In this case,study our group select Sky City as our research company. Sky City is one of aleading gaming and entertainment business in New Zealand and Australia whichalso has a remarkable icon with a great brand value. It mainly operates casino, hotels, convention centers, restaurantsand bars at various place across urban area in New Zealand and Australia.
This assessment will give out an investing advice forinvestors after discussing these subjectsin terms of the calculation of Weighted Average Cost of Capital (WACC), the average dividendgrowth rate and dividend discount model theprice of SKYCITY Entertainment Group Limited and comparing the current marketprice with our valuations. Data and information were extracted from NZX companyresearch and AUT Blackboard. WACC is described as the cost of financing firm assetswhich is an appropriate way to determine whether undertaking that project willincrease the value of the firm (McMahon et al., 1993). The weights in thecalculation of WACC should be based on the firm’s target capital structure. Dueto there are two costs of capital for Sky City which are the cost of equity and cost of debt. Thecalculation of the cost of equity shouldbe based on the CAPM approach Er=rf+beta(rm-rf) (Abraham et al., 2008).
In ourcase, the Sky City has a beta value of1.28, risk free rate is 1.94% and the market premium of 7%, which are the mostrecent value. Then, our calculated the cost of equity is 10.87% (Appendix 1). In the financialstatements, the company has separately calculated two debt costs which areweighted average interest rate (6.7%) and weighted average debt cost (6.98%)respectively.
The difference is that because of the exchange rate, SKYCITY hasissued the United States Private Placement (USPP) Notes over the past fewyears. However, the exchange rate of the New Zealand dollar has fallen bynearly 10% from last year to this year. As a result, more New Zealand dollarsneed to be exchanged for U.S dollar when the interest is paid.
The formula tocalculate the cost of debt is interestpaid divided by total borrowings. Interestpaid is 30,713,000 and the total borrowings is 395,002,000 (Skycity,2017), thus the actual cost of debt is 7.78% (Appendix 1), which are much higher than thedata in the financial statements. This will result in higher financing costswhich WACC is 9.45% (Appendix 1). In thiscase, we will use the earnings data (6.
98%) as a measure of WACC’s debt costfor final discussion. The profit before incometax is 95,763,000 (Skycity,2017) and theincome tax expense is 50,901,000 (Skycity,2017)then we calculate the tax rate is 53.15%, but the prima facie income tax is28%. So we use tax rate of 28% to calculate WACC. The total value is equityplus Interest-bearing liabilities which equal to 1,465,939,000 (Appendix 1). To calculate the WACC we useformula WACC= Cost of Debt * D/V* (1-Tax Rate) + Cost of Equity. As a result,WACC is 9.29%.
Therefore, Sky City should invest the project has a higher return than 9.29% to make profits. Basedon the theory of capital budgeting, capital projects can be classified asreplacement projects and expansion projects (Bakry, 2016).
In the financialstatements, the company Mentioned it will continueto maintain the operations in Skycity Auckland and SkyCity Hamilton. They will spend $700 millionto build the New Zealand International Convention Center (NZICC) and Hobsonstreet hotel to expand the business. The NZICC is are expected to generate $90million in economic benefits for New Zealand annually (Skycity,2017).We calculate the average dividend growth rate is 5.66%(appendix 2) and the free cash flow to the firm (FCFF) in 2014, 2015, 2016, 2017was in terms of 239,174,300, -26,429,100, 149,977,400 and 152,594,100 (appendix2) respectively.
These two values represent the average dividend growth annuallyand the cash available for discretionary purposes (Walters & Halliday,2004). FCFF is cash available to all investors, both equity owners and debtholders. The value of a company depends on the level of FCFF and WACC, thelower the financing costs will have a higher corporate value. Skycity’s FCFF isgood, Interest paid is 30,713,000 (Skycity,2017)in 2017 and FCFF value is 152,594,100 (Skycity,2017)which means the company has the cash to pay a dividendto equity owners and the dividend growth rate of 5.
66% Proof of this.Dividend discount model is an approach divide thedividend expected to be distributed in the future into the present value at anappropriate discount rate in order to assess the value of the stock (Garrow& Valentine, 2010). In this case, weuse average dividend growth rate of 5.66% and the cost of equity of 10.87%calculate the value of Skycity is 4.26 (appendix 2). The average dividendgrowth rate represents average dividendgrowth annually from 2013 to 2017 and this value represents the dividend growththe company may pay in the next five years, therefore we choose this value as growth rate (g). we use CPAM approach tocalculate the cost of equity is the recent value of financing cost of equityfor SkyCity, therefore, we choose thisvalue as the discount rate.
Compare thevalue we calculated with the market price we find that our valuation value is alittle larger than the market price (market price 3.94), therefore, the stockprice is undervalued now. To invest a company, we should consider other factorsaffect stock prices such as Macroeconomicfactors, Industrial and regional factors and company factors. In the financial statements, the companyMentioned it will continue to maintainthe operations in Skycity Auckland and SkyCityHamilton.
They will spend $700 million to build the New Zealand InternationalConvention Center (NZICC) and Hobson street hotel to expand the business. TheNZICC is are expected to generate $90 million in economic benefits for NewZealand annually (Skycity,2017).Investors should be cautious about the following data, WACC represents thecompany’s financing costs, the company’s dividend growth rate represents thecompany’s dividend capability, the increase in dividend growth rate willincrease the company’s value and the reduction in the cost of equity will also increase the company’s value. Accordingto the current value and the company’s future project planning, it isrecommended to buy this stock, then sold it around 4.26.
