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1.1.1 BOC

The BOC Group is one of the major producers of industrial gases in the world. Its major products include the atmospheric gases (oxygen, nitrogen, argon and the rare gasses, neon, krypton and zenon) produced by the separation of air by plants chiefly of its own design and manufacture. The Group also markets carbon dioxide, helium and liquefied petroleum gas. Transport costs and the physical properties of industrial gases limit the distances over which the products can be transported economically as a result the production facilities are located close to the markets they serve.

BOC Gases operates in more than 50 countries around the world, including the UK, the United States, South Africa, Australia and many Pacific rim countries, supplying customers with over 20,000 different gases and mixtures. For administrative purposes, BOC Gases' operations are divided into Process Plants and six regions; Europe, the Americas, North Pacific, South Pacific, South Africa and South West Asia. In each of these there is a regional director who responds to the managing director of BOC Gases. To take full advantage of BOC's unique geographical spread of business, marketing is also organised on a global market sector. The world market for gases and related products is estimated to be some £14.7 billion/year. BOC's position among the leading producers is estimated as shown in the table below (based upon the published sales of gasses and related products).

Market share (Gasses)

20%L'Air Liquide


12%Prax Air

9%Air Products



6%Nippon Sanso

4%Liquid Carbonic


Although industrial gases are an important part of many manufacturing and production processes, in many applications the cost of the gas itself is a very small part of the total cost of production. While price is an important competitive factor, security of supply and correct gas purity as well as innovative technology for gas applications are often essential.


The Group, like some of the other major international producers, designs and manufactures its own air separation plants, both cryogenic and non-cryogenic, through its Process Plants division. The only significant 'raw material' apart from the air itself, is electricity, which is used in large quantities to drive compressors, pumps and other equipment. The production process in modern air separation plants is highly automated, so few on-site employees are needed for normal operation and maintenance of the plant.

BOC Process Plants, which has operations in both the UK and US, and through Cryostar in France and Switzerland, designs and manufactures specialised plant machinery, equipment and systems for producing, liquefying, storing and transporting liquids and gases at very low temperatures. it also designs and builds non-cryogenic separation plants.


Most gases have to be stored and distributed either under great pressure, which requires them to be carried in heavy and bulky cylinders, or at extremely low temperatures in specially insulated tankers, which limits how far they can be transported before carriage costs become unacceptable. As a result, there is little international trade in industrial gases. Production has to occur in or near the market being served and there is a trend towards production at the customers' own sites. The industrial gases business is capital-intensive, with increasing demand, together with economies of scale, leading to the need for large production units and distribution networks. BOC Gases operates in six global market sectors in order to pursue business in the fields of Electronics; Chemicals and Petroleum; Food; Glass; Metals; Fabrication.


BOC's health care business is now known as Ohmeda and has traded under that name throughout the world since 1993. All parts of the business focus on anesthesia and critical care products for use in hospitals. There are four operating divisions as defined below:

Pharmaceutical products division

Medical systems division

Medical devices division

Specialty products division


This business segment is a some what strange combination of four independent operating units:

Edwards Vacuum Products: Covering the production of vacuum pumps and instrumentation.

BOC Edwards, Calumatic: dealing with freeze drying systems

BOC Coating Technology: As the name suggests the coating of product (usually whilst under vacuum).

BOC Distribution Services:



This assignment aims to cover the following topic areas from the recent course. The author each section is also stated:

Advanced financial analysisAuthor: Hal

Failure predictionAuthor: JeanMarc

Market efficiencyAuthor: Jo

Share and company valuationAuthor: Jean Marc

Risk managementAuthor: Hal

Financing (The cost of capital) Author: Paul

Dividend policyAuthor: Jo

Mergers, acquisitions and divestmentsAuthor: Paul


Analysis of the financial statements of companies can be carried out in several ways, but most often, the process of ratio analysis is used. The main reason for this, is that the critical indicators are reduced to ratios, thus we can compare like with like, and find the unit indicators of success, failure, or somewhere between the two. Ratio analysis enables the users of financial statements to form an opinion of the concern. The business can be compared against predetermined norms, previous years, other companies, and anticipated/projected budgets. There are many different ratios that can be used, and the hidden folly in them is that injudicious choice of ratio can leave the user with a mass of meaningless numbers which convey little. A framework is therefore required around which the analysis can be built, similar in some respects to a mosaic, viz. you don't see the whole picture until all the pieces have been put into place. We shall therefore use the framework of the SLAP system: Solvency, Liquidity, Activity, Profitability. Each of the above parameters will be examined by means of the appropriate ratios for each company, and the overall picture for each will then be drawn by means of a DuPont Analysis, a system devised on behalf of the DuPont Chemical Co. when they went through an acquisitions phase, and required some methodical means of assessing the overall performance of a potential acquisition.

2.01: Solvency:

Solvency refers to the debt-paying ability of a business. This in turn is expressed by the extent to which the total assets of the enterprise are exceeded by the total liabilities. If the liabilities of the company exceed the assets, the company is said to be insolvent, and the owner's equity shall have a negative value. The solvency ratio is given as:

Solvency ratio = Total Assets

Total Liabilities

A ratio of less than one indicates insolvency.

The type of debt that a company owns also gives a good indicator of solvency, and it is of great interest to the examiner of statements whether the debt is interest-bearing, and to what degree. Consequently, the second ratio pertaining to solvency is given by:

Interest bearing debt equity

This tells the reader the extent of debt that is interest bearing per unit equity.

2.02: Liquidity:

Liquidity is the ability of a concern to meet its short-term obligations. Measures of liquidity compare the amount of current assets with the amount of current liabilities. It is by and large, a matter of degree. A slight lack of liquidity may prevent a concern from taking advantage of favorable cash or quantity discounts, and from availing itself of other profitable business opportunities as they arise. A more serious lack of liquidity may cause the enterprise to be unable to pay its current liabilities as they fall, with the consequent deterioration of supplier relationships, the requirement of sale of investments and other fixed assets , and in its most severe form may cause insolvency. There are four ratios which are commonly uses to assess liquidity, the Current ratio, the Quick ratio, the Available Cash Ratio and the Cash Flow ratio. The current ratio indicate the degree of liquidity of the enterprise taking into account the length of the operating cycle , the quick ratio indicates the ability to pay creditors when the urgency of the matter does not enable the time taken for the completion of the operating cycle to be completed ,the available cash ratio indicates the degree of readiness the enterprise shows to pay its creditors from immediate cash balances, and the cash flow ratio relates the total debt to the flow of cash rather than the absolute value. Of the four, the current ratio is the most commonly-used, and familiar.

The Current ratio, also known as the working capital ratio indicates the extent to which the enterprise can pay its current liabilities from the proceeds of its current assets, taking into account the normal operating cycle of the business. It is calculated as follows:

Current Ratio = Currents Assets

Current Liabilities

A current ratio of 2:1 indicates that the currents assets exceed the current liabilities twofold, i.e. for every $1 in liability there are $2 of asset. This state of affairs is regarded as being safe by the majority of observers, since in the event of company failure, it is not uncommon for assets to be sold for far less than their true book value or worth, upon liquidation.

However, the "safe" current ratio will vary from one industry to another, and the 'comparing like with like' factor is again evident. The current ratio therefore not the universal measure of financial strength that it may appear to be upon first inspection. For example, a concern which deals mainly with cash only, and hence has no accounts receivable , and an inventory which moves rapidly, will have a low current ratio and still be able to operate efficiently. A business with a sound but slow moving inventory which deals largely with credit will have a correspondingly higher current ratio if it wishes to be healthy. Consequently, this ratio must be viewed withstanding other factors and not exclusively in its own light. A more judicious use of the current ratio is not to use one isolated calculation, but an average of several successive ones, since it is affected by seasonal fluctuations. A rising trend in the currents ratio indicates that surplus cash resources are building up, or stock is doing the same. A falling trend may indicate that a dangerous working position is being approached.

This is also one ratio which may be manipulated managerially, since it is (often mistakenly) universally seen as a benchmark of financial health. This practice is termed window dressing, and the ratio may be changed by deliberately paying debts the day before the balance sheet is calculated, or may be lengthened by purchasing large amounts of goods on credit, thus incurring larger liabilities before the balance sheet is calculated.

The overall indication given by this ratio, is the ability of the enterprise to meet its current obligations assumed to require payment in the every near future. Currents liabilities contain items covered by the latter, but also liabilities payable up to one year away. Similarly, currents assets contain very liquid cash, to not so liquid stock and accounts receivable, which can be up to sixty days in being realised. With the above in mind, the Quick ratio may be used to good effect.

The Quick ratio excludes from current assets debtors and stock in trade, which are one step, and two steps respectively from being converted into cash. These two steps take time which creditors may not be prepared to grant, and thus debts must be paid from readily available cash and those debts which are immediately recoverable. These items are generally referred to as "quick". Consequently, the Quick ratio relates the current liabilities to the immediately collectable and payable assets. These are commonly taken to be current assets minus stocks, the latter being two steps from being liquid cash;

Quick ratio = Quick assets

Current Liabilities

This is also the "acid-test" and a good indicator whether the company could settle its liabilities at shorter notice than the current ratio. A quick ratio of 1:1 is said to be a pass of the acid test, and leaves no doubt that the criterion is satisfied. The ratio depends on cash reserves, the terms granted to the debtors, and the quality of same.

The Available Cash ratio indicates the ability of the enterprise to meet its obligations in a tie frame shorter than both the current ratio or the quick ratio, i.e. in a dire emergency. The type of assets which would be used includes cash or very temporary and negotiable investments e.g. government bonds . It is given by:

Available cash ratio = Cash plus cash equivalents

Total Liabilities

2.03: Activity

Activity refers to the "speed" of turnover of various parameters in the enterprise. Low activity may equate to a sluggish business with a long operating cycle, longer perhaps than is strictly necessary. Broadly speaking, the following activity ratios can be equated with the effective us of working capital, and in many texts, are referred to as such. The supervision and control of working capital are facilitated by activity ratios, and these reflect the intensity with which the enterprise uses its current assets and current liabilities. They involve comparisons of the level of sales and the investments in various working capital items. Once again, the optimum level for said ratios varies from business to business.

The asset turnover is given by:

Asset turnover = sales

total assets

This ratio shows the number of times that the value of the assets has been turned over during the accounting period, and in turn indicates the amount of sales that each pound invested in assets has generated. It will of course vary from business type to business type. Manufacturers with large amounts invested in fixed assets and a relatively small working capital will have a low asset turnover. The opposite is true for, for example, wholesalers with large amounts of stock and debtors, and a relatively low amount invested in fixed assets. An exceptionally low rate of turnover coupled with a relatively high current ratio may be an indication of undertrading, i.e. the situation in which the amount of working capital is too large for the volume of sales. The asset turnover can be further refined to the fixed asset turnover:

Fixed Asset Turnover = Annual Sales

Fixed Assets

The rate of turnover of working capital is determined by the relative rates of other variables, such as stock, debtors, creditors, and cash. The bottom half of the Du Pont analysis links these factors to give the overall picture.

Stock management is critical in any meaningful discussion of activity. Large amounts of stock mean that the relative percentage of stock being turned over becomes less, more capital is tied up in stock, and this in turn leads to problems of its own. Stock is two steps from being cash, and consequently is an asset which may be current, but cannot be described as quick, and hence cannot contribute to the quick ratio (acd test). Furthermore, stock incurs costs of its own, such as storage, insurance, risk of obsolescence, security, pilferage etc., and the optimum level of stock can be determined by Operations Research (Economic Order Quantity Model). Two ratios are worthy of note here:

Stock Turnover = Annual Cost of Sales


which gives the proportion of fraction of the years stock on hand at any one time;

Days Stock = Stock

Daily COS

which gives the days stock remaining on hand at the time of accounting.

The other imperative factors concerned in activity are debtors and creditors. Debtors are amounts owed due to the credit sales of goods and services supplied, creditors the same for goods/services received. debtors are currents assets, but not necessarily quick assets. Debts owed is proportional to the volume of credit sales, and control and age analysis of debts owing is a crucial operation in financial management of all, but particularly smaller concerns. The following ratios are pertinent at this point:

Debtors Turnover = Annual Sales


Days debtors = Debtors

Daily Credit Sales

Days debtors represents the number of days sales represented by the amount of debtors outstanding at the end of the year, and is given in days. It indicates the likely collection period for these debts also.

Similarly, creditors are analyzed by:

Days Creditors = Creditors

Daily COS

The above assuming a 365 day trading year.

2.04: Profitability:

Profitability is the overall measure of success of a business enterprise. The effective use of resources is judged by the income generated by those resources. The amount of profit in absolute terms is not however a good measure of success or failure, since it has to be related to the resources which gave rise to it, and compared to the opportunity cost forgone by use of those resources. Consequently the Rate of Return gives an empirical indication of profitability and is given by:

Rate of Return = Income


and is calculated thus:

Rate of return = Earnings = Earnings x Sales

Capital Employed Sales Capital Employed

The numerator gives the income from the investment put into the enterprise.

This can be further refined into the following ratios:

Return on Shareholders Equity = NPAT


where NPAT is net profits after tax;

Return on Total assets (ROTA) = EBIT

Total Assets

where EBIT is earnings after interest and tax;

NPAT as percentage of turnover = NPAT


and Gross profit percent = Gross profit



The following describes the ratios calculated from the balance sheet and income statement of BOC Group 1994. Also pertinent is the Du Pont analysis attached, which examines activity and profitability graphically. All figures in (pounds) millions.

2.11: Solvency.

From the financial statements:

Assets:Fixed:2604.6Liabilities:Long Term:1730.7



Solvency Ratio = 3910.1 = 1.40


Equity = assets - liabilities = 1126.4

Interest Bearing Debt = 855.8 = 0.759

Equity 1126.4

EBIT = 333.8 = 4.17

Interest 80.7

The above values indicate that BOC is solvent, but below the generally sought-after value of 2 for the solvency ratio. The EBIT/interest value compares well with averaged UK companies which had a value of 3.5 in 1992 . The IBD/Equity value seems anomalous, the UK average being 53, consequently there may be differing perceptions of what an interest bearing debt is.

2.12: Liquidity.

Current ratio = 1305.5 = 1.24


Quick ratio = 1305.5 - 328.1 = 0.99


Available cash ratio = 132.8 = 0.13


The latter ratio based upon cash plus short term deposits.

The current ratio paints a good picture of the liquidity of BOC. The current assets outstrip the liabilities by almost 50%, and even the quick assets are on a par with current liabilities. The acid test has therefore (almost) been passed but for 1%. The available cash ratio indicates that from cash reserves alone, BOC could not settle current liabilities, however this value takes no account of other less liquid assets, and is the status quo in only the direst of emergencies. Overall then BOC is liquid all other factors being equal.

2.13: Activity.

Asset turnover = 0.84, fixed asset turnover 1.26

Debtors turn = 57, debtors days = 6.35

Stock turn = 4.4, stock days = 83

Creditors days = 48

The activity ratios show that the debt management at BOC seems to be excellent in terms of collection, but the figures also suggest that by enforcing such a rigorous debt recovery system, they may be losing in turnover by not having the incentive of normal terms. Stock is turned over 4.4 times per year, and stock days of 83 suggests that perhaps the days stock could be reduced, since normally this would be excessive bearing in mind costs of holding. This in turn may be explained by the unique nature of BOC's product, liquid gases can only be made in large quantities, but the other side of the same coin suggests that they are notoriously expensive to store, requiring both high pressures and low temperatures to do so. A compromise perhaps may be in order, 83 days stock on hand seems to be excessively high no matter what the produce. The days creditors value of 48 implies that BOC takes full advantage of credit terms, but this is offset by their overlong days debtors. If the two were equal, then BOC would be "breaking even" and better still, the days creditors should be higher than the days debtors. The asset turnover for BOC is low at 0.84, which suggests that the capital employed may not be employed as efficiently as it should be. The comparison with ICI will put this last factor into some context.

2.14: Profitability.

NPAT = 113.6 = 0.1

Equity 1126.4

Return on Total assets = EBIT = 333.8 = 8.5%

(ROTA) Total Assets 3910.1

NPAT = 113.6 = 3.45%

Turnover 3292.3

Gross Profit percent = 57.2%

Total Expenses percent = 39.3%

Net Profit % (nil basis)=10.1%

Net Profit after Tax and interest %3.45%

Earnings per 25p Ordinary share = 23.82p

The ROTA for BOC shows that the total worth of the assets in the company yielded 8.5% before tax and interest. This is comparable to the type of return one might expect from a financial institution having similar sums invested within it. The net profit after tax and interest is however not so spectacular. 3.45% on assets of 3910.1 million pounds seems to be a poor return, for no immediately apparent reason. Gross profit as a percent of sales is 57.2%, consequently there seems to be a significant loss of value as the gross becomes the net. This may be due to factors such as high expenses associated with the type of high technology processes BOC uses, and other factors such as high storage costs etc. This is reflected in the high value of total expenses percent.


2.21: Solvency:

From the financial statements:

Assets:Fixed:4032Liabilities:Long term:1617



Solvency ratio = 9004 = 2.13


IBD = 1759 = 0.37

Equity 4779

EBIT = 496 = 5.64 (interest cover)

Interest 88

The ratios described indicate that ICI is, as expected completely solvent, with assets far outstripping liabilities. the solvency ratio, widely accepted to be the benchmark of solvency stands at 2.13, well above the figure of 2 which is the mark of a well solvent company. The interest cover, the number of times that earnings could pay off interest due is a comfortable 5.64, and thus overall our criteria for solvency are satisfied for ICI.

2.22: Liquidity.

Current Ratio = 4972 = 1.9


quick ratio = 3739 = 1.43


Available cash ratio = 1759 = 0.67


Once again, the current ratio implies that ICI is well able to settle its current liabilities, almost twice over. The acid test gives a ratio 0f 1.43, which is almost 50% more than required to pass said test, and the available cash ratio stands at 0.67, which implies that ICI could pay off 67% of all its current liabilities with cash without having to see a single other asset. All of the above are evidential of the liquidity of ICI.

2.23: Activity.

Asset turnover = 9189 = 1.02


Fixed asset turn = 2.27

Debtors turn = 25, debtors days = 15

Stock turn = 7.4, stock days = 49

Creditors days = 145 (credits of less than one year, i.e. trade credits)

The ratios suggest that ICI makes full use of terms with creditors, 145 days for payment being on the long side. It also has its collection policy well geared toward collecting, reducing debtors days to a nominal 15, which almost makes debtors a quick asset for ICI. Stock days is a reasonable 49, but bearing in mind the nature of ICI products t could be reduced to lower cost of holding. Stock is turned 7.4 times per year, and assets turned 0.979. In a company the size of ICI, this is a reasonable figure, bearing in mind the massive capital investment in plant and machinery that the company has.

2.24: Profitability.

ROTA = 5.5% nil basis, 2.08% after tax and interest.

Net profit after tax as percentage of turnover = 2.04%

Gross profit % = 29%

Net profit % nil basis = 5.4%

Total expenses % = 26.9%

Earnings per share (one pound) = 37.3p

The ROTA implies that although ICI is profitable in absolute terms, the return on investment is not as good as may be expected. The Earnings per share do not confirm this, and the fact that the assets did not give rise to a similar return is unrelated in some respects to the share dividend. The gross profit of 29% as a percentage of sales helps explain the resulting low value for net profit percent, 2.04% appears lower than it should be for a company of this type.


The most satisfactory way of comparing the two companies, is by looking at either a table of the ratios, or equally well, the Du Pont analysis which gives a more dynamic version of events. If we assume a nil basis for all the relevant ratios, i.e. all profits before tax and interest such that the differing tax situations for both companies do not distort the values, we can see the gradual differences of the two. We should however realise that although technically ICI and BOC are both chemical companies, they are vastly different. BOC does no manufacturing per se, it obtains gases by the fractional distillation of air. Its raw materials are in effect free, but the technology involved in this type of process involves low pressures and temperatures which are expensive, and transport and storage costs are high. There is little R&D involved relative to ICI who spend a a lot of money on their R&D budget, and all the above should be taken into account when analyzing in this manner.

Consideration of sales in itself is a folly, since sale is a function of the size of the company rather than much else. Profit percentage of sale however tells us that more than half the revenue received by BOC was gross profit, whereas ICI showed only 29%. This may be in part due to the fact that R&D has to be worked into the cost of sales for ICI but not for BOC. Expenses are higher for BOC probably for reasons already explained. The nil base net profit percent tell a similar story, with 10.1% for BOC outstripping the 5.4% of ICI. This is once again reflected in the Return on total assets, with BOC at 8.5% and ICI at 5.5%. It would seem then that BOC are using their capital in the form of all their assets to better advantage. This fact is not however reflected in the asset turnover for the companies, which gives ICI and BOC 1.02 and 0.84 times respectively. The BOC figure implies a certain sluggishness with their assets not even being turned once in the year, whereas ICI turned assets round once. Fixed assets had a similar variance, with ICI lengthening the gap to 2.27 versus 1.26.

The other factors which require addressing include the debtors days, stock days and creditors. The points already addressed can be underlined, ICI makes good use of terms for creditors, but seems not to extend the same courtesy to debtors, which means they technically gain. BOC on the other hand is not breaking even with the creditors versus debtors parallel, and a review of their collecting policy might be in order.

The above points are valid upon first inspection, but these are two companies in the same area if not the same field. They sell totally different products, and one, ICI is very research intensive by virtue of necessity, the other not so but has a more delicate product which requires extremes of pressure and temperature to manufacture, store and distribute. These factors must be taken into account by the reader of such statements, and like must be compared with like.



All authors seem to agree : attitudes to corporate failure has changed in the last decade and management structures have accepted that failure is a fact of economic life and can strike any healthy business at any time. Each author has a different approach : J. Argenti identifies the need to detect the failure sequence early enough and D. Clutterbuck & S. Kenagham "in the Phoenix factor" believe that corporate failure is a failure of management focus. However, they all agree that corporate failure should be analysed from two points of view : the financial and non financial one. Models have been designed to predict corporate failure. The authors' advice is to run more than one model to assess a company and to take great care before drawing conclusions.

The 3 most common approaches have been :

- Basic Accounting Methods : using financial ratios

- Multivariate models which incorporates more than one ratio, each ratio weighted according to its usefulness

- The A score model which looks at non financial signs of failure.

Rees summarises the key concepts behind those models. Different parties will have different motivations when assessing business : auditors, bankers and investors will be looking for different signals. The information required is for example ability of the firm to service debts, position of the debt in the firm's financial structure, behaviour of the share price on the market, credit rating (liquidity, adequate profits, cash flow, capital structure), future earnings, management structure and policies etc.

Most research on failure prediction models have been carried out on quoted businesses. Writers such as D. Storey, K. Keasey, R. Watson, P. Wynarczyk in "Performance of small firms" studied the application of models to small firms. Their findings will be discussed later.

Briefly, the most common failure prediction models will be discussed and applied to ICI, BOC. General considerations found in the literature will be made .

3.1 Univariate Models using key financial ratios :

Univariate models use traditional key financial ratios. This raises problems since it relies on company's accounts.

-Accounts do not always reflect the time picture of a company's condition : in period of high inflation, creative accounting in the 80's has helped companies in hiding difficulties.

- Accounts are only one point in time.

- The ratios can be difficult to interpret. In most cases there will be a need to look at the ratios in conjunction with the actions of management at the time.

- To enable the interpretation comparing ratio between years and companies will be necessary.

There are 9 key ratios described by J. Argenti in "Accounts Digests", #138, 1983, which are :

1/ The liquidity ratio:

it looks at whether the company has got enough money to meet its immediate liabilities

Quick Assets (debtor + cash)


Current liabilities (creditors, tax dividends, overdrafts)

This ratio is considered as the most useful predicting ratio.

2/ The current ratio :

This ratio is similar to the quick ratio but includes stocks in the current assets. this test of liquidity is not as stringent as the previous one :

Current Assets Debtors + cash + stock

R2= ------------------ = ---------------------------------------------------

Current liabilities Creditors, taxes, dividends, overdrafts, etc.

3/ The gearing ratio :



capital employed

This ratio helps identifying possible problems for the company to meet its debts.

4/ Income gearing :

Profit before tax and interest



This ratio measures directly a company's ability to service its debts instead of measuring the mere relative size of the debt. This shows that a company could carry an immense debt as long as the profits were high and the interest rates low.

5/ Working Capital Ratio :




This ratio measures how quickly the company is turning its stock over in comparison to other companies in the same trade.

6/ Debtors Ratio :




The debtor ratio monitors the ability to collect outstanding money.

7/ Profitability Ratio :

Profits before interest and tax


Capital employed

This ratio measures the return on capital employed. If the return on Capital employed does not exceed the cost of borrowing, the business will not survive.

8/ Profit Margin :




This ratio compares the trading profit to the sales turnover.This rate should be compared to other companies in the same trade.

9/ Asset Turnover :



Capital Employed

this ratio tells us how effectively company's assets are being employed by comparing sales turnover with capital employed.

Authors have different views which are the best ratios to use. The profitability (rate of return) and gearing ratios are the preferred ones.

The profitability is a long term predictor as gearing a short term one. Gearing seems to increase rapidly when failure approaches. The rules to observe is to use more than one set of ratios and compare them between years and industries.

3.2 The multivariate Models : the Z scores :

One drawback of univariate models is that occasionally some of the ratios will move in the wrong direction and assessment of companies will require a lot of data crunching and comparison.

The Z score model tries to incorporate more than one ratio, weighing them according to their importance. The benefit of that model is a single pass mark which covers a considerable spectrum of companies and industries.

J. Argenti suggests to use the Z score with the Accounting ratio.

The most commonly multivariate model found in Manuals is Altman model.

Z = 1.2X1 + 1.4X2 + 3.3X3 + 0.6X4 + 1.0X5

where :

working capital

X1 = ---------------------------

total assets

returned earnings

X2 = ----------------------------

total assets

profit before interest and tax

X3 = --------------------------------------

total assets

market capitalisation

X4 = ----------------------------

book value of debts


X5 = ----------------------------

total assets

Pass Mark > 3.0

Fail Mark < 1.8

Some research (ref. Rees) suggests that multivariate models could outperform the univariate models. Altman model may however not be as reliable if the horizons are greater than 2 years. The drawbacks of this technique are :

- it does not take into account all economic factors

- it relies on accounting ratio

- should it include other ratios?

3.3 The A score (non financial model) :

The A score is an attempt to find other signs of failure and rank them in order of significance and sequence in order to derive a process failure. This model expects the assessor to know what is happening inside the business at a deeper level than Balance Sheets could do.

J. Argenti suggested that a failure sequence can be derived because, broadly, companies fail for the same reasons in a similar manner. At the beginning, there would be defects at company's management level which eventually would lead to management mistakes. Later signs of failure will show (symptoms).

The most common defects are an autocratic chief, passive directors, lack of strong financial direction, lack of management in depth, lack of accounting systems. These defects would at some stage generate mistakes such as heavy gearing, overtrading, etc.

The symptoms would be of 2 nature : financial (Capex deployed, dividend cut etc.) and non financial (rumours, high staff turnover etc.)

D. Clutterbuck and S. Kernagham describe a "failure of Management focus". Failure is usually accompanied with a management attitude which leads to failure. They suggested management should understand what controls are needed and why, in order to adjust the working of the business. These adjustments cover items such as sales, turnover, costs, pricing, overheads, growth, risk, vision of the business, customers and marketing etc.

3.4 Other considerations :

In their manual "Performance of small firms", D. Storey, K. Keasey, R. Watson and P. Wynarczyk describe the application of predictive models on small firms. Their conclusion is that small companies are more sensitive to economic fluctuations. Their access to funds, their capital structure and ownership's are very different of quoted businesses. Many of the small firms are young (higher turnover of small firms) and usually there is not sufficient data for the calibration of a model. Assessing small firms will require further consideration and investigating. Models (univariate or multivariate) will have to be used with care.

Rees recommends to consider the fluctuation of the share price. Since it reflects what analysts believe future cash flows could be, share price could be considered as a good predictor. It conveys the available information on the market : market prices reflect a consensus forecast of future earnings.

Bankruptcy (drop of earnings) would show in share price fall.

Beaver confirmed in his research that share price movement could be detected as far as 5 years prior to the bankruptcy. this could take us back to J. Argenti concepts of defects years before the symptoms.

Finally, another common mean to investigate a business is to contact the credit rating agency.

3.5 Assessing ICI and BOC .

Three techniques have been described.The A score will not be considered here since no sufficient data is available.

The financial ratios have been tabulated in two tables.Table 1 calculates for both companies the key financial ratios and Table 2 presents the calculation of the Z score.

Following are summarised the results of these calculations:

Table 1:

R1:The liquidity ratios for ICI and BOC are acceptable.The liquidity of BOC has well improved over the last twelve months of 1994.

R2:The current ratio appears too low for BOC.

R3:BOC appears to have a strong gearing ratio.Investors will investigate the ratio further and assess its risk. Both companies seem tom have increased their gearing in the same proportion.

R4:These ratios show that both ICI and BOC are profitable as their profits are sufficient to cover the repayment of their interest on debt.

R5:The ratios show a high turnover of stocks for ICI and BOC.The difference between the two would require further investigation .

R6:The two companies allow long delays before collecting monies from their debtors.The figures have not improved over the year.Is it due to the type of activities and contracts?Is it affecting the cash flow of the businesses?

R7:ROCE have dropped by 4% for each company - nevertheless they are still excellent promising figures.

R8:Margins have narrowed ; BOC has an excellent margin for a chemical company.

R9:Both companies have acceptable ratios.

In conclusion, the financial ratios have highlighted a few areas where investors could do more investigations:BOC liquidity and gearing require attention

The Z score of the two companies are just below the pass mark 3 indicating that further research would be needed to clear any doubt.Signals sent by the market such as high P/E ratios and increase in share price from 1993 to 1994 suggest market confidence.

The predicting models in these cases seem to indicate that both companies are well run and wouldn't be close to failure.


The issue of Market Efficiency discusses the importance of information in valuing stocks and shares and how the response to information and the information given reflect the efficiency of a market. The efficient markets theory argues that share prices reflect all available information (Higson, 1986). Capital markets are also assumed to be operationally efficient in that the intermediairies provide a value for money service (Copeland and Weston,1983)This is an important theory for managers, investors and shareholders. It assumes that shares are, in general, correctly valued, it follows therefore that investors would not be able to consistently ‘beat the market' by making above average returns through trading shares. Cost of Capital calculations which inform management decisions rely on share prices being correctly valued. Market efficiency implies that there is no correct or incorrect time to issue shares as shares are always valued correctly, so timing would not be an issue for managers to consider. Lumby (1991) highlights takeovers as another important issue raised by the Market Efficiency debate. As the share price will reflect a company's true value a takeover would not result in a postive NPV investment

Fama (Copeland and Weston, 1983) defines three types of market efficiency weak, semi-strong and strong - form efficiency. Weak-form efficiency : the present price reflects all information contained in earlier prices so that past and present prices give no indication of prices in the future, there are no predictable trends that investors can follow. Semi-strong form efficiency : prices reflect all information available to the public, therfore no investor can beat the market by using publically available information. With Strong-form efficiency : prices reflect all information whether publically available or not, therefore no investor can beat the market even with inside information. If the market is weakly efficienct technical analysis is of no value. If the market is sem-strong efficient technical analysis and fundamental analysis (which means use of share-valuation models) are not worthwhile. Strong market efficiency would not even allow insiders to value from priveleged information. In short, according to Fama (Copeland and Weston,1983) there is no way to beat the market, random events will affect prices positively or negatively , there are no clear trends Two important criteria of Fama's theory are that investors are rational and that they trade on new information.(Nichols, 1993) Many studies found that financial markets displayed both weak and semi-strong efficeiney but that strong efficiency was rarely found (The Economist, 1992).

Fama's theory was superceded by the Capital Asset Pricing Model which went on to say that rational investors will look for extra returns from risky investments. It follows that diversification in investment will lead to greater returns. Risk is related to returns, the higher the risk, the greater the returns expected. (Markowitz in Nichols, 1993). Sharpe (Nichols, 1993) formulated Beta which is a measure of risk. compan;ies with high volatility and high betas are judged to be riskier investments by the market.

The Efficient Market Hypotheses, CAPM and Beta have all been disputed in recent years. Anomalies have been found such as shares doing better in January and small capitalization stocks getting better returns than large ones. Nichols, 1993, underlines that anomalies such as these should not exist in an efficient capital market. Moreover Beta has been argued to be the wrong measure of risk even by Fama (Nichols, 1993) Lowenstein (1983) argues that CAPM has led managers into making unnecessarily “safe investments with clear, short-term returns instead of investing for the long term and competing on a grand scale.” (p55 Nichols, 1993) It has led managers to be highly concerned with value for the shareholders.

Schiller (p56 in Nichols,1993) argues that “real world financial markets do not follow textbook rules” If they did The Stock Market crash of 1987 would not have happened, he proposes that it was caused by “speculative panic”. He argues that investors are not necessarily rational, markets are not always efficient and investors should focus more on company fundamentals, managers should look for people willing to invest long-term.

Chaos theorists like Farmer and Packhard (Nichols, 1993) on the other hand believe that predictions can be made by studying the markets in great detail, examining the multi-dimensional factors affecting movements. They make use of complicated equations and computers! Peters (Nichols, 1993, p60) claims that “The efficient market hypothesis assumes that investors are rational, orderly and tidy. It is a model of investment behavior that reduces mathematics to simple linear differential equation, with one solution. However, the markets are not orderly or simple. They are messy and complex.” Nichols argues that chaos theory may help managers think about investments in new ways, managers need to aim to get a competitive advantage by investing in Research and Development and through small investments which may lead to larger returns. Using merely CAPM analysis and relying on the Market being efficient may lead to missing investment opportunities. Unfortunately the Chaos theorists analysis techniques are so complex that managers are very unlikey to use them anyway, Nichols (1993) argues that the Chaos theory should inform management decisions not totally replace old methods like CAPM.

It is argued that although evidence of Market Inefficiency has increased (eg the anomalies) this does not necessarily mean that markets have become less efficient rather with increasing technology anomalies are easier to spot.


The companies will be analysed in relation to Market Efficiency theory focussing on a test of semi-strong form theory and a test of the presence of anomalies.

The Semi-strong form theory tests try to assess whether the companies share prices react to new items of information including company reports, particularly dividend payments and newspaper articles. If prices do no react it would mean that the market cannot correctly interpret economic events and that potentially investors could make substantial returns.(Firth, p.128) The price on the day after the event compared to the day before is very important, as is the time it takes to settle down after the event. In an Efficient Market the price would settle down almost immediately.

4.1 BOC

The annual reports for 1991 are optimistic despite a difficult year and the board decides to raise the dividend by 7.8%. The market responds positively, the share price rises and the rise is maintained, the high for that year being 774 pence compared to 625 pence the year before. At the end of 1992 BOC take a risk in order to maintain a stable dividend payout, they leave (12.7) in retained profits, the market is not convinced, the share price falls and remains low on average for 1993.

BOC's healthcare interests suffer because of the lack of success of the Forane chemical. On 12 August 1994 the Financial Times runs an article on this. The next day the shareprice is down, however, on subsequent days it rises, this could be because of the announcement on 16 August 1994 that BOC has bought a Dutch group for £10.8, restoring confidence.

Considering the presence of anomalies now the ‘Year-End' effect is shown for BOC. At the end of each year from 1990 to 1994 with the exception of 1993 the shareprice falls.

4.2 ICI

In 1992 ICI maintain a dividend of 55 pence despite retained profits being left at (963). The market respond positively to this the shareprice rises and continues to rise. ICI

In February 1991 ICI announce that the company will focus on seven main businesses and eliminate ambiguity between divisional responsibilities, and write off £300 million to cover the costs of restructuring. The stock market responds to this and the share price goes up but not enough for ICI, shareholders realise that the company still has to become more efficient.

In May 1991 the Hanson conglomerate with a reputation for taking over badly managed companies announced that it had acquired 2.8% of ICI. The day after this announcement the share price fell.

In the 1990s the demerger of Zeneca dominates news about ICI. News of the demerger is recieved well by the stock market. In 1993 when it is clear that ICI will demerge the shareprice becomes much healthier and this continues after the demerger.

ICI shareprices show the anomaly of falling at the end of each year i.e., the Year end effect.


Information given by ICI and BOC in the form of financial reports as well as events which occur, have both been shown to be followed by a rise or fall of the share-price on subsequent days. This would suggest that the market is efficient. There is also, however, evidence of some anomalies for ICI and BOC shareprices which would indicate that the market is not completely efficient. These results are an example of the complexities and contradictions of the Market Efficiency debate and demonstrate why there is so much debate in this area. Much deeper analysis would need to be carried out in order to dispute the Market Efficiency theory.




Investment analysts will have different views of what should be the true value of a share and would decide to buy or to sell it accordingly. Investors need to believe that the market is well run and that share prices represent accurately the value of the business. If they didn't, people would decide to speculate or not to invest, thus it would damage the stock exchange mechanism and limit the availability of funds to expanding businesses. Businesses could be undervalued and attract take-over interests or suffer from difficulties in raising finance.

To ensure that the share price reflects the value of the business, knowledge and information have to be readily available. The investor will be looking for parameters such as cash flows, earnings, dividends, asset values etc. According to Michael Firth," in a perfect market", knowledge would be conveyed in share prices. In a world where information is not free nor always available, reaching a perfect market is impossible . However, in a semi-efficient market such as the British market, the valuation exercises run by investment analysts will be as good as the information is.

There are several reasons why valuations take place:

1/ As mentioned above, if companies are not valued correctly it could seriously damage the well being and running of the free market economy and allocation of the capital resources.

2/ If a company wishes to go public, how would an investor assess its value ? At what price would you pitch the offer bearing in mind it must be attractive, when compared to other businesses of the same category. What is the value of goodwill and what would it be, if the management was replaced ? Key financial and management information will help the analyst in his valuation.

3/ Valuation takes place when a business wishes to merge, acquire or take over another one.For example,it may help a business about to be taken over to defend itself by raising its market value and making the bid become too expensive. If a listed company wishes to acquire another listed company, the quantities of shares to be purchased will be higher than usual and a revaluation based on future new earnings will be required.

4/ An individual or a PLC wants to buy shares of a company. Value of the shares depends on each party's shareholding and aims,the rights attached to the shares (voting power, dividends).

5/ Valuation of business are necessary for assessing capital gain tax or for capital transfer tax purposes.


From the examples cited above, it is clear that shares are valued differently according to one's different objectives and aims. When determining the share price, consideration should be given to the following :

- is it a quoted or unquoted business ? Is the purchaser an individual or a quoted company?

-Is the purchaser making a short or long term investment ?

- Is the shareholding dispersed ?

- Are the management and ownership separated ?

- Is the business marketable and easy to sell ?

All these points will have to be considered in order to choose the appropriate valuation technique.


When buying shares the investor's objective is wealth maximisation and he should only be interested in the net present value of the future cash flows. Unlike profits, cash is more difficult to manipulate, thus cash flow will provide a better picture of the company's activities and future performance. It will show if it can pay its tax, interest, debts, dividends etc., if the business is stable financially.

However, the annual movements around the working capital and tax make it difficult for internal and external financial professionals to predict the future cash flows and investment analysts have had to come up with other techniques described in the next chapter.


5.4.1 Dividend valuation model : ref (Samuels,1986, Management of Company Finance, chapter 7)

This technique should only be used when the transaction of shares is done on a small scale i.e. an investor wishes to buy shares of a quoted or unquoted business with a minority shareholding. (The investor has no influence on the dividend policy). This model is based on the concept that a share entitles the share owner to a stream of dividends. Discounting that stream by the average cost of capital for that industry will give you the possible value of that share.

Dividends are not always predictable nor stable since dividend policies may change. Financial managers who face difficulties in forecasting dividends in the long term, prefer to use the second model which tend to smoothe the stream of dividends with a growth rate underlying usually the growth rate of that industry.

Do (1+g)

M.V. = ---------------


Do : current dividend

g : growth rate

r : return required

This model would not be appropriate to use in a proposed take-over bid, purchase or sale of block of shares. The P/E ratio explained later would cater these cases.

For an unquoted company, the investor can use an average dividend for listed published companies. An allowance should then be made for the lack of marketability and the higher risk involved.

In summary, dividend valuation model (with growth) requires knowing the current dividend, estimating the average growth rate and the discount rate which would be a function of the risk free discounted rate at the time plus the risk premium on the market times the risk on the asset relative to the market. This concept is formulated in the C.A.P.M. (Capital Asset Pricing Model).

This model raises an interesting question. If a company decided to pay out big dividends, would that make the share price go up and increase the market value of the business ?

Modigliami and Miller argued that if certain assumptions were made it could be shown that payment of dividends should not affect the value of the company nor the wealth of shareholders. They based their argument by showing that an increase in dividends would be offset by a drop in the value of the share.

As mentioned above, the financial markets are not perfect since information is not always complete nor available. Increase in dividend payment is perceived as a rise in confidence which would provoke an increase in share price.

M and M explained that share price fluctuations in line with dividends are caused by changes of shareholders expectations and beliefs,not by a real growth of future earnings.

In the real world,where tax and the clientele effect exist, increase in dividends will usually be followed by an increase in share price.

5.4.2 Three models based on earnings :

These models can be used when valuing a share of a quoted or unquoted company. When using a model based on earnings the aim is different than prior when using dividend based model. The investor is here interested in acquiring or selling a major shareholding of the business and wishes to value the entire business .

1/ P/E ratio : ref (Samuels, Management of Company Finance, chapter7

Michael Firth, the Valuation of shares and the efficient markets theory)

Mostly used for valuing big quoted business, this model could also be used to value unquoted businesses. Its principle is based on multiplying today's earnings per share by a factor which takes into account growth expectations (P/E ratio).

Market price per share = P/E ratio * EPS

P/E ratio : Price Earning Ratio

EPS : Earnings per share

For a quoted business the investor would look at the P/E ratio which reflects the future prospect of that business in relation to its competitors in its sector of activity. A high P/E ratio would indicate that the market is confident that the company's earning will grow fast. Looking at the P/E ratio, the investor can then decide if business is under- or overvalued. For an unquoted company, the investor would use a P/E ratio of similar companies which are listed, look at the marketability of the business and apply a factor to cater its marketability.

Two problems arise when using that model because it relies on two parameters difficult to derive accurately. The EPS is based on current earnings and fails to look at the future earnings. The P/E ratio is based on what the market or investor believe it should be (expectation of future performance of the class of shares in its category). If a company is volatile it will be difficult to assess its EPS in the short and long term and its P/E ratio against the overall market P/E ratios. This technique is widely used because of its practicality but remains subjective since it relies on the investor to evaluate future performance, P/E ratio and earnings.

2/ Accounting Rate of Return Model :

Another suggested model is to evaluate the profits stream and discount it by the required return on capital employed.

Estimated Profits

Valuation of business = --------------------------

Required R.O.C.E.

This valuation model can be used for quoted or unquoted companies. The difficulty in this model lies in estimating future profits ( will they be maintained in the long run ?) and using profits level which are not always representative of the business performance - and again assessing the rate of return.

3/ Superprofits model :

This model is usually used for valuing unquoted businesses. The model looks at the earnings in two parts :

i) the expected return on the value of the tangible assets employed

ii) the superprofits regarded as the goodwill of the business which are usually discounted at a lower ratio to cater these higher risks profits.

The difficulty in this model is to derive a discount rate for the superprofits.

5.4.3 Models which are assets based : ref (Advanced Financial Acc., Woolf

Corporate Finance and Investment, Pike and Neale)

Another means of valuing the business would be to use the accounts. The balance sheet gives the fixed assets, current assets, stocks, debts, short and long term creditors thus the owners equity can be derived. However, variation in accounting policy (historical cost basis, CCA depreciation rules ) does not allow the investor to rely on accounts figures. The asset valuation is based on the valuation of the separate assets and does not represent the true earning power of these assets. This model can only help the accountant in determining the lower limit of the company value. He should pay attention to the debtors and stock figure which are usually suspect.


5.5.1 General :

As mentioned above all these models are to be used in conjunction with the aims and objectives of the investor. Consideration should be given to the size of the shareholding in relation to other shareholding and the status of the purchaser and seller. The investor will have to evaluate the economic climate, the level of accuracy of the information (reasonable efficient market) the market position of the business within the industry and to investigate the marketability of the business.

He will need to assess the reliability of profit forecasts, the ability of the management to perform, the dividend policy and its effects, the gearing and level of risk involved, the nature of the assets and the proportion of goodwill, the existence of restrictive clauses etc.

5.5.2. Risk :

To minimise risk the investor will use the CAPM to calculate the cost of capital. The CAPM model is equal to a riskless rate of return and a risk premium which is usually representative of that chosen industry (ref : Samuels, Management of Company Finance, chapter 13).

5.5.3 Forecasting technique : (ref Michael Firth, chapter 3, The Valuation of Shares and the Efficient Market Theory).

Forecasting usually involves forecasting three of four years of profits and the growth rate. This is done by breaking down the company's activities, its revenues, cost structures, taxes and forecasting these different activities. Annual Reports and Accounts can provide basic information such as trends in share prices according to management decision etc., but can not be used to predict trends. The Chairman's report can give information in the forthcoming year.

In general, investment analysts give preference to earnings forecasts and concentrate on estimating P/E ratios. Services such as consensus forecasts will provide a benchmark for industries.

They will also follow share prices which can send signals of possible future performance. The P/E ratio attached to the share will indicate the confidence of the market in the reliability of the earnings stream.

5.6 Valuating ICI and BOC

A few valuation techniques have been described. In this following assessment and valuation of two quoted businesses, three techniques have been considered. Forecasting the future cashflows has not been retained since inside information was not available. The three models tried here are the Asset Based Model ,Dividend Based Model and the P/E ratio Model.

5.6.1 Valuation of BOC Asset Based Model (table 1) :

The valuations based on that model are tabulated in the table 1. Different sources of information were used such as Extel, Datastream, the FT.

the conclusions that can be drawn are:

-Depending on the way that data is analysed, processed and presented , the net asset values can be different i.e. outside organisations will consolidate the net equity figures differently.

-When compared to the market valuations , it is obvious that asset based valuations tend to give the lower value of the businesses. The difference read in table 1 is about 50%. Dividend Valuation Model (table 2) :

In order to challenge the dividend model , two approaches have been taken:

1/Use past data and observe how close to the market are the valuations derived from the dividend model

2/Use existing data to calculate 1995 average value and compare it to other valuations derived from other techniques.

One definition tells us that:

cost of capital = (D1/P0) + growth rate of dividend

where (D1/P0) is the expected dividend yield.

To simplify the arithmetics, it is proposed to value businesses at the end of the financial year, to use next year dividend and current dividend yield. For comparison purposes, valuations using average dividend yield have been also computed.

For past years, valuations based on the average yield are closer to the market figures and P/E ratio based models figures. For BOC dividends models seem to follow over the years the PIE model.

At the end of year 1995, the forecasted dividend is 26.8p and the dividend yield 3.8%. This gives a share price of 705p and a total value of 3,392£M. This compares to share pricing 890p and a market value (P/E) ratio based of 4,300£M at the end of year 1995. P/E ratio model (table 4) :

For the previous years , average EPS and P/E ratio have been used to calculate average valuations. These have been compared to valuations based on the December figures. There can be a great difference explained by the fluctuation of analysts view of the future performance of BOC. December is only one point in time and perception of the business was certainly different to what it was three months ago. This is clear when looking at the 1995 figures. Market valuations are based on this model because analysts find it easier to use. The high expected EPS on BOC and confidence of the analysts bring BOC market value to its highest point. On the other hand, in table 5, one P/E ratio model calculation for 1995 is very close to the estimate given by the market (also based on P/E ratio model). This is telling the investor that BOC is correctly priced on the market. It would be a hold decision or buy. Conclusions :

Each valuation process has to be considered within its prospective. Dividends models recommended for small investors tend to give a value below the one based on P/E model used by big investors. P/E model based on expectations is giving high values for BOC in December since the confidence is very high at this time of the year. The dividend model seems to give a lower valuation since it does not convey the high confidence of analysts and looks at shares in a different prospective. The small investor is interested in the capital gains and dividends paid on one share as the big investor who may consider purchasing a right in the company is interested in the real value of the business and will be looking for different signals.

5.6.2. Valuation of ICI : Asset based model (table 1) :

The first finding is that the net asset value of ICI has started to decrease after the demerger. The accounts show that during the restructuring, some activities have been sold off during the last past 3 years.

The market valuation of ICI before 1993 was about 1,000£M which shows that Net Asset Value was about 50% of its market value.

Overall, looking at 1994 figures Net Asset Value is the lowest of the 3 valuations. Dividend valuation model (table 3) :

The same approach as with BOC has been applied. Valuations have been calculated at each end of year using the next year dividend when known (for past years) and forecasted for 1996. The values have been compiled for average yield and December yield. The average yield based model gives higher value since the average yield is lower than the December yield.

The data has been computed for 5 years but will not be compared to other models prior to 1993 (due to capital structure changes of ICI).

The average yields for 1993, 1994 not being known accurately, averages have been estimated. The finding are similar to BOC. Average yield calculation will give slightly higher valuation at each year end than with the December yield. The dividend model values are lower than the market values but in line.

For the year 1995, a forecast of 31p dividend has been used based on the Chairman's report and first interim growth. It gives a valuation which is lower than the current market one. P/E Ratio Model (table 5) :

Valuation based on average P/E ratio have been calculated. Compared to market values, they are lower which shows that around December time, analysts were optimistic.

Looking at December 1994 figures, the F.T. was giving a P/E ratio of 62 for a market value of 5,574£M. Either the EPS had dropped to 12p or the market was so confident of ICI's future performance that here the P/E ratio was telling the investor to buy.

1995 calculations suggest that the market value is close to its real value.


Different valuation techniques have been described. Different investors with different purposes will use different models.

To value ICI and BOC, 3 models have been considered. They show that the Net Asset Based is usually undervaluing companies, that dividends and P/E ratio models follow more or less the market figures.

Two approaches have been taken :

For previous years, choosing one point in time (December), using averages and specific data, valuations generated from different models show that P/E ratio models tend to give higher figures that the dividend model does. In the case of ICI, valuations in 1995 seem more accurate than the 2 previous years (due to disruption of the demerger).

The P/E ratio model is the favoured model used by investors but tends, because of its optimistic touch, to overvalue businesses at specific points in time (December 1994) or is it sending signals to the investor to buy ? Dividend models are more difficult to build. To calculate the dividend yield requires a lot of work and assumptions (refer to Paul's work).

There are no perfect models nor an exact share price. There are only signals on the market suggesting what one market value should be.

Assuming that dividends and EPS are well forecasted, ICI and BOC share prices seem to be correctly priced. BOC's higher dividend cover, P/E ratio and lower gearing may be a better buy than ICI. Further work is required such as comparison to the market (FTSE 100) performance.


The risk associated with any venture differs from uncertainty. Risk is the presence of a selection of outcomes from a particular action or series of events, of which the eventual outcome cannot be known, but may be predicted. This prediction can be carried out by Operations Research techniques such as Decision Trees and other forms of probability analysis. Uncertainty on the other hand is the situation whereby there are no fixed outcomes, and there is no method of predicting even a selection of outcomes. Probabilities cannot be assigned. Consequently, risk can be assessed as a criterion for investment, uncertainty cannot. In another way, risk can be defined as the probability that a prediction will turn out to be wrong rather than the more optimistic view that it will turn out to be right.

Generally, when considering the risk of a project, the possible outcomes are assigned a probability, and the net present value of each outcome calculated. It is in the assignment of these probabilities that the attitude to risk is becomes a variable which should be taken into account. Individuals can be risk loving or risk averse, and this factor will dictate the eventual decision taken as to whether to proceed with a venture. This is true for both the manager of a venture, or a potential investor. Managers are assumed to be risk averse, as are investors, however entrepreneurism may stem in part from a greater or lesser attitude to risk. There are thus two main types of risk,

(1) market or beta risk, which is a measure of risk from the standpoint of the investor who holds stock in the company under consideration in a diverse portfolio. A stockholder with a holding restricted to one company will not be viewing this type of risk, and;

(2) total, or corporate risk which is the firms risk viewed without consideration of the effects of the stockholders diversification.

There are additionally two further refinements to these definitions, business risk is the absolute risk of the business in the absence of debt, and financial risk is the additional risk placed on the common stockholders as a result of the decision to use debt as a financing tool.

Assessment of project risk and risk management is central to this type of discussion and we shall consider both factors with respect to the concerns we are examining.

6.10: Why deal with risk ventures at all ?

One might ask the above question when considering investment in companies such as ICI and BOC. Managers of such companies after all have a duty to safeguard their custodial assets, and on paper at least, risking such assets seems folly in itself. The answer lies in the risk versus return paradox. Every type of venture and every type of investment carries an element of risk, i.e. absolute certainty just does not exist. However, the paradox is caused by the fact that as risk increases, so does possible (but not probable) return. Consider by way of example the following types of investment; government bonds, a high interest building society account, preference shares in a large established company, ordinary shares in a small, fledgling company, a game of roulette, and a ticket for the National Lottery. Reading from left to right, at the start, the return on investment is commonly known to be low, but the investment is relatively safe, i.e. low risk. As we move to the right, risk increases, but so does potential but not probable return.

6.11: Methods of Viewing Risk.

One method of dealing with risk in calculations of possible return is to ignore it altogether, which may seem to not to be any type of methodology at all. However, the reasoning behind this approach is that if it can be decided that it is random in its incidence and that it can be expected to cause better results as it is to cause worse results, then the approach appears to have some merit. If, when we aim at a rate of return of 12% per annum and we discover that this on average is the result, then we can apply the "swings and roundabouts" principle, and risk can safely be ignored, all other factors being equal. In practice this does not occur, since rarely do all other factors end up being equal. A method more commonly used to deal with this factor, is the use of risk premium discounting factors. If the cost of capital is 15% per annum but experience has shown that projects are less successful than expected, and yield on average say 2% less than was envisaged, then all calculations are made at 15% + 2%, i.e. the required rate of return then becomes the real required rate of return plus a risk premium. This should in theory give the 15% originally required. A more sophisticated and realistic approach is the examination of all possible outcomes, and the payoff from each. This involves the use of probability distribution. The weighted average of the possible outcomes is then calculated, and is thus the expected return of the project. the word expected is used, since the value of this return is almost never one of the original values in the probability distribution, in the same way as the average car does not contain 1.3 persons. This type of calculation can be done for future years of any project, but as one looks into the future, the risk factor tends to increase due to the increase in possible outcomes.

The above process may be refined to the extent that one can derive a statistical analysis of returns, and the standard deviation, i.e. the degree of spread of results from the average can be calculated. If a project gives projected results with a mean of £x and a standard deviation of £y, then the expected return is £x and the degree of risk is £y. The mean-variance rule applies to this theory and is as follows:

Using expected values and the measure of dispersion, and assuming that investors are risk averse then:

- the investment opportunity with the lowest standard deviation (i.e. the least amount of spread) will be selected from two investments offering the same expected return;

-if two investment opportunities have the same standard deviation , the one with the higher expected return will be selected.

The other consideration when viewing risk, is that of what is being risked, i.e. the stake. The concept of expected return implies that a large number of projects is being undertaken such that the net result will be that they will even out. By analogy, if one is offered the chance to win 5p on the correct prediction of a toss of a coin, with a required stake of 1p, one might expect to play indefinitely. One would expect to win 50% of the time, and after 1,000 games, one would have won £25 but lost only £5. If however the stake required to play was raised to £10,000, although the values increase proportionally, it is unlikely that most people would play since they can ill-afford to lose on the first toss. The payoff in the long term would be substantial, but the player would have only a 50% chance of surviving into the long term. Risk evaluation therefore depends not so much on what you stand to lose in absolute terms, but on what you stand to lose as a proportion of what you already have. Companies thus will probably be unwilling to take even a small risk on a project so large that it would absorb all or a very large proportion of their total resources.

6.12: Methods of Assessing Risk.

The starting point in analysing corporate risk involves determining the uncertainty inherent in the projects cash flows. There are many ways of doing this, varying from taking the best guess to complex computer simulations. We shall briefly consider three of these:

Sensitivity Analysis:

We know that most of the variables that determine a projects cash flows are based on probability rather than certainty. If therefore some variable changes, so then will then NPV. Sensitivity analysis reveals exactly how much the NPV will change in response to the change in given input data of a variable. Its is also called the "what if ?"analysis, since it tries to look at all the various scenarios, (but not to be confused with scenario analysis) and calculate the change in NPV for each. The derived NPVs are plotted against each variable separately, and for a choice of project, the one with the steeper line for each variable is said to be riskier.

Scenario Analysis:

This procedure was developed to overcome limitations of sensitivity analysis. Consider by example a proposed coal mine whose NPV is sensitive to both output and sales prices. If a utility company has contracted to buy most of the mines output at a fixed price plus inflation adjustment, then the mine may be quite risk free even though the sensitivity lines are steep. Therefore the risk element depends on the sensitivity to key variables and the range of likely values of these variables reflected in their probability distributions. Sensitivity analysis does not cover the second factor. Scenario analysis considers the situation in which three sets of circumstances apply, the worst case, the best case and the base (average) case. The cases must be selected by hand, which may be considered a shortcoming in the procedure due to the presence of subjectivity. Thus this procedure although improves upon the last, does not attach a specific probability to each case, some other form of analysis must do this, one example of which is the Monte Carlo simulation.

Monte Carlo Simulation:

this procedure was derived primarily to attempt to beat the gambling houses in Monte Carlo in the 1600's. It is a computer simulation which uses random numbers in a mainframe computer, the latter point being one of its drawbacks. The steps involved are as follows:

1. the computer picks a random number on the first run, assigning it to a variable, e.g. incremental sales.

2.Depending on the random number selected, a value is determined for each variable.

3.Once a value has been determined for each variable, the computer then generates a set of income statements and cash flows. these cash flows are then discounted at the cost of capital, and the NPV of the project can be determined for this first run.

4.The NPV for the run is stored then the computer then repeats the exercise for another set of random numbers . The NPV for run 2 is stored, and the process repeated for perhaps 500 runs.

5.The results of the 500 runs are printed in the form of a frequency table, together with the expected NPV, and standard deviation of the NPV and other associated statistics.

6.13: Financial Risk and Leverage

Financial leverage involves the use of funds for which the firm pays a fixed cost in the hope

of increasing the return to its common stockholders. Since increases in leverage also increase the

risk of the earnings stream to common stockholders the trade off between risk and return is

evident. We should therefore attempt to assess the risk to the shareholders for each of the two companies. Broadly speaking, financial risk involves at worst, insolvency, and otherwise, a lowering of earnings to the shareholders. As a firm increses its level of debt, the cost associated with that debt also increases. This type of risk analysis involves loking at EBIT-EPS analysis. There are sveral ways that a company can raise finance, but we should consider the mst common, that is, ordinary shares, preference shares and debt at interest.. Indifference analysis of the above will give us an insight to the most risk free alternative. Graphically, if EBIT is plotted against earnings per share, and straight lines are drawn for each alternative. Where two lines cross, there is a point at which the EPS for the latenatives are equal. Above this point, the steeper line is the most profitanble, and risk free, below it, the shallower point. Alternatively, the indifference point can be derived from the following equation:

(EBIT-C1)(1-t) = (EBIT-C2)(1-t)

S1 S2


EBIT = the EBIT indifference point between the two methods of financing for which we solve

C1, C2 are the annual expenses or preferred stock dividends on a before tax basis for financing method alternatives,

t=corporate tax rate

S1, S2 are the number of shares of common stock to be outstanding after financing for methods 1 and 2.

From the above, the most risk-free alternative for financing may be calculated.

614: Cash-Flow Ability to Service Debt:

The interest cover calculated in section 2 gives us an indication as to the degree of ease which the company feels with respect to payment of interest. A coverage ratio f 1 shows that the company is using all profits before interest and tax to pay its interest, after taxes, there will indeed be a shortfall. Principals of the debt will remain untouched and the firm will be marking time on the debt.A more useful ratio would be the debt-service ratio which includes a term for the principal:

Debt-service coverage = EBIT

Interest + Principal payment/1-tax rate

Overall, firms attempt to determine their optimal capital structure, whereby they try to get the right mix of financing tools to attain the maximal earnings for shareholder. EBIT/EPS analysis is the most direct was of doing this, coupled with EPS indifference analysis.


In this section we will consider the financing of the two companies, BOC and ICI. Due to the large scope of this topic and the word limit for the assignment the main focus will be the application of the cost of capital theory to these two companies.

In order to find an estimated cost of capital we need to consider both the share capital and the debt capital. The estimates are based upon the Weighted Average Cost of Capital (WACC) models which enables the costs of the various methods of finance to be accounted for in proportion to their size. However, due to the limited detailed information available from the published accounts and other sources, such as EXTEL finance, these estimates should be treated with some caution. Where the information required is not available assumption will be made based upon relevant market information.


7.1.1 The cost of capital

The cost of BOC's capital is estimated (based on the 1994 annual report) as being 10.078%. This is based on the following calculations and assumptions.


First we consider the Share Capital. As BOC utilise both Ordinary and Preference Shares (of which different issues attract different rates) the Cost of Equity will be addressed individually by type.

Preference shares

The preference shares are defined in the 1994 published accounts (note 12) as follows:

0.5 million 4.5% Cumulative Preference shares @ £1, giving a total capital figure of £0.5m.

1 million 3.5% Cumulative second Preference shares @ £1, giving a total capital figure of £1m.

1 million 2.8% Cumulative second Preference shares @ £1, giving a total capital figure of £1m.

These figures can be incorporated directly into the WACC calculations

Ordinary shares

The total number of ordinary (25p) shares issued is 477.9 million, this provides a total ordinary share capital figure of £119.5m. In order to find the cost of this equity capital we must first identify the dividend growth so that it may be applied in the "Gordon's" growth model.

Using the model, defined in Reference 1, the growth rate is:

g = ((23.2/19.0)E0.333)-1

Note: This is based on the published dividend for the four years 1990 to 1993 (1994 was not included as the high and low share values were not available for the this year in the EXTEL finance report).

The growth rate = 0.0688 or 6.88%

Using this value in the modified "Gordon's" model, of r = ((d0 (1 + g))/mv) + g (as described in the 1995/6 DMS Finance lecture notes) , we can establish the cost of the ordinary share capital.

mv :- the market value for the shares = 680p ( this is based on the average of the high (770p) and low (590p) share prices at the end on 1993 as quoted in the EXTEL Finance data sheets.

d0 :-the total dividend paid for the period to the end of 1993 = 23.2p (this was used to ensure consistency with the 1993 figures used for the value of "mv").

r = ((23.2 (1 + 0.0688))/680) + 0.0688

r = 0.1053 or 10.53%

There are, however, "minority shareholders' interests" to the amount of £220.9m. As there is no explanation of these in the accounts they are be treated as "ordinary share capital" for the purposes of this calculation and the cost will be taken as 10.53% accordingly.


We now consider the debt/loan capital.

Of the £905.7m long term (greater than one year in this case) debt/loan capital only £855m is identified. The remaining £50.7m is not spit down into elements with quantifiable interest rates. This figure could be ignored and hence removed from all equations or a value for the interest could be assigned. As £50.7 equates to 5.6% of the total debt/loan capital this has some effect on the outcome therefore the average value of interest payable on the £885m will be applied.

The £855m long term debt/loan capital is split in to three elements, as defined in Note 11 of the 1994 accounts, as:

"Loans other than from the bank": £582.1m.

The interest rate is taken to be 9% based on the perceived average bank rate for 1994. This also takes into account of the logic used in the calculation of ICI's loan capital (please refer to Appendix 1).

"Bank loans": £269.0m

The interest rate is taken to be 8% based on the perceived rate for 1994.

"Finance leases": £3.9m

The interest rate is take to be 13% based on the £0.6m interest paid on the total of short and long term finance leases (£4.7m), as stated in Note 3 of the 1994 accounts.

The general assumptions for the calculations may be seen in Financing Appendix 1.

The interest on the £50.7m of unidentifiable capital is taken to be weighted average of the above Loan/debt capital:

weighted average interest = ((582.1/855).9%)+((269/855).8%)+((3.9/855).13%)

= 8.7%

Therefore the interest to be applied to the undisclosed £50.7m will be 8.7%.

The short term debt/loan capital of £247.9m, entitled "Borrowings and finance leases" under the current liabilities section of the balance sheet, is not broken down into its component parts. Therefore a "cost" will have to be assigned in order for the figure to be considered as part of the over all cost of capital.

The same rational will be applied as that used for the £50.7m unidentified capital and a rate of 8.7% will be used.


The basic formula for the Weighted Average Cost of Capital is take from Reference 2, section 14.4.

Two basis of calculation will be utilised for the WACC; firstly the Book value and secondly the Market value.

i) Book values:

For the Book value the total capital is taken as:







Debt capital(non bank)582.1@9%


(finance leases3.9@13%


(short term)247.9@8.7%

Reserves(share premium)243.5@n/a


(P&L account)993.2@n/a

(rel. u'taking res)69.9@n/a

TOTAL "T"=2884.3

The WACC book value therefore equals:

Equity (119.5/T*10.53%)+(0.5/T*4.55%)+(1.0/T*3.5%)+(1.0/T*2.8%)+(220.9/T*10.53%)


Loan/Debt capital



ii)Market values:

The main difference from the book value calculations are that ordinary and preference share prices are taken at the market rate and the reserves are not included in the total capital figure. In the case of the ordinary shares the market rate for September 1994 is 691.5p (source:-DATASTREAM). This gives a total value of £3304.7m (Note this is not he same as the value used in the growth rate calculation (mv) due to the late availability of the data). The average preference share market value for 1994 has been taken from DATASTREAM as follows:

0.5 million 4.5% Cumulative Preference shares @ 69.82p, giving a total capital figure of £0.35.

1 million 3.5% Cumulative second Preference shares @ 55.07p, giving a total capital figure of £0.55m.

1 million 2.8% Cumulative second Preference shares @ 44.35, giving a total capital figure of £0.44m.

It is interesting to note that the share price has dropped from the initial values. This is most likely due to the fact that the dividend payable is lower than can be gained else where (i.e. banks etc..). Hence the lower the share value dividend the larger the drop.

For the market value the total capital is taken as:







Debt capital(non bank)582.1@9%


(finance leases3.9@13%


(short term)247.9@8.7%

TOTAL "t"4680.5

Equity (3304.7/t*10.53%)+(0.35/t*4.55%)+(0.55/t*3.5%)+(0.44/t*2.8%)+(220.9/t*10.53%)


Loan/Debt capital



Comparing the two basis of calculation it can be seen rates that the market value is higher than the book value, confirming the "text book" theory. This higher value of 10.078% should therefore be used in assessment of the company in order to err on the conservative side.

7.1.1Finance observations

Following are some general observations on the financing of the BOC group:

The proportions of the debt capital to the share capital (Based on the 1994 book values, identified above) is approximately 3.25 : 1. This suggests that BOC did not wish to finance the business through the issue of further shares which would dilute the voting rights of the existing shareholders (Some preference shares have been raised, without voting rights, which overcome this dilution problem). However, the minority share equity has increased by 46% (from 150.8% in 1991 to 220.9% in 1994), but, as the details of this equity are not available no comment can be made.

The proportion of debt capital, as a percentage of the total capital is 24.6% (using the market values), this is within the "preferred" range of 20-30%.

As the approximate proportions of the above finance mix have changed very little over the previous four years to end 1994, the cost of capital will be very similar.


7.2.1 The cost of capital

The cost of ICI's capital is estimated (based on the 1994 annual report) as being 8.146%. This is based on the following calculations and assumption.


First will consider the Share Capital.

Ordinary shares

The total number of ordinary (100p) shares issued is 724 million, this provides a total capital figure of £724m. In order to find the cost of this equity capital we must first estimate the dividend growth so that it may be applied in the re-arranged "Gordon's" growth model. This is not as straight forward as for the case of the BOC growth figures, following the divestment of Zeneca reduced the dividend from 55p in 1992 to 27.5p in 1993. Also the dividend before and after the divestment remained constant, shown below:







(source: EXTEL finance report)

However, there is some dividend growth for the first half of 1995 (as may be seen in the 1995 interim report). The total divided paid for the first half of the year was £83m compared with £76m for the first half of the previous year an increase of 9.2%. Bearing in mind that part of the reason of the restructure of ICI (to form new ICI and Zeneca) was undertaken to foster growth, the first half year dividends will be considered for the years 1993 (£76m total), 1994 (£76m total) and 1995 (£83m total).

Using the model, defined in Reference 1, the growth rate is calculated by:

g = ((83/76)0.5)-1

The growth rate = 0.045 or 4.5%

Again, using this value in the modified "Gordon's" model, of r = ((d0 (1 + g))/mv) + g, we can establish the cost of the ordinary share capital.

mv :- the market value for the shares = 830p ( this is based on the average of the high (868p) and low (792p) share prices at the end of 1994 as quoted in the EXTEL Finance data sheets.

d0 :-the total dividend paid for the period to the end of 1994 = 27.5p (this was used to ensure consistency with the 1994 figures used for the value of "mv").

r = ((27.5 (1 + 0.045))/830) + 0.045

r = 0.0796 or 7.96%

Therefore the cost of the ordinary share capital is 7.96%

There are, as was the case for BOC, "minority interests - equity" to the amount of £338m. As there is no explanation of these in the accounts they will be treated as "ordinary share capital" for the purposes of this calculation and the cost was taken as 7.96% accordingly.


We now consider the debt/loan capital.

The assumptions in Financing Appendix 3 should taken into consideration.

The loan/debt capital is split into two main components: first; The total long term (greater than one year in this case) debt/loan capital equates to £1703m (split as "Loans - over one year" = £1522m and "current instalment of loans" = £181m); second; The remaining £142m is classified as "short term borrowings".

Long term:

The £1703m debt/loan capital is split in to two elements for the WACC calculation, as defined in Note 20 of the 1994 accounts, these are:

"Secured loans": £168m

The interest rate is taken to be 8% based on the perceived rate for 1994.

"Unsecured loans": £1,535m

The interest rate is taken to be 9% based on the rational in appendix 2.

Short term:

The £142m debt/loan capital is split in to two elements for the WACC calculation, as defined in Note 18 of the 1994 accounts, these are:

"Bank borrowings": £89m

The interest rate is taken to be 8% based on the perceived rate for 1994.

"Other borrowings": £53m

The these are assumed to be Debentures, Bonds etc.. therefore the interest rate is taken to be 9% based on the rational in appendix 1.

Note: Useful information on Equities, Eurobonds and Government bonds may be found in the relevant sections of Reference 4.


As before for BOC, the basic formula for the Weighted Average Cost of Capital is take from Reference 2, section 14.4. and the basis used for the WACC calculation is firstly the Book value and secondly the Market value.

i) Book values:

For the Book value the total capital is taken as:




Debt capital(long term-sec.)168@8%

(long term-unsec)1535@9%

(short term-bank)89@8%

(Short term-other)53@9%

Reserves(prem. share acc.)569@n/a


(Assoc'd u'takings)60@n/a

(P&L account)2346@n/a

TOTAL "T"=5919

The WACC book value therefore equals:




Loan/Debt capital



ii)Market values:

The main difference from the book value calculations are that ordinary share prices are taken at the market rate and the reserves are not included in the total capital figure. The market rate for December 1994 is 749p (source:-DATASTREAM). This gives a total value of £5422.8m (Note this is not he same as the value used in the growth rate calculation (mv) due to the late availability of the data).

For the market value the total capital is taken as:




Debt capital(long term-sec.)168@8%

(long term-unsec)1535@9%

(short term-bank)89@8%

(Short term-other)53@9%

TOTAL "t"=7635.8

The WACC market value therefore equals:




Loan/Debt capital



This again confirms the theory that the market value is higher than the book value and should therefore be used in assessment of the company in order to err on the conservative side. Therefore the higher value of 8.146% should be used.

7.2.2Finance observations

Following are some general observations on the financing of ICI:

The proportions of the debt capital to the share capital (Based on the book values) is approximately 2.5 : 1. This suggests that ICI did not wish to finance the business through the issue of further shares which would dilute the voting rights of the existing shareholders (unless preference shares without voting rights were used).

The proportion of debt capital, as a percentage of the total capital is 24.5% (using the market values), this is within the "preferred" range of 20-30%.

Note: The minority share equity has increased by 18% form 288% in 1991 to 338% in 1994, but as in the case of BOC, no information on their content is available to enable comments to be made.

As these approximate proportions of the finance mix have not changed greatly over the previous 3 years the cost of capital will be very similar.

As noted in Reference 2, section 12.6 (based on Accountancy, July 1991) ICI hold its treasury functions centrally in order to maximise the benefits from changes in the finance market globally.


Comparing the book values for the two companies show that ICI is roughly twice the size of BOC (as calculated at the end of 1994).

The two organisations differ in there approach to financing there operation in the following ways:

ICI do not utilise Preference Shares as part of their equity, only ordinary shares (plus some minority shares which are undefined). Where as BOC utilise some £2.5m of preference shares.

Both companies have financed their respective growth through the use of long term debt capital. Avoiding the increase in the WACC if equity were raised (and the associated higher costs of raising equity).

Both companies prefer unsecured capital as opposed to secured with ICI having 47% of the book value in long term debt capital compared with BOC's having 32% of the book value in long term debt capital.

The minority shares have increased sizeably over the past years for the two companies. It is not possible to compare the origins of the increases due to the lack of information.

The amount of profit carried forward by the two companies, as a percentage of the book value, is 34% for BOC compared with 40% for ICI. The fact that ICI has a slightly higher figure may indicate that ICI operate in more uncertain markets, therefore requiring more profits carried forward in order to smooth the dividend payments through the profitable and unprofitable years.

The WACC (based on market values for the two organisations is very similar (10.078% for BOC and 8.146% for ICI. The difference will be due to the respective acquisition/divestment policies of the two companies. See section 9.0(mergers, acquisitions and divestments) for further details of these policies.

The higher value for BOC may indicate greater confidence in the future.

There is no mention of Hire purchase, Lease back, Leasing/Contract hire, debt factoring etc.. at this level of the organisation. This is to be expected as these aspects of financing would show themselves if the individual operating companies, within the Group companies, were analysed. There are some references to "franchising" in the ICI accounts where the rights to manufacture certain chemical/compounds are sold to another company.


What dividend policy to have is a very difficult decision for any company. There are many conflicting theories on this area which send different messages to managers and investors.

Traditionally it was believed that the higher the dividends were the higher was the value of the company. Investors need for certainty would lead them to require high dividends. What is known as the ‘Bird in the hand' philosophy was that a £1 of dividends was worth more than a £1 of retained earnings. (Lumby 1991) If a company retained earnings there is a degree of uncertainty as to whether subsequent investments would lead to future earnings and therefore it was better to give the money to the shareholders for certainty of immediate gains i.e., less risk.

Miller and Modigliani ( in Lumby,1991 p47) alternatively assert that the pattern of dividends is irrelevant to the value of the firm they should be treated as a residual left-over after the investment decision has been made. If a shareholder is not happy with the dividend policy of a company they can sell their shares in it or some of their shares thus creating a ‘home-made dividend . There have been many criticisms of the M.M. theory not least that the home-made dividend policy ignores the tax implications and transaction costs of buying and selling shares. Moreover the character of investors is often such that they prefer the certainty of dividends. Dividends also give information to investors, high dividends may give the signal to investors that the company is doing well.

The ‘Clientele Effect' theory builds on the argument against M and Ms theory by emphasizing the fact that company's attempt to attract and provide for the investment preferences of shareholders. “Shareholders may positively prefer companies to supply them with a dividend pattern which matches fairly closely with their desired consumption pattern, thereby relieving them of having to adjust this cash flow themselves.”(p479 Lumby,1991) Elton and Gruber (Pike and Neal, 1993) highlight that this is one of the reasons behind companies trying to follow a stable, consistent dividend policy. In conflict to this however following a policy such as this may prevent a company from investing enough money in business ventures and therefore will eventually effect the shareholder. Lumby (1991) concludes that “following a consistent dividend policy, the company attracts to it a clientele of shareholders whose consumption pattern accords with the dividend pattern.” (p480) i.e. if the clientele theory is valid the worst thing a company can do is to change its dividend policy.

Theorists such as Bhattacharya (Pike and Neal, 1993) have emphasized the importance of dividend policy as a way of communicating information to investors. “Dividend policy may say things the managers don't say explicitly” (Black,1976). Black (1976) argues that in general managers don't like to reduce dividends so that if dividends are increased investors are given confidence that the company's prospects are good which may in turn lead to a rise in share price. In recent research Marsh (1992) finds that although people generally have a more accepting attitude towards dividend cuts, dividend cuts still have a dramatic effect on the share- price which does not necessarily correct itself in time Marsh emphasizes that shareholders will interpret reduction in dividends as a bad signal.

Black (1976) highlights how taxes can affect an investors decision. If capital gains tax is higher than tax on dividends then investors may prefer to receive higher dividends. Elton and Gruber (Pike and Neal, 1993) highlight that due to the importance of taxation for shareholders companies should follow a consistent, recognized dividend policy so that shareholders can choose companies which best suit their individual tax needs. When a country's taxation policies are changed, however, the company will need to decide whether to change dividend policy or not.(Lumby,1991)

The main theories of dividend policy have been outlined above. Now research into what companies actually do with their dividends will be discussed.

Lintner (Higson, 1986 ) examined the dividend payout ratio finding a much stronger link between earnings and dividend pay-out than investments needs. Companies, in Lintner's study tended to raise the dividend if earnings were high and vice versa without condidering how much money they wished to retain for investment.

In a later study Fama and Babiac (Higson, 1986) also found that dividends were strongly related to earnings, companies were concerned that their dividend pay-out was the same or higher than the year before. A more recent study by Cable and Theobald found that many companies set a target for their dividend payout ratio and mainly considered trends in historic cost profits as well as expectations of shareholders, rather, than tax considerations.

In conclusion to this section, there are many critieria to consider when forming a dividend policy and making dividend pay-out decision. Black (1976) describes it as a puzzle and there certainly are many pieces to it. A company must, however, make their own decision about which theory to follow, taking into account their own particular cultural, historical and financial situation and to a certain extent it would seem advisable that when a decision is made, it is stuck to without too many changes. There have been many reasons outlined above as to why a consistent dividend policy is beneficial : from a tax perspective, for shareholder information and in order to consider the needs of the shareholders. A consistent, stable policy and pay-out is therefore advocated. It has been proven (Marsh 1994) that dividends give signals to investors as to how well a company is doing. A cautionary note should be that dividend pay-outs should not be maintained at all costs, the investment decision is of equal importance. A company that pays out all its profits in dividends would find itself with nothing to invest.


It follows therefore that a company has two main decisions to make. Firstly whether to retain funds or pay them as dividends and secondly whether the dividend policy will effect the value of the firm. That is, what should the dividend policy be?

In this section the 2 companies' dividends policies will be analysed....Firstly an introduction to each company's dividends policy will be given.

8.1 BOC

There is a great emphasis in every BOC chairman's statement from 1990-1994 on a stable, consistent dividend policy. BOC have an underlying objective of raising the dividend slightly each year. The dividends are just below average for the sector but steady e.g., dividend yield on 28/11/95 is 3.8

1993 : “BOC's dividend policy remains committed to dependable and sustainable growth...”


ICI also promote a consistent policy with an emphasis on shareholder loyalty. Their objective is to at least maintain the same dividend in line with inflation and moreover to improve the dividend cover. ICI's dividend yield on 28/11/95 is 4.7 which is above average for the sector but not in the highest bands. ICI have a high dividend for the chemicals sector of 55 pence until 1993, the year of their demerger when it halves.

It could be presumed, other factors being equal, that these companies would attract investors who were looking for capital gains in the long-term but steady dividends meanwhile.


Both companies` dividends are seen very much as giving signals to shareholders This is demonstrated by BOC in 1991 when despite a difficult year the Board decide to raise the dividend by 7.8% because of their confident forecast for 1992. The message is clear; we may not have being doing very well this year, however, “our underlying performance remains strong” (p.9, BOC, 1991)

BOC are in a confident mood at the end of 1994 and want to show this to their shareholders, the dividend rises by 7% despite only a 2% rise in earnings per share :

“The economic uncertainties that clouded BOC `s prospects last year have largely dissipated. Economic recovery became evident this year in almost all markets in which we trade.” (P.3, BOC, 1993)

ICI also struggle to maintain their dividend in difficult times in order presumably to give appropriated signals to shareholders, although unlike BOC the dividends have not risen since 1989. ICI are careful at the end of 1991 not to raise the dividend for 1992, despite the fact that earnings per share have risen. It could be supposed that they are wary of raising the dividend and then having to drop it as this would give a bad impression to shareholders. This is just as well because at the end of 1992 they have a loss of retained profits at (963).

BOC and ICI certainly do not adhere to M and Ms theory that dividends should be irrelevant. A paragraph of each chairmen's statement is given to explaining the dividend policy and as has been stated above a great emphasis is put upon serving the needs of the shareholders. ICI have a very strong loyalty to their shareholders i.e. the clientele effect (Elton and Gruber 1970 ) This is emphasised in every chairman's statement between 1990 and 1994 and is highlighted by the fact that the dividend remains the same between 1989 and 1992 at 55 pence despite difficulties.

“...While still not satisfactory, this is a solid result in view of the difficult conditions and we are therefore recommending that the dividend is maintained.” (p.4 ICI, 1991)

“...the dividend be maintained despite the fact that it was not covered. Shareholder loyalty should be rewarded.” (p.4 , ICI, 1992)

Similarly, BOC have a strong consideration for the expectations of their shareholders This is also shown through their emphasis on maintaining a stable dividend pay-out, examined above. They are also anxious to demonstrate a loyalty to shareholders. The worst thing either company could do, according to the Client effect theory is to change their policy. ICI only does this in 1994 as a result of the demerger of Zenexa

Black's (1976) arguement that companies should consider the effect of capital gains tax and tax on dividends on investors is another reason why it is important that both the companies should have consistent dividend policies. BOC`s only change to its dividends is a slight rise each year whereas ICI keep the same dividend each year up to and after their demerger.ICI.

A relationship between earnings per share and dividends is also very common. BOC show a fair amount of reliance on the previous year as Lintner's studies indicate, but, as will be shown below other factors also influence their policy.

In the BOC chairman's statement for 1993 he emphasises the link between earnings per share and dividends :

“resumed growth of earnings will be reflected in higher dividends when the Board considers it prudent” (p. , BOC, 1993)

BOC `s earnings per share are related to a certain extent, however, BOCs desire to maintain dividends pay-outs at times overides this link. For example, in 1991 earnings per share dropped by 18.3% from 50.8 pence in 1990 to 41.pende in 1991. Despite this drop the dividend rose from 21.20 pence in 1991 to 22 pence in 1992, a rise of 7.8%. The chairman justifies this in the 1991 statement :

“This reflects our view of the sustainable level of dividends, based on our expectations of future growth in earnings.” (p.4, BOC, 1991)

BOC are still, however, relating the dividend to earnings, but to a confidence in future earnings rather than past earnings, this relates to the section on sending signals to shareholders.

In 1994 earnings per share rise only by 2%. Despite this the proposed dividend rises by 7% to 24.8 pence. This is another example of BOC wanting to maintain an increase in dividends and not calculating their dividend payouts solely on earnings per share information.

It is more difficult to find a relationship between ICI`s earnings per share and their dividends. In 1991, for example, earnings per share rise by ?% from 69.0 pence to 76.4 pence, the dividend however for 1992 remains the same as for 1990 and 1991 i.e., 55pence. Nevertheless, in 1992, the year before the demerger, earnings per share are very low at (79.9 pence) and this is reflected in the dividend which falls to 27.5pence. This 27.5 pence dividend, however, doesn't necessarily reflect earnings per share but is a result of the demerger process.

The important question is whether the companies have made the right decision in their dividend policy. One indicator of this is whether the share price has remained optimistic -

The share price for BOC has risen with some fluctuations from a high of 622 pence in 1991 to 903 pence in 1995. The share price for ICI rose steadily from a high of 689.3 pence in1991 to 868 pence in 1994, with a dip in 1995 of 849.5 pence.

A second indicator is whether the company left enough money in retained profits to invest i.e., what was their dividend cover?

In 1990 and1991 BOC `s retained profits were substantial. .BOC took quite a risk in 1992 in order to maintain a stable dividend payout. The board paid £101.1 million in dividends, leaving (12.7) in retained profits. This did not necessarily benefit them as in 1993 share prices dropped, possibly shareholders were not convinced by the signals given. Despite this, by 1993 BOC were able to raise the dividend by ##% and still have 93.8 million retained profits. In 1994 BOC again have to plunge into retained profits to maintain the same dividend as 1993, leaving only 3million to invest from retained profits. This time they are rewarded by shareholders with the shareprice risng to 765pence.

ICI take similar risks, but to a greater extent than BOC. In 1992, 1993 and 1994 retained profits are at a loss. In 1992 the retained profits are at a loss for the first time in the 1990s; (963) so that the dividend can be maintained at 55pence, shareholders seem to be convinced by this as the shareprice continues to rise. The same pattern is repeated in 1993 with retained profits at (433), despite the lower dividend of 27.5 pence the shareprice rises again, although the demerger also gives the market cause for optimism. The 1994 defecit of 11 million, however, is followed by a drop in shareprice in 1995, this corresponds with a fall in the ftse 100 but also may be a reaction of shareholders to the retained profits being negative for the third year in a row. Possibly with a smaller dividend on offer shareholders are less dependable.

It seems therefore that both our companies have on the whole made good decisions in their dividend policies with the possible exception of ICI in 1994 and have at least achieved the important factor of consistency, whether this has been to the detriment of their investment policies is another matter.


In this section we will consider the mergers acquisitions and divestment's made by BOC and ICI. Due to the impact of the ICI divestment of ZENECA the main focus of this section will an analysis of this action.

The following definitions are used (as found in Reference 2, chapter 17):

Horizontal- Acquisition of companies who's production is at the same stage in a similar business.

Vertical - Acquisition of companies who's stage of production is forwards (closer to the "end customer") or backwards from the from the current stage of production.

Congeneric - Acquisition of related businesses (as similar product, raw material, etc..).

Conglomerate - Acquisition of an unrelated company who product is different.


Following are some of the more interesting acquisitions, mergers and divestment's that have take place over the period covered by the last four years company accounts, For the full list please see Mergers Acquisitions and Divestment's Appendix 1.:


Acquisition: Acquired Delta Biotechnology Ltd from Bass Plc and the Stroh Brewing Co for £23m. This is conglomerate acquisition to broarden the company's technology base.


Acquisition: Acquired German hydrogen business from Huls AG. This horizontal acquisition was a key step in the expansion of BOC's industrial gases businesses in continental Europe. It complements the existing gases business in continental Europe and is a significant step in the expansion of the hydrogen business around the world. The assets include the longest hydrogen pipeline grid in Europe, extending over 210 kilometres and currently serving customers in oil refining and chemicals, together with a cylinder and trailer filling station for hydrogen and other gases. Hydrogen is supplied under long-term contractual arrangements, principally by Huls.

Merger: New joint venture (horizontal) established with Fushun Iron & Steel Co at Fushun, northern China. Fushun BOC Industrial Gasses Co Limited started business on 1 April. Fushun Iron & Steel Corporation has put into the joint venture its industrial gas business which is one of the largest in China.

The joint venture further strengthens BOC's position in China and is one of the most substantial to date, both in size and potential, and also extends the our business into a new region.

Acquisition: Acquired Calumatic Group of companies in the Netherlands, a manufacturer of filling, sterilising and packaging equipment for injectable pharmaceuticals. Acquired in August at a cost to BOC, including debt assumed is Dutch Guilders 29.4 million (£10.7 million). The consideration was paid in cash with a proportion deferred and contingent upon future performance of the business. Calumatic was be integrated (horizontally) with Edwards Freeze Drying, which is a part of the vacuum technology division of BOC and is a market leader in the supply of freeze driers to the pharmaceutical industry.

Acquisition: Acquired the London Cargo Group, a Heathrow based airside cargo-handling specialist . This is a vertical takeover which will protect BOC's product distribution channels and hence reduce the dependence on sub contract cargo handling for urgent items.


Very little information on the activities of ICI's acquisitions is available in the EXTEL Finance report. However, when coupled with the annual reports some data may be gleaned. Following are some of the more interesting mergers, acquisitions and divestment's that have taken place over the period covered by the last four years company accounts. For the full list please see Mergers Acquisitions and Divestment's Appendix 2.:


Divestment: Of UK lime business to Minorco SA for £117m in December. ICI's lime operation, a business within ICI Chemicals & Polymers Ltd, comprises quarries and processing facilities with proven reserves of around 400 million tonnes of limestone. The lime business was profitable and in 1990 had sales in excess of £55 million, made almost entirely to UK customers. However, it falls outside ICI's long term strategy of developing business in which it has strong global positions.


Divestment: Westralian Sands Limited - This was no longer required by ICI Toxide as a raw material safe guard. It is stated that new technologies enabled a wider range of ores to be processed, the suppliers of which were adequately protected by existing purchasing agreements. This is very clearly a "vertical" divestment.

Divestment: ZENECA. In June 1993 the bioscience operation were demerged from the company. This is effectively a "conglomerate demerger". Please see the review of this action below.

Note:It is interesting to note that in the 1993 accounts ICI give the following details on their divestment policy "These divestments reflect the groups strategy of developing strong global businesses and transferring other businesses to companies in which they can grow and prosper".


Divestment: EVC International NV (a joint venture for the production of PVC between ICI and EniChem SpA of Italy): The divestment took place in November 1994 with both parent companies disposing of their shares and the company being floated on the Amsterdam stock exchange through the issue of new share. £83M was raised from this divestment (note: ICI now hold 15.8% of the newly floated company).

Divestment: ICI acrylics operation, based in California. This divestment was required by the US federal Trade commission as part of the 1993 nylon-acrylics transactions.


Of all the activities during the period under review the most prominent is the divestment of the then (1993) newly created bio technology group:- ZENECA.

The main reason for this divestment (demerger), according to the published accounts, is to facilitate the maximum possible growth in both the remaining ICI businesses and the newly formed Zeneca group. This is the most dramatic example of ICI's “core business” strategy.

Following is a synopsis of a recent Harvard business School review, Reference 1, of this divestment:

Although the divestment took place in June 1993, the foundations for this were laid in the 1980's when ICI sought new sources of growth to offset the sluggish sales of its older products. However it only increased the complexity of an already complicated and hard-to-manage portfolio of businesses. ICI was faced with the indignity of a takeover threat as the value of the "best" businesses it owned wasn't reflected in the price of its stock.

ICI's response, however, was unusual: a demerger that split the organisation into two separate companies, new ICI and Zeneca. ICI's businesses could be grouped into two technological clusters.

The synergy's and mutual interdependence on which ICI had always assumed that its success depended existed almost entirely within each of the clusters but not across them. Each cluster faced different strategic priorities and required different technical capabilities and managerial skills. However the structure of the company, with powerful divisional managers who were determined to preserve and expand their span of control, made it difficult for ICI to change direction.

Two previous large US takeovers which widened this divide were Flidden in 1986, which made ICI the world's largest paint producer, and Stauffer in 1987 (to strengthen ICI's agrochemical position). In the late 1980's the pharmaceuticals division was ICI's most profitable business, and ways of accelerating its growth through acquisitions or alliances were explored and rejected. The push into specialties and the purchases in the United States only created new management problems, while the booming markets of the mid 1980's blunted the immediate pressure to withdraw from commodities. Growth rates in ICI's two biggest trading areas, Western Europe and North America, promised to be modest, while dynamic growth in the Asia-Pacific region argued for greater expansion into those markets. After the acquisitions of the mid 1980's, however, ICI's cash flow was down and expansion would have required external funds.

Sir Denys Henderson initiated the process of questioning/internal debate and set up task forces to examine strategy and the organisation. The strategy task force concluded that ICI was still trying to do too much. The task force recommended a more selective strategy, with resources focused on seven sectors; pharmaceuticals, agrochemicals and seeds, specialties, explosives, paints, materials and industrial chemicals. Concluding that ICI was not properly equipped to respond to the rapid change that had been taking place in the world chemical markets.

In February 1991, ICI top management announced that the company would focus on these seven main businesses and would eliminate the ambiguity between divisional and territorial responsibilities. The company wrote off £300 million to recover the costs of restructuring. Although the stock market received the news well investors did not close the value gap in the ICI share price. With pharmaceuticals submerged in the rest of the group, the whole company was still worth less than the sum of its parts. During the spring and early summer of 1991, ICI explored various ways of rectifying the under valuation - a megamerger with another international company, demerging ICI Chemicals and Polymers, or a pharmaceutical alliance.

In May 1991 the Hanson group announced that it had acquired 2.8% of ICI. According to the chairman, Lord Hanson, it acquired a percentage because it thought that the shares were undervalued and that ICI would benefit from an injection of the management style on which Hanson's success had been based. ICI regarded the move as a precursor to a hostile takeover. By October 1991, it was clear that the Hanson Group would not launch a bid, but the episode underlined for ICI directors the urgent need to raise share holder value as this would undoubtedly be the precursor to future take over attempts by others.

Due to the costs of restructuring and of reinvesting in winning businesses ICI would almost certainly need to raise new equity. The internal discussion moved towards splitting ICI - possibly by grouping the high-value-added businesses together and launching them as a separate company. Sir Denys Henderson decided to enlist the John Mayo, a director of ICI merchant banking advisers S.G. Warburg, to assist in providing an objective view of the situation.

Note of interest: John Mayo was later appointed finance director of Zeneca.

Mayo's first priority was to understand how ICI's activities fit together in industrial and technological terms, which he used to test the financial viability of various alternatives. Mayo concluded that the key to successful restructuring was recognising a technological fault line within ICI. Pharmaceuticals and other bioscience-related activities on one side and the traditional chemical businesses on the other.

Executive and nonexecutive directors discussed the proposal at length in the early months of 1992, and in April 1992 they agreed that further detailed work should go ahead. They approved the final plan in July 1992.

In order to convince the "old" ICI senior management John Mayo was able to demonstrate the divergence between the two, technologically distinct, clusters of businesses. As shown below:

i)In technology, the connection between pharmaceuticals(bioscience) and most of ICI's chemical businesses had become tenuous (This cluster of bioscience businesses became Zeneca). Zeneca's bioscience businesses were able to sell highly differentiated products, designed to produce a specific effect, for which customers were prepared to pay high prices.

ii)Most of the chemical businesses (the new ICI) used large plants for high-volume production, and they had similar needs in chemical engineering and project management. The chemical companies could sell less differentiated products in much bigger volumes and at much lower prices.

The creation of new businesses often stemmed from initiatives taken at headquarters. But as the divisions of the "old" ICI acquired greater responsibility for their own profitability, the competence of headquarters to provide the divisions with informed strategic direction weakened. The divisions also had the sharpest reactions to the markets.

Whether alliances with Beecham or Wellcome would have been feasible or desirable is arguable, but ICI's board could not devote the focused attention to pharmaceuticals that such a decision would have required. The old ICI was not capable of driving its world-class businesses hard enough. The advantage of the proposed structure was that it aligned corporate objectives much more closely with those of the individual business. Simpler organisation is part of the value of a demerger, but not the whole of it. The two successor companies faced different management challenges:

i) Zeneca's task was to manage high growth based on innovative new products; the emphasis was on strengthening the company's worldwide sales organisation and on improving the productivity of research and development.

ii) ICI's chemical businesses are cyclical, supplying such industries as mining, textiles and construction. They are mostly capital intensive and much less dependent on research.

The injection of new equity, a necessary ingredient to the restructuring plan as previously mentioned, came in June 1993 with a £1.3 billion stock issue for Zeneca.

It was to be expected the separation of two sets of businesses (that had been united for more than 50 year) involved some transitional pain. In technology, for example, the new ICI no longer has direct and intimate access to the skills in organic chemistry embodied within the Zeneca companies.

There was some concern over the loss of ICI's global influence, but in most of the larger markets, the two successor companies were sufficiently strong and well established to stand alone. However, in reality neither company has suffered any significant loss of status in the eyes of customers or governments. It is interesting to note that in the world league of international chemical companies the effect of the demerger was to move ICI from fifth to sixth place and Zeneca's pharmaceutical side makes it rank among the top 20 pharmaceutical companies. In the longer term, the two companies are still on trial, not least because, on the Zeneca side, the external environment in the pharmaceutical industry has grown far more turbulent that anyone anticipated. As for ICI, the product portfolio establishment at the time of the demerger is not necessarily permanent.


As the divestment of a major part of a company is very rare, the focus of this section has been on the divestment of Zeneca by ICI. There are no such major activities within BOC over the period of the reports to compare making any comparisons very one sided. However the difference in merger, acquisition and divestment strategy is quite clear as highlighted below.


ICI confronted three choices in early the 1990's: to break itself up into a number of pieces (or to be acquired and broken up); to soldier on with existing policies; or to devise a new structure that would match the parenting needs of its businesses with the parenting skills of the corporation. The demerger of ICI has been a clear financial success. In December 1994, the market capitalization of the two companies combined stood at £13.2 billion, compared with the £7.6 billion valuation of old ICI in July 1992, the time of the demerger announcement. The combined valuation has increased by 57% (after adjustment for stock issue proceeds), compared with 25% for the Financial Times Stock Exchange 100 index over the same period (source:-based on data in reference 1).

The other smaller divestment in this period emphasis the Groups strategy to concentrate on the core businesses, with all other interests being sold off.


By contrast BOC has opted to increase the portfolio of companies in pursuit of growth and operating efficiency. The majority of acquisitions have been horizontal in order to gain access to new markets. Also a number of vertical acquisitions have taken place to strengthen the distribution network. As stated in all texts "very few companies get it right" (acquisitions) but BOC seam to be the exception (at the moment!).

These differences in policy/strategy are due to the fact that ICI has grow so diverse by its various acquisitions (prior to the 1990's) that the value of the total company was less that the value of the constituent parts. It was this factor that was the driving force behind the demerger/divestment policy, which rationalised the company into two main product lines. Thus giving management the ability to match the managerial skills more closely to the two companies than could possibly have been achieved under the one company. While BOC are still growing by acquisition and are not at the stage where they are so diverse as to be uncontrollable.

Both companies take advantage of the risk diversification provided through acquisitions and joint ventures, this protects the share holders in the Group company) - Note: Theory contained in Reference 2, chapter 17.






J. Argenti, Accountant's Digest, #138, 1983

Rees, Financial Analysis, 1995

D. Clutterbuck, The Phoenix Factor, 1990

D. Storey, K. Keasey, R. Watson, P. Wynarczyk, The performance of small firms, 1987


Copeland T. and Weston J., (1983), Financial Theory and Corporate Policy, Second edition, Massachusets: Adisson-Wesley.

The Economist, (December 5th 1992), “Beating the Market”.

Firth, The Valuation of shares and the Efficient Market Theory.

Higson C. J., (1986), Business Finance, Butterworth and co : London.

Lumby S., (1991), Ivestment Appraisal and Financing Decisions, London : Chapman and Hall.

Nichols,N. (March-April, 1993), “Efficient? Chaotic? What's the new Finance? Harvard Business Review.



Michael Firth, The valuation of share and the efficient Market Theory

Samuels and Wilkes, Management of Company Finance, 4th Edition, 1986

Rees, Financial Analysis, 2nd Edition, 1995

Pike and Neal, Corporate Finance Investment, 1993

Woolf, Advanced Financial Acc.



Reference 1:- INVESTMENT APPRAISAL AND FINANCING DECISIONS by S Lumby, published by Chapman and Hall (forth edition)


STRATEGIES, by Richard Pike and Bill Neale, published by Prentice Hall.

Reference 3:- FINANCIAL MANAGEMENT, by R J Chambers (Third edition), published by the Law book company.

Reference 4:- UNDERSTANDING CAPITAL MARKETS, Published by D C Gardener .


Black, F., Winter 1976, “The Dividend Puzzle”, Journal of Portfolio Management.

Higson, C J, 1986. Business Finance, Butterworths.

Lumby, S., 1991, Investment Appraisal and Financing Decisions, Chapman and Hall.

Marsh, August 1992, “The Market gets it right”, Investors Chronicle.

Pike and Neal, 1993, Corporate Finance Investment.


Reference 1:- The Harvard Business Review, March-April 1995

Reference 2:- FINANCIAL MANAGEMENT, by R J Chambers (Third edition), published by the Law book company.


The following general assumptions have been made for BOC debt capital calculations:

i) As the length of the long term loans is not stated it is assumed to be in excess of 5 years (as per the definition of “long term” used in Note 3, iii) Therefore the repayment date will not be taken in to consideration.

ii) No instalment information is available from the accounts therefore they are not taken into consideration in the calculations.

iii) Tax implications of the various forms of finance have been ignored.


Rational for the cost of the loan/debt capital (i.e.: 9%) used in the WACC calculations is as follows:

The cost of the loan/debt capital may be found by solving the equation stated in the finance notes for the calculation of the cum interest price:

cum interest price = I(1-t)+((I(1-t)/(1+k))+...+((I(1-t)/(1+k)y)+(R/(1+k)y)

Using the example of the 8% eurodollar bond, with a value of £64m and with two years left to run, from the ICI 1994 published accounts :

Note: the use of Eurobonds as source of finance offers the benefits of: lower cost than domestic bonds, a more flexible market, it is easier to raise larger loans then in domestic markets, hedges against currency movements. However the secondary market is limited. See Reference 1 section 12.5. More information on Eurobonds can be found in Reference 4, section - Eurobonds: A practical introduction.

The following assumption are necessary in order to utilise the equation:

i) The start date is not known for the debenture etc and will, therefore, be taken as 1994 (i.e. the date of the accounts).

ii) The cum interest rate is not known and therefore needs to be deduced. The value for a similar bond was sought in the financial press (The Daily Telegraph) for use as a basis. A 8.75% treasury bond proved the closest match with 2 years to run and in interest rate of 8.75%. The cum interest value stated was 104% (this higher than 100% as the interest payable (8.75%) is higher than the "standard" interest rates.

The lower interest rate of 8% for the 8% eurodollar bond, coupled with the fact that the Treasury bond is more secure (hence commanding a slightly higher price) would reduce this percentage. A reasonable figure might therefore be 97%.

The following figures may now be substituted in to the equation:

Cum interest value = (97% of the total value(£64m) = £62.08m

y(the term) = 2

I(annual interest) = 8% of £64m = £5.12m

R(redemption price) = £64m

t(corporation tax) = 0.4 (40%)

62.08 = 5.12(1-0.4)+(5.12(1-0.4)/(1+k))+(5.15(1-0.4)/(1+k)2)+(64,000,000/(1+k)2)

The equation is solved when k = 0.092 (giving a cum interest value of 62.13)

The cost of this loan capital is, therefore, approximately 9%.

Due to the number of assumptions and deductions required for this calculation there would not appear to be any benefits in calculating the cost of the capital for all of the debentures, Bonds and Notes stated in the accounts. The figure of 9% will, therefore, be applied to all loan/debt capital of this type.


The following general assumptions have been made for ICI debt capital calculations:

i)The same rate has been used for ICI's bank loan interest as that for BOC, in reality this is unlikely to be the case as the two companies would use a differing range of banks with differing interest rates.

ii) For the purposes of this calculation the debentures, bonds and notes within the debt/loan capital will all be treated in the same manner.

iii) No instalment information is available from the accounts therefore they will not be taken into consideration in the calculations.

iv) Tax implications of the various forms of finance have been ignored (with the exception of corporation tax in appendix 2).


BOC acquisitions, mergers and divestment's that have take place over the period covered by the last four years company accounts:.


Acquisition: Equity stake in Industrial Gases Lagos (IGL), Nigeria doubled to 60%. A Horizontal acquisition.

Acquisition: Acquired Delta Biotechnology Ltd from Bass Plc and the Stroh Brewing Co for £23m. This is conglomerate acquisition to broarden the company's technology base.


Merger: Gases joint venture formed in Tianjin, northern China with Hua Bei Oxygen. A horizontal merger.

Acquisition: Spalding Haulage a vertical acquisition in May, of a distribution contractor(supplier) to strengthen the distribution of products.

Divestment: Remaining share of Glasrock Home Health Care business sold for £38 million.


Acquisition: Acquired German hydrogen business from Huls AG. This horizontal acquisition was a key step in the expansion of BOC's industrial gases businesses in continental Europe. It complements the existing gases business in continental Europe and is a significant step in the expansion of the hydrogen business around the world. The assets include the longest hydrogen pipeline grid in Europe, extending over 210 kilometres and currently serving customers in oil refining and chemicals, together with a cylinder and trailer filling station for hydrogen and other gases. Hydrogen is supplied under long-term contractual arrangements, principally by Huls.

Acquisition: Purchased 70% interest in part of Poland's state industrial gases sector based at Siewierz, Wroclaw and Poznan. A horizontal acquisition.

Acquisition: Increased holding in IOL Ltd to 51% by subscribing for new shares. A horizontal acquisition.

Acquisition: Acquired distribution operation of Gaymer Group. A vertical acquisition to strengthen the distribution network.

Acquisition: Acquired Dutch distribution company Kroeze. A vertical acquisition to strengthen the distribution network.


Acquisition: Afrox (part of the BOC group) acquired LPG business from Engen.

Afrox settled the £15.7 million purchase price in cash. The purchase meant that Afrox expanded its network to over 500 agents and distributors, an increase in the network of over 50%. A part horizontal part congeneric acquisition.

Merger: New joint venture (horizontal) established with Fushun Iron & Steel Co at Fushun, northern China. Fushun BOC Industrial Gasses Co Limited started business on 1 April. Fushun Iron & Steel Corporation has put into the joint venture its industrial gas business which is one of the largest in China.

The joint venture further strengthens BOC's position in China and is one of the most substantial to date, both in size and potential, and also extends the our business into a new region.

Divestment: Sold Flick pest control business in Australia. This is the divestment of a non gasses related business.

Acquisition: Acquired Calumatic Group of companies in the Netherlands, a manufacturer of filling, sterilising and packaging equipment for injectable pharmaceuticals. Acquired in August at a cost to BOC, including debt assumed is Dutch Guilders 29.4 million (£10.7 million). The consideration was paid in cash with a proportion deferred and contingent upon future performance of the business. Calumatic was be integrated (horizontally) with Edwards Freeze Drying, which is a part of the vacuum technology division of BOC and is a market leader in the supply of freeze driers to the pharmaceutical industry.

Acquisition: Acquired the London Cargo Group, a Heathrow based airside cargo-handling specialist . This is a vertical takeover which will protect BOC's product distribution channels and hence reduce the dependence on sub contract cargo handling for urgent items.


ICI acquisitions, mergers and divestment's that have take place over the period covered by the last four years company accounts:.


Divestment: Nalco Chemical Company. ICI completed the sale of its share in this joint venture company for US$168m in March.

Acquisition: Continental Polymers Ltd - A horizontal acquisition of a Californian manufacturer of acrylic polymer and sheet.

Divestment: Of specialty compounds business to Kawasaki Steel Plastics for US$100m in September. (Kawasaki Steel has been diversifying geographically from its Japanese base into the USA and Europe, and in product terms from its traditional metals business into plastic materials.)

Divestment: Of the Soda Ash businesses (UK and Kenya) for £90m in September.

Divestment: Of UK lime business to Minorco SA for £117m in December. ICI's lime operation, a business within ICI Chemicals & Polymers Ltd, comprises quarries and processing facilities with proven reserves of around 400 million tonnes of limestone. The lime business was profitable and in 1990 had sales in excess of £55 million, made almost entirely to UK customers. However, it falls outside ICI's long term strategy of developing business in which it has strong global positions.


Only general information available for this year. The general concept continues from the previous year as "back to core business". This may suggest that ICI is having more serious problems and are attempting to "hide" data which may be useful to others (Hanson for example).


Acquisition: USA Acrylics business - no clear data found.

Acquisition: 50% share in US Titanium Dioxide pigment plants - no clear data found.

Acquisition: AECI explosives limited. In the horizontal acquisition ICI took a 51% stake in the explosives business.

Divestment: Westralian Sands Limited - This was no longer required by ICI Toxide as a raw material safe guard. It is stated that new technologies enabled a wider range of ores to be processed, the suppliers of which were adequately protected by existing purchasing agreements. This is very clearly a "vertical" divestment.

Divestment: ZENECA. In June 1993 the bioscience operation were demerged from the company. This is effectively a "conglomerate demerger". Please see the review of this action below.

Note:It is interesting to note that in the 1993 accounts ICI give the following details on their divestment policy "These divestments reflect the groups strategy of developing strong global businesses and transferring other businesses to companies in which they can grow and prosper".


Acquisition: AEL part of the £37M acquisitions for 1994 - no clear data found.

Divestment: EVC International NV (a joint venture for the production of PVC between ICI and EniChem SpA of Italy): The divestment took place in November 1994 with both parent companies disposing of their shares and the company being floated on the Amsterdam stock exchange through the issue of new share. £83M was raised from this divestment (note: ICI now hold 15.8% of the newly floated company).

Divestment: AECI Petro-chemical, A nett reduction to 13% in the interests in AECI Ltd, excluding the explosives acquisition the previous year. This is in line with ICI's declining interest in AECI. The disposal of the Petro-chemical business, however, raised £80m.

Divestment: Nureal SA (European Fiber Business) sold in February 1994 due to high trading losses of approximately (£31m in the previous year) trading. ICI also incurred exceptional losses on the sale of Nureal to the tune of £17M due to lost good will.

Divestment: AECI ltd. In December ICI disposed the remaining 13% holding in AECI Group (AECI the stakes in explosives were retained).

Divestment: The Monckton coke and Chemical company: Producers of starch based Polys.

Divestment: ICI acrylics operation, based in California. This divestment was required by the US federal Trade commission as part of the 1993 nylon-acrylics transactions.