Monsanto Company offers agricultural products including seeds, herbicides, biotechnology trait products as well as digital agricultural products. The company is determined to help farmers improve their productivity produce the best food for human and animal consumption and to reduce farming costs. The company has two major segments that include agricultural productivity and food genomics with the food genomics segment driving the future growth of the company. Monsanto delivers value to its investors and is renowned the world over for the great technology platform that gives it a dominant edge over its competitors (Monsanto, 2017). The following is an analysis of the company's financial statement to determine its current situation and projected future activities that will form the basis for determining the proposal by Bayer. The analysis will involve the financial statements for 2015 and the additional information that will help compute different parameters for the analysis.
Assumptions
The announcement of the proposal led to an increase in the share price for Monsanto by 8.7%. The company’s sale for the year was $15 billion a decline of 5% from the previous year. Monsanto has a tax rate of 35% and its cost of debt is 12%. The company is expected to grow by 3% in the current year. The sales are projected to be $15,239,000 and equity will be $9,141,333 and the total debt is $12,359,333. The profit margins and the total asset turnover remained the same. However, EBIT, depreciation, change in net working capital and capital spending are expected to grow at 3%. Capital investment will remain the same.
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The alternative proposal involves the expansion of the operations of the company to include pesticide production. Sales increase under this arrangement will be $3,950,000. The company has no excess capacity and therefore fixed assets will increase by 70% of the increased sales. The cost of sales will be 20% of sales. The company issues 1.98% of the net sales as dividends. The current sales for the company are $15,239,000 and the new division will contribute $2,950,000 as sales. The proposed project has a risk and weighted average cost of capital and beta which is the same as Monsanto
Weighted Average Cost of Capital
WACC= E/(E+D) * cost of Equity + D/(E+D)* Cost of Debt *(1-T)
Where E- equity and D –debt, T- tax
WACC= E/(E+D) * cost of Equity + D/(E+D)* Cost of Debt *(1-T)
Cost of equity (CAPM) = Rf +ᵝ * Risk premium
=1.5 + 1.05 *(13.87 -1.5)
=14.49%
= 9,141,333/(9141333 + 12359333)*0.1449 + 12,359,333/(9141333 + 12359333)*0.12 *0.65
=0.061606 + 0.04484
=10.64%
Discounted adjusted cash flows
Cost for the new division =$62 billion
Increased sales =3,950,000
Fixed assets needed = 70% * 3950000= 2765000
Cost of sales =20%*3950000 =790000
Dividends =1.98%*3950000 =78210
Current sales for the division =$2,950,000
Growth rate =3%
WACC =10.64%
Beta = 1.05
Sales after 1 year = 3950000 *1.03 =4068500
Discounted cash flow =4068500/1.1064
DCF =$3,677,241.504
CFA = $3,728,464
The CFA is more than the discounted cash flow meaning that the company is better off operating without the division. This is because the future cash flow will have a lower value compared to the present value if it is discounted using the computed WACC.
The present value of the sales after 1 year is $3,677,241.504
Cost of sales =20% * 3677241.504 =735448.3
Dividends =1.98% * 3677241.504 = 72809.4
Profits from the new division in 1 year = $2,868,983.8
The profits generated by the new division assuming that there are no depreciation and additional investments in the following year will be $2,868,983.8
The return on investment for the new division will therefore be ($2,868,983.8 + $72809.4)/62B =4.7%
The return on investment is slightly lower than the return on investment without the new division which is 4.8%. Using the discounted cash flows, the company will therefore not benefit from the new division since it does not have excess capacity for the new division. Similarly, the returns of the new division do not add value to the current outlook of the company (Berk & DeMarzo, 2014). The investment is therefore not worth undertaking given that the company will not benefit from the new investment but will tie more of its capital in the new division. The shareholders are also likely to lose if the new division does not generate adequate revenues or if the sales decline.
Ratio Analysis
According to the financial statements for 2015, the company reported a decline in sales, EBIT, net income, diluted earnings per share, diluted shares outstanding and capital expenditures. However, the company realized significant growth in its free cash flows and depreciation and amortization. According to the operating results, the company realized a decline in its net sales, income from operations, income from continuing operation including a portion of the non-controlling interest and net income attributed to Monsanto Company. However, the company had an increase in income from discontinuing operations. The total assets for the company, the working capital, the current ratio, the long-term debt and the debt to capital ratio had slightly increased in 2015. The dividend per share also increased but the stock price per share decline. The basic share outstanding and the diluted shares outstanding reported a slight decline in the year under review.
Selected Ratios
Debt to equity = Total debt/Total equity
=8,429/6,990 = 1.29
Debt to capital = Total debt/Total capital
= 8,429/111464 = 0.56
Interest coverage = EBIT/Interest expense = 3,161 ÷ 433 = 8.30
Net fixed asset turnover = Net sales ÷ Property, plant, and equipment, net = 15,001 ÷ 4,973 = 3.02
Total asset turnover = Net sales ÷ Total assets = 15,001÷ 21,920 = 0.68
Equity turnover = Net sales ÷ Total Monsanto Company shareowners' equity = 15001 ÷ 6,990 = 2.15
According to the debt and solvency ratios, the company had a debt to equity ratio of 1.29 which is higher than the previous year when it was 0.99. The debt to capital had also slightly increased to 0.56. However, interest coverage declined by half to 8.30 from the previous year’s 16.43. The company’s short term and long term debt increased in the year to an all high value of $9,044,000,000. Equity declined from 7,875 million to 6,990 million. The net fixed asset turnover was 3.02 a slight decline from the previous year’s 3.12. The total asset turnover was 0.68 indicating a decline from the previous year’s 0.72. Equity turnover was 2.15 and increase from 2.01 reported in 2014. Ratio analysis indicates that the company is undergoing a challenging financial situation which has affected most of its ratios (Atrill & McLaney, 2011; (Kieso, Weygandt & Warfield, 2011). The company seems to have increased the size of its debt. However, the situation is not serious given that some of the changes can be attributed to the changing economic condition in the global market.
The company should accept the offer given that it is higher than the current value based on the current market price per share of $106 and a 52-week range of 81.22- 120. However, the company reported a 7.06% decline in its 1-year return. The value of the company can be calculated using the capitalization approach to determine if it's worthless or more. The market price and the share outstanding are multiplied to obtain the valued as follows;
Market capitalization of Monsanto =436,845*106 = 46,305,570,000. The $62 billion offer should be accepted if the market valuation at the current price is used. The company has a market capitalization of $46.3 billion which is lower than the offer price. If the company uses the highest share price recorded in the year to determine its value. Monsanto will be valued at $52.4 billion which is still lower than the offer price (Koller, Goedhart & Wessels, 2011).
If Monsanto decides to take the alternative, proposal, it will have to borrow more long-term debt to be used to invest in the new division. This will increase the debt-equity ratio which might increase the risk if the current trend continues for sometimes (Kieso, Weygandt & Warfield, 2011). However, the investment can be financed from company reserves which will have minimal effect on its current operations.
The sustained growth rate for the company = ROE *(1-D)
= 14.93 *(1-0.135)
= 12.91%
Internal growth rate = Retained earnings/ Total assets or return on assets =8.56%
The company has a high sustained growth rate and internal growth rate which implies that the investors have nothing to worry about concerning the future prospects of the company and its ability to pay its operating expenses and dividends.
References
Atrill, P., & McLaney, E. (2011). Accounting and finance for non-specialists . Harlow: Financial Times/Prentice Hall.
Berk, J., & DeMarzo, P. (2014). Corporate Finance. Boston: Pearson Education.
Kieso, D., Weygandt, J., & Warfield, T. (2011). Intermediate accounting . Hoboken, NJ: Wiley.
Koller, T., Goedhart, M., & Wessels, D. (2011). Valuation - Measuring and Managing the Value of Companies. Hoboken: John Wiley & Sons, Inc.
Monsanto. (2017). Annual Report 2017. St. Louis: Monsanto.
Monsanto. (2015). Annual Report 2015. St. Louis: Monsanto.
