FINANCE ASSIGNMENT

BADRIYA FATEEL –201500592

Part One

Answer 1:

The discount rate is the interest rate that is deducted from cash flow analysis to get the present value of
the future cash flow. The Discount rate is important to find the discounted cash flow because it will
show how much the series of cash flow is worth in the future. (Moffatt, 2017).

To explain, in this case we are looking for the present value of the amount that should be deposited by
Britain in order to cover the pensions of European Employees who contribute in Britain success.
Therefore, we have to take in consideration that the payment may continuous for about 70 years, so
definitely the amount of the benefits should be discounted at some point. This discounted amount
represents the discount rate.

Answer 2:

The high discount rate will benefit the UK when calculating the pensions. To illustrate, when the
discount rate increases then the presume expenses will decrease which will benefit UK. As an example,
the EU calculated the UK's pension liability using a nominal rate of 1.7% and a real rate 0.3% which is a
low rate. As a result, the EU claimed a pension liability of €67.2bn which is a high amount. However,
when the discount rate rose in 2016; Bruegel conclude that if this discount rate used to calculate the
UK's pension then it will fall by between a third and more than half until the UK's bill reaches €2.5bn-4bn
which is quite lower than the one calculated by the EU. Also, when we compare between the amounts
we can see significantly the difference between them and the major factor in creating this difference is
the discount rate.

Answer 3:

A nominal rate is the simple interest rate paid for the lenders without taking in consideration the
inflation or the compound interest, while the real rate is the interest rate counted after affected by the
inflation. To explain, after deducting the inflation rate from the nominal rate we will get the real rate.
(Nominal Interest Rate)

The real rate= nominal rate – inflation

Answer 4:

The EU calculated the pension payment with nominal rate of 1.7% and a real rate of 0.3%, so they want
the UK the pay €67.2bn. However, the UK can compare it with the discount rate that used by EU in their
balance sheet and it will be clear that this rate is much higher as it will reduce the amount into €2.5bn-
4bn. The UK can argue that the pension is representing a lability for their government which is a part of
their balance sheet, therefore the discount rate used for the EU's balance sheet should be equal to the
rate used for UK's balance sheet.

1
Answer 5:

The amount has increased significantly from €35bn to €67.2bn, because of the discount rate that has
decreased sharply. The discount rate is based on the interest rate paid on European Union government
debt. This happened because the cost of the liability or the estimation of the cost depends on the
discount rate that is used by European Union. According to Why Discount Rates Should Reflect
Liabilities: Best Practices for Setting Public Sector Pension Fund Discount Rates (2015), the discount rate
is a decisive element of the liability, and the lower the discount rate the higher the amount of liability.

Answer 6:

1980 1993 1994 2004 2017

PV= 110/1+5%^0= €110 billion

PV= 110/1+9%^13= €35.87 billion

PV= 110/1+7%^1= €102.80 billion

PV= 110/1+2.5%^10= €85.93 billion

PV= 110/1+0.25%^13= €106.48 billion

The rate that will be most representative of future is 0.25%, because the amount that UK wants EU to
pay in the future is €110 billion, and the amount of present value in this rate amount is between €110
billion were it is different by €3.52 billion, it is not much difference between these amounts. If we
considered looking at the other amounts, we will find that 2.5% is less than the amount that UK wants to
pay by 24.07 billion which is big difference. Moreover, if we looked at 7% the amount is less but not that
much different from the future amount, while 5% the amount is similar to what UK wants to pay for
EU.

Page Break

Answer 7:

Discount rate mean (nominal rate) = 5+9+7+2.5+0.25/5= 4.75%

Great Britain should choose the annual payment, because the amount will be less than paying pension
liability in one payment that is €50 billion, by paying the annual amount Great Britain will pay €48.46
billion using the nominal discount rate. Hence, if Great Britain choose to pay annually instead of paying
all the amount in one installation, it will be much better for them because they will benefit from this and
will not be a loss, because the amount is less in both rates.
Although in this section we used Annual Payment CPI increase in the formula by adding the increase to
the annual payment, and by this amount we did the NPV.

The NPV calculation will be in excel.

2
Part Two

Answer 1:

Facebook is 10 times more valuable than Ford (as measured by market capitalization).

Using 5 different ratios/indicators from the above tables (or others you may have found) to explain why
there is such a large difference between the two companies market capitalization. Explain each ratio you
use.

P/E ratio: is the ratio that indicates how much an investor is willing to pay in order to receive one dollar
of the company, in Ford the amount is 11.05 while in Facebook it is 33.51. This means that the investors
that are expecting the Facebook to grow more than for so they invest in Facebook more than Ford. Staff,
I. (2017, November 29).

Quick ratio: it is the indicator of the company short term liquidity obligation to pay off their debt with
their liquid assets. The ratio in Ford is 1.10 and in Facebook 13.40, which means the Facebook has the
ability to use their quick assets that are liquid to pay for their debts using the liquid or quick assets.
Momoh, O. (2017, November 21).

Current ratio: measures the ability of the company to pay the short-term obligations, and the business
analyst decied from this ratio if they should lend this company money or invest in. Current ratio. (2017,
November 27). The ratio in Ford is 1.20 and in Facebook is 13.40, which means that that Facebook is
able to pay for their short-term liabilities efficiently more than Ford.

Debt to equity ratio: it is a procedure to measure the company's financial structure risk. Also, it shows
what the company uses from debts percentage and equity financing. Debt to equity ratio. (2017,
November 2). The amount of this ration in Facebook is 0.00 and in Ford is 4.49, Facebook does not have
any debts that they cannot pay while Ford has debt that they did not pay.

Pay-out ratio: rate of earnings that are paid as dividends to shareholders and it is presented as
percentage, or cash flows. Moreover, it is used to assess the stock dividends stability. Picardo, C. E.
(2017, December 15). The amount of this ratio in Facebook is 0.00% and in Ford is 54.10%, this means
that Facebook has more opportunity than Ford to grow and stand low profits, while Ford cannot and
might be a sign that they will have low profits soon.

Answer 2:

Ford on one hand, chose to pay dividend because it attracts investors and they will find it more
interesting to buy and invest in their stocks. It also makes it more attractive for the investors as they see
a dividend payment like a sign for a company’s strength. Facebook on the other hand, uses a strategy
where it reinvests the profit in the business particularly in research and development because it
operates in the technology industry where it rapidly changing because of fierce
competition. Investopedia. (2016, May 27)

3
Appreciation can be a way of making money out of stock where the investor buys a stock at a low price
and sell it with a higher price. Another way is to hold a stock and receive dividend payment. This can be
different between the companies depending on the company’s dividend payment policy. Fontinelle, A.
(2017, December 27).

Answer 3:

A stock market index is a combined value created by collecting more than one stocks or other
investments together and stating their overall values against a base value from a certain date. They are
planned to show a whole stock market and consequently track the market’s variations over time. The
market index also helps investors track the variations in market values over long period of time.

Facebook’s stock price is $168.09 higher than Ford’s. The stock price of Facebook is almost 15
(180.25/12.16) times the price of Ford’s stock. This is also reflected in the market capitalization of the
two businesses whereas Facebook’s market capitalization is $ 523.48 billion compared to that of Fords’
whose market capitalization $ 48.54 billion. The stock price is an absolute measure not relative one.
Therefore, the comparison of the stock prices alone is not sufficient to form an overall opinion on the
two businesses. A more relative measure is the EPS which calculates the earnings per share of each
business hence valuing each sharer relative to the earnings of the respective company. In this
comparison Facebook also has a much higher EPS (5.38 vs 1.10).

According to S&P stock market index historical graph (N.D), it shows that during the past 10 years ended
July of 2017, the S&P 500 had a rank of 9 with a return of 70%. The highest ranked index during the
period was the NASDAQ 100 Index, with a return of 204%. The lowest performing index during the 10
years’ time period was the CAC 40 Index with a return of -10%. The middle return for the indexes during
the last 10 years was 65%. The average return for all stock market indexes over that time frame was
57%

Answer 4:

The payout Ratio is calculated as follows:

Payout Ratio = (Dividends per share (DSP) / Earnings per share (EPS)) x 100

33.27 / 5.38 = 6.184 x 100 = 618.40

Ford current Ratio will be 1.07 as a liquidity ratio which is calculated as current assets dived by current
liabilities.

Ford payout ratio is measured by dividing the paid dividend by the net income. So, it is 54.10.

Answer 5:

P/E is the price earnings ratio which is the ratio for valuing a business which measures its current share
price relative to its per-share earnings and it is calculated by dividing the price per share by the earnings
per share. It measures the market’s confidence in the share.

4
Comparing the P/B ratio between Facebook and Ford:

The investors are more confident in investing in Facebook stocks more than ford as they are willing to
pay 33.1 dollar in order to get 1 dollar only. Even though the ford P/E ratio in is spectacularly high which
11.03 dollars.

P/B is the market price per share divided by the book value per share, where the book value per share is
the total assets minus the total liabilities divided by the number of shares outstanding. If the P/B ratio of
the company is low it means that the stock is undervalued. Undervalued stock is a financial term
referring to a security or other type of investment that is selling for a price supposed to be lower than
the investment's true essential values.

Comparing the P/B ratio between Facebook and Ford:

The P/B ratio in Facebook is 7.35 which is considered as high and it means that the stock is not
undervalued. Meanwhile Ford B/B ratio is 1.45 which is considered very low compared to Facebook P/B
ratio and it means that their stocks are undervalued.

ROA is the return on assets which is calculated by dividing the net income by the total assets. It
represents the percentage of profit a business makes in relation to its total resources.

Comparing the P/B ratio between Facebook and Ford:

Facebook's return on assets is 22.20% and the Ford's return on assets are 1.80%. It is noticeable by
comparing the two companies that Facebook has much bigger and higher profit than Ford in relation to
its total resources.

Profit margin (for Ford, also try to explain why its profit margin is higher than its operating margin.
Define these two forms of margin (operating and profit along with gross margin)

Profit margin is a profitability ratio that can be calculated by dividing net income by revenue, or by
dividing net profits over sales. Net income or net profit can also be determined by deducting all of a
company’s expenses, in addition to operating costs, material costs (including raw materials) and tax
costs, from the total revenue. Profit margins are shown as a percentage and, in effect, measure how
much out of every dollar of sales a company actually keeps in earnings.

Operating margin is a measurement of what amount of a company's revenue is left after paying for
variable costs of production like wages, raw materials, etc. It is calculated through dividing a
company’s operating income (also known as "operating profit") during a certain period by its net
sales during the same period. Operating margin is also expressed as a percentage.

Gross margin is the cost of goods sold (COGS) subtracted from the company's total sales revenue,
divided by total sales revenue, expressed as a percentage. The gross margin symbolizes the percent of
total sales revenue that the company retains after the direct costs associated with producing the goods
and services it sells.

5
If there is a big discrepancy between the profit margin and the operating margin, it suggests that it is
more efficient in creating and selling its products, but maybe less efficient in managing training,
administration, research or other day-to-day business costs.

Debt/Equity is measured by dividing a business’s overall liabilities by its stockholder’s equity. It is used to
measure the business’s leverage. The Debt and Equity ratio shows how much debt a business is using to
finance its assets relative to the value of shareholder’s equity.

Comparing the Debt/equity ratio between Facebook and Ford.

Ford Debt to Equity ratio is 4.49 and Facebook Debt to Equity is 0.00. Investors hardly want to buy a
stock of a business with very low debt ratios and it would specify that the business does not finance
increased actions through borrowing at all, which borders the total return that can be realized and
passed on to shareholders. There is some risk associated with having too little debt. A higher debt to
equity ratio which is Ford in this case makes it harder to borrow money as Lenders do not give extra
credit to businesses that are overleveraged.

The answer of question 6, 7 and 8 is in the excel sheet

Answer 6:

Monthly Return for Facebook

Monthly Return for Ford

Answer 7:

SD = 1.2884 for Ford

SD = 69.8810 for Facebook

Answer 8:

CV = 0.10923 for Ford

CV = 45.16833 for Facebook

6
Answer 9:

If you had 30,000BD to invest and could only pick one of the two companies to invest in, which company
would you pick? There is no right or wrong answer, but you must justify your choice with reference to
each stock’s ratios (and any other research you may have done) by explaining

Facebook is the chosen company.

Your risk tolerance

Our risk tolerance is neutral as I have chosen Facebook because it is a big company, less risky and it is
historically profitable. It is also a leader in the market as it invests heavily in the research and
development a lot. I think it is less risky because it has purchased some of their competitors for
example, WhatsApp and Instagram so this have made the company less competitive and therefore less
risky.

Your investment timeframe

We decided that our investment timeframe is 5 years because it is suggested by Uswitch (N.D), to invest
money at least five years in order to be in a good position to handle these vacillations.

Your investment goals

Our main investment goal is to earn more money. As investors will get more money because they will be
earning interest on what you put away or by buying and selling assets that increase in value.

The stock’s growth potential

As we mentioned above, Facebook is a continually growing company and historically profitable too. This
company is stable and it invests a lot in its research and development.

The stock’s potential to fall

This company has a rapidly changing environment as there will be many new technologies coming in the
future. Therefore, it will have fierce competition.

References

Staff, I. (2017, November 29). Price-Earnings Ratio - P/E Ratio. Retrieved December 24, 2017, from
https://www.investopedia.com/terms/p/price-earningsratio.asp

Momoh, O. (2017, November 21). Quick Ratio. Retrieved December 24, 2017, from
https://www.investopedia.com/terms/q/quickratio.asp

Current ratio. (2017, November 27). Retrieved December 25, 2017, from
https://www.accountingtools.com/articles/2017/5/16/current-ratio

Debt to equity ratio. (2017, November 2). Retrieved December 25, 2017, from
https://www.accountingtools.com/articles/2017/5/15/debt-to-equity-ratio

7
Picardo, C. E. (2017, December 15). Payout Ratio. Retrieved December 25, 2017, from
https://www.investopedia.com/terms/p/payoutratio.asp

Why Discount Rates Should Reflect Liabilities: Best Practices for Setting Public Sector Pension Fund
Discount Rates. (2015). [ebook] Truong Bui and Anthony Randazzo. Available,at:https://reason.org/wp-
content/uploads/files/pension_discount_rates_best_practices.pdf

Investopedia. (2016, May 27). Market Index. Retrieved January 03, 2018,
https://www.investopedia.com/terms/m/marketindex.asp

Fontinelle, A. (2017, December 27). Why do some companies pay a dividend, while other companies do
not? Retrieved January 03, 2018, from https://www.investopedia.com/ask/answers/12/why-do-some-
companies-pay-a-dividend.asp

S&P stock market index historical graph . (n.d.). Retrieved January 03, 2018, from http://www.forecast-
chart.com/historical-sp-500.html

Moffatt, M. (2017, September 14). What Is the Discount Rate? . Retrieved from ThoughtCo.:
https://www.thoughtco.com/discount-rate-definition-1146078

Nominal Interest Rate. (n.d.). Retrieved from Invistopedia :

https://www.investopedia.com/terms/n/nominalinterestrate.asp\

Uswitch . (n.d.). Retrieved January 04, 2018, from https://www.uswitch.com/investments/best-

investment/

Profit Margin. (2017, December 18). Retrieved January 04, 2018, from
https://www.investopedia.com/terms/p/profitmargin.asp

Read more: Gross Margin https://www.investopedia.com/terms/g/grossmargin.asp#ixzz53CKiBLdP

Follow us: Investopedia on Facebook

Read more: What's the difference between profit margin and operating margin? |
Investopedia https://www.investopedia.com/ask/answers/102714/whats-difference-between-profit-
margin-and-operating-margin.asp#ixzz53CS2KUVJ
Follow us: Investopedia on Facebook