A Critical Examination Of Fisher-Hirshleifer Model, Cost Of Capital, Stock Market, And Dividend Policy

Capital assets pricing model

Capital assets pricing model is used to estimate the company’s cost of equity, weighted average cost of capital and its share price After analysing the annual report of company it is revealed that the capital assets pricing model is the model used to determine the value of the assets and required rate of return before investing in the particular project. This method assists Man Group Plc Adr (Mngpy) to determine whether the earned profit should be plugged back into the business or distributed to shareholders (Prasad, et al, (2015).

In order to compute the required rate of return through the CAPM, firstly beta of company needs to be computed.

The computed beta of company is taken from the online sites.

The beta value of the company is 1.354 (Financial times,   2017).

After that by using the CAMP method, required rate of return of company will be computed.

Computation of the required rate of return

CAPM= RF+ (Rm-RF)*B

An RF= Risk-free rate of return

RM= Market Risk

B= Beta of company

Computation of required rate of return

It is observed that this required rate of return is the amount of cost of capital which is required to be paid by the company to its shareholders. However, this rate is also used by the company to set the present value of the future inflow and outflow from the business.  This rate of return plays the pivotal role in determining the dividend policy in the company. For instance, if the company uses dividend discount model or Gordon model then it could use required rate of return to compute the future share price and dividend growth rate of the company. This model has reflected that if the company want to manage the cost and financial risk of its business then it will first have to set up equilibrium point between the cost of capital and financial risk of the business. The Man group company has high financial leverage and with the high decrease in its total revenue, it may destruct the sustainability of the company and may result in the destruction of its business at large (Sanlorenzo, et al. 2015). 

The Weighted average cost of capital is the rate that company expected to pay on average to all its security holders to finance its assets. This WACC is highly influenced by the financial leverage and cost of capital of the company.  It is evaluated that company has more than 53% of equity capital and 46% debt capital in its financial structure. It reflects that company has higher financial leverage in its business. Ideally, the financial leverage of company should be low otherwise at the time of sluggish market condition; it will destruct the business value of the company. However, the cost of debt of the company is already way too low. Man group has used this debt portion to keep its cost of capital low. At the same time, use of this debt portion will also increase the financial risk of the organization.  This weighted average cost of capital will assist the company to identify the areas which could be improved to lower down its cost of capital. However, the company has high financial leverage and due to the increased financial risk, company needs make payment of its debts otherwise it may destruct the business in the long run in case of loss of its business. It has shown that company has been bearing high financial leverage due to increase debt portion in its capital structure. Man group first needs to reduce this debt portion by decreasing the debt portion from its capital structure. However, it will increase the overall cost of capital of company but also reduce the financial leverage of the company Treanor, et al. (2014),  

Computation of the required rate of return

The computation of the weighted average cost of capital has been given as below.

There are several factors which may affect the dividend policy and adoption of the same by the listed companies. It is very difficult to lay down an optimum dividend policy which would maximize the long-run wealth of the shareholders resulted in increment and decrement of the firm’s value. In this case, Man group Company has been taken which followed profit based dividend policy to distribute the return of the company to its shareholders.

The dividend policy is an important component of the corporate financial management policy. It could be defined as the amount of profit or return earned by company distributed to shareholders on their shareholding proportioned basis. For a long-term, the subject of dividend policy has captivated the interest of many investors and researchers (Zhu, 2014). It is evaluated that the dividend policy of the company is highly based on the profit earning capacity and the future growth of the company.  There are several factors which have been affecting the dividend distribution decision of company such as nature of the business, the profitability of the company, future growth, market share price and return on capital employed by the company and the inflation rate the Inflation rate of UK is 2.7%.  It is observed that the growth rate of the company is 3% which is higher than the inflation rate. Inflation is generally defined as increase price of goods and services over certain period. It divulges that if shareholders invest their capital in JB Hi-Fi Company then it will increase the value of their capital investment and save them from the time value present factors risk. Company should have higher growth rate as compared to inflation rate if it wants to offer high return on capital value to its shareholder. As per the point of views of the general investors, dividend serves an important indicator of the strength and future perspective of the business (Brigham and Ehrhardt, (2013),  if company reduce its dividend offered rate then it has been decreasing its earning capabilities and vice-versa. Ideally, the big organization such as GE capital, Wesfarmers, JB Hi-Fi Company are following stable dividend policy to maintain an effective brand image in the mind of investors irrespective of their earning capacity. However, in case of loss of its business, it keeps its dividend payout zero. Nonetheless, extensive level of literature reviews and research papers have been formulated on determining the optimum level of dividend policy for an organization but nothing such qualitative information has been collected which could be used to evaluate the best dividend policy of company (Man Group, 2017).

Weighted average cost of capital

There are several factors which may influence the dividend policy and dividend payout decisions such as cost of the equity, debt interest rate, inflation rate of market, growth available in business, shareholders return, capital employed by company and financial leverage of company. The share price fluctuation is based on the earning and market situation of the company. However, the share price of the company has increased by 20% since last five years (Duchin, and Sosyura, (2014)

Man group Company has followed profit based dividend policy. It is evaluated that the net income of the company has increased from USD 72 million to 255 million in 2017. On the other hand, it has decreased the dividend payment due to the sluggish market condition (Man Group, 2017).

Man Group Company has followed hybrid dividend policy. It is analyzed that the company is offering the way too high dividend to its shareholders in the market. This strategy is highly useful to attract investors for raising capital in the market (Ehrhardt, and Brigham, (2016) However, in 2016 and 2015 company followed dividend policy and kept its dividend payment stable. It reflects that company has been following stable divided policy since last three year. On the contrary to that, the company has been increasing its profit throughout the time.

There is below share price of Man group and LSE have been given.

The main important point is related to the fact that in spite of having lost in its business, company consistently offered dividend to its shareholders. This reflects that company is more inclined towards attracting the shareholders and keep them attracted toward its business (Garrett, Hoitash, and Prawitt, (2014) It is analyzed that if the company is having high growth in its business then it should instead of offering its dividend amount to its shareholders, put more efforts to plug back its profit in its business. It will not only help the organization to provide capital for the business growth but also establish the proper linkage between organization development and economic growth. After evaluating the annual report of Man group Company, it is analyzed that company has been following hybrid dividend policy to distribute its dividend to its shareholders. This policy reveals that company keeps its dividend payment stable in some years and at the point of time it follows residual dividend policy. This strategy is highly attractive towards investors. It is used by the company to maintain an effective brand image to attract more investors. The cash flow statement of Man group Company has shown that company has increased its dividend payout amount with the increase in its profitability. Nonetheless, in several years, the company has increased its retained earning with a view to plug back its profit for the future growth of the company. Company is having high profitability and will give offer high dividend to its shareholders. 

Dividend policy of the Man Group plc

There are several valuation models. However, these models could be used by company to value the shares of Man Group Plc. There are several valuation models such as dividend valuation model, free cash flow to equity model, price earnings ratio model and value ratio model. This valuation model reflects that company has issued good amount of dividend to its shareholders. However, there are several valuation modes which could be used by the company to assess the value of its company. Nonetheless, the dividend valuation model is the most suitable method to analyse the future value of the company.   

The market share, profit, dividend, share price index, and current inflation rate have been used to determine the future share price of the company by using dividend growth model. This model is used to identify the true value of the company based on the stock price and sum of all the future dividend payments. This model is used to evaluate the net present value of the future dividend available to shareholders (Kundakchyan, and Zulfakarova, 2014). 

Future value of stock = 

 (Yahoo finance, 2017).

With the help of dividend discount model, the future stock price of the Man group of the company would be USD $ 4.02. It is evaluated that Man group Company has overvalued its shares in the market as compared to its book value. As per the point of view of the investors, it will give less return to investors on their investment. Nonetheless, with the increasing profitability of the Man group company, investors would be having more value creation on their investment (Laeven, and Valencia, (2013).

After analyzing the given model, it is inferred that share price of company is undervalued; the required rate of return of company is 15.22%. The dividend growth model is used to identify the future value of inflow in the business. The share price of company has been determined as $4 which is way too lower than its market value. The weighted average cost of capital is computed on the basis of capital assets pricing model.

The dividend policy, payment, and managerial decision play the pivotal role in the success of organization influence the value of the firm in determined approach. In this ramified economic, investors are more inclined towards investing their capital in those companies which are offering the high dividend to shareholders. However, long-term shareholders are more inclined towards the long-term value creation of the company.  

In simple words, dividend policy could be described as the set of guidelines which company uses to decide how much of its earning and amount of profit it will pay out to its shareholders. However, some of the researchers are of the view that investors are not concerned with the dividend policy of company since they could sell a portion of their portfolio of equities if they want to earn money.

The Man Group Plc Adr (Mngpy) has been paying the dividend since last five years. However, there is no such detail which could be used to determine as the basis on which this dividend payment was done. However, Capital assets pricing model could be used to analyze the dividend policy and true value firm in the market.

Fisher-Hirshleifer model has been used to examine the firm’s investment decision and role of the capital market The Fisher-Hirshleifer model, stipulates that the goal of any firm is to increase the future value of the company and increase the overall return on capital employed. This Fisher-Hirshleifer model could be broken down into three key assentation such as firm’s investment decisions are separate from the preference of firm’s owners. As per the Fisher-Hirshleifer model, it is considered that consumption and investment decisions of an individual are examined in the presence of frictionless of the capital market Vogel, (2014) in the simple words, Fisher-Hirshleifer model revealed that total investment of the investors should be equivalent to his saving. However, the interest rate should be more than saving interest rate when investors want to invest his funds in the market. The Fisher-Hirshleifer model provides the conceptual frameworks for the Net present value model. As per this model, the only way to increase the value of its investment is to invest in the market so that it could compensate the time value of money.  In context with the dividend case, it is inferred that investors would be inclined towards investing money only in those firms which offer the good amount of return to its investors. On the other part, if the company is having the good option to create value on its investment then instead of distributing the dividend to shareholders, it would plug back its funds in its business. The Fisher-Hirshleifer model clarifies all the possibilities and issues of the capital market. It also helps investors to assume that the capital market is offering the good amount of return and less fluctuated.

The investment decision of Man’s Group is aggressive. It has been plugging back most of its funds in its business to expand the business chains in the market. Nonetheless, the role of capital market in the investment decision is very pivotal. The capital market is highly unstable and as per the Fisher-Hirshleifer model if investment made in the capital market in the particular time period then the yield output would be received only in the next period (Weygandt, Kimmel, and Kieso, 2015).  The investment decisions of the Man’s group is highly based on the present value, discounting factors and return available in the capital market. It has invested most of its capital market with a view to increasing the overall return on this investment. However, hedging process has also been used as per the Fisher-Hirshleifer model with a view to mitigating the market transactional risk factors. Fisher only focuses on the consumption of the value and investment. If the company keeps its capital idol in it a business then it will destruct the value of the investment. Nonetheless, the capital market offers the good amount of return. The company needs to opt best option to save its capital from the capital market loss and risk arise from the inflation rate.

After evaluating all the details and theory given by the Fisher-Hirshleifer model, it is clear that Man group needs to keep its capital investment decision active. It needs to assess all the available profits and competitor’s offering in the market.

Conclusion 

The dividend policy of company should be based on the profit, inflation rate, interest rate and external factors of the business. The Man group company has followed hybrid dividend policy to offer the dividend to its shareholders. This dividend policy is used to attract the investors. The Man group has used this dividend policy to attract more investors in the market. Now, in the end, it could be inferred that Man group plc should lower down its dividend payment otherwise it would have to face the high amount of loss in its business. The company should plug back its investment to expand its business instead of offering the dividend to its shareholders. It is analyzed that for the long-term sustainability, Man Group Company should use this retained earnings in its business. It is analyzed that retained earnings are the cheapest source of finance available to the company. It will assist in increasing the overall return on capital employed in determined approach. 

References 

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Ehrhardt, M .C. and Brigham, E.F., 2016. Corporate finance: A focused approach. Cengage Learning.

Garrett, J., Hoitash, R. and Prawitt, D.F., 2014. Trust and financial reporting quality. Journal of Accounting Research, 52(5), pp.1087-1125.

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