Staff Advantage Ltd is an outsourcing company that specialises in the provision of human resource management facilities. It has been operating for 12 years and both revenues and earnings have grown steadily over that time, in line with its financial objective of year-by-year growth in sales revenues and in earnings per share. Annual revenue growth has required additional investment in non-current assets equal to 3% of additional sales and also additional investment in working capital equivalent to 7% of the additional sales. This incremental investment has been entirely funded by reinvesting all of the company's after tax profits, allowing the company to remain debt-free.
A number of individual shareholders - who collectively own 40% of the equity - and two private-equity investment companies - who together own the other 60% - currently hold the company's shares.
You work as an assistant to the chief financial officer of Staff Advantage. Recently, the company has been considering a proposal from one of the private equity investors, that the company becomes listed on the London stock exchange where, it is thought, investors would require Staff Advantage to generate a 10% annual rate of return on capital.
This proposal raises three immediate issues for the company's board of directors. The first is that the board believes that the company will need to re- think and re-formulate its future financial objective. The second issue is to estimate a possible valuation for the company, prior to any floatation. Finally, the board recognise that if they do become listed on the stock exchange, then the company will need to formulate a suitable dividend policy. Currently, the company retains and reinvests all after tax earnings.
Below is the company's simplified income statement of Staff Advantage for the last two years:
|
Income statement
|
2015
£ millions
|
2016
£ millions
|
|
Sales revenues
|
7.22
|
7.80
|
|
less Cost of sales
|
2.96
|
3.20
|
|
Gross profit
|
4.26
|
4.60
|
|
less Expenses
|
1.68
|
1.82
|
|
less Depreciation
|
0.93
|
1.00
|
|
Operating profit
|
1.65
|
1.78
|
|
less Taxation
|
0.33
|
0.36
|
|
After tax profits
|
1.32
|
1.42
|
The board believes that the pattern of growth exhibited over these last two years is likely to continue up until the end of 2021, which is as far as the company feels that it has the ability to forecast.
Required:
a) Write a short report to your CFO that critically analyses the company's current financial objective and recommend, with reasons, what might be a more suitable financial objective.
b) Write an appendix to your report that critically discusses how companies create value and which briefly identifies how the shareholder value of a company such as Staff Advantage Ltd can be measured in order to assess the performance of its management.
c) Produce a reasoned report for the board of directors that estimates the possible worth of Staff Advantage Ltd on the basis of a shareholder value analysis, using the data given above. Be careful to state clearly any assumptions that you may make in your analysis. (Undertake your calculations rounding to nearest £1,000).
d) The CFO is due to lead a board discussion on the issue of dividend policy and its impact on shareholder value. Write a briefing document for her that critically analyses the arguments surrounding this issue.