BAE system is one of the world leading company in the defense sector. In the present research, equity valuation is done by using DCF, PE ratio and dividend yield approach. Varied ratios are calculated to measure dividend affordability by the firm. Corporate life cycle and shareholder value created by the company is evaluated.
(a) Capital structure and cost
(1) Cost of equity and cost of debt and WACC for five years
Cost of equity is computed by using the CAPM model which is also known as capital asset pricing model. By using this model return that investors must earn for taking particular intensity of risk by making investment in equity is determined. Required rate of return on equity fluctuate regularly. This happened because market of UK is very volatile in nature and in last five year return generated by it is changing constantly. Changes in geopolitical conditions and slow economic growth rate of major economies affect stock market globally which affect FTSE Index and make it more volatile (Howard and et.al., 2016).
In the year 2015 market return was -4.67% and in the year 2016 return percentage was 17.22%. Further, in the year 2017 market return percentage was 7.10%, which was very low relative to 2016. In the year 2018 return percentage become negative and become -12.3%, followed by 2019 when return was 12.66%.
Overall, fast change in the market return lead to fast change in required rate of return on BAE shares. The beta value in each year remains in the range of 0.74 to 1 which means that equity of BAE system is highly volatile in nature. Hence, in the year 2015 and 2018 those who make investments in BAE systems face heavy loss on investment. In 2017 and 2018 low return generated by BAE for investors.
Interest burden on the BAE system seems in control in the business as after 2016 it is declining regularly. The rate may also be high because the firm failed to pay to creditors on account payable on time. For one month suppliers do not charge any interest, but in case of late payment interest is charged from their side and this may be reason behind high interest rate. In computing, the WACC always cost of debt post tax is considered and due to this reason in calculation of cost of debt tax rate is also taken into account (DeGrasse, 2016). In the years when CAPM show negative results WACC is negative. WACC is fluctuating regularly in line to same in market return.
Company’s equity is overvalued in the market based on DCF model. A company financially is in good position and is capable to pay interest and the loan on time. Relative to LM major rival BAE give similar performance, but due to less CAPEX is slipping to seventh position in the defense market. Instead of declaring dividend every year firm must make a heavy capital expenditure in the business to regain its previous position in the defense sector.
Books and journals
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BAE annual report 2018., 2018. [Online]. Available through:< https://investors.baesystems.com/~/media/Files/B/Bae-Systems-Investor-Relations-V3/PDFs/results-and-reports/results/2018/annual-report-2018.pdf>.
Debt/EBITDA ratio., 2020. [Online]. Available through:< https://www.readyratios.com/reference/debt/debt_ebitda_ratio.html>.
Dividend information., 2020. [Online]. Available through:< https://investors.baesystems.com/shareholder-information/dividend-information>.
Lockheed Martin Corporation., 2019. [Online]. Available through:< https://www.lockheedmartin.com/content/dam/lockheed-martin/eo/documents/annual-reports/lockheed_martin_annual_report_2019.pdf>.
Top 100 for 2019., 2020. [Online]. Available through:< https://people.defensenews.com/top-100/>.