Royal Mail Plc Case Study
Essay Preview: Royal Mail Plc Case Study
Report this essay
FINANCIAL MANAGEMENTASSIGNMENTCASE 6: ROYAL MAIL PLCPrepared By – Anurag Pan (G19058)Henna Handa (G19067)Saquib Raza (G19087)Sreya De (G19093)(SECTION B, GMP 2019-20)INDEXCase Background…………………………………………………………………….
Critical Financial Problems Identified in the CaseFive critical problems identified in the case –Whether the capital structure weights considered by Kyle Brooks were up to the mark?Kyle Brook had considered the book values of sources of capital, i.e., debt and equity for calculating the capital structure of weights. Whereas Brooks should actually have considered the market values of debt (bonds) as well as equity for calculating cost of capital because otherwise the book values may underestimate the equity and thus the cost of capital. As on 20th July 2015, the share price stood at 511 pence and the market value for firm’s equity should have been considered as GBP 5.11 billion.No such data has been shared for debts. Current debts were rightly considered at their book value; however, long term or non-current debts which also compose 12% of total capital (in book value) should have been considered at their market value.Whether the cost of debt calculated by Brooks was correct?Brook has estimated Royal Mail’s cost of debt as 3.188% which is the weighted average between 0.9% rates Royal Mail is paying on current debt and 4.375% it is paying on non- current debt. This 4.375% rate is the annual coupon rate for a 10 year bond that Royal Mail issued on July 29, 2014. This rate is from one year back and it simply tells us what their cost of debt was back then and not what the cost of debt is today. It would have been better if Brook had looked at the yield on debt in today’s marketplace. Since it is known that the bond was rated as BBB by S&P who had recently also reaffirmed that rating, it would have been better to consider the prevalent UK corporate benchmark bond yield for 10 year maturity in GBP as on July 14, 2015. Further, the total book value of bond is only given and the maturity wise break up for the total bonds issued by the Company are not mentioned. This also skews the calculation of WACC.Whether the cost of equity calculated by Brooks by Dividend Yield model approach was correct?Brook estimated cost of equity using dividend yield model. In doing so he has not considered that estimated growth rate for dividend. There is not much historical data in this regard as the Company has been privatized only as recently as October 2013, nor there is much data provided by analysts in view of the turbulent times the Company is facing. Hence, the calculation by this model is wrong as it is does not encompass the growth rate for dividend. Additionally the volatile security market risk is not adjusted for Royal PLC equities. Thereby, the method Adopted by Brook would provide wrong analysis in estimating cost of capital.Whether the cost of equity calculated by Brooks by CAPM estimate was correct?For calculating cost of equity by this method Brook has used risk free rate as per the average yield on 5 year government bond in the last 18 months. He should have used to figure for 10 year bonds considering the long term nature of debt and equity both.Additionally during the period Royal PLC has gone through privatization due to which variable beta has been estimated so, short period will not give unbiased and holistic overview of the company to estimate accurate discounting rate.  What are the other issues being faced by Royal Mail Plc?Reduction in its share price which rose to as high as 600 pence in January 2014, which now closed at 511 pence as on July 20, 2014.Allegations of maintaining pricing power and engaging in competitive pricing by other players.Increased competition from private players in the industry.Change of orientation from Government controlled behemoth to increasing returns for investors for survival in the market.Reduction in share of revenues from delivery of letter.Office of Communication’s regulatory policies and impeding review of policies and practices of Royal Mail by them.Analysis and Interpretations for Solving the Case