TBS assign 1

2015
































FINANCIAL STRATEGY
TBS907
ASSESSMENT 1
Submitted By: Shaheen Tariq
Student Number: 4997359
Submitted To: Dr. Martin Gold



Table 1.1: TELSTRA Data
Share Price
$6.19
Beta
0.5
Industry Beta
0.37
EPS
$0.373
PER
18.6 times
Div (2014)
$0.285
Rm
6.0%
Rf
2.96%

Answer no. 1
Capital Asset Pricing Model or CAPM explains the link amid risk and return explaining that the expected risk premium which shows difference between the return on market and interest rate on bills, on any security equals its beta or systematic risk times the market risk premium (Brearly, Myers and Alan 2006). To calculate the return on equity using CAPM we use the following formula;
Expected return = r = rf+B{rm-rf}
Where; rf is the risk free rate on the government bonds, rm is the return on portfolio of the market and beta value for the stock is denoted by B also known as the systematic risk. Systematic risk or undiversifiable risk is the one which cannot be completely eliminated or avoidable and have a huge impact on the economy hence, on the market e.g.; interest rates, inflation, recession are the types of risk which cannot be controlled or diversified and according to Brearly, Myers and Alan 2006, these are generally the only types of risk investors care about.
According to the asset pricing model the return on the security is higher than the return on government bond is known as the risk premium which the investor gets from the market for taking the systematic risk which is measured by beta. Also, risk premium is the highest return which an investor can expect for taking a higher risk on that particular security (Sheeba Kapil).
For TLS's expected return;
r = 2.96% + 0.5(6.0%-2.96%)
= 2.96% + 0.5 (3.04%)
= 2.96% + 1.52%
r = 4.48%
Since the systematic risk is below 1 i.e. 0.5, that is the reason why the return is also not so high.

Answer no. 2
Model with constant growth which is also known as Gordon growth model is used to determine the fundamental stock's value relying on future dividends that grow at an invariable rate which means that the growth rate remains the same for the required period of time, the model helps in solving the current price of the unlimited series of forecasted dividends. Investors compare the value of the stock to the market price of the stock in order to determine if the stock is being traded at a fair or actual value.
The key concept of this dividend discount model is that the investors will invest in a stock which would reward them with some future payment in cash and so, the future payment of dividend is used to determine the worth of the stock at this time.
P= Dividend/return – growth
= 0.285(1+0.035)/0.0448-0.035
= 0.2949/0.0098
P = $ 30.09
In 2014 investors were paid a dividend of $0.285 and forecasted dividend in the following year 2015 would be 0$0.2949. The forecasted growth in dividend was about 3.5% a year over the foreseeable future. If investors required a return of 4.48% from Telstra's stock then the constant-growth model gives a share value in 2015(current price: P) of over $30.09
Answer no. 3
PER valuation is the most widely used approach for investment decisions by the analysts. Price-Earnings ratio is a way in which a company is valued through its current price compared to its earnings per share. Investors see the price to earnings ratio in order to gauge the earning strength of the firm in the future. Firms which have high ratios have high growth potential whereas companies with lower P/E ratio have lower growth opportunities.
For Telstra, using the dividend discount model we calculated the current stock price and given EPS we get;
PER=Current price/EPS
=$30.1/$0.373
PER= 80.7
The price to earnings ratio of 80.7 explains that even though it might look like an attractive investment, but buyers would think of it as an overpriced stock.
However, we will look at five core valuation factors of Telstra using the 1H15's financial statements which include the risks, growth and see if these factors have any impact on the company's performance and affect the future market price.
These five factors in my view are those which might have an impact on the future performance of the company in such a way that each factor always have a standardize affect on any company e.g. Any one element which reduces the NPAT (net profit after tax) of the company, leaving the company with a lower profit than it made in the given period, resulting in lower earnings per share leading up to decreased dividends hence, decline in the market price of the company.
Sales Revenue (+): Telstra's sales revenue increased by 0.6% which is a good sign for the company as it will elevate the future market price of the company however if we closely notice and compare it with last few years the sales growth rate has dropped down by a big difference.
Finance Costs (-): FC are the costs of borrowing e.g. interest which in TLS's case decreased by 28 %(YoY) which could be due to a decrease in the net interest charges. This could be positive for the company's value for investment perspective.
Expenses (-): TSL's other expenses increased by 7.6% due to an increase in advertisement, promotion and services agreement etc. An increase can prove to be bad for the company's future performance since the historical figures show that these expenses occurred in huge amount this year.
Gearing (-): This shows how much of the company's operations are funded by lenders against shareholders. TLS's gearing ratio increased to 49% this year than 43% last year. This increase is due to an increase in the net debt and a decrease in the equity because of the share buyback during the period. This can affect the company's performance in the short run however things look retainable in the long run.
Free Cash Flows(-): There was a decline in the company's free cash flows by 84.1% which proves to be extremely alarming for the company because this might restrain the investors as they would get a negative picture of the company since, maybe the company will not be able to pay its debts, or dividends to its investors. However, this could be due to shares buyback by TSL in this period.

Value of each share= (EPS)(PER times)
=($0.373)(18.6)
=$6.9
PER Multiple Valuation Approach= $6.9(a)(b)(c)(d)(e)
Where; a=sales revenue, b=finance costs, c=expenses, d=gearing ratio, e=free cash flows
PER Multiple=$6.9(+0.006)(-0.28)(+0.076)(+0.49)(-0.841)
=$0.000363

Answer no. 4
The return on shareholder's funds for Telstra Corporation of 4.48% shows that the stock is less sensitive to systematic risk factors, so it will be a good addition to the portfolio in a way to minimize the overall risk in entire selection of stocks considering beta sensitivity only. Since, investors who are more risk averse will be more interested in this kind of investment which gives a handsome return and probability of loss is minimum. However, if we look at the larger picture where the risk of the industry is 0.37 lower than the company's 0.5, there is a possibility that investors will be worried about taking a lot more risk than they have to if they buy TLS.
The calculated future value of the share of stock is $30.1 and investor's sole purpose for purchasing the stock at this price is to receive the dividends which the model helps us forecast whereas, it is difficult to predict all these numbers which are used in the calculation, which may yield incorrect results. Also, estimating the future sales of the company may be complex as the analysts might exploit the numbers in order to show the company's stock more desirable (Heim et all).
Even though the company's PER is very high, for some investors this maybe an overpriced stock which might lead the investors to regret later when they have actually bought the right stock but at a higher price and get a return lower than they expected (Aswath Damodaran). This reason might pull back a lot of investors from investing in TLS. But there are also other factors such as technology; more people are subscribing to Telstra's prepaid and postpaid, mobile broadband, 4G and an increase in the mobile margin by 40% from which the company earns its revenues. It is important for an investor to be wiser in the investment decisions than the market e.g. buy the stock of a company which has a lower price to earnings ratio when the prospects of the firm are much better than shown in the ratio.
In my view the five factors which may affect the future market price of the company can be taken care of in the future time periods. Sales revenue did increase by 0.6% but it can still do better and this can be done through new ideas and innovations which also the investors find attractive. Other factors such as finance costs, expenses can also be improved if these costs are cut down such as promotions, advertising expenses etc, if not done so, the EBITDA will keep falling for the years to come and drag the company in a position where even the gearing ratio would keep increasing and will cross the target zone of staying between 50%-70%.
By and large, I recommend the investors to buy TLS's shares for their portfolio at the given price in order to enjoy the return of 4.48% or more keeping in mind the constant growth rate of 3.5%, handsome dividend and the fact that the company is listed as the top 10 stocks in the S&P/ASX index. Not only this, also as the systematic risk is low at 0.5, it might balance the overall risk of the portfolio and reduce it in case there is a loss on any other stock in the portfolio will be offset by the gain on TLS's stock.














BIBLIOGRAPHY
Brearley, R.A, Myers, S.C, & Allen, F. (2006) Fundamentals of Corporate Finance 7th edition, New York: McGraw-Hill/Irwin
Heim, L. & Post, T. (2005) Investments, Harlow: Pearson Education Limited
Fama, E.F. & French K.R. (2004) " The Capital Asset Pricing Model: Theory and Evidence", Journal of economic Perspectives, Vol. 18 Iss: 3, pp.25-46
Aswath Damodaran (2012) "Investment Valuation: Tools and Techniques for Determining the Value of any Asset".
http://www.telstra.com.au/uberprod/groups/webcontent/@corporate/@about/documents/document/uberstaging_291152.pdf
Telstra Corporation limited-Financial results for the half-year ended 31 Dec 2014, released on 12th Feb 2015.
Sheeba Kapil, Financial management (2011).












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