Applied Valuation (E102)Assignment Answer TemplateMarker feedbackComment on overall performance: Begin your assignment answers from this point. Question 7:Coates’ revenue growth is dependent on demand for equipment rental services, and its ability to supply this demand. In turn, demand is dependent on the level of activity in construction, mining, and oil drilling; and construction, in particular, is sensitive to the overall state of the Australian economy and perceptions of future trends. (While Coates does have some presence outside Australia, the vast majority of its business is domestic. ) Coates’ ability to supply increasing demand for its services will depend on its ability to acquire additional equipment, either by purchasing new equipment or by acquiring other companies with appropriate stock of equipment. The high growth forecasts for 2007 and 2008 assume that overall economic activity in Australia will increase, or at least remain stable; and that Coates will be able to expand its equipment-rental fleet in order to improve its market share.
If the economy suffers any unexpected reversals (which could reduce the level of construction activity), or if Coates is unable to increase its fleet size fast enough, these growth forecasts will not be met. [I’M NOT REALLY SURE ABOUT THIS ONE – I DIDN’T SEE A CUSTOMER-INDUSTRY BREAKDOWN IN THE ANNUAL REPORT! ] Sustained declines in commodity prices would reduce activity in the mining and oil sectors – and thus reduce Coates’ revenues from these sectors.
Given that Coates derives most of its revenue from construction rather than resource extraction, the effect of such a decline on Coates’ revenues should be only marginal. While oil prices have declined since mid-2006, they remain at relatively high levels, and are unlikely to decline further – at least not for long.
As a result, drilling activity should remain at a stable or increasing level. Since the oil industry represents only a small proportion of Coates’ overall business [CHECK THIS! ], Coates’ overall revenue shouldn’t be affected much one way or another – barring a major interruption in oil supply or a sustained and severe increase in oil prices. The main reason earnings per share grew at a lower rate than after-tax profit from 2005 to 2006 is that a larger number of shares were outstanding – 249 million compared to 208 million. Question 8:[NOTE: PLEASE TREAT THIS AS VERY MUCH A FIRST DRAFT.
I’D LIKE TO GET SOME CONTENT INPUT FROM YOU (PARTICULARLY “SPECIFIC EVENTS IN THE INDUSTRY”), AND INCORPORATE IT INTO A REVISED VERSION. ]Threat of Entry: There is no absolute barrier preventing new firms from entering the equipment-hire industry, as there are no patents, proprietary methods, or other factors allowing existing firms to offer a unique product. On the other hand, large firms may have an advantage in arranging favorable terms for purchasing and financing new equipment, and customers are likely to remain loyal to suppliers from whom they’ve received good service in the past.
A firm that already has a presence throughout the target market will have an advantage over a startup, in that large customers can rely on the established firm to provide a wide range of equipment over a wide geographical area. Customer Bargaining Power: Customers have a low cost of switching between suppliers of equipment rental; but on the other hand, the number of customers for equipment rental is large.
Thus, customer bargaining power is moderate: customers can easily switch to a different supplier, but they cannot easily combine forces to bargain as a collective. Supplier Bargaining Power: There are a number of different firms providing the various types of equipment that make up a rental fleet, although the competition between suppliers may be relatively limited for more specialized items. Overall, supplier bargaining power should be relatively low. Threat of Substitutes: While large construction firms can purchase their own equipment and use it efficiently, many smaller firms would not be able to do so.
There is no practical substitute for proper equipment; labor costs I a developed economy like Australia’s are simply too high to use more workers as a substitute for inadequate tools and equipment. Competitive Rivalry: The above items all factor into the overall assessment of competitive rivalry. Thus, we have moderate ease of entry into the equipment-hire business; moderate customer bargaining power; low supplier-bargaining power; and a low threat of substitutes. Since any given piece of equipment can be hired out at most 100% of the time, there is a limit to the amount of business any given firm can do; assuming that a firm is operating at or near capacity, the only way to expand the business is to purchase more equipment.
Equipment-rental firms are thus likely to cut prices only when they are operating at significantly less than full capacity; and even then, they are not likely to cut prices to a level that would be inadequate to cover depreciation of their equipment fleet through use. At the same time, customer loyalty, reputation, and other good-will factors will not be sufficient to raise prices significantly above those of the competition.
At least in stable times, rivalry in this industry should be significant but not extreme.