to fall to 2% in the 2006. See Figure 4 below. Like the other ratios, the company was able again to increase the rates after the fall when its ROA increased to 6% in 2007 but again drove down to 3% in 2008.  On the average, the company was getting only about 3% at return out of its assets for the last five years and when inflation is factored in, the return could actually be almost wiped out. ROA is computed by dividing Net Income After tax by the Total Assets of the company for the year. See Figure 4 below.

      The company’s return on equity in particular could offer an additional way of understanding the company’s profitability performance. It will be observed that like the gross margin, net operating margin and net profit margin ratios, the return on equity also showed fluctuating trend.  Starting at 6% return on equity in 2004, Kingfisher was able to have increased the rate to 8% in 2005 but failed to maintain the same rate when it went down to 3% in 2006. Again the company appeared to have done well in 2007, when it was able to bring the ROE to 10% but only to allow it to fall again to 5% in 2008. See Figure 4 below.  From the point of view of an objective analyst or researcher, the lack on control in the increase and decrease of the company’s profitability ratios is an evidence of lack of control with operations and may indicate lack of proper planning or strategy formulation.

Figure 4.  ROA and ROE Graph, Source MSN, 2008b

       When viewed in the context of the home improvement retailing industry, Kingfisher may be said to be performing below competition. The company had only shown a return on equity of 6% in 2008 as against the industry average of 21.01%.  From a simpler point of view, other players are earning more than three times than the company does. See Appendix I.

2.3 How has the company performed in terms of liquidity and solvency position?

      One way of evaluating a company’s performance is by looking at it liquidity position which may broken down into liability position and cash position for the past five years. This part will therefore discuss on how the company is managing its debts and it cash for the purpose of determining the efficiency of the use of cash in the way the management of Kingfisher runs the business.

       Kingfisher like other companies has its share of liabilities which are broken into current and non-current liabilities.  The company’s assets are not fully owned by stockholders as indicated by the presence of liabilities which constitute not less than 25% of the total assets as shown in the Figure  5 below.

Figure 5- Liability Position Graph of Kingfisher

Source: MSN, 2008b

     Given the company’s assets in relation to liabilities, it is very relevant to examine the company’s liquidity ratios which include the current ratios and quick asset ratios.  The current ratio of Kingfisher was pegged at 1.03 in 2004, improved a little to 1.06 in 2005, declined to 0.98 in 2006, decreased further to 0.97 in 2007 and still further down to 0.91 in 2008. See Table 1 below.  In the p of five years, it was only in 2005 that the company’s current ratio experienced an increased and the others are joined in declining movement. This means that the company’s low profitability was not able to sustain it liquidity ratios because of noted decline in the later.

     The quick asset ratios of Kingfisher almost behaved similarly as that of the current ratios since from 0.24 in 2004 in increased slightly to 0.32 in 2005.  After this increase, the same was followed by two periods of decline when it went down to 0.30 in 2006 then to 0.25 in 2007. See Table 1 below.  Instead of declining in 2008 as that of current ratio, a slight increase to 0.31 was fortunately noted.  However, the improvement in quick ratio in 2008 was almost not felt since even if there was increase, the company appears to be still below to what is normal ratio for a liquid company.  The current ratio was already below 1.0 in 2008 hence the slight increase in quick ratio will almost be not appreciated  by creditors, which will most likely be affected by the declining liquidity ratios.

Table 1- Liquidity and Solvency ratios, Source MSN, 2008b

       Liquidity means the company’s capacity to meet a company’s currently maturing debts and obligations. The current ratio and the quick asset ratio are the conventional ways of measuring the company’s liquidity. To get current ratio, current assets will have to be divided to current liabilities and to get quick assets ratio, current assets must be reduced by the amount of inventory and prepaid expenses to get the quick assets before the dividing to the total current liabilities that was used in current ratio. Thus, it is normal to have quick assets in the form of cash, marketable securities and accounts receivable. These quick assets are more readily convertible to cash; hence they are called to be quick assets. If compared therefore with current ratio, quick asset ratio is a theoretically a better measure of liquidity because of its more readily convertible to cash characteristics. In the case of Kingfisher, its current ratio has been declining to even below 1.0, hence looking at quick asset ratio, could only indicate that the latter could be lower and indeed the same was found to be true.

     If the company’s declining liquidity is related with poor revenue and growth and low profitability, it could be deduced that the result was somewhat expected since profitability is one of the best source of liquidity.  Since the company could barely sustain operations because of low profitability, improving its liquidity could not also be attained. In a sense it could be stated that low profitability is causing declining liquidity.

      A more specific way to examine the company’s capacity to avoid the risk of running into bankruptcy is the use of the company’s cash position.  See Figure 6 below. The company in the figure below has shown too much dependence from cash from operations.

Figure 6: Cash Position Graph

Source: MSN, 2008b

        It can be learned that Kingfisher has been able to keep positive cash position for the last five years with cash basically derived from operating activities.  This could be based for both investing and financing activities when Kingfisher was a net user of cash, except in 2004 when cash from investing activities appeared positive through out the five year period from 2004 through 208.  This is an indication that without the company positive cash flow from operations, the company would have had negative cash balances for the fast five years.  It could be recalled that the company has already suffered continuously decline in revenues except in 2008 and fluctuating yet low profitability level of the company.  To be informed that the company is depending from operations given such situation for the company would make it very precarious for Kingfisher as if a slender stem is being made to hold many branches of a tree.  This could be confirmed by the fact that if the net cash from operations are compared or divided with the current liabilities, where the resulting ratios are very much below what a normal health company has. From a ratio of 0.17 in 2004, it increased a little to 0.27 in 2005, but only to fall again in 2006 to 0.14 and then rose again to 0.24 in 2007 but followed again by a decline to 0.18 in 2008. See Table 2 below.

Table 2- Operating Cash Flow Ratios, Source MSN, 2008b

      This   confirms earlier findings of declining liquidity which could lead the company to bankruptcy brought by its inability to meet its currently maturing obligations. It could be asserted that Kingfisher failed to avoid the danger of having low revenue growth and low profitability.   The best thing that could be done by done by a company with a low profitability is to at least maintain its short term health by maintaining at least good liquidity position but the company appears to be least concerned on the matter. It could be taken as poor use of limited funds and inefficient use of money.

      As to whether there is further basis to the claim of inefficient funds may be examined further by looking at the solvency ratios of the company.     Kingfisher’s debt to equity ratio was pegged at 1.00 in 2004, improved to 0.95 in 2005, and then improved further to 0.94 in 2006. Indeed the improvement in the ratio was consistent as the company  has further improved to 0.76 in 2007 and then to 0.62 in 2008. See Table 1 above. The ratios are certainly eye-catching since the continued decline to below 1.0 is an indication that the company is bent on really strengthening its long-term health. It would mean however that the company is giving priority to long-term health over that of short term health because of the declining liquidity.

       A company is said to be solvent if it has the company’s long-term capacity to maintain its stability over the long term. The industry makes use of the debt to equity ratio, which is computed by dividing the total debt of the company to its total equity.  A solvent company may be inferred also to have the capacity to balance long term risk and could be taken as evidence of a well functioning capital structure if the supported by increasing stock price of the company.   A deeper analysis would however reveal that such was not the case. It is undeniable that the company has been able to continuously improve its debt to equity but when compared with the way its stock price has improved for the recent year, the end of strengthening solvency seems to be not justified because of the declining stock price.  The same could be further confirmed when solvency is compared with the resulting profitability and liquidity of the company.  There is clear evidence that liquidity position is being considered a less desirable objective as that of improved solvency position is given priority yet not producing the expected result in the price of stocks.

     Given the desirability of all the ratios, it must be made clear that one ratio could influence the result of the other ratios. Generally a profitable company should be interested to maintain its liquidity ratios at desirable level so that creditors would be assured that they would be paid on time and which cause said creditors to continue transacting business with the company.  At the same time, a company would want to have long-term health since investors and creditors want to be assured of their investment without thinking or worrying that the next day would not be good day or next month for these investors and creditors. The profitability, liquidity and solvency ratios must all be brought to their desirable level and that by doing so, it would be easier to see the effects in terms of higher stock price of the company which will assure investors or present stockholders that they could sleep and wait to have higher wealth in the future because the business the business is generating profits above cost of capital.

    In the case of Kingfisher, declining revenues or low revenue growth could only produce low profitability level and that the company was being force to choose whether liquidity or solvency is more important over the other. The company has incidentally chosen solvency but unfortunately, the effect was not seen in terms of increasing prices of its stocks for the period concerned.

2.4   Conclusion – Evaluation of financial strategy, policy and practices of Kingfisher.

      The framework for evaluation is whether the company’s financial strategy is accomplishing corporate objectives in terms of revenue growth and profitability, liquidity and solvency. In particular, there is need to determine whether the company makes and executes its financial strategies in relation to its competitors.

       The management cannot be said to be doing well in accomplishing its objectives when its stock prices and revenues are not increasing and its profitability continued to be low for the last five years. Compared with its competitors, the company is doing poorly.

By Kingfisher’s failure to stop the decline it its stock price as shown earlier, there is basis to deduce a management failure to accomplish what the investors expect the company to attain.  There is a strong evidence of failure to maintain an increasing growth in revenues for the past years and being made more bothersome by its low profitability level.  The noted increase in revenues in 2008 after four years of decline was not complemented by an increase in profitability; hence a poor way of handling financial strategy could only be derived or extracted from said results.

         The company’s competitors include among others Home Depot, and Land of Leather. The company’s poor financial performance is very much evident given its 6% Return on Equity which is very much below that of Home Depot of 16.69% and that Land of Leather at 40.35%. (MSN, 2008) The average ROE of the three companies including that of Kingfisher was at 21.01% which is more than three times that of the company.  See Appendix I.

Second Part

3.1 Determination of intrinsic stock price whether it represents “fair value”

3.1.1 Estimate of cost of capital for Kingfisher

        To determine the value of Kingfisher’s stocks of Kingfisher requires the use of the company’s cost of capital which is the opportunity cost of choosing an alternative. By the cost of capital the investor is guided whether one is earning from the choice of alternative or not.  This cost of capital is aimed to be minimized by every business so that wealth maximization objective is best attained.  Upon determination of the cost of capital, the same will be used as discount rate in bringing cash flows for the company to their present values.  The same cost of capital will be used in determining the estimated selling price of the company stocks under the dividend discount model.

          The same cost of capital may be determined using the capital asset pricing model (CAPM). The model requires the use of risk free rate investment which may be represented the rate in earned in government Treasury bill plus a premium for the additional risk as a result of making investment decisions which carry higher rate of return than risk free investments.  CAPM formula is described as follows:   Required (or expected) Return (Ks) = RF Rate + ((Market Return – RF Rate) * Beta)

        RF stands for risk free rate as may be represented by the Bank of England (2008) base rate of 5%.  The same rate assures the investor of getting more or less the said rate without any risk since it is the government which will make it sure the rate is honoured since it assumed that no government will become bankrupt.  The beta in the formula above measures market risk, or the extent to which the returns on a given stock move with the market. The formula still needs the market return which is estimated at 15.15% derived by taking the average market rates of at least three players in the industry including that of subject company.    Kingfisher’s beta is 1.17 (MSN, 2008a).  By substituting the given and extracted data into the formula, the estimated cost of capital of the company is 16.875% calculated as follows: Required (or expected) Return = RF Rate + Beta (Market Return – RF Rate) = 5% + 1.17 (15.15%- 5%) = 16.875%.

         Based in the computation above using CAPM, Kingfisher has a required rate of return of 16.875%. An investor who plans to invest in the stock of the company should be earning at least 16.875% return on his investment. The inability to earn a minimum of this required rate of return or cost capital would be a sign for financial management decision since earning below this would just be waste of time and money.  If the average 6% ROE of Kingfisher is brought at this point, it could be asserted that the rate is very low considering this double digit cost of capital that the company has. Thus to see investors of Kingfisher disposing their stocks would be a normal expectation given the low profitability level of the company and high cost of capital.

         An alternative way to arrive at the cost of capital is extracting the reciprocal of the price of the company’s price earnings (P/E) ratio.  Arriving at P/E ratio required dividing the market value per share of Kingfisher’s stock by the company’s earning per share as taken from its financial statement.  As applied, using the reciprocal of the P/E ratio, Kingfisher was found to generate an estimated cost of capital of 11.76%. See Appendix I.

3.1.2 Computing the intrinsic value of the company’ stock using discount rates as estimated above

      The market value using the constant growth model is determined by using the growth rate of the dividend per share of -7% per year (See Appendix III) and the cost of capital computed at 16.875% using the CAPM.

     The resulting market value per share would be is £0.66. See Appendix II. Computation of  the market value necessitates information on Dividend last year D0, expected growth rate in dividends (g), and the discount rate (Ks).  The dividend paid the latest year (2008) is given at 0.07 pence while the expected growth rate was computed by getting the average rate of the dividend per shares for the prior years computed at negative 7% while the discount factor used is the one computed using the CAPM model at 16.875%. If the 11.76% discount rate as computed using the reciprocal of price-earning ratio, the stock price for Kingfisher is £1.37.

3.1.3 Does the company’s stock price represent fair value?

     The determination of whether the stock of the company is quoted at its fair value or not needs comparison to the same the intrinsic value as computed. Using last sale of £0.98 quoted price from stock exchange by the company (Kingfisher, 2008a)  as against £0.66 intrinsic value, the stock price of Kingfisher may be concluded to be overvalued by £0.32 per share. If the price using P/E reciprocal is used, where the intrinsic value of £1.37 was found, the stock value of the company’s stock may be asserted to be undervalued by £0.39. It would appear that the there is over or undervaluation depending on the formula that is used.

3.2 Conclusion

      Using CAPM model, this paper discovered that that Kingfisher has a required rate of return of 16.875% or using the P/E reciprocal to be 11.76%.  The resulting prices of stock using these two discount rates led to the discovery that the company’ stocks are indeed overvalued or undervalued depending on the method compared with quoted price from the London Stock Exchange.  This would mean that holders of the present stocks of the company would be advised to dispose of their stocks in the CAPM method is used on valuation since there was a finding of overvaluation of £0.32 per share or keep their stock if the P/E reciprocal is used because of undervaluation of £0.39 per share. For the purpose of this paper, this researcher believes that the use of CAPM is more accurate than simple getting the reciprocal of the of P/E ratio, then this paper adheres to finding of overvaluation.

      Given the failure of the company to prevent the declining sales and low profitability as well as declining liquidity, the overvaluation may be in order.  Investors are therefore advised to dispose of their stocks from Kingfisher based on the finding of overvaluation.

4. Appendices

Appendix I- Competitors data and averages

Appendix II- Computation under Dividend discount model

Appendix III- Computation of dividend growth rate

Source: MSN, 2008b

5. References

Bank of England, Base rate- July 4, 2008, {www document} URL http://www.bankofengland.co.uk/, Accessed July 7, 2008

Kingfisher (2008) 2008 Annual Report, {www document} URL, http://www.kingfisher.co.uk/, Accessed July 7, 2008

Kingfisher (2008a) Company Website- Share Price Detail from London Stock and Brand Names Carried by the Company
Exchange, {www document} URL, http://www.kingfisher.co.uk/index.asp?pageid=156, Accessed July 7, 2008

MSN, 2008a, Financial Statements 2004 to 2008, {www document} URL, http://moneycentral.msn.com/investor/invsub/results/statemnt.aspx?Symbol=US%3aKGFHF, Accessed July 7, 2008

MSN 2008b, Stock price graph of Kingfisher for 5 years, {www document} URL http://moneycentral.msn.com/investor/charts/chartdl.aspx?iax=1&Symbol=US%3aKGFHF&CP=0&PT=9, Accessed July 7, 2008

MSN, 2008c, Beta and P/E and ROE for Land of Leather {www document} URL http://moneycentral.msn.com/detail/stock_quote?Symbol=US%3ALOLHF , Accessed July 7, 2008

MSN, 2008d,  , Beta and P/E and ROE for Home Depot , {www document} URL http://moneycentral.msn.com/detail/stock_quote?Symbol=HD, Accessed July 7, 2008

A financial intermediary is a person or an entity, which connects provider of a financial service to a buyer of a financial service, or the vice versa. Thus, a financial intermediary plays “an important role in the transfer of funds from savers to the final users”. A bank is the typical example of a financial intermediary, collecting funds (deposits) and lending the same, without any intervention of the depositors.

Presently, with barriers being removed for cross border trades and other similar measures, flow of resources from one place to other; from one country to another, has become easy, and this ensures speedy and efficient productive deployment of financial resources. Despite this the importance of financial intermediary continues to be significant even in today’s modern world. One of the major reasons is that most people or users of financial resources rarely come into direct contact of the lenders of these resources.

Herein lies an important role, which a financial intermediary plays: lending directly is always riskier than lending through an intermediary. Secondly, a financial intermediary has the capacity to diversify by lending to multiple people and corporations, which an ordinary lender does not have. Secondly, a financial intermediary acquires specialization, knows the financial market well, and is able to raise and lend funds in an efficient manner.

Thirdly, modern financial markets are marked by “financial innovation and the process of securitization”, and they require not only a large capital and resource base but also a deft handling of the activities like the ones seen in forex market or derivative market. The foregone conclusions are obvious: the `modern world` with its great allocative efficiency and productivity could not exist without financial intermediation. The modern world with all the globalization and integration of economies requires financial intermediaries for still more efficient allocation of financial resources.

The following tables show the appropriate NPV values of the proposed project assuming the discount rate is 15% as the literature states. Tables have also been included to represent discount rates of 10% if the project exceeds expectations or 30% if the project doesn’t meet forecast. The financial assessment method of NPV has been chosen as the primary assessment method as NPV includes all relevant cash flows irrespective of when they are expected to occur and takes into account date of flows with discount factors.

The discount factors take into account that a is worth less in a years time than its present value due to inflation so an investment to be worthwhile has to exceed inflation. NPV has a direct impact on the wealth of shareholders in the company and as a company’s main aim is to create wealth a positive NPV enhances a company’s wealth thus a negative NPV reduce company wealth. The NPV of the project shows positive figures for all the discount rates applied showing that even if the project doesn’t perform to expectations it will still produce a positive NPV even if 30% discount factors are used as a worst-case scenario.

Other Methods of Evaluating Project The pay back period or PP as it is often quoted could be used to show how long the project would take to payback the initial investment from the projects cash inflows. This could have been used only in the project to show how long the project would take to repay the initial investment in the vehicles. Payback period isn’t of any real benefit in this projects context, as PP doesn’t show profitability and only deals with cash flows until payback has been achieved.

PP also has no mechanism to deal with problems of risk or uncertainty relating to the project. Pay back as a method of analysing the project has been discounted because of its shortcomings in providing a complete analysis of the projects potential. Accounting Rate of Return or ARR method, which takes the average accounting profit that the investment will generate and expresses it as a percentage of the average investment over the life of the project.

This basically would show the percentage return of the capital at the end of the investment and ignore s cash flows. ARR is not really suitable to measure performance over the life of the project; it is cash flow rather than accounting profit that is important. Cash is the measure of economic wealth generated by an investment. This is particularly important with the TOSA Project, as cash is needed to buy the licence each year so cash flow is an important measurement when gauging the projects potential.

Internal Rate of Return or IRR have also been overlooked as an analysing method in assessment of the project as IRR doesn’t address the question of wealth generation although it would indicate the same signal as NPV as to whether a project should go ahead. IRR would also ignore the scale of investment made and assume that a high rate of return being preferable without taking into consideration cost of capital, which is an important investment decision in any project.