The Current Capital Structure of Woolsworths Limited


 


Executive Summary


            Woolsworths Limited is one of the huge companies in the Australia. Having the sufficient number of employees and the better image to customers, there is high risk debts behind these successes. The company is high when it comes to leveraging its debt as well its equity. There is a huge percentage for the company to have paid its long term debt which can result to high risk. In this manner, the analyzation of its having high capital structure had resulted to some of the recommendation which the company needs to follow in order to have a high and maximum value while alleviating its cost of capital. In this regard, the suggested strategy for the company is to continue and diversify its better services while minimize the investment of debt.


 


Introduction and Purpose of Analysis


            The examination for the current capital structures of the company is an ample movement for most of the business which can recognize current and future optimality of its debt-to-equity ratio. In this manner, it can determine the finances for the assets of the certain corporation for some of the combination of the debt, equity, and the hybrid security. This is therefore important in structuring the composition or the analyzation of its liabilities. In this regard, this structure can determine the profitability of the company and how it can leverage or come up to its debt and with respect to its equity. The company that serves as the best example for understanding its capital structure is the Woolsworths Limited.


            Woolsworths Limited is the best and one of the most trusted and recognizable brands in serving and retailing for the everyday million of customers while having the great choice, outstanding quality, and low prices. This had been covered by the group in the entire New Zealand and Australia which as more than 3,000 stores with 180,000 employees. The expertise of the company are primarily revolving into liquors, general merchandise, food and grocery, consumer electronics, and its service for the million of customers everyday. The company is also considered to be one of the major investor in the communities of New Zealand and Australia. It go through the creation of job, development of infrastructures, shareholders wealth are growing, growth of the manufacturing and agricultural production, and its innovation of products. Through better social commitment, it resulted to the educational and training development for majority of the employees while having the advancement of the food industry and the safety for the workplace and improvement of retail technology. It has also committed itself to the serious address of environmental footprints while suing the scale in influencing and bringing the improvement positively to the performance of environment to the stores, and to its supply chain (WoolsWorths Limited Corporate Website, 2008).


            Studying the current capital structures of WoolsWorths Limited and to the other large listed companies will determine constraints and other variable which has the significant effect the growth of the company. Since, most of the large and listed companies, they have the easier access to the international market which can resulted to their financing decisions will be less subject by the imposition domestic market into the institutional and international constraints. Thus, the objective of this analysis is the examination on leveraging and the maturity of debt as the options are made by the company to countries. In this particular paper, the focus is the understanding of the factors that can influence the finance decisions for the Woolsworths Limited with the use of the debt and its equity ratio and to other variables and how its affect to its long term decisions and growth can.


 


Optimal Capital Structure


            Since, it had been known that the capital structures is the significant amount for the permanent debt whether it is for short or long term manner, the common equity and the preferred stock in financing the firm. On the other hand, we can say that the capital structure is optimal if it occurs to the point wherein the cost of the capital had minimized while the value is maximized. In this regard, it consists primarily to the debt if ever the corporate income tax had exists while there are no agency costs and financial distress costs. If this had given, the optimal capital structure commonly consists some of the combination for both equity and debt. The debt capacity of the firm is the amount for the debt contained in the optimal capital structures. Therefore, these can be determined by the factors that includes in the business risk of the firm, the extent for the forecasted financial distress, tax structures, and the agency costs as well as the role played by the policy of capital structure that provides signals in the capital markets with regards to the performance of the firm (McGuigan et. al., 2005, p.345).


            If the optimal capital structure exists, the management needs not only to finance the firm but with the aide of its objectives of maximation and optimal proportions for the firm’s value will assured. As a matter fact, whatever movement in connection to the optimal capital structure will reduce the cost of capital while there is an increase in the value of the firm (Stonehill, et. al., 1993, p.126). Its concept is primarily based on the policy of capitals structure that involves the trade-off in the midst of return and risk. This means that if the use of the more debt will be risky to the earnings of the firm but the higher debt ratio leads to the higher expected rate of return. In summary, the higher risk is associated to the greater debt which have the possibility of decrease the stock prices though the higher expected rate of return will increase to it. This means that the optimal capital structure is the one which can strikes the optimal balance in the midst of the returns and risk which can maximize the price of the stock while minimizing the WACOC (Beenhakke, 2001, p. 177).


            The optimal capital structure is part entirely by the company’s package for the financial policies that includes the amount and type of the debt and equity claims and the dividend policy being issued. This can be evaluated by the done by the assessment financial flexibility, optimal debt arrangements, and weighted cost of capital. The financial flexibility had defined as the ability in funding its expenditures for the short notice to the reasonable cost at the range of financial and economic market conditions. This is primary refers to the internal borrowing and funding sources which are always available. This financial flexibility can have the ability to predict the deviations from the business plan without undermining the market position or destructing the operations. This can also have the ability to fund the profitable opportunities of investment. There can also have the excess for the financial flexibility and it includes the relaxation of the normal cost and the cost control disciplines which pursue the opportunities of revenues. The cost of capital or the weighted average cost of capital is the cost of equity and debt being weighted in connection to the contribution of the total capital of company. The reason behind using the assessment of the optimal capital structure to the framework of shareholders value is the determination for the amount of the capital required in maximizing the business value wherein the amount of capital which can be an excess to the optimal amount is returned to the shareholders. There is also impact of the debt to the shareholder value which needs to assess properly. The developing of the debt policy can requires the review for the way whereas the different arrangement can have the significant effect to the shareholders value. Therefore, the criteria in selecting the precise mix of floating and fixed rate debt must be based on minimizing the variation of shareholder value that arises from the changes of nominal interest rate.


 


The Existing Debt-to-Current Ratio – an Analysis


            The debt-to-equity ratio is considered to be one of the most often used ratios of financial leverage. This means that the debt-to-equity ratio needs to analyze the cash flows of the firm whereas the stable cash flows can have the predictable higher debt levels (Gaughan, 2002, p. 479. The measurement for Woolworths Limited and its financial leverage can be calculated as dividing the total liabilities by its shareholders’ equity. This proportion indicates that the equity and debt for the company is using in order to finance its assets. Before taking into the account of the current debt-to-current ratio, it is also important to determine the past years ratio so that there will comparison in building to the proper analysis.


            The table shows the shareholders equity of Woolworths Limited with respect to the total liabilities with their debt-to-equity ratio.


(in $M)


2008


2007


2006


2005


2004


2003


Shareholders Equity


5,992.90


5,275.30


4,027.80


1,974.20


2,163.80


1,464.30


Total Liabilities


9,437.20


9,140.80


9,318.60


6,800.90


4,681.10


4,651.00


Debt-to-Equity Ratio


0.63502946


or


63.50%


0.57711579


or


57.77%


0.4322323


or


43.22%


0.29028511


or


29.03


0.46224178


or


46.22%


0.31483552


or


31.48%


Source: Financial Statement of Woolworth Limited


            For the year 2003, the company has the 31.48% of debt to equity ratio which means that there is not much expected return in the debt ratio. The progress continues for the following until the current year of 2008 which can be seen in the table above that the ratio for the debt-to-equity is 0.6350 or simply means that Woolworths has the long term debt of 63.50% as large as its equity. This implies that for this year, the company will be at the high risk in its shareholders due to the fact that the creditors are always in line first for the compensation. This implies as well that for every dollar in the equity financing, this is the 63.50% in its debt financing. There is also the potential to generate the many earnings in the greater amount as compared to the cost whereas the shareholders’ benefits are spread to the shareholders. Nevertheless, since the company has the sufficient amount of equity, then, this is not bad. On the other hand, even the current debt-to-equity ratio of the company is risky in its earnings; there is still the optimism for having the high debt ratio as it leads to the higher expected rate return in the future.


The Weighted Average Cost of Capital is used in measuring the cots of capital of the firm and can be computed as:




The companies given values are:


Re = 4.16


Rd = 11.5


E = .50 x 2.2% = 27.5


D = 3.68


V = E + D


Tax rate = 32.8%


Then, the computed value of WACC will be:


WACC = 27.5 /(27.5+ 3.68) (4.16) + 3.68/(3.68+ 27.5) (11.5) (1 – 0.328)


WACC = (27.5 / 31.18) (4.16) + (3.68 / 31.18) (11.5) ( 0.672)


WACC = (0.881975) (4.16) + (0.118024)(11.5) (0.672)


WACC = 3.669016 + 0.9120


WACC = .58


This means that the company can have the interest of .58 fort every dollar it pays in its finances which seems to be lower considering it is a large company which added to the riskiness of the company.


            Since the company has still the room for the minimizations of its capital and its value needs to maximized, therefore, the said current structure is not yet optimal. Moreover, the company is also risky when it comes to debt and to its capital. There are also no possibility and assurance that this will continue in the long term manner. These are the reasons why the company needs to change its capital structures so that growth will be for the long term manner. In order for the company to minimize its cost of capital, it is important to divert its capitals and debt to less cost with high amount of value to the company.


 


Recommendations


            Most of the analysts suggest that the choices of the firms for the capital structures will depend primarily on the existence of the cost of agency and the asymmetric information. Thus implies that costs are mitigated by the structure of ownership as well as the financial contracts and commonly depends to both the institutions and to the characteristics of the firm into the economy that can monitor and facilitate the financial contracts. For the most of the extended time frame, the company can have the option of including and raising more of the equity. This equity raising has the possibility that they may not be limited to the cases to the government-owned entities.


            The improvement or the maximization of the value of Woolworths can be done by its development of its capability of supply chain, in depth of talent, and the low cost culture which can result to the continuous commitment of the customers and having its growth. The continuous acquisition and evaluation for the opportunities can also help to leverage the strengths while can augment the existing business of the company. In order to have the better value, it is important for the company drive up its retail business by bringing its customers in the greater convenience, lower prices, better quality products and services. The company needs to have the best track records for its continuous growth in order to deliver growth and to accept the opportunity for growing the market share in the entire business for both in New Zealand and in Australia. The value can be maximize with aide of reinvestment to the current business, needs to continue to re-invigorating its offer, improvement of the new businesses as well as adjacencies, and the development of new categories. The company can also have the better opportunity in leveraging its scale and to its store distribution in introducing the new services, products, formats, and categories. In general, most of the opportunities are existing n driving into the future growth through continuing to reinvest into the business so that the company can generate the high value. This development can have the options for the company to do it until end year of 2009.


            Some of the suggested recommendations that can be use by the company are the continuation to invest to range of merchandise, price and quality on all brands, store execution and customer service. There must also be expansion on the private levels which ranges from organics and other products which can continues customers’ acceptance and increased the market research as well as data analysis. In connection to the development of the product roadmap, this can leverage the cards program which has the plans in offering to the general insurance of the customers and the offering t the customers of the general insurance and to the convenience of the financial services. Upon the continuing expansion of the activities of global sourcing, the company can increase the capabilities of the said area in order to continue in securing the costs price savings while improving the range and quality. There are also opportunities in the leveraging the expertise of supply chain which can follow by the company in order to maximize its value.


 


Summary and Conclusion


            Since the company had known for having the high risk at debt and equity, then, the suggested strategies will be a great help for the company in leveraging its debts and equity and in order to achieve its goal. Its customers can continue to support the company as well as it new products and services due to its commitment that brought in every heart of its customers.


 


Reference Lists


Gaughan, P 2002, Mergers, Acquisitions, and Corporate Restructuring, John Wiley and Sons, Manhattan.


Beenhakker, H 2001, The Global Economy and International Financing, Greenwood Publishing Group, United States.


McGuigan, J et. al., Contemporary Financial Management, Thomson South-Western, United Kingdom.


Stonehill, A 1993, International Financial Management, Taylor & Francis, United Kingdom.


Woolworths Corporate Website 2008, Woolworths Limited, viewed 11 September, 2008, http://www.woolworthslimited.com.au/phoenix.zhtml?c=144044&p=our-profile.


 



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