capital budgeting examples

BCF7044: Corporate Finance Group Project

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DIGI.COM


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1.0 Historical Data Analysis

In this session, we will analyze DiGi‟s financial historical data from 2004 to 2008. All

financial data are extracted from DiGi‟s financial year report in those respective years

(DIGI: Appendix 6.0-8.0).

FORMULA

Liquidity Measures

2004 2005 2006 2007 2008

Short Term Solvency

Current Ratio Current Assets /Current liabilities 0.73 1.08 0.69 0.54 0.34

Quick Ratio Current Assests -Inventory /Current liabilities 0.72 1.07 0.68 0.54 0.34

Cash Ratio Cash /Current liabilities 0.56 0.91 0.53 0.33 0.15

Short term solvency provides information about a firm‟s liquidity. According to

DiGi‟s current ratio from 2004 – 2008, we notice that DiGi only achieved positive net

working capital in year 2005. Most of the time, DiGi operated under negative net

working capital. It shows that DiGi did not have sufficient cash convertible assets to

cover its liabilities in short term. This could be a real concern to DiGi‟s supplier as the

company did not have sufficient liquidity to pay off the short term debt. We also

noticed that quick ratio was similar to current ratio. This is because DiGi always has

low inventory level. In spite of negative net working capital and low inventory level,

we see this as the nature of telecommunication business rather than unhealthy

company performance. Likewise, DiGi‟s biggest competitor Maxis also experience

negative net working capital in its 2009 Q3 performance (Appendix 1.0). DiGi‟s cash

ratio was rather low compared to its current liabilities obligation. Last year, DiGi‟s

cash in hand was only sufficient to cover 0.15 times of its current liabilities.

Financial Leverage

2004 2005 2006 2007 2008

Long Term Solvency

Total Debt Ratio

Total Assests - Total Equity /Total

Assets 0.50 0.47 0.40 0.59 0.59

Debt-equity ratio Total Debt/Total Equity 1.00 0.89 0.67 1.44 1.44

Equity multiplier Total assests /Total Equity 2.01 1.88 1.68 2.46 2.45

Long term solvency ratios are intended to address the company‟s long-run ability to

meet its obligations or, more generally, its financial leverage. In 2004, DiGi‟s total

debt ratio was still 0.50. It means DiGi has RM 0.50 in debt for every RM 1 in assets.

Therefore, there was RM 0.50 in equity for every RM 0.50 in debt. However, the total

debt ratio increased to 0.59 in 2008; hence debt-equity ratio became 1.44 from 1.00.

This shows that capital structure of DiGi has changed significantly. The drastic

change between 2006 and 2007 where we see the debt-equity ratio was increased

from 0.67 to 1.44 was due to the capital repayment done by DiGi in 2007.


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Turnover Measures

2004 2005 2006 2007 2008

Inventory Turnover Cost of Goods Sold /Inventory 38.16 78.78 94.83 102.66 63.96

Days' Sales in Inventory 365 days /Inventory turnover 9.56 4.63 3.85 3.56 5.71

Receivables Turnover Sales /Accounts Receivables 12.62 13.45 14.55 12.41 11.44

Days' Sales in

receivables 365 days /Receivables turnover 28.92 27.14 25.08 29.42 31.90

Total Asset Turnover Sales /Total Assests 0.81 1.02 1.24 1.48 1.24

In this session, we shall see how efficient DiGi was in dealing with its assets.

Impressively, DiGi‟s inventory turnover was very quick in last 5 years. From 2005 to

2008, DiGi‟s inventory was sold in less than 1 week (Days‟ Sales In Inventory).

Likewise, DiGi needed approximate 1 month to collect outstanding credit accounts

(Days‟ Sales in receivables). DiGi‟s total asset turnover was improving from 0.81 in

2004 to 1.24 in 2008. It means that DiGi was making RM 1.24 sales for every RM 1

in asset in 2008 almost 50% up from 4 years ago. We may conclude that DiGi was

improving in asset management.

Profitability Measures

2004 2005 2006 2007 2008

Profit Margin Net Income /Sales 14.21% 16.33% 22.06% 24.36% 23.69%

Return on Assets ( ROA) Net Income / Total assets 8.90% 11.13% 19.77% 27.40% 24.50%

Return on Equity (ROE) Net Income /Total Equity 17.86% 20.95% 33.19% 67.35% 60.13%

Based on the profit margin of DiGi in last 5 years, we can see that the profit margin

was improved from 14.21% in 2004 to 23.69% in 2008. However, we do not expect

this margin continues to rise due to price pressure and market maturity. And the latest

DiGi 2009 Q3 report only made the forecast more solid by showing deteriorating

profit margin at 19.70% (DIGI : Appexdix 2.0).

1.1 Financial Highlight Summary

Year Ended

31 Dec 2004

RM ‘000

Year Ended

31 Dec 2005

RM ‘000

Year Ended

31 Dec 2006

RM ‘000

Year Ended

31 Dec 2007

RM ‘000

Year Ended

31 Dec 2008

RM ‘000

Revenue 2,233,703 2,884,324 3,652,536 4,362,635 4,814,475

Profit before taxation 446,843 661,550 1,087,139 1,445,314 1,546,896

Net profit 317,355 470,955 805,653 1,062,595 1,140,715

Total assets 3,566,347 4,232,319 4,076,147 3,877,491 4,655,852

Shareholder‟s fund 1,777,193 2,248.148 1,752,401 1,577,645 1,897,172

Long term liabilities 655,546 681,548 685,105 573,791 491,557

Net profit as % of revenue 14.2% 16.3% 22.1% 24.4% 23.7%

EBITDA 43.83% 43.66% 46.40% 48.36% 45.10%


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EPS (sen) 42.3 62.8 107.4 141.7 148.5

Net tangible assets per share (sen)

2.30 3.00 2.34 2.10 2.44

According to DiGi‟s financial summary from 2004 to 2008, we are impressed by the

solid growth achieved by the company every year. The revenue growth maintained

double digits except 2008 down to 9% compared to its previous year. EBITDA was

maintained at around 45% every year with peak recorded at 2007 where EBITDA

rose to 48.36%. At the same year, net profit also recorded its best margin at 24.4%.

Likewise, ROA & ROE of 2007 were also the highest in recent years. Therefore, we

may conclude that DiGi was growing rapidly from 2004 to 2007 where its best

performance was recorded in that year but slow down the pace in 2008. We will

explain the reason of the slow down performance in next chart.

1.2 DiGi’s key areas performance

The chart above shows the key areas performance of DiGi from 2004 to 2008. We are

comparing DiGi‟s EBITDA, net income growth and relate them to revenue and

operating cost growth. We notice that DiGi‟s revenue growth was above its cost

before 2008 therefore DiGi achieved year-to-year positive growth in EBITDA and net

income. However, in 2008 the cost was growing faster than revenue resulted EBITDA

and net income fell from its peak at 2007.

1.3 DiGi’s Operating Cash Flow Summary

Although DiGi‟s financial highlight summary shows it‟s profitable, but it‟s still too

early to conclude the company is healthy. In order for a company to be sustainable, its

business not only needs to make profit but also needs to generate enough cash flow to

support daily business operating expenses. Now let‟s look at DiGi‟s operating cash

flow from 2004 to 2008 as below:


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Year Ended

31 Dec 2004

RM ‘000

Year Ended

31 Dec 2005

RM ‘000

Year Ended

31 Dec 2006

RM ‘000

Year Ended

31 Dec 2007

RM ‘000

Year Ended

31 Dec 2008

RM ‘000

(1) Operating

profit/(loss) or

EBIT

509,427 675,831 1,066,899 1,428,760 1,535,137

(2) Depreciation 465,553 579,449 584,581 598,566 572,940

(3) Tax expense 129,488 190,595 281,486 382,719 406,181

(4) OCF

(1) + (2) – (3)

845,492 1,064,685 1,369,994 1,644,607 1,701,896

As shown by the chart diagram above, DiGi‟s operating cash flow was improving

since 2004 from RM 845 million to RM 1.7 billion in 2008. Therefore we could

conclude that DiGi is a profitable and healthy company.

2.0 DiGi’s 3G project: Capital Budgeting and

Discounted Cash Flow evaluation

On 14 November 2007, a strategic alliance was announced between DiGi and Time

dotcom Berhad to have 3G license transferred from Time dotCom to DiGi; meanwhile

with 27.5 million of DiGi shares acquired by Time dotcom. In order to achieve the 3G

license, DiGi has initial investment of 27.5 million of shares which equivalent to RM

695 billion (RM25.20 per share at that point of transaction happened). After 3G

spectrum transaction was completed on May 7, 2008, DiGi announced that additional

CAPEX of RM 600 million to RM 800 million in the first 3 years (of which RM 150

million to RM 200 million is expected in 2008) will be invested in 3G infrastructure.

In this session, we will evaluate DiGi‟s 3G project via capital budgeting as well as

discounted cash flow methods to justify whether the said project shall be taken or not.

In this evaluation, straight line depreciation will be used. Government tax rate is 26%

and discount rate of cash flow is 5.8%. We proposed RM 10 million of initial working

capital and 8% of yearly revenue will be used as net working capital in the subsequent


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years as project expansion occurs. However, all working capital is assumed to be

recovered at the end. The evaluation period is 10 years since the license will be

expired in early 2018.

The capital budgeting analysis of the project is as below:

WORKING CAPITAL RM’000

Initial Investment in Work.

Cap= $10,000

Working Capital as % of Rev= 8%

Salvageable fraction at end= 100%

Year 0

RM’000

Year 1

RM’000

Year 2

RM’000

Year 3

RM’000

Year 4

RM’000

Year 5

RM’000

Year 6

RM’000

(1) Revenue 0 38,800 168,480 324,000 518,400 777,600

(2) Cost 200,000 300,000 300,000 100,000 100,000 300,000

(3) EBITDA [(1) – (2)]

(200,000) (261,200) (131,520) 224,000 418,400 477,600

(4) Depreciation 69,500 69,500 69,500 69,500 69,500 69,500

(5) EBIT [(3) – (4)]

(269,500) (330,700) (201,020) 154,500 348,900 408,100

(6) Tax @ 26% (70,070) (85,982) (52,625) 40,170 90,714 106,106

(7) EBIT(1-t) [(5) – (6)]

(199,430) (244,718) (148,755) 114,330 258,186 301,994

(8) + Depreciation 69,500 69,500 69,500 69,500 69,500 69,500

(9) - ∂ Work. Cap (10,000) (6,896) 20,374 12,442 15,552 20,736

(10) Total CF

[(7) + (8) + (9)]

(705,000) (119,930) (168,322) (99,629) 171,388 312,134 350,758

(11) Discount Factor 1 1.058 1.119364 1.184287 1.25297 1.32564 1.40253

(12) Discounted CF (705,000) (113,355) (150,373) (84,126) 136,785 235,458 250,088

Year 7

RM’000

Year 8

RM’000

Year 9

RM’000

Year 10

RM

’000

(1) Revenue 1,036,800 1,296,000 1,555,200 1,814,400

(2) Cost 300,00 100,000 50,000 50,000

(3) EBITDA [(1) – (2)]

736,800 1,196,000 1,505,200 1,764,400

(4) Depreciation 69,500 69,500 69,500 69,500

(5) EBIT [(3) – (4)]

667,300 1,126,500 1,435,700 1,694,900

(6) Tax @ 26% 173,498 292,890 373,282 1,694,900

(7) EBIT(1-t)

[(5) – (6)]

493,802 833,610 1,062,418 1,254,226

(8) + Depreciation 69,500 69,500 69,500 69,500

(9) - ∂ Work. Cap 20,736 20,736 20,736 20,736 (10) Total CF 542,566 882,374 1,111,182 1,302,990

INITIAL INVESTMENT RM’000

Initial Investment= $695,000

Opportunity cost (if any)= $0

Lifetime of the investment 10

Salvage Value at end of project= $0

Deprec. method Straight line

Tax rate on net income 26%

Discount Rate 5.8%


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[(7) + (8) + (9)]

(11) Discount Factor 1.483883 1.569948 1.661005 1.757343

(12) Discounted CF 365,639 562,040 668,982 824,052

NPV = RM 1,990,190,000

IRR = 22.12 %

As we may see the project cash flow will be only positive after 3 years due to low

subscribers‟ base and heavily network expansions.

2008 2009 2010 2011 2012 2013 2014 2015 2016 2017

BB Subs 0 30000 130000 250000 400000 600000 800000 1000000 1200000 1400000

BB ARPU 0 1296 1296 1296 1296 1296 1296 1296 1296 1296 Revenue

(RM)

0 38800 168,480 324,000 518,400 777,600 1,036,800 1,296,000 1,555,200 1,814,400

BB = Broadband

ARPU: Average Revenue Per User

Project RM „000 Year 0 (705,000)

Year 1 (113,355)

Year 2 (150,373)

Year 3 (84,126)

Year 4 136,785

Year 5 235,458

Year 6 250,088

Year 7 365,639

Total Cash Flow (64,884) Year 8 562,040

Total Cash flow 497,156

Pay Back period = 7 years & 6 weeks

Though the payback period of the project is very long, but considering the net present

value of the project is approx RM 2 billion therefore we still consider the 3G project

is worthwhile for the investment. Similar conclusion is reached if we are using the

IRR as the project investment measure. IRR of this project is valued at 22.12% which

is higher than discount rate of 5.8 therefore the project should be undertaken.

3.0 Strengths and Weaknesses

One of the key strength of DiGi is the company capability to sustain growth and profit

by generating unbelievable double digit growth from 2004 to 2007. EBITDA of the

company is maintained at 45% every year. Company operating cash flow is very

healthy as well. Such an impressive financial achievement must thank to the tireless

management team for their continuous innovative approach to their products. As we

all might know, DiGi has been one of the most innovative and creative company in

the country. The famous „Yellow Man‟ is well known in the community. Besides that,

DiGi is actively participating in CSR (corporate social responsibility) activities. As a

result of that, DiGi became the first corporate organization to be awarded the

Anugerah Pendukung Seni by the Ministry of Cultures, Arts and Heritage. All these

efforts actually turned into better corporate image which increases the company

intangible assets. Therefore, we see their subscriber base grew from around 3 million

subscribers in 2004 to 7 million subscribers at the end of 2008.


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One of the main reason of DiGi‟s share becomes the favorite of investors is their high

dividend payout policy. DiGi even paid more dividend than EPS in year 2007 and

2008 due to excess cash in hand. This indicates that DiGi has turned into „cash cow‟

position since 2007. Due to high market penetration and less expansion is required,

DiGi announced to increase their payout ratio to at least 85% of their net profit since

Q3 2009.

However, one of the key weaknesses of DiGi is their poor financial short term

solvency. In spite of strong cash flow of the company, DiGi‟s current ratio, quick

ratio and cash ratio have been deteriorating in recent year. Besides that, price pressure

and high market penetration may erode future revenue growth. Though in some

developed nations the market penetration can go up to 140%, but the room for growth

is very limited due to highly competitive market and lower profit margin.


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Another concern we would like to raise here is DiGi‟s operating cost grows faster

than revenue in recent years. As future revenue growth is limited, higher cost margin

will further dampen the net profit of the company.

4.0 Recommendations

As mobile voice market penetration has exceeded 100% (116% in Q2 2009), business

focus and strategy of DiGi shall shifted from traditional voice traffic to data traffic.

By looking at the low broadband market penetration at only 21.10% last year,

broadband business is certainly the next drive of growth in the telecommunication

industry (Appendix 3-5). Therefore, DiGi must grasp the next wave of change in

order to sustain the growth in future.

Cost efficiency campaign must be launched to counter fast growing operating cost.

DiGi may re-structure its business units into smaller size and consolidate redundant

functional groups into fewer groups to reduce cost. In short run, marketing expenses,

O&M expenses, CSR expenses should be revised to control variable cost. In long run,

low productivity plants should be considered to shut down in order to control fix cost.

As DiGI‟s biggest customer segment is foreign workers, therefore the company

performance is more vulnerable to global economy down turn. It‟s time for DiGi to

redefine their customer segments and shift the focus from heavily rely on single

segment to multiple market segments.


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Malaysia Airline System


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Reporting Period Financial Ratios

FORMULA Liquidity Measures

2004 2005 2006 2007 2008

Short Term Solvency

Current Ratio Current Assests /Current liabilities 1.25 0.83 0.82 1.4 1.36

Quick Ratio Current Assests -Inventory /Current liabilities 1.14 0.72 0.74 1.33 1.28

Cash Ratio Cash /Current liabilities 0.64 0.28 0.32 1.00 0.72

Financial Leverage

Long Term Solvency

Total Debt Ratio Total Assests - Total Equity /Total Assets 0.52 0.68 0.74 0.62 0.60

Debt-eqity ratio Total Debt/Total Equity 1.08 2.12 2.85 1.63 1.5

Equity multiplier Total assests /Total Equity 2.08 3.13 3.85 2.63 2.5

Turnover Measures

Inventory Turnover Cost of Goods Sold /Inventory 20 20.2 31.6 35.2 36.2

Days' Sales in Inventory 365 days /Inventory turnover 18 18 12 10 10

Receivables Turnover Sales /Accounts Receivables 4.43 4.21 5.29 7.3 6.64 Days' Sales in

receivables 365 days /Receivables turnover 82 87 69 50 55

Total Asset Turnover Sales /Total Assests 1.14 1.25 1.68 1.3 1.33

Profitability Measures

Profit Margin Net Income /Sales 0.08 0.03 -0.02 0.07 0.02

Return on Assets ( ROA) Net Income / Total assets 0.1 0.04 -0.03 0.89 0.02

Return on Equity (ROE) Net Income /Total Equity 0.19 0.08 -0.11 0.23 0.06

Market Value

Measures

EPS Net Income / Shares outstanding 36.8 26 (10.9) 58.0 14.6


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2004 2005 2006 2007 2008

Cash Flow Statement RM'000 RM'000 RM'000 RM'000 RM'000

Net cash (used in)/generated from 1,099,856 -610,599 -175,311 2,319,123 -632,584

operating activities

Net cash generated from/(used in) 157,890 -377,361 -471,573 358,890 -

1,353,415

investing activities

Net cash generated from /(used in) 0 -31,331 1,050,000 991,842 490,812

financing activities

NET INCREASE / ( DECREASE) IN CASH 1,257,746 -1,019,291 403,116 3,669,855 -

1,495,187

AND CASH EQUIVALENTS

The above date shows the ratios anlaysis and cash flow statement in generating/

(used) cash from operating, financing and investing activities from 2004 to 2008.

Based on the abpove data we can see that, during 2004 and 2007 MAS has net cash

generated from operating, financing and investigating activities as it shows positive

values as compare to year 2005, 2006 and 2008. This indicates that there is huge

decrease in current assests and increase in account liaibilities in generating cash.

However, in year 2005 all acitivities shows net cash used and decrease in cash due to

financial crisis and also due to high operational and fuel costs. (MAS: Appendix 3.0).

We will further discuss on the findings and impact based on the historical and

financial date as below.

Malaysia Airlines Financial Highlights

Year

Ended

Revenue Expenditure Profit/(Loss) Shareholders

EPS after

tax

(RM '000) (RM '000)

after Tax (RM

'000)

Fund (RM

'000) (cents)

31-Dec-04 11,364,309 11,046,764 ▼326,07 3,318,732 ▼26.0

31-Dec-05 9,181,338 10,434,634 ▼(1,251,603) 2,009,857 ▼(100.20)

31-Dec-06 13,489,549 13,841,607 ▼(133,737) 1,873,452 ▼(10.90)

31-Dec-07 15,288,640 14,460,299 ▲852,743 3,934,893 ▲58.05

31-Dec-08 15,503,714 15,259,027 ▼245,697 4,186,000 ▼14.62

Based on the historical data for the financial Year ending 2004 to 2008 MAS has

shown less performance in generating profit due to financial crisis incurred in 2005.

As we aware, MAS was reported a loss of over RM1.3 billion for the Financial Year

2005. It was unacceptable to many parties such as the stakeholders and the

government especially the announcement was made at the same time as some of MAS

regional competitors reported strong profits in the same year. As a results, the airlines

http://en.wikipedia.org/wiki/Earnings_per_share

http://en.wikipedia.org/wiki/Earnings_per_share

http://en.wikipedia.org/wiki/Malaysia_Airlines








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was expected to cut up to 5,000 jobs and spend a maximum of 850 million ringgit

(US$236 million; euro198 million) in compensation packages as part its plan to return

to profitability. The retrenchement was a measure to reduce cost due to crippling fuel

prices and lower load factors. The carrier was also battling a cash shortage,

overstaffing and an inefficient and unprofitable route network. However, as of

February 2006, MAS reached profitability by 2008 where it posted a gross profit of

240Mil for the 3rd

quarter ending September 2006. This has been successfully

achieved due to implementation of Business Turnaround Plan (BTP) which has also

provided more recommendations for battling their dwindling sales.

Although in 2005 MAS reported loss however, by comparing the current ratio from

2004 to 2008 it explains that in year 2007 and 2008 has higher current ratio as

compare to 2004 to 2006. This indicates that‟s the total revenue increase

dramastically from year 2004 to 2008 (RM 7,306,476,000 to RM 13,247,237,000).

2.0 Current Data Analysis Fundamental Strength

Strength

EPS Growth Strength 55.37

Profit Growth Strength 61.50

Revenue Growth Strength -1346.11

Margin Strength 868.14

ROE Strength 82.31

SMR Strength -123.32

Funda Strength -55.76

Stability

EPS Growth Stability 99

Profit Growth Stability 99

Revenue Growth Stability 17

Margin Stability 7

ROE Stability 99


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ROE (Return On Equity)

Year EPS (RM) NTA (RM) ROE

30-Sep-2009 0.7883 0.0700 1126.14%

30-Sep-2008 0.2835 2.4700 11.48%

30-Sep-2007 0.5530 2.0000 27.65%

30-Sep-2006 -0.6977 1.4100 -49.48%

MAS have reported a smaller operating loss in the third quarter which amounted to

420.8 million ringgit in April –June due to weak passenger demand and higher costs.

As results, Malaysia Airlines cut its capacity by 12 percent and grounded three planes

in the first half of this year, but there are no plans to further cut capacity or routes.

Based on the latest updates MAS will beat its earnings forecast of RM500 million

ringgit after it agreed to buy fuel at below market rates and cut operating costs. The

airline will get 29 percent of its fuel next year at the rate of $69 for a barrel of crude,

24 percent below the current price and the remainder will be bought at market price.

Therefore, MAS will save 1 billion ringgit next year through reducing sales

commissions, selling more tickets on-line and paying less for ground handling. The

company is cutting costs as it faces greater competition from AirAsia Bhd. and Tiger

Airways Ltd, scheduled to start flights between Singapore and Kuala Lumpur next

year. However, to mitigate the effect of the oil price because it‟s impossible oil prices

to sta such continuously, thus MAS have to make sure that they attract as many

customers to fly with them and increase the load factor.

As results, the airline currently reported a 52 percent profit jump in the third quarter

as passenger revenue climbed and the carrier cut costs. MAS expect that it may

exceed its full year net income target of as much as 700 million rinngit. For the first

nine months, the carrier posted a record 610 million ringgit profit. The carrier spent

3.46 billion ringgit on fuel in the first nine months of the year, 1.1 percent less than a

year earlier. Malaysian Air is about 60 percent hedged for this year at about $62 a

barrel. MAS also do competitive hedging, based on the average market competitors in

the area that they operate. Furthermore, MAS will make sure that they put up their

fares and fuel surcharges in line with the competition.

Interm of loan factor MAS will increase the proportion of seats sold on each flight to

80 percent from 75 percent next year. The carrier also aims to reduce the turnaround

time at airports for each plane by 5 percent, freeing them up for more flights. Further,

the airline which plans to buy more than 50 narrowbody planes and a similar number

of widebody aircraft plans to replace all its aging fleet to boost fuel efficiency.

Although several action or plan was in placed to boost fuel efficiency national carrier

Malaysia Airlines suffered a net loss of RM 300 million in the 3rd

Quarter mainly

because of wrongway bets on fuel prices as mentioned above. The carrier‟s loss for

the 3 months through September marked a reversal from a RM38 million net profit in

same 3 months of last year. Looses on derivatives contracts used to hedge against

volatile fuel prices totalled RM202 million.

http://www.bloomberg.com/apps/quote?ticker=AIRA%3AMK

http://www.bloomberg.com/apps/quote?ticker=MAS%3AMK


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MAS hedged 57 per cent of its fuel needs at $90 a barrel for 2009. It has hedged 60

per cent of its fuel needs at $100 a barrel for 2010. Revenue for the quarter fell 28 per

cent to RM2.9 billion, hit by the cuts in ticket prices that airlines made to attract

travellers during the global downturn. Therefore, MAS need to raise fares to boost its

bottom line. Since fare wise, the current low levels are not sustainable in the long

term, MAS would continue to offer competitive and compelling fares.

MAS reported a January to March net loss of 695 million ringgit ($198.5 million)

versus a year earlier profit of 120 million ringgit. It had a first quarter fuel hedging

loss of 557 million ringgit, and an operational loss of 138 million ringgit. This is the

first operational loss for Malaysia Airlines since the third quarter of 2006 as it faced a

triple squeeze; overcapacity, extreme fuel volatility and a global slump which hit

passenger and cargo demand.

Before the latest results, analysts were expecting MAS to post 2009 net profit of 187

million ringgit. MAS shares have risen 6.5 percent this year, trailing a 24 percent gain

on the main Malaysian stock index KLSE.


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2.1 Capital Budgeting and Investment

To recover from the huge losses occurred in 2005; MAS launched Business

Turnaround Plan as their good capital investment budgeting for future operations

where it has turned losses into profits between 2006 and 2007. When the Business

Turnaround Plan came to an end MAS posted a record profit of 851 million Ringgit

(265 million dollars) in 2007, ending a series of losses since 2005. The result

exceeded the target of RM300 Million by 184%. The Business Turnaround Plan will

turnaround MAS in 2 years, following a series of specific cost and revenue actions,

which had result in a profit of RM500 million in 2008.

NPV= - Initial Cost + CF Yr 2006 + CF Yr 2007

NPV= - 25Mil (1+ R*) 1 (1+ R*) 2

NPV= - 25Mil + (175,311,000) + 2,319,123,000

(1.07) 1 (1.07) 2

NPV= - 25Mil + (163,842,056) + 2,025,611,844

NPV= RM 1,836,769,788 (Positive NPV accpet the project).

This indicates that, to evaluate how effective is this project that result in profit of 851

million Ringgit in 2007 by calculating one of the capital budgeting method that is

NPV as above. The positive NPV summarize that this is a good investment decision

turned the 2005 losses into profit through the BTP project in just 2 Years of period.

R* = “Real” (constant-dollar) interest rate used for economic efficiency impact evaluation of transporation

investment typically range from 4% to 8%. The U.S Office of Management and Budget recommends the use of a

rate of 7% to reprsent the private sector rate of return on capital investment. (Transporation decision making:

Principles of project evaluation and programming by Kumares C.Sinhna, Samuel Labi.

Nevertheless, to increase the profit MAS is expected to announce to buy 55 new

Boeing (narrow-body aircraft worth up to 11 billion ringgit ($3.4 billion) to be

delivered from 2011 onwards, as part of the airline's replacement programme for its

ageing fleet of 111 aircraft. As we aware, Malaysian Airline made a net profit of

851.4 million ringgit last year, snapping two straight years of losses following a

business turnaround plan that has seen better yields and cost reductions. Therfere, by

doing this estimates put the airline's 2008 net profit consensus at 758.5 million ringgit,

rising to 989.7 million in 2009.

To further reduce operating costs to as low as 20 percent over a low cost carrier‟s cost

base over five years MAS aims to continue to implement cost control on redundant

activities and other unnecessary costs that had accumulated over time, weighing down

its profitability. MAS also intend to improve revenue by convincing consumers to pay

30 per cent above a low-cost carrier's fares for a 5-Star Value Carrier. This

implentation is an imporatnt activity because from 2006 to 2008, the airline trimmed

operating costs by RM665 million, RM738 million and RM936 million, respectively.


17

Figure 2: The MAS Way: Business Turnaround Plan

Currently MAS making good investment decisions in provding better services to

customers. In other words, MAS is investing RM 480m in its Passenger Services

System (PSS) over 10 years in an effort to simplify and enhance the travel

experience of customers and also to generate revernues several years for future use

from the raised capital. They believe that, over a period of 10 years it will give

benefits worth over RM2 billion as a future value from now. The airline expects a rise

in online sales this year with the PSS in place. Furthermore, to generate more revenue

in future MAS is now on an integrated SITA platform new reservation system,

allowing customers to enjoy seamless service delivery and a suite of new services

including mobile.

10 Years

PV= RM480m

FV= RM2 billion

FV= PV (1+r) * number of periods

2b = 480m (1+r) *10

2b /480m = (1+r) *10

4.1667 = (1+r) *10

1+r = 4.1667 (1/10)

1+r=1.1533

R = 0.1533

R= 15.33%

Therefore, the capital budgeting for PSS will give a good rteurn over 10years due to

high rate of return 15.33% by investing in this investment together integration with

SITA platform new reservation system.


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3.0 Strengths and Weakness

Many initiatives taken by MAS to indicate that it has strength to build on. BTP plan

will not only continue to reverse the loss and return MAS to profitability, but also

transform the company into a strong and vibrant institution those aggressively

tackling new opportunities. This further support by the strong short term solvency or

liqudity measures MAS especially in year 2007 and 2008 which indicates that, it has

been showing good progress to pay any short term debt with available current assests.

Apart from ratio anlaysis valuation tools, we also can conclude that MAS have taken

action to improve the growth or increase revenues by implementing several activites

or events inspite of losses incurred due to wrongway bets on fuel prices.In other

words, their major strengths is meeting their customer expectation by providing better

services. MAS would continue to offer competitive and compelling fares.

Furthermore, their plan to invest RM 480m in its Passenger Services System (PSS)

over 10 years in an effort to simplify and enhance the travel experience of customers

and also to generate revernues several years for future use. MAS believe that, by

doing this over a period of 10 years it will give those benefits worth over RM2 billion

as a future value from now. This is both in terms of revenue for customers due to the

enhancement that they are giving as well as better efficiency that they expect to get

from the system. In addition to their capital budgeting plan, PSS enabled MAS to

achieve 100 per cent e-Ticketing. Although this investment projected benefits worth

over RM2 billion however, it also subject to various limitation such as Internet

penetartion wroldwide. In other words, the airline expects a rise in online sales this

year with the PSS in palce but due to system issue it could decline any time which

indicates one of the weaknesses of this projected plan that MAS will be facing in

future.

Although the weakness is the high debt ratio each year however, during year 2007

shareholders expectation would have been met by the management due to high return

on equity (ROE) 23 % as compare to the rest of the years. This is because of higher

profit after tax of RM 852,743,000 in year 2007. This has been achieved due to the

implementaion Business Turnaround Plan that has turned losses into profits between

year 2006 and year 2007. (MAS: Appendix 2.0).

However, interm of long term solvency measures the company‟s have issued more

debt than equity from 2004 to 2008 (2004 -52%, 2005 – 68%, 2006 – 74%, 2007 –

62% and 2008 -60%). This explains that the status of the company‟s capital structure

in which less percent has allocate for equity thus this is one of the weakness of the

company because it debt to equity ratio will determine the value of the company for

future. In other words, company failed to generate more cash flow than it uses as

results, shareholders and bondholders failed to receive dividens and interest when the

initial loan is repaid. Further, it also limits the company to retain the earnings for any

future investments. (MAS: Appendix 4.0).

Moreover, despite the hard work that has been done as of today, MAS is currently in a

much weaker position than our regional peers. This is because their pricing power

significantly lags the industry. The main factor of the losses was high operating costs as

MAS substantially lags its peers on yield and this is their central issue but much of it

is due to weaknesses is their pricing and revenue management, sales and disribution,


19

brand presence in foregin markets and alliance base. In addition, MAS might not have

full flexibility to make changes to destinations or pricing. As results, MAS‟ costs have

risen out of control and showed no signs of flattening.

MAS is cost competitive

MAS has a real revenue disadvantage


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4.0 Recommendation

Based on the historical and current event or financial issues to become much more

efficient with their resources and also to see a disproportionate increase in cocts, from

corporate finance point of view, we would recommend MAS to show higher

productivity than their peers such as Air Asia and Firefly. This also will help MAS to

survive and prosper in their small revenue enviornment due to high cost factor. From

the financial report analysis, we are more concern about their fixed cost base because

we can conclude based on our findings that, MAS have millions of ringgit invested in

some real estate and equipment through its offices around the world that do not

directly contribute to revenue production. Prompt action has to be taken to continue

improve profitability and also avoid from any losses. Therefore, MAS has to focus on

enhancing customer staisfaction, generating revenue and intensifying cost reductions,

thus in future MAS has to perform or implement effective capital budgeting on how

budget of funds to be invested for future and current operations.

In nutshell, consistent with MAS‟ philosophy of „aiming for the best, and assuming

the worst‟, we believe that they are aimed for the best, stretch their limits and go for

the impossible, to achieve an annual profit of at least RM1.5 billion by 2012 even

after factoring in the industry„s challenges such as overcapacity, air traffic

liberalisation and rising fuel costs.


21

PROTON BERHAD


22


Based on the above-mentioned topics, we will attempt to assess the performance of

Proton Berhad based on historical data that spans from 2005 to 2009 as well as the

current trends.

Figure 1: Excerpt of Balance Sheet as at 31 March 2009, Annual Report 2009

From the data above, we are able to explain the ratio figures below. So far through out

the past five years Proton has maintain between the bracket of [1.80, 2.30] indicating

its financial strength and its liquidity.

Liquidity Measures 2009

2008

2007

2006

2005

Current Ratio 1.81 2.10 2.06 1.89 2.27

Quick Ratio 1.06 1.43 1.23 1.29 1.83

Cash Ratio 0.48 0.74 0.41 0.67 1.11

Table 1: Short Term Solvency Calculation

Short-term solvency provides information about a firm‟s liquidity. According to

Proton‟s current ration from 2005 – 2009, Proton achieved positive net working that

showed able to pay off its short-term liabilities. This is due to Proton‟s steady growth

in the market as a viable player in the global auto industry, however, it has

experienced a declined (not critical plunges but a steady drop in cash ratio). However

over 42% of its equity is owned by a government-owned company Khazanah

Nasional Berhad, making it government-linked allowing it the liberty and safety net

of maintaining a healthy short-term solvency.


23

Figure 2: Excerpt of Balance Sheet as at 31 March 2009, Annual Report 2009

From the data above, we are able to extract and explain the ratio below. So far

through out the past five years Proton has maintain between the bracket of [1.80,

2.30] indicating its financial strength and its liquidity.

Financial Leverage

2009

2008

2007

2006

2005

Total Debt Ratio 0.28 0.25 0.25 0.29 0.33

Equity multiplier 1.39 1.34 1.32 1.41 1.50

Table 2: Long Term Solvency Calculation

Financial advantage ratios as calculated above provide an indication of the long-term

solvency of Proton Berhad. The ratios above help us to measure Proton‟s ability to

service its debt and meet its other obligations. Proton‟s total debt ratio has maintained

in a steady bracket and has remained so for the past five years. From the table above,

we can see that Proton had depended on debts to finance their asset base but that ratio

has been decreasing with a 0.05 hike in year 2009.

Turnover Measures

2009

2008

2007

2006

2005

Inventory Turnover 102.66 83.78 34.94 42.66 63.96

Days' Sales in Inventory 15.6 9.63 3.8 9.56 10.1

Receivables Turnover 12.22 14.55 9.25 12.1 10.14

Days' Sales in receivables 31.92 24.14 20.08 22.42 23.90

Total Asset Turnover 1.59 1.02 0.98 1.48 1.24

Table 3: Turnover Measures

The table above helps s gauge Proton‟s asset management. Proton experienced some

tough times especially in year 2006/2007 when sales dropped, its credibility as a

efficient car maker questioned and customer dissatisfaction. However, Proton expects

2009 net profit to surpass RM200 million, driven by increased sales, operating

efficiency and the launch of new models which will make up for losses incurred

during the previous years.

1.1 Dividend and Shares Analysis

Dividends are payments made by a company to its shareholder members. It is the

portion of profits paid out to stockholders. When a corporation earns a profit, either

that money is re-invested in the business or it is paid to the shareholders as a dividend.

Many corporations like Proton Berhad retain a portion of their earnings and pay the

remainder as a dividend. In a financial market, a share is a unit of account for various

http://en.wikipedia.org/wiki/Shareholder

http://en.wikipedia.org/wiki/Profit_%28accounting%29

http://en.wikipedia.org/wiki/Unit_of_account


24

financial instruments including stocks, and investments in limited partnerships, and

REITs. The income received from shares is called a dividend. The figure below

depicts the basic earning per share as well as the dividends earned by Proton‟s

shareholders. The figure explains the changes experienced since 2005 up to this year.

Figure 3: Excerpt of Key Financial Indicators, Annual Report 2009

Dividend payout ratio provides an idea of how well earnings support the dividend

payments. More mature companies tend to have a higher payout ratio. A low dividend

payout ratio indicates that a large fraction of the profits were retained invested for

growth. These earnings were channeled into further enhancing their R&D department

as well as the development of Proton City situated at Tanjung Malim, Perak (to be

fully developed in year 2020). Earnings per share serve as an indicator of a company's

profitability. The portion of a company's profit allocated to each outstanding share of

common stock. Below shows the changes experienced in the dividend payout. Proton

had experienced very bad press since year 2007 due to its unfavorable car production

capabilities. It faced a tough competition between with the introduction of “Myvi”,

and “Viva” from Perodua as well as “Swift” from Suzuki. Proton‟s “Savvy” and its

“Gen-2” were considered very weak compared to the other car models. However, with

the introduction of a few new models the latest being “Exora” has managed to breath

in a good flow and vibe into the company brand allowing Proton to redeem itself.

Year 2009 2008 2007 2006 2005 Dividend Payout Ratio

37.5% - -390.2% 15.5% 58.7%

Earning Per Share 13.65 -15.65 5.72 9.00 0.70 (http://www.mbaware.com/dividend-payout.html) (http://www.csgnetwork.com/epscalc.html)

http://en.wikipedia.org/wiki/Stock

http://en.wikipedia.org/wiki/Limited_partnership

http://en.wikipedia.org/wiki/Real_estate_investment_trust


25

Figure 3 shown below clearly depict Proton‟s retained earning as well as the net asset

per share. The graphs below explain the company‟s healthy reserve, allowing them to

focus on important areas of business for further improvements. Proton recognized the

key areas of improvement and dwelled in research and development that resulted in

the introduction of new proton models in the market such as

Proton Saga

Satria Neo

Exora

Figure 4: Excerpt of Key Financial Indicators, Annual Report 2009

With the world moving towards green cars, Proton has made a smart decision to

follow suit car giants like Honda in this venture. Proton with its partner Lotus

Engineering would be able to produce a less expensive hybrid system at its newest

plant that has the facilities needed for mass production. Proton is definitely off to a

positive boom in sales with the introduction of new models at highly competitive and

consumer-friendly prices and now its bold step towards green car production.


26

2.0 Capital Budgeting and Cash Flow Evaluation

Proton Berhad-Malaysia‟s official carmaker was found in 1983. Khazanah Malaysia,

the Malaysian government's investment arm, holds about 42.74% of Proton, followed

by the Employees Provident Fund with 15.4 per cent and Petronas with 7.9 per cent.

Table 4: Source MIDF Analysis on Proton Berhad.

Collaboration

Proton Holdings Bhd and Detroit Electric Holdings Ltd recently announced a strategic

licensing and contract assembly agreement that allows Detroit Electric to utilize

PROTON platforms for its production of Pure Electric Cars (PEV).

Under the agreement, Proton will license the use of two platforms - Persona and

Gen.2 - to Detroit Electric, thus making way for them to build its line of Pure Electric

Vehicles (PEV) for the global market. The electric cars will be built in Proton‟s

Tanjung Malim plant.

Proton anticipates RM2b sales boost from this collaboration alone. Proton Holdings

expects to record a revenue of RM2bn over the next four years following its strategic

tie-up with Detroit Electric Holdings Ltd

Sales Distribution Expansion

Proton Holdings Bhd expects 2009 net profit to surpass RM200 million, resulted

driven by increased sales, operating efficiency and the launch of new models. Its net

profit in the first half-ended September 30 2009 rose 42 per cent year-on-year to

RM136.6 million, while revenue was up 11 per cent to RM3.96 billion. In the

financial year ended March 31 2009, it made a net loss of RM320 million on revenue

of RM6.5 billion.


27

Table 4: Source MIDF Analysis on Proton Berhad.

From the table above below we can translate that revenue rose 11.1% with pretax

profit growing at a faster pace (+43.9% year on year), regardless of the strong demand

for the higher margin products led by Exora and Saga. Proton vehicle sales caused an

improved market share at 29%, which proofs to be much better compared with the

total industry volume sales, which experienced a decline of 7%.

For its second quarter ended Sept 30, Proton showed a net profit of RM82.1mil, (14.9

sen a share) compared with RM43.8mil, (8 sen a share) in the previous quarters.

Revenue rose 14% to RM2.1bil from RM1.85bil as the company‟s sales bucked the

industry-wide trend by showing a strong increase.

Improvement on operating profit was largely due to the increase in domestic sales

volume and profit margins that continued to strengthen through a better product mix.

Domestic sales grew by 11% compared with the immediate preceding quarter driven

by the increase in sales of our top three models – the Persona, Saga, and Exora. Apart

from better domestic sales, ongoing efforts to cut cost – the latest through the

rationalisation of its dealer and vendor network

3.0 Strength and Weakness

PROTON was incorporated on 7 May 1983 with three national policy objectives: To

lead the growth of component manufacturing industries, to acquire and upgrade

technology and industrial skills within the automobile manufacturing industry and to

strengthen the international competitiveness of Malaysia's industrial capability.

The failure by Proton to find a foreign partner is a warning signal that it is no longer a

competitive and economically viable entity with current market situation and

questionable management decisions that causes Proton to lose money when other

finds profits.

Therefore, Proton Holdings Berhad latest venture of joining forces with Detroit

Electronics to build Malaysia‟s first green car (Gen-2) is not only a bold move but

also a very smart move as Proton with its partner would be able to produce a less

expensive hybrid system at its newest plant that has the facilities needed for mass

production. Proton is definitely off to a positive boom in sales with the introduction of

new models at highly competitive and consumer-friendly prices and now its bold step

towards green car production


28

Figure 5: Design model of Gen-2; Proton’s Green Car

National car company Proton Holdings Berhad once dominated with a majority share

in the market. It has since not only lost that majority, its sales in unit terms have even

dropped below that of unlisted Perusahaan Otomobil Kedua Berhad (Perodua).

UMW Holdings Berhad is the biggest in the sector, with a market value of RM5.9

billion, compared with Proton's RM1 billion. Although, UMW has an important oil

and gas division, it derives most of its profits from its Toyota division, the most

profitable in the industry. In contrast, Proton reported a loss of RM75 million in the

October - December quarter last year. It is exceeded in market value by Oriental

Holdings Berhad (RM2.3 billion) and DRB-HICOM Berhad (RM1.4 billion), both of

which are diversified motor-based groups.


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4.0 Recommendation

In conclusion, Proton should continue to seek strategic alliances and further expand

its market globally due to the termination of talks with Volkswagen AG in the year of

2007. We believe Proton needs to integrate more into the global supply chain and the

global market to cement its presence in the industry. We have not attained the kind of

export penetration projected when the company was established. Global motor vehicle

industry was undergoing a consolidation and Proton should be part of this trend.

Figure 6: Stock Watch Snapshot; Bursa Malaysia

Proton should look into venturing into new territories for instance its latest project of

exploring the Chinese market Apart from expecting gains from the China market;

Proton can also seek export growth from other markets in the Middle East and in the

future, India. Proton is already exploring green technology and aims to launch a fleet

programme with the Government where between 50 and 100 of its electric cars used

by the civil service.

Proton should continue to focus on enhancing their returns by investing in the

development of new value-for-money products, expansion into key selected markets

and the execution of operational efficiency initiatives such as the rationalisation of

dealers and suppliers, improvements in quality and capacity optimization,

capital budgeting examples

Business

digis current ratio

digis total debt ratio

digis cash ratio

short term debt

days inventory turnover

current liabilities

capital structure of

efficient digi