Investment Strategy

Future Telecom plc, a leading company in the telecommunication sector is planning future expansion, by providing new services including cable TV, fibre optics internet technology and a landline telephone network. The planned investment strategy is a step towards the achievement of the company’s main corporate objective of becoming a major provider of cable TV and internet services, rivalling the only two major competitors in the media and entertainment sector.

As the new project will be totally financed by equity, Future Telecom plc shareholders are demanding a full analysis of the company’s financial performance, policies and strategies over the last 4 years and an investment appraisal of the proposed project before any Board decisions are made.

The CEO of Future Telecom plc has commented on the performance and financial position of company.

“…………… a picture of great strength moving forwards. The last four years have seen our company’s operations become increasingly diversified, and our turnover has increased by more than 40% over the last four years – a clear indication of successful management. Our share price has risen over the same period. The sales from the new project will surely result in a substantial increase in the company’s share price, further boosting shareholder value ……………”

Investment Strategy

Future Telecom plc plan to offer international TV channels from all over the globe to capture the market of non-native residents in the country. The company also intends to provide cheap international calls through the newly proposed landline network.

A clear need for such an investment has been established by our comprehensive market research survey, which has just been completed at a cost of £50,000. The impact of this project on the company’s existing products has also been studied. Since the company is currently a mobile telephone network provider, the new fixed line network is expected to have an adverse impact on the existing sales which is estimated to be not more than £2 million a year. Future Telecom plc consider this a price worth paying for the increase in overall market share and brand visibility.

The capital cost of setting up the fibre optics internet, cable TV services and the aerial sites would be £50 million, an expenditure that would attract capital allowances on a straight-line basis over 10 years, commencing from the first year of operation. The capital expenditure will happen one year before operations start.

The company’s current 30,000 square foot headquarters office in Buckinghamshire can accommodate the required customer service offices for the new departments, which is assumed to make use of only 50% of the total space. The annual mortgage cost for the building is approximately £80,000.

Working capital of £1½ million will need to be invested before commencing operations, and it is expected that the same level of working capital would be sufficient for the duration of the project.

The proposed services that will be offered include fibre optics internet, cable TV and a landline telephone network. The total costs associated with the research implemented for development of these new technologies were £1,000,000 paid before the setting up process. The sales forecasts suggest that:

Landline subscribers are going to be 10,000 in the first year and would double each year over the following four years. Thereafter, the number of customers is going to remain constant for the rest of the project’s life.

The number of internet subscribers is expected to be 30,000 in each year.

Cable TV subscribers are expected to be 20,000 over the first five years of the project and would increase to 40,000 subscribers in year 6 where they would remain constant for the rest of the project’s life.

The number of the bundle subscribers is expected to be 10,000 in the first year and would increase by 10,000 each year until the tenth year when it would settle unchanged for the remaining life of the project.

The project does not have a limited lifetime, and although technology would develop in the future that would affect the type of services provided, Future Telecom plc are assuming that the sales and market share will remain unaffected. The company’s marketing department has estimated the average prices of the range of services as follows:

the annual landline subscription is going to be £240

the internet subscription is going to be £180 per year

the annual TV cable subscription is £240

the annual subscription of the bundle product is averaged at £400

The prices will be expected to rise every year according to inflation levels.

The main operating cost would be the annual staff costs, which is expected to be 30% of the same year’s revenue, while the maintenance and inventory costs are forecasted at 10% of the revenue. Other significant operating costs would be services such as gas, electricity, water, and other miscellaneous costs amounting to £1 million per year.

All the above revenues, costs and values are estimated at current prices before the implementation of the project, and take no account of inflation. The current level of inflation is 3% per year, and is expected to continue at this level for the foreseeable future, therefore a careful appraisal of this project necessitates adjusting both revenues as well as costs for inflation.

Based on current market rates of return, the after tax weighted average cost of capital for companies within the same industry is 18% (nominal or money interest rate). This rate would represent the opportunity cost of capital to fund the new project. The company will continue to pay corporation tax at the rate of 30 percent per annum for the foreseeable future.

The company is conservatively assuming that this project will not have a termination date. Although the equipment installed in year zero are to be depreciated over the next 10 years, the company does not require any further investment.

Financial Information

Income Statement summaries for the years ending 30 September (£ million)
	2013	2014	2015	2016
Revenue	35	40	43	50
Gross profit	25	27	29	34
Operating profit	12	14	18	22
Interest payable	(1)	(1)	(2)	(2)
Earnings before tax	11	13	16	20
Taxation	(3.3)	(3.9)	(4.8)	(6)
Net Income	7.7	9.1	11.2	14
Dividends	(6.16)	(7.28)	(8.96)	(11.48)
Retained earnings	1.54	1.82	2.24	2.52

Statement of Financial Position for the years as at 30 September (£ million)
Non Current Assets	36	37	39	42
Current Assets
Inventory	3	3.8	4.6	5.5
Debtors	3	3.2	3.2	3.6
Cash	1.1	1.5	1.5	1.6
Total Current Assets	7.1	8.5	9.3	10.7
Total Assets	43.1	45.5	48.3	52.7
Current Liabilities
Trade payables	3	3.6	3.8	4.3
Taxation	1	1.6	1.8	2
Overdraft	0	0	0	0
Other	0.6	0.8	0.9	1
Total Current Liabilities	4.6	6	6.5	7.3
Long-term Liabilities
Irredeemable debentures	15	15	18.06	21.88
Total Liabilities	19.6	21	24.56	29.18
Equity
Ordinary shares (50p pence par value)	16	16	16	16
Share premium account	5.96	6.68	5.5	5
Profit and Loss account	1.54	1.82	2.24	2.52
Shareholders’ fund	23.5	24.5	23.74	23.52
Capital Employed	43.1	45.5	48.3	52.7

Other Information

	2012	2013	2014	2015	2016
Future Telecom plc Share Price	97	130	160	177	180

Share prices of major competitors over the last 4 years period (in pence)
Competitors	2012	2013	2014	2015	2016
Sky TV	480	562	736	732	748
Virgin	7	14	24	25	31
Talk Talk	95	112	140	126	187
BT Telecom	167	129	149	179	234

Major competitors’ key ratios over the last 4 years period (in pence)
Competitors	P/B	2016	Dividend yield	2016
Sky TV		8.2		3.4%
Virgin		2.1		4%
Talk Talk		4.0		4.5%
BT Telecom		5.7		3.39%

Indexes prices of market and industry sectors over the last 4 years period (in pence)
	2012	2013	2014	2015	2016
FT-SE All share index	2012	2561	2923	2735	3067
Mobile telecommunications	2950	3166	3648	3777	4250
Fixed line telecommunications	2337	1852	1976	2070	2738

Required

As the junior finance team of Future Telecom plc, prepare and submit the written report required by the CEO. The report should consist of two parts:

Part 1 Financial Performance Analysis – requires analysing and commenting on the financial performance and position of the company based on the financial information provided. A 4-year trend analysis (15 relevant ratios) and cross-sectional analysis is required. Any interpretations and recommendations should be based on clear reasoning and explanations. A critical evaluation of the chairman’s comments should also be included.

Part 2 – 10-Year Investment Appraisal – requires forecasting the future cash flows of the proposed project and implementing capital budgeting methods (NPV, IRR and PI). An excel spreadsheet of the investment appraisal should be included in the report. The report narrative should include a commentary on the relevant cash flows included in the appraisal and justifications as to the exclusion of others. Your conclusions should reflect your results from the first part and the fact that the company will need a substantial funding for the new project.

Students should also recalculate the NPV and IRR, assuming the project has an unlimited life.