Capital Structure And Financial Analysis Of JB Hi-Fi Limited

Background of JB Hi-Fi Limited

Question:

Discuss about the Analysis of Project’s Feasibility JB Hi-Fi.

JB Hi-Fi is the retailer for consumer goods that carries on its business in Australia and New Zealand and is specialized in Blu-rays, CDs, Video games, DVDs, hardware, electronics, home appliances and mobile phones. The company has two segments – New Zealand and Australia. Approximately the company has 60 home branded stores that include more than 4 in New Zealand. The company is well known for its community and social responsibilities and is not solely focussed for maximizing the profits. The social responsibilities of the company include development of the business with positive relationship to society under which they operate (Jbhifi.com.au 2018).

The capital structure is the way company finances the overall growth and operations through usage of various fund. Equity capital is the investors or owner’s fund and the retained earnings states the previous years profit that are not distributed as dividend to the shareholders. The equity capitals are used for financing the debt or business expansion (Rampini and Viswanathan 2013). On the other hand, the debt capitals are the borrowed funds usually the long-term funds for mitigating the interest rate with long maturity period. Generally, the companies prefer to optimize the capital structure for achieving the debt equity ratio that will be lower than the industry average (Feld, Heckemeyer and Overesch 2013). 

Capital structure of JB Hi-Fi Limited over the last 4 years is as follows –

From the above, it can be observed that for all the 4 years the debt of the company is lower as compared to the equity. Since 2014 the debt component of the capital structure has been in reducing trend and the equity component is increasing. However, in the 2017 the debt component is increased to 45.52% from 25.81% in 2016 and the equity component has been reduced from 74.19% to 54.48% over the years from 2016 to 2017 (Jõeveer 2013).

Looking at the capital structure and capital management policy of the company it is found that the board reviews the capital structure on regular basis. Further, the main objective of the company maintaining the optimum structure for capital that can reduce the overall capital cost and that will assure that the company will have access to the adequate level of capital for sustaining in the future business development. Further, for adjusting or maintaining the capital structure, the company adjust the dividend level paid to the shareholder, buy back the shares, returns capital to the shareholders sell assets for reducing debt and issue new shares (Campello and Giambona 2013). 

The optimal capital structure is best debt to equity ratio for the company that can maximize the value of the company. It is that structure of the company at which the balance is maintained between debt and equity and minimizes the company’s cost of capital. Generally an equal mix of debt and equity that is 50% is considered ideal structure for capital (Florou and Kosi 2015). However, the optimal structure depends on various other factors as follows –

Capital structure of JB Hi-Fi Limited over the last 4 years

Advantages of debt against equity –

• The lender does not have any claim on the share of the business. In other words, debt does not reduce the interest of the shareholders in the company
• The lender is only entitled to the repayment of the amount agreed upon as principle plus interest and is not entitled to the company’s future profits.
• Except for the loans that are obtained on variable rate, interest and principle obligations are the amount that is known to the borrower and therefore the payment method can be planned in advance (Pianeselli and Zaghini 2014).
• Interest payment on loan is a deductible expense under tax which in turn, reduces the actual cost of borrowings.
• Raising amount through debt is easier than raising fund through equity as the company does not have to comply with various rules and federal laws.

Advantages of equity against debt –

• Debt has to be repaid in regular interval, however the dividend on equity is paid only when the company makes profit
• Interest is the fixed cost to the company and increases the break-even point. Higher cost of interest leads the company to insolvency. However, there is no such risk involved with equity
• Generally the company is required to pledge some assets of the company with the lender as collateral. However, there is no such requirement in case of fund raised through equity (Belo, Lin and Yang 2014).

Therefore, the company is suggested to raise further fund through equity as it will reduce the total cost of capital. Further, if the company raise through equity, it will not have to pay dividend it does not have sufficient earning available.

Dividend paid by the company for last 4 years are as follows –

• 2014 – 84 cents per share
• 2015 – 90 cents per share
• 2016 – 100 cents per share
• 2017 – 118 cents per share

It can be observed that the company is regular in payment of dividend and the dividend payment is in increasing trend for the last last 4 years. The board is in the view that their dividend payout ratio of 65% balances appropriately the profit distribution to the shareholders and earnings reinvestment for the purpose of future growth (Banker and Fang 2013.). Therefore, the company’s payout policy is stable and regular.

As of 11^th April, 2018, Masters Limited is considering a new project that will move in the new product market. As the company is facing stiff competition from the oversees manufacturers with significant lower costs it is considering various analysis like NPV, IRR, discounted payback period, payback period and profitability index to analyse the acceptability of the project. After analysing the project financially following findings were attained for various measures –

NPV or net present value is value of entire future cash flows whether negative or positive over the period of project’s useful life. NPV is form of the intrinsic valuation and it is extensively used to determine the business value, capital project, cost reduction plan, new venture and valuation associated with cash flow. It is used for determining the value of project, investment or the cash flow series. This metric is all encompassing as it takes into consideration all the expenses, revenues and cost of capital associated with the investment in the free cash flow. Apart from that it also takes into consideration the cash flow timing that has big impact on the investment’s present value and . The project is generally acceptable if the resultant NPV of the project is positive. On the contrary, the project is not viable and therefore not acceptable of the NPV is negative. Looking into the computation of net present value of the project it is found that the net present value of the project after taking into consideration all the expenses and revenues and discounting the cash flows at 15% comes to $ 50,26, 677.07.  As the NPV of the project is positive, the project is acceptable.

IRR or internal rate of return is interest rate at which NPV of the entire cash flows whether negative or positive from the investment or project is equal to zero. IRR is used for analysing the investment’s r project’s attractiveness. While calculating the IRR, the expected cash flows of the investment or project are already given and the NPV equals to zero. Once the internal rate of return is computed, it is compared to the company’s cost of capital. If IRR of the project is equal to or more than the capital cost, the project is acceptable. On the contrary, if IRR of the project is less than the capital cost, the project is not acceptable. However, in reality various other things are there those are required to be taken under consideration before accepting or rejecting any project. Looking into the computation of IRR of the project it is found that the IRR of the project after taking into consideration all the expenses and revenues and discounting the cash flows at 15% comes to 14.20%.  As the IRR of the project is less than the company’s cost of capital, the project is not acceptable.

Capital management policy of JB Hi-Fi Limited

The payback period states the period required by the business to recover the amount of initial investment made into the project. It helps the company to compare various alternative opportunities for investment and take decisions regarding the selection of the project. The project with lower recovery time is considered better. The payback period is generally analysed initially without applying too much technical knowledge. It is simple measure of analysing risk through computing the period of return. However, under simple payback period calculation the time value of the money is ignored. For countering this limitation the alternative method that is discounted payback period is used that takes into consideration the time value of the money. Discounted payback period is the upgraded method of capital budgeting as compared to the simple payback period. It calculates the time required by the project to break even. Incorporating the discounted payback period method along with various other methods the management can take the right decisions and can assume the exact risk that is involved on the project. Looking into the computation of simple payback period of the project it is found that the payback period of the project after taking into consideration all the expenses and revenues comes to 2.44 years. On the other hand, under discounted payback period after taking into consideration all the expenses and revenues and discounting the cash flows at 15% the payback period comes to 3.15 years. Under both the methods the payback period is less than the useful life of the project and therefore the project is acceptable. However, various additional considerations must be taken into consideration before accepting or rejecting any project.

Profitability index is the technique for investment appraisal and is computed by dividing present value of the future cash flows of the project by the initial investment needed for project. It is actually the modification of NPV. While the present value is absolute measure, profitability index is the relative measure as it gives the figure as ratio. Project is accepted if the profitability index is more than or equal to 1. On the contrary, the project is not acceptable if the profitability index is less than 1. It is also called as the benefit cost ratio and is used for the capital rationing as it assists to rank the projects on the basis of the per dollar return. Looking into the computation of PI of the project it is found that the PI of the project after taking into consideration all the expenses and revenues and discounting the cash flows at 15% comes to 1.44.  As the PI of the project is more than 1, the project is acceptable.

 Finally, if all the above mentioned analyses are taken into consideration, it can be found that except for the IRR method under all the methods the project is acceptable. Therefore, if only IRR is taken into consideration then the project is not acceptable. However, if all other methods like NPV, Profitability index and payback period is taken into consideration then the project is acceptable.

Thank you for giving me the opportunity to analyse the project using various approaches. I would love to discuss the matter farther in person, if required.

References

Banker, R.D. and Fang, S., 2013. Loan financing and real cost management. Working paper, Temple University.

Belo, F., Lin, X. and Yang, F., 2014. External equity financing shocks, financial flows, and asset prices (No. w20210). National Bureau of Economic Research.

Brooks, R., 2015. Financial management: core concepts. Pearson.

Campello, M. and Giambona, E., 2013. Real assets and capital structure. Journal of Financial and Quantitative Analysis, 48(5), pp.1333-1370.

Feld, L.P., Heckemeyer, J.H. and Overesch, M., 2013. Capital structure choice and company taxation: A meta-study. Journal of Banking & Finance, 37(8), pp.2850-2866.

Florou, A. and Kosi, U., 2015. Does mandatory IFRS adoption facilitate debt financing?. Review of Accounting Studies, 20(4), pp.1407-1456.

Gallo, A., 2014. A refresher on net present value. Harvard Business Review, 19.

Jbhifi.com.au., 2018. JB Hi-Fi | JB Hi-Fi – Australia’s Largest Home Entertainment Retailer. [online] Available at: https://www.jbhifi.com.au/ [Accessed 11 Apr. 2018].

Jõeveer, K., 2013. What do we know about the capital structure of small firms?. Small Business Economics, 41(2), pp.479-501.

Kerzner, H. and Kerzner, H.R., 2017. Project management: a systems approach to planning, scheduling, and controlling. John Wiley & Sons.

Larson, E.W. and Gray, C., 2013. Project management: The managerial process with MS project. McGraw-Hill.

Pianeselli, D. and Zaghini, A., 2014. The cost of firms’ debt financing and the global financial crisis. Finance Research Letters, 11(2), pp.74-83.

Rampini, A.A. and Viswanathan, S., 2013. Collateral and capital structure. Journal of Financial Economics, 109(2), pp.466-492.

Žižlavský, O., 2014. Net present value approach: method for economic assessment of innovation projects. Procedia-Social and Behavioral Sciences, 156, pp.506-512.

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