Nowadays,

business cooperation among countries becomes more common, and companies from

different nations start to collaborate for mutual benefit. The trade barriers

for international business are likely to be thinner at this time. Free trade

agreement (FTA) aims to help the countries to maximize their benefit, and

strengthen their competitive edges. With the help of FTA, the regional economic

in Australia is enhanced within these years, and bring a lot of opportunities

to the local market (Department of Foreign Affairs and Trade, n.d).

As

a reliable vitamins and related products provider, Australia’s health care

supplements are extremely popular in China, and the products are reputable due

to the superior quality. Menza Group Ltd is a local producer for vitamins, baby

formula, and other necessities of life. FTA brings a lot of chances to Menza,

because the tariffs are eliminated by the agreement, and as a multinational

company, Menza could expand its business into foreign markets with less

spending.

Weighted Average Cost of

Capital (WACC) is generally used as a discount rate for evaluating the

company’s projects. As Menza operates in the global market, the manager notice

that the current WACC is not appropriate at the moment. Therefore, Menza is

required to have a new WACC by using Capital Asset Pricing Model (CAPM) to

calculate the WACC of an Australian company which is in the same industry.

Blackmores is a suitable proxy because it also offers health care supplements

as Menza, and it has a similar capital structure.

2. Product

Selection

With the increasing attention

are paid to health in China, Chinese people are craving for products that

enhance their beauty or their inner health, such as cranberry slices, hair,

skin and nails (Taylor,2015). The group

collective awakening of health and well-being has been proved by the huge

profit made by the manufacturers of vitamins Blackmores(Desloires, 2016). In January

2016, Blackmores shares price soared to $220 as the Chinese consumer demanded

the purchase of a high-quality “clean and green” brand from Australia

(Evans, 2017).

Additionally, the Chinese government currently has opened up official

distribution channels, businesses can sell their products over the Internet

without tax, and competition to enter the market and protection of

potential buyers is still continuing (Taylor,2015). It is reported that the value

of vitamin supplements in Australia is between 1 billion U.S. dollars and 2

billion U.S. dollars, which have been fostered a thriving market by Australia’s

close business relationship to China (Taylor, 2015). After researches demonstrated

above, the vitamins industry fulfill the requirement of that might successfully

be ‘exported’ to China and also related to the considering projects in vitamins

market of Menza.

3. Company

choosing and justifying

i.

Blackmores company information

In the healthcare supplement

industry, Blackmores is Australia’s leading natural health company. Blackmores

was founded in 1930, has nearly 87 years of history. After 87 years of hard

work, the high-quality range of vitamins, minerals, herbs and nutritional

supplements, as well as continuing support for our community and the

environment, make Blackmores have grown to be the most trusted lifestyle

technology health food company in Australia and the rest of the world. In May

1985, Blackmores officially became a listed company. With a strong naturopathic

heritage, now Blackmores is an ASX 200 publicly-listed company with a market

capitalisation of $1.5 billion and currently is headquartered in Sydney,

Australia. The Group employs 1,000 people across Asia-Pacific.

ii.

Justifying

According to Andrew Page, an

equities analyst at the Motley Fool, cited in Stewart (2016), the profits soared by about 80%

in their full-year results last year and most of profit growth of Blackmores

comes from China. And chief Christine Holgate of Blackmores is confident about

up forwarding increase on profit in China because each regulatory

environment of evolution in China is familiar to Blackmores since they’ve been

in China for 40 years (Sarah

& Jane, 2016).

In additional, the company’s

annual financial report (2017, p49) demonstrated that the percentage of debt is

43.09% ?detailed calculation process shown in

following parts), and the percentage of equity is 56.91% (detailed calculation

process shown in following parts), which means the capital structure is similar

as that of Menza noted as 40% 10-year bonds and 60% ordinary shares.

These data could prove that

Blackmores successfully export vitamins product to China and could be to

provide valuable and crucial information that make valuation of business of

risk of this Menza’s project of healthcare supplement products could be easier

and more accurate.

4. Calculating CAPM

4.1 Assumptions of CAPM(capital asset

pricing model)

As Blitz (2014, p2) said “the CAPM can

be mathematically derived from a set of assumptions, it follows that an

empirical CAPM failure must be attributable to a violation of one or more these

assumptions in practice.” So, before calculating the risk and returns, we need

to keep assumptions as follows:

1.

Investors are risk averse, which means they

want to maximize the expected wealth and care only about the mean and variance

of return.

2.

Markets are perfect (there are no transaction

cost and no taxes)

3.

There is only single period.

4.

Investors have homogeneous expectation to all

products.

5.

All unsystematic risk can be diversity.

4.2

Calculating beta

i: Sampling interval

The sampling interval to calculate

beta are chosen from 10 years’ period monthly data. In “Research design issues

in the estimation of beta”, Brailsford (1997, p11) suggested that the common

choices of sampling interval are daily, weekly, monthly and quarterly, but

researcher will usually be stuck by the availability of data. Monthly data is

more commonly use than daily or weekly data; in the meanwhile, quarterly data

are unlikely to be sufficient if observations do not include at least ten

years’ data. On the other hand, the beta is sensitive to the return interval,

longer period will make the calculating result be more accurate than shorter

time interval.

ii. Calculation

To obtain beta estimates, returns are

required for the Blackmore stock asset and market index proxy (Brailsford,

1997). ? is the slop of

linear regression of excess market returns and excess stock return, which Y-

axis is the excess market returns (Blackmores stock rate of return – risk free

rate of return) and the X- axis is excess market returns (market rate of return

– risk free rate).

As for Blackmores’ stock rate of return, the

adjust closing price is used to calculate in equation:

Where:

is the Blackmores rate of return

in month t.

is the adjust closing price in

the month t

is the adjust closing price in

month t-1

.

The reason to use adjust price is that it adjusted for both dividend and

splits. The data obtain the end of every month’s stock price from January 2008

to December 2017 download from Yahoo Finance. After using equation above to

calculate the Blackmores stock rate of return, the number need to multiple 12

to adjust as annualized data in order to pair with the risk free rate. The risk

free rate download from Reserve Bank of Australia website, which is the 10

years yield to maturity of government bond, which is already annualized.

As for market rate of

return, the data is accumulated index from S/ASX from Jan 2008 to Dec

2017, which use the increased rate of index as the market rate of return.

Calculated by the same equation as the stock rate of return, the number still

need to multiple 12 to ensure the monthly increasing rate annualized.

After dealing with those data, using EXCEL to calculate the slope (Ri – rf, Rm– rf) to get ?=0.304 as follow:

iii. sensitivity analysis

From public sources (Returns website), the

beta of Blackmores is 0.54, which is bigger than our estimated. As observing

the graph above, there are some points are far from main area may influence the

result of beta. So some data need to be adjusted to make the beta more

accurate. After adjusting, the new ?=0.4020:

iiii. Adjustment of beta

In the

adjustment of number for any differences in the capital structure between the

Blackmores and that of Menza, if we assume that debt of carries no market risk

(has a beta of zero), the beta of equity alone can be written as a function of

the unlevered beta and the debt-equity ratio

?L = ?u (1+ ((1-TC) D/E))

Tax effect

would be considered by influence of company tax rate in Australia. In relation

to Australia tax office of Australia Government, the full company tax rate

is TC =30%,

The

company’s annual financial report (2017, p49) shows that the book value of debt

is $44,717,000; it also reveals that the volume of outstanding share is

17,266,000, and the price for each share on 2017 balance sheet date is $3.42,

thus the market value of equity is $59,049,720. Thus, the percentage of debt is

DB =43.09% (44,717,000/(44,717,000+59,049,720)), and the percentage

of equity is EB= 56.91% (59,049,720/(44,717,000+59,049,720)).

And

according to ?u B we calculated from historical data in the excel

attached,

?u B =0.4020

Therefore,

?LB= 0.4020 (1+ ((1-30%) 43.09%/56.91%))=0.6151

According to

public resources from Yahoo Finance 2017, the publicly released beta is 0.54,

which means the ?LB has subtle difference.

And since

the Blackmores and the Menza have similar capital structure, and DM=40%,

EM=60%, ?LB could be assumed as same as ?LM =

0.6151,

?u M=0.6151?1+?1-30%?40%/60%=0.4194

? = 1 means

share as risky as market

? < 1
means share less risky than market
? > 1

means share less risky than market

Estimated

beta equals to 0.4194 show Blackmore is less risky than market.

4.3 Calculating CAPM

Zopounidis (2014) explained that the capital asset pricing model(CAPM)

related to portfolio theory to provide solutions of risk and returns. CAPM

calculated the rate of return of equity by following equation:

Where,

i

(Ri – rf, Rm– rf)

E(rm)

is the expected return on the market

According to market-risk-premia website, in

the end of December 2017 risk free rate(equal to 2.86, risk premium (4.31. After calculating the expected return of Blackmore( is 4.43.

5. Rate of return on debt

The rate of return on debt of Blackmores is 3.33%. This

value is obtained by adding risk free rate in Australia and the credit spread

up together. The formula is shown below:

Rate of return on debt= Risk free

rate + credit spread

In this report, the securities issued by Menza Group is

assumed to have a credit rating of A. In order to calculate the U.S credit

spread, it is important to find out the YTM of 10-year corporate bond with

credit rating of A. This value is 3.12% obtained from the S website.

(‘S/ASX Corporate Bond A Rating Band Index’, 2018)

The rate of return on 10-year treasury bond is used as the

risk free rate. According to the data from Bloomberg website, the risk free

rate of Australia is 2.86%, and the risk free rate of America is 2.65%. Thus,

the US credits spreads equals 0.47% by using 3.12% minus 2.65%. The rate of

return on debt for Australia companies is 3.33% obtained by adding 0.47% and

2.86% up.

6. Weighted Average Cost of Capital (WACC)

WACC

generally stands for discount rate for companies. However, for Menza the

existing rate is no longer applicable for the company’s operation. As

Blackmores and Menza belong to the same industry and have similar capital

structure, so Menza’s WACC could refers to the WACC of Blackmores.

In

advance, the task has been pointed out using the imputation tax system to analysis

the case. Therefore, the formula of calculating WACC is:

WACC=Re*(1-T)/1-T?1-??*E/V+Rd*(1-T)*D/V

Re: expected rate

of return on equity

Rd: expected rate

of return on debt

T=30% (company tax

in Australia

?: proportion if

franking credits valued by the company’s shareholders; generally approximately

to 1

E,D,V: market value

of equity, debt and the firm, respectively

If using the formula of WACC, some assumptions should be

satisfied. Then, the value of debt is equal to book value instead of real

market value, because not all bonds are actively traded in public market and

value of debt is relatively stable (Titman, 2016).

The first step to calculate WACC is to determine the ratio

of debt and equity respectively in the total capital of Blackmores. The Menza

has a capital structure 40% 1o-year corporate bonds and 60% ordinary shares.

Thus the value of D/V is 0.4, and the value of E/V is 0.6

According

to the part 4 and 5, the rate of return on debt is 3.33% and the rate of return

on equity is 4.43%. Therefore, the weighted

average cost of capital (WACC) of Blackmores is:

WACC=4.43%*(1-30%)*60%+3.33%*(1-30%)*40%=2.78%

Under the method of WACC, the tax shield brought by the

debt has been concerned. In addition, if the firm does not change its capital

structure policy, the WACC would be stable for a period. Since Menza owns a

similar capital structure, rate of debt and rate of equity to Blackmores, Menza

could refer to the discount rate of Blackmores. However, when the project has a

greater risk than the average level of the company’s previous operation, the

calculated WACC is not suitable to be used as a discount rate. If the company

use the WACC for a risky project, the discount rate may bias the investment

decisions made by the company, thus the project may become risky.