The previous calculations of the costs of equity and debt were independent. They did not take into account their weighted values. A cost of 14.72% in equity, when multiplied by the weighted value of 60.8% yields 8.9%. The cost of debt, 10.59% against its weighted value results in a cost of 4.15%. The company’s weighted average cost of capital can now be estimated as the weighted cost of equity (8.9%) plus the weighted cost of debt (4.15%), equalling 13.05%.
Calculating a WACC of 13.05% is an estimation of the rate of return that Rolls Royce should adopt when assessing future project investments. As stated before capital employed also included capital reserves and revenue reserves or retained earnings. The above calculation of the WACC seems to have ignored these factors. However, since both capital reserves and revenue reserves are owned by shareholders they are incorporated into the market price of the shares. In the calculation of the WACC the adjustment of dividend cost in terms of the current market share price accounts for these reserves.
Rolls Royce posted record profits during the second half of 1998. Estimates showed that sales would continue to rise as the result of a boom in aircraft orders during the late 1990’s. Supplying engines for plane manufacturing companies, including Boeing’s 777 jumbo jet, the Airbus 330, and the Eurofighter, the company posted record income at 260 million pounds, up from ï¿½225 the previous year. Earnings per share rose to 17 pence, an 11 percent increase, and paid a dividend of 6.55 pence per share.
Entry into 1999 was promising with rises in sales and net profit. Investor confidence was high with shares trading as high as 288 pence early in the year. March 4, 1999, after a posted 20 percent rise in profits shares began to fall by as much as 5.6 percent. Although the company was reaping the benefits of orders placed in the mid-nineties investors became doubtful that it would continue. Many were concerned that the company was gaining market share at the expense of profit, cutting prices to compete with rivals, number one largest engine maker General Electric, and United Pratt & Whitney.
May 6, shares continued to fall despite winning a contract valued at $300 million, to supply New Air, based in New York, with twenty five Airbus planes. This proved to be a small feat when on July 7, General Electric announced it had won a bid, valued $25 billion over twenty years, to supply Boeing Co engines for their new 777 jetliner. General Electric won the bid over second and third top engine makers, Rolls Royce and Pratt-Whitney respectively.
In late Oct of 1999, things began to pick up with developments in a joint venture with Germany’s Bayerische Motoren Werke (BMW). BMW announced it would raise its stake in Rolls Royce from 2 percent, to 10 percent and a $545 million value. Rolls gained full control of the project and with the news came a 29.75 pence rise in share price to around 220 pence per share. With increased pressure on their margins to gain market share and a reduction in demand from the Boeing Co, Rolls was forced to improve efficiency. On Dec. 10th, the company announced that it would be cutting a total of 1,000 jobs from its England based aerospace unit. With its goal set at reaching a 10 percent increase in earnings for the next year, the company stated it was forced to cut manufacturing costs, therefore reducing its workforce in Derby, England by 7.8 percent.
With a reduction in its work force and lower demand in the industry shares continued to decline in early 2000. The order book for engines had declined and margins of profit were falling in the aerospace and industrial divisions. While profit at the year’s end for 1999 increased 10.1 percent to ï¿½284 million, and net income rose from ï¿½152 million, to 161 million pounds, analyst’s estimates were at ï¿½291 million. Shares fell in early March by as much as 13.4 percent to 180 pence in lieu of cash flow worries.
The market value of shares remained above 200 pence through July. On Aug. 24, the company announced that it would fail to meet its 10 percent increase in earnings for 2001. “A combination of factors have affected the outlook for 2001, when we now expect underlying earnings to be flat, but the strength of our businesses and the actions taken in 2000 and 2001 will enable earnings growth to resume in 2002.” (Sir Ralph Robins, Chairman. Rolls Royce plc. Annual Report 2000, www.rollsroyce.com.)
A 22 percent decline ensued as analysts abandoned Rolls fleeing in numbers. Prudential downgraded their rating of Rolls Royce from a “buy” to “hold”, Societe Generale (SA) from a “buy” to “under-perform”, and Merrill Lynch moved to a “neutral” position. However, Morgan Stanley Dean Witter took and interesting position in declaring it a “strong buy” placing faith in the company’s previous increase in net profits.
A 13.5 percent value was regained over the next week. On the 30th share’s rose to as much as 193 pence after Vickers Defence Systems, a company purchased in November of 1999 won a 250 million-pound order from the British Defence Ministry for 66 Challenger tank engines. In line with the rest of the economy Rolls Royce continued to be pressured by the economic slow down late in 2000. Nov. 9, it declared that it would have to further reduce its work force, cutting jobs from in the Marine, Defence, and Engineering sectors for a total of 1,300 jobs. This following the announcement in August that they would not be able to meet expected earnings.
As the world economy dragged itself into the first year of the new millennium, Rolls Royce sought to secure itself a place in the world market of engine makers. Things began to pick up in April when the company unveiled a deal to provide the United States Navy and Coast Guard a range of products and services including ship engine building and maintenance. Allowing president of the Rolls Royce Marine sector, Saul Lanyado, to boast of the company’s global spread serving thirty navies worldwide. Share value began to increase steadily through May reaching a spike of close to 295 pence in June. Share market value would see a decline although remaining healthy through July and August.
Leading economic indicators in global markets and composite indexes for August of 2001, showed signs of weakening economies around the world. Stock prices, vendor performance, interest rates, a growing unemployment rate and consumer expectations all showed major countries including the United States, the UK, and many Asian territories heading for recession. Entertainment and air travel industries were already suffering decreasing traffic. Analysts had a number of outlooks for the future. Non of them would be able to predict the economic blow that would serve as a catalyst for further deterioration.
Suffice it to say that the attacks on September 11th were unspeakable. They came at a time when the world’s economy was already in a state of erosion. Estimates in October declared that the attacks would “siphon $350 billion out of the world’s economy” by the end of the year. Ian Kinniburg, Director of UN Development of Policy Analysis said it would trim world growth a full percentage point to 1.4 percent.