Master of Business Administration Strategic Investment Management Assignment

Assignment Brief As part of the formal assessment for the Master of Business Administration you are required to submit a Strategic Investment Management assignment. Please refer to your Student Handbook for full details of the programme assessment scheme and general information on preparing and submitting assignments. Learning Outcomes: After completing the module the student should be able to: 1. Identify key models and use them to calculate the stand-alone valuations of a target company in a potential acquisition bid. 2. Assess the likely strategic components in formulating a bidding strategy for the acquisition. 3. Undertake strategic investment decisions using a range of methodologies; 4. Critically appraise the strengths and weaknesses of a number of investment decision techniques; 5. Communicate the potential impact of behavioural aspects on financial management decisions Assignment Task Sir Walton Hamilton, the incumbent Chief Executive of Sesperian plc, had recently resigned after successfully directing the company for the past twenty years. During that time the company had become a relatively successful business in its sector achieving moderate market share through organic growth. Rebecca Donato had recently been appointed as Chief Executive to replace Sir Walton Hamilton. Rebecca was quite young for a chief executive, but had been chosen for her drive and enthusiasm, and was seen as someone who would grow the company. Rebecca Donato was particularly keen on expanding the company quickly through merging or acquiring companies which would provide a strategic fit with the long-term goals of the company. This had been discussed at previous Board meetings of the executives and it had been broadly agreed that such a strategy would provide faster results rather than just relying on organic growth. Not everyone had been in complete agreement and some of the members thought that such a strategy would change the culture of the business and had inherent risks if the acquisition was not successful. However, at these meetings, the new Chief Executive had been able to persuade the members that it was the best way forward if the company was to achieve growth in the short term. At these Board meetings, some potential targets for acquisition had been discussed and one in particular had been highlighted. Therefore, Rufus Banda, the Finance Director had been given the task of working with Henshaw Investment Bank, to arrive at a valuation of the target company in order that a bidding strategy for the acquired company could be determined. Details of these valuations were to be brought to the next Board Meeting for discussion. At the subsequent Board Meeting called by Rebecca Donato at the beginning of July the valuation of the potential target company, Agrosolutions plc, was tabled and discussed. It had been agreed that Sesperian would bid for all the assets of Agrosolutions plc (the whole firm). Working with Henshaw Investment Bank, Rufus Banda presented the following details regarding the target company and its valuation.

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Present revenues (year 0) amount to £10 million. These revenues are expected to grow at a rate of 7 per cent per annum. The cost of goods sold (COGS) is 60 per cent of sales and selling, general and administrative (SG&A) expenses are expected to be 15 per cent of sales. Net working capital is 21 per cent of sales and depreciation is estimated at £1.2 million per year. Henshaw Investment Bank had also valued Agrosolutions’ Net Property, Plant and Equipment (NPPE) to be £12 million, and the capital expenditure (CAPEX) required per annum is given as £1.3 million. The tax rate had been estimated at 39 per cent. Henshaw had also estimated the steady state growth of Agrosolutions’ to be 6.5 per cent per annum. Rufus Banda explained that after evaluating the various valuation methods available Henshaw Investment had advised using the Discounted Cash Flow Technique. He went on to explain that the first step involved calculating the Free Cash Flows of Agrosolutions plc over a period of five years to ascertain its stand-alone value. Rebecca Donato commented that surely synergies could by achieved which may well increase the value of the targeted company. The Finance Director explained that any synergies could be added in at a later stage. He further explained that it was prudent to establish a stand-alone price as it allowed the target’s shareholders to justify a floor for their negotiations, as well as comparing it with the target’s current market value. In addition a terminal value which reflects the free cash flows after the end of the forecast period needs to be calculated and added to the last year of the forecast period. The Investment Bank had also advised using the constant-growth valuation formula to calculate the terminal value. These free cash flow figures would then need to be discounted to obtain their present values. The discussion then moved on to the appropriate discount rate to apply to the free cash flow computation. Doug Freebold, the Production Director, thought the present weighted average cost of capital (WACC) of Sesperian would be the most appropriate to use. However, Rosemary Hilton, the Marketing Director thought that as Agrosolutions plc was not in the same sector as Sesperian, as well as the capital structure being different, it may well be the case that they should use the WACC of Agrosolutions as the discount factor. Rufus Banda agreed with Rosemary Hilton stating that it is better to, ‘‘focus on where the money is going, rather than where the money comes from” in determining the target’s risk and financing in order to ascertain the appropriate discount rate. He added that this may reflect the different business risk and financial risk involved in the acquisition. Rufus Banda, in consultation with the Investment Bank provided the following information regarding the data required for the calculation of the WACC of both companies.

Bond rating Yield to maturity of bonds Tax rate Beta Debt as % of capital Equity as % of capital 10-year treasury bond yield Market risk premium

Bidder Sesperian plc A 7.05% 39.00% 1.01 20.00% 80.00% 5.88% 6.00%

Target Agrosolutions plc BBB 7.45% 39.00% 1.2 25.00% 75.00% 5.88% 6.00%

Possible synergies from the merger became the next topic of conversation. The Marketing Director, Rosemary Hilton, felt certain that after discussion with the Investment Bank that she would be able to improve Agrosolutions’ marketing and distribution capabilities. Doug

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Freebold also indicated that operational efficiencies could also be improved. Rufus Banda then explained that Henshaw Investment Bank, in conjunction with the various managers and directors of Sesperian, had estimated an addition of three percentage points of revenue growth for the target company, and subtracted one percentage point from SG&A/Sales ratio relative to the stand-alone model. It is further assumed that all the merger synergies would be realised immediately and would fall within the five-year forecast period. Doug Freebold felt that although the acquisition might be useful to diversify their portfolio, and there may be some synergies to be made, he was still unsure of the risk involved, and was particularly concerned that they should not overpay for Agrosolutions plc. In contrast, the Marketing Director, Rosemary Hilton, thought that as marketing opportunities were available from the acquisition, she was particularly eager that it should go ahead. Jay Sixsmith, the Human Resources Director, however, also cautioned against excessive enthusiasm to acquire this new business at any costs. He mentioned that a considerable amount of research had recently been undertaken in the field of behavioural finance, part of which focused on the psychological effects of financial decision making in situations such as mergers and acquisitions. Doug Freebold also mentioned that he read recently that it was difficult for the acquiring firm to benefit from acquisitions in an efficient market, as shareholders have access to the same information as managers. However, Rebecca Donato disagrees stating that it is debateable that markets are efficient at all levels and there are many instances where executives have information about future gains from an acquisitions that is not known by shareholders. The Chief Executive, Rebecca Donato, concluded by saying that as she had been employed to grow the company she was keen that this type of acquisition activity went ahead. However, she had also taken notice of the cautionary remarks of her colleagues Doug Freebold and Jay Sixsmith. She therefore asked Rufus Banda, with the aid of Henshaw, to make the necessary calculations regarding the valuations of Agrosolutions, so that a definitive bidding strategy could be formulated at the next Board Meeting, which she proposed to call for the next week.

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Question 1 (a) Calculate the weighted average cost of capital (WACC) for both Sesperian plc and Agrosolutions plc, and then determine which one should be used in the valuation calculations. No explanation is required of your choice of WACC. [7 marks] (b) Using the Discounted Cash Flow method, calculate the stand-alone valuation of Agrosolutions plc prior to the inclusion of synergies. [20 marks] (c) Recalculate the stand-alone valuations of Agrosolutions plc after the inclusion of the synergies. [8 marks] Question 2 (a) Outline a bidding strategy that the Board of Sesperian plc might have formulated based on the valuations calculated in parts (b) and (c) above. [15 marks] (b) In the discussion regarding which WACC to use for the valuation of Agrosolutions plc Rufus Banda mentioned that different WACCs might be needed to reflect different financial risk and business risk. Using suitable examples, including those drawn from the case study, distinguish between business and financial risk and from your research discuss how such risks can be alleviated in practice. [15 marks] Question 3 (a) Explore how behavioural aspects can influence financial decisions in general, and then more specifically to the case study. In particular draw on the comments made by Jay Sixsmith regarding the fear of overpayment for the acquisition of Agrosolutions plc. [17 marks] (b) Provide a critical appraisal of the comment made by Rebecca Donato that it was debateable that efficient markets exist at all levels. You are expected to appraise the general concept of efficient financial markets, as well as exploring the implications of efficient markets to this case study in particular. [18 marks]

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Guidelines: You MUST underpin your analysis and evaluation of the key issues with appropriate and wide ranging academic research and ensure this is referenced using the Harvard system. The My Study Skills Area contains the following useful resources; Study Skills Guide (containing a Harvard Referencing section) and a Harvard Referencing Interactive Tutorial. You must use the Harvard Referencing method in your assignment. Additional notes: Word count: 4000 words (maximum) The word count excludes the title page, executive summary, reference list and appendices. Where assessment questions have been reprinted from the assessment brief these will also be excluded from the word count. ALL other printed words ARE included in the word count. Printed words include those contained within charts and tables. See ‘Word Count Policy’ on the homepage of this module for more information. Assignments submitted late will be marked as a 0% fail, unless you have withdrawn your intent to submit for this module in advance of the deadline. Your assessment should be submitted as a single word or pdf file. For more information please see the “Guide to Submitting an Assignment” document available on the module page on iLearn. You must ensure that the submitted assignment is all your own work and that all sources used are correctly attributed. Penalties apply to assignments which show evidence of academic unfair practice. (See the Student Handbook which is on the homepage of your module and also in the Induction Area).

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Assessment Criteria
Level 7 is characterised by an expectation of students’ expertise in their specialism. Students are semi-autonomous, demonstrating independence in the negotiation of assessment tasks (including the major project) and the ability to evaluate, challenge, modify and develop theory and practice. Students are expected to demonstrate an ability to isolate and focus on the significant features of problems and to offer synthetic and coherent solutions, with some students producing original or innovative work in their specialism that is worthy of publication or public performance or display.

Generic Learning Outcomes (GLOs) (Academic Regulations, Section 2) Mark Bands Outcome Knowledge & Understanding
Exceptional analysis of key issues/concepts/ethics with very clear originality and autonomy. Exceptional development of conceptual structures and argument making an exceptional use of scholarly conventions. Demonstrates independence of thought and a very high level of intellectual rigour and consistency. Work pushes the boundaries of the discipline and may be considered for external publication

Intellectual (thinking), Practical, Affective and Transferable Skills
Exceptional analysis of key issues/concepts/ethics. Exceptional development of conceptual structures and argument, making consistent use of scholarly conventions. Exceptional research skills, independence of thought, an extremely high level of intellectual rigour and consistency, exceptional expressive/professional skills, and substantial creativity and originality. Exceptional academic/intellectual skills. Work pushes the boundaries of the discipline and may be considered for external publication Outstanding analysis of key issues/concepts/ethics. Very high level development of conceptual structures and argument, making consistent use of scholarly conventions. Outstanding research skills, independence of thought, a high level of intellectual rigour and consistency, outstanding expressive/professional skills, and considerable creativity and originality. Exemplary academic/intellectual skills Excellent analysis of key issues/concepts/ethics. High level development of conceptual structures and argument, making consistent use of scholarly conventions. Excellent research skills, independence of thought, a high level of intellectual rigour and consistency, excellent expressive/ professional skills, and considerable creativity and originality. Excellent academic/intellectual skills, and considerable creativity and originality Good analysis of key issues/concepts/ethics. Development of conceptual structures and argument, making consistent use of scholarly conventions Satisfactory knowledge of key issues/ concepts/ethics in discipline. Descriptive in parts but some ability to synthesise scholarship and argument. Minor lapses in use of scholarly conventions Basic knowledge of key issues/concepts/ethics in discipline. Generally descriptive, with restricted synthesis of existing scholarship and little argument. Use of scholarly conventions inconsistent. Limited research skills impede use of learning resources and problem solving. Significant problems with structure/accuracy in expression. Team/Practical/ Professional skills not yet secure. Weak academic/ intellectual skills. Limited use of scholarly conventions Little evidence of research skills, use of learning resources and problem solving. Major problems with structure/ accuracy in expression. Team/Practical/Professional skills virtually absent. Very weak academic/intellectual skills. Little evidence of use of scholarly conventions Inadequate use of research skills, learning resources and problem solving. Major problems with structure/accuracy in expression. Team/Practical/Professional skills absent. Extremely weak academic/intellectual skills. Inadequate use of scholarly conventions

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