BMW Scandal Analysis

BMW is a company that is well known in the automobile industry. It is recognized for its high status branding. Bayerische Motoren Werke Aktengesellscaft is commonly known as BMW is the top automobile manufacturer all over the world. It has been in the business since 1916. The company has its headquarters in Munich, Germany. Over the years, the company has grown significantly to become the worldwide manufacturer from Europe. BMWs are the ultimate driving machine for hard-core enthusiasts and daily drivers.

In 2008, BMW as faced with a financial crisis .It has a global presence with 3000 dealerships in 41 countries and it has local importers in more than 100 countries. The company has over 100,000 employees. Apart from manufacturing cars, the company also deals in aircrafts under the name Rolls Royce. It operates in America and Europe and had revenue of $78,270.9 million in 2008. It also deals in financial services. It operates in three main divisions which are the financial services, motorcycle and automobiles (Verbeke, 2013). BMW has a strong geographic presence. BMW has been reporting has had sustainable operations over the years. It is because of the good management decisions. Additionally, the company is always in the fore front when it comes to producing luxury cars.

The recent scandal that has faced the company was the installation of the wrong software. The company was forced to recall 11,700 cars in order to fix the software (Reuters, ND). The scandal affected the cars made between 2012 and 2017. The company had admitted to updating over 11,400 of its vehicle with incorrect software. However, it had informed the authorities about the issue. It is not the only German company to have been hit with the emission cheating scandal. Its main competitor Volkswagen was also faced with the same scandal. Volkswagen admitted to using engines that helped it cheat in the diesel emission tests. The company had to spend billions of dollars just to fix the cars that had this software. The scandals have seen tougher regulations being imposed for diesel cars. BMW is the latest company to be victim of the emission testing cheating.

Risk-and-return - Beta

Risk and return is one of the techniques used in analysing a firm’s financial performance. The paper will look beta which is vital for measuring an asset’s risk that relates to the market (NASDAQ, ND). BMW currently has a beta of 1.47. It is an indication that the company’s stock is 47% stronger in relation to the market movements. It shows that more risk is implied. It also means that there is a 47% return as compared to the market. According to Reuters (2016), the automobile industry has a beta of 1.19. Based on this beta, BMW is more sensitive to the movement in the market than its industry. The primary competitors of BMW are Mercedes and Volkswagen. Volkswagen has a beta of 1.51 and Mercedes has a beta of 1.66. Both companies have a higher beta than BMW. All three companies are headquartered in Germany. The scandal led to the stock being sensitive.

DCF

One of the methods that will be used in measuring the emission’s impact on the company’s shareholders is the discounted cash flow.

. A Free cash flow to firm analysis has been chosen as leverage is relatively high and above 50%, thus makes the application of FCFF more useful for all investors. Moreover, the FCFF will be a two stage model. First a transition stage which includes the impact of the emission scandal and second, a terminal infinitive growth stage. VW is one the biggest automobile producers in the world with stable and predictable cash flows. However, the current crisis will be a damper in bottom line, thus must be reflected in the growth and cash flows of the company.

To determine the intrinsic value of VW, all cash flows to all investors will be summed and then discounted at the cost of capital. This will result in the value of the operating asset (Damodaran, 2012).

Discount factor – WACC

The WACC is also another method used in evaluating the company’s performance during the scandal. In order to get the correct results, it is necessary to discount the cash flows to their present value. The discounted factors are always determined by the cost of capital when using the free cash flow method. The cost of capital refers to the cost of debt resulting from the WACC. The formulas used in calculating the cost of equity are as follows:

Cost of equity = Risk free rate + levered Beta * (Equity Risk premium)

Cost of Debt = (Risk free rate + default spread) * (1-t)

The weighted cost of capita formula is as follows:

WACC = (E / (E + D)) * cost of equity + (D / (E + D)) * (cost of debt * (1- t))

CAPM

There are different sections that are used in estimating the cost of equity.

Risk free rate

According to Bloomberg (2016), the risk free rate is 1.02% and it is based on the 30-year bond yield. There is need to use a 10-year bond rate to evaluate the firms valuation (Damodaran, 2012). The 30-year bond will be appropriate in this scenario.

Beta

The beta used in evaluating the company’s performance is 1.44; it is a levered beta (Reuters, 2016). The beta is an indication that a firm’s stock is sensitive as compared to the market.

Equity risk premium

The equity risk premium refers to the additional return which investors expect in comparison to the risk free investments. It is a measure of equity risk premium. BMW has revenues from all over the world. Therefore, it is necessary to adjust the equity risk premium.

Conclusion

This paper critically analyzed the valuation of VW in times of a scandal and provided possible scenarios in valuations. Each scenario given, concluded in an undervalued asset. The multiples support this statement, in comparison to competitors or industry averages. The triangulation with other techniques such as RONA or EVA contrasts this statement, as they concluded in destruction in wealth. One has to mention, these values are based on previous quarters, and therefore in the future wealth will be created as the emission scandal will fade out. As seen in the FCFF model.

References

Bloomberg.com. (2016). German Government Bonds. Available at: http://www.bloomberg.com/markets/rates-bonds/government-bonds/germany (Accessed: 12 May. 2018).

Damodaran, A. (2016). Country Default Spreads and Risk Premiums. Pages.stern.nyu.edu. Available at: http://pages.stern.nyu.edu/~adamodar/New_Home_Page/datafile/ctryprem.html (Accessed: 12 May. 2018).

NASDAQ.com. (n.d.). Definition of “Beta” - NASDAQ Financial Glossary. Available at: http://www.nasdaq.com/investing/glossary/b/beta (Accessed: 12 May. 2018).

Reuters.com. (2016). Volkswagen AG (VOWG_p.DE) Quote| Reuters.com. Available at: http://www.reuters.com/finance/stocks/overview?symbol=VOWG_p.DE (Accessed: 12 May. 2018).

https://www.nytimes.com/2018/03/20/business/energy-environment/bmw-diesel-emissions.html