Based on the case study, it is clear that Monsanto has a problem of capital structuring. The company needs to decide on the best financing strategy. Also, the preferred option should serve the interest of the shareholders which is to maximize wealth. In comparison to the current operating level of competitors, Monsanto is a large company. Thus, taking debts would be a feasible idea for the company. In consideration of this company's growth in debt ratio, (excluding long-term debt), it might be an LBO (Leveraged Buyout) target. The major reason is that due to low leverage, Monsanto does not have an optimum capital structure. Most significantly, lack of long-term debt in the capital structure minimizes the value of the firm. In the long run, the shareholders’ interest may be negatively affected. In view of the financial position of this company, it has the capacity to acquire debt that can improve its value. The major benefits of acquiring debt are that the company will utilize borrowed funds to generate profits ( Ventures, 2016). If Monsanto decides to take more debts, the company will be leveraged and at the same time, there is an opportunity of generating more returns. With this, an increase in debt will also make impacts on the net income, EPS, and also ROA of the company. Another advantage is that interest on debts is tax deductible. This means that it will gain from debt tax shield. Also, it will be important for Monsanto to consider external debt rather than create value. Notably, cost of debt or interest is deductible. After introducing the tax in the cost of debt, the overall cost of capital decreases.
EFN
Since the interest of Monsanto is to build the investor's esteem, there is the importance of looking for an option that will not result in a decrease in the firm's offer. On the other hand, the association is aiming at extending it's to pesticide operations which are expected to yield an increase of $ 3.95 million. If the plan of expansion is settled, the resources needed would be equal to 70% of the totals deals. With this, the offer will cost 20% of the offer. The new deals will have a profit rate of 1.98% and thus, the company will maintain a proportion of 98.2%. Using this information, we can calculate the settled resources for the expansion (3.950 x70% = $ 2.765 million). The firm has two strategies of financing either by value or obligation ( Scott, 2018). However, in this case, the company is not ready to issue shares or value and thus, the only remaining option is through creating debts to subsidize this venture. As a result of an increase in sales, the income statement will be adjusted to reflect these changes.
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| $(Million) | |
| Total Sales | 15.239 |
| COGS (20% of Sales) | 3.0478 |
| Gross Profit | 12.1912 |
The expected increase in the gross profit margin is equal to $ 12,191,200
EFN =
Ao/So (S1-S0)- Lo/So (S1-S0) – (PM) (S1) (b)
S0 is the Current Sales = $15.239 million
S1 = Forecasted sales
= (1+g) S0 = (1+0.03) 15,239,000 = $15,696,170
Whereby g is the sales growth rate forecasted
Liabilities to $12,359,333 (L0)
Profit Margin (PM) = 0.55
1.98% is the retention ratio (b)
Ao/So (S1-S0) is the increase in assets required = $2,765,000
EFN = $2,765,000-(12,359,333/15,239,000) 15,696,170-15,239,000-(1.98%) (15696170) (0.55)
EFN = 2,223,288.72
Sustainable Growth Rate
Sustainable growth rate represents a growth that a company may undertake without straining financially. A company with SGR will not look for external funding or raise financial leverage. The shareholders will take it a feasible idea as it measures how faster and how big the company can grow without any external financing. It is calculated as:
Sustainable growth rate = ROE*(1-dividend payout ratio)
SGR = 14.93% x (1-1.98)
= 14.63%
Internal Growth Rate
The internal growth rate is the highest level of growth attainable without leveraging the firm through outside debts. To the investors, this rate is important as it measures the level at which the business will grow and fund its operation. Also, it demonstrates the ability to increase the level of sales and profit without affecting the capital structure.
IGR = ROA*b/(1-ROA*b)
Whereby ROA is the Return on Assets
IGR = 0.1056*0.982/1-(0.1056*0.982)
IGR= 11.57%
Monsanto WACC
| Equity | Debt | ||
| Fully-Dil. Shares O/S | 545.06m | BV of Debt | 1803 |
| Current Share Price | $72.5 | Net Interest Exp | $58 |
| Levered Beta | 1.1 | Average Maturity | 15 |
| Rf Rate | 3.69% | Pre-tax Cost of Debt | 6% |
| Expected Return | 10.25% | Tax Rate | 30% |
| Equity | Debt | WACC | |
| Market Value | $39,516.85 | 1315.64 | 40382.49 |
| Weight in Cost of Capital | 96.78% | 3.22% | 100% |
| Cost of Component | 10.24% | 0.14% | 10.37% |
In comparison with the WACC provided in the Company’s FY 2009 10-K, the WACC is 10.5% and I assumed that it equals 10.5% after rounding up. Further, since the Monsanto has a WACC of 10.5% and growth rate terminal of 6%, the target share price calculated under the DCF model is $94.83.
|
Discount Rate |
||||||
| Terminal Growth | 9.5% | 10% | 10.5% | 11% | 11.5% | |
| 5.0% | $102.02 | $91.04 | $74.62 | $82.08 | $68.33 | |
| 5.5% | $111.54 | $98.35 | $87.82 | $79.22 | $72.07 | |
| 6.0% | $123.78 | $107.48 | $94.83 | $84.73 | $76.48 | |
| 6.5% | $140.09 | $119.23 | $103.60 | $91.47 | $81.77 | |
| 7.0% | $162.94 | $134.89 | $114.88 | $99.89 | $88.24 | |
| Methodology | Valuation | Weighting | Weighted Price |
| Absolute Valuation | $90.08 | 20% | $18.02 |
| Rel. Valuation S&P 500 | $88.03 | 20% | $17.61 |
| Rel. Val: Comps | $88.12 | 20% | 17.62 |
| DCF Valuation | $94.83 | 40% | $37.93 |
| Weighted Target Price | 100% | $91.18 |
The WACC is an essential metric tool in the capital structure of the company. It is used to measure the potential impact of the anticipated project on the growth of the business. In this sense, it provides the benchmark of making a decision whether the project is profitable for the company. If the rate of return on the project is less than the WACC, the company should reject the project. However, in cases where the rate of turn is greater than WACC, this means that the anticipated project would have a positive NPV. The company should divert its resources and invest in such a project. The best way that Bayer’s to evaluate whether the project would be profitable is to run an NPV analysis. As analyzed, the results of the NPV are positive. Thus, based on an evaluation of the project should be accepted by the management ( Hernandez, 2014) . From the investor's point of view, WACC is the minimum return that a company may earn from a project or investment. Similarly, investors, bondholders, stockholders, and preferred stockholders would use this rate or return to make their investment decisions. On the other hand, WACC should be benchmarked with IRR which is the rate of return that is applied when estimating the break-even point of an investment. It is the rate that equates the NPV to zero. Further, at this point, the discounted cash flows of the investment are equal to initial cash outlay.
The DuPont Ratio Analysis is the method used to decompose and examine Return on Equity (ROE) into three components:
Financial Leverage (equity multiplier)
Profit Margin
Asset Turnover
= ((0.80) x (2.43) x (22.85) = 44.42%
So to make it clear this claims that Monsanto has generated more profit from invested shares. With this, the second option for the company is to create values or sale of shares. With this, the company will be able to source a large amount of money which may increase its growth in the long-run ( Christou, 2013). However, the problem is that should take into account the possibility of a hostile takeover. By selling shares of huge amount, an external firm may opt to buy these shares with an intention of management move or acquiring the company. As a result, the purchasing firm will have the control over the company as it has more shares compared to the owners of Monsanto.
Conclusively, Bayer is considering to acquire Monsanto and as analyzed in the case, this decision would add value to the company. In this view, there is a possibility of a simultaneous increase in profits and share prices. However, it is important to consider the large amount of money that the company will incur in stock to acquire another firm ( Weber, 2013) . Through this option, Bayer is exposed to the risk of acquisition not performing well and thus, affecting it negatively. In my view, the process of acquiring another company requires a long-term planning. Bayer should hold off this decision and take time to consider others issues affecting acquisition.
References
Christou, P. (2013). Plant genetic engineering and agricultural biotechnology 1983–2013. Trends in biotechnology , 31 (3), 125-127.
Hernandez, J. G. V. (2014). REPUTATIONAL CAPITAL AS AN ETHICAL QUESTIONING OF TECHNOLOGICAL INNOVATION The case of MONSANTO.
Scott, A. (2018). MERGERS & ACQUISITIONS Bayer clears the path for Monsanto purchase.
Ventures, M. G. (2016). R&D NEWS.
. A comprehensive guide to mergers & acquisitions: Managing the critical success factors across every stage of the M&A process . FT Press.
Scott, A. (2018). Ventures, M. G. (2016). Weber, Y. (2013)
