Becoming the market leader has been the main goal of all players in the Aerospace and Global defence industry, and with government budget cuts (Wachman 2010), especially in the US, competition on securing large contracts have never been intense. Overall cost of production is significantly high in this field, firms may tend to overproduce and reduce prices to sell more. Strategy recommendation.
BAE needs to be aware of its Book value and its total earnings, especially on depreciating assets. The strategy recommended, is to continue to acquire financially stable companies to add key improvements to the group, this is just one way to reflect a high closing book value, and dispose or sell, non performing divisions of the group. The BAE group should create a plan to maximize shareholders value by buying back their market shares by allocating an appropriate portion of their capital.
And due to lack of future contracts, they may opt to cut a portion of their work force just to drive down costs and focus the need to drive efficiencies across the business and the continued development of four global initiatives Land, Security, Readiness & Sustainment and Unmanned Aircraft Systems. Financial forecast To be able to compare and contrast the current and the proposed strategy, financial projection will be employed, to outline key differences and possible improvements for the Board of Directors for BAE System, and base their decision on its results. 3. 3. 1 Financial forecast based on current strategy.
Using the residual Income and Dividend Valuation Models, we can forecast the 5 year financial projections based on the current strategy, all of the necessary inputs are available in the Balance Sheet of BAE systems (see Appendix 3) except for the Ke (Cost of Equity) in which we will compute as follows. Ke = 17. 6p (projected dividends next year with 10% value projection) + 0. 10 330. 30 GBX ( source: current FT Market data) Ke (Cost of Equity) = is valued at . 15 or 15%. Now we can compute for BAE Systems residual income using data we already have. On Table 3 we can see each individual outputs in millions of ?.
Our key inputs for computation are listed on Table 2 as: Table 2 INPUT DATA ? Earnings -45000 Earnings growth 0. 10 Div pay out . 10 Ke 0. 15 No. of shares 34407. 00 Net assets 25407. 00 Net equity 4655. 00 Inputs Earnings per share projected for next year, given the average earnings growth of 10% (Financial Times 2010). Total number of shares posted at 34 million, Net Assets is at 25 million and total equity is listed at 4655 million. Outputs For Table 2 opening book value starts at 7289 million at the start of the fiscal year, then closed at 4727 million at the end.
With a net loss incurred for the fiscal year ended 2009, The Net present value or NPV turns starts negative at year 2 following the current strategy and continues to be until reaching the 5th year of the projection. Which means given those figures and compounded with the annual inflation rate, the next 5 years would be very difficult in terms of overall profitability of BAE. Table 3: Residual Income and Dividend Valuation Model Projections Source : Authors own computation We will also use the Capital Asset Pricing Model (CAPM) to gauge our cost of equity. To calculate for the CAPM, the formula is:
Assuming our stock beta is at . 5 and the risk free interest rate is at 3. 5% ( assumption on historical data). And the expected market return is at 10%. Our results based on this model would be as follows: Equity Market Premium % is at 6. 5% Expected Return on Capital Asset % is at 6. 75%. 3. 3. 2 Financial forecast based on recommended Strategy Still using the supposed EBITA on BAE systems annual report (2009) and following the strategy disregarding the penalties incurred, reduction of workforce due to lack of future contracts, BAE systems earnings could reach 1,921 ?
Million minus tax expenses. Table 5 shows the inputs on the recommended strategy and table 6 shows the computation of the same residual income and dividend valuation models. Inputs Table 4 INPUT DATA Projected Earnings based on strategy 1921. 00 Earnings growth 0. 10 Div pay out 0. 10 Ke 0. 15 No. of shares 34407. 00 Net assets 25407. 00 Net equity 4655. 00 Outputs Table 5 Residual Income and Dividend Valuation Model Projection based on Strategy suggestion. Source : Authors own computation.