Module Title: International Finance

Module Handbook 2020/21

Module Code: BMG704 (86966)

Course/s: MSc International Business

Department of Global Business and Enterprise

Ulster University Business School

Salman Iravani
Module Coordinator
Email: salman.iravani@qa.com

Office Hours: Online via email

 Table of Contents
Introduction.................................................................................................................................................1
Section A: Recent Development affect the performance of BAT Plc...........................................................1
Impact of Covid-19 over BAT Plc and its’ strategy to cope with that difficulties......................................1
Dutch Tax Scandal of British American Tobacco Plc................................................................................1
Section B: Dividend Policy & Sources of Finances........................................................................................2
Dividend Policy:.......................................................................................................................................2
Three Dividend Policy..........................................................................................................................2
Dividend of British American Tobacco Plc...........................................................................................3
How BAT Plc manage the risk associate with dividend........................................................................3
Two Capital Structure Theory..................................................................................................................3
Capital Structure of British American Tobacco Plc...............................................................................4
BAT Plc borrowing risk and the way to mitigate the risk.....................................................................4
Section C: Ratio Analysis..............................................................................................................................5
Profitability Ratio.....................................................................................................................................5
Return on Capital Employed................................................................................................................5
Operating Profit Margin.......................................................................................................................5
Efficiency Ratio........................................................................................................................................6
Inventory Turnover Days.....................................................................................................................6
Account Receivable Days.....................................................................................................................7
Liquidity Ratio..........................................................................................................................................7
Current Ratio.......................................................................................................................................7
Acid Test Ratio.....................................................................................................................................8
Shareholder Raito....................................................................................................................................8
Earnings Per share...............................................................................................................................8
Dividend Payout Ratio.........................................................................................................................9
References.................................................................................................................................................10
Appendices................................................................................................................................................12
Introduction
British American Tobacco is one of the world’s largest tobacco and nicotine product
manufacturers which is established in 1902. From the inception the company is growing
gradually and at present it has its’ operation in more than 150 countries. This assignment is
assigned us to make us familiar about the various financial theories based on which investors and
managers make their decision. To elaborate capital structure theory and theories of divided will
also be discussed here. Finally recent two important events which impact the selected company
drastically will be analyzed here.

Section A: Recent Development affect the performance of BAT Plc

Impact of Covid-19 over BAT Plc and its’ strategy to cope with that difficulties
At present the whole world is afflicted with Covid-19 virus attack. This virus first attacked China
in November 2019. In late January 2020, this virus first discovered in UK like any other
countries of the world.

During the Coronavirus invasion BAT Plc has lost almost 8% of its’ sales revenue which is
almost $56 billion. Due to the increasing of unemployment during Covid-19 attack experts are
projecting that sales revenue will fall down to $651 billion from $707 billion (Morton, 2020).
According to Finance Director Tadeu Marocco, BAT Plc faced manufacturing disruption in
China during Covid-19 a little in February 2020 (Cavale, 2020).

According to Chief Executive Officer Jack Bowles of BAT Plc, Covid-19 did not have
significant impact over the customer’s sales habit (Cavale, 2020). BAT Plc has many crisis
management teams which ensures that BAT Plc’s Covid-19 response strategies are being
formulated in proper way (Bowles, 2020). Online medical support, counselling services are
arranged for the employees of BAT Plc (Bowles, 2020). BAT Plc has planned to start new
product line in its’ e-cigarette which they expect will increase sales revenue further (Cavale,
2020). BAT Plc will extend its’ cost saving program known as “Quantum” to save extra £1
billion to reinvest in new product line (Cavale, 2020).

Dutch Tax Scandal of British American Tobacco Plc

In 2019, Dutch Tax authorities claimed that BAT Plc has evaded tax by artificially inflated fees
paid by BAT’s UK subsidiaries to Dutch subsidiaries for providing loan. Consequently Dutch

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Tax Authorities £900 million of bill from BAT Plc (Johal, 2019). Dutch Tax Authority claimed
that this is amount owed to BAT Plc during 2003 to 2016.

BAT Plc is trying to deal with this difficulties with typical strategic response. Very first, one of
BAT spokesmen tried to deny the allegation. According to BAT spokesperson, this was neither
for tax evasion nor a breach of law (Goodley, 2019). Finally BAT Plc decided to appeal in
supreme court for further consideration. BAT Plc has appointed Linklaters and Salughter Law
firms to investigate and to provide consultancy to BAT Plc in this regard (Geller, 2017). As a
response BAT Plc is trying to shift its’ product line from traditional nicotine to e-cigarette called
as vapor (Goodley, 2019).

Section B: Dividend Policy & Sources of Finances

Dividend Policy:
Dividend policy is the decision of management of a company regarding its’ dividend payment.
Management of a firm can either declared dividend from earnings or can carry forward the
earnings in following years based on its’ strategy.

Three Dividend Policy

Residual Theory of Dividend: Residual theory of dividend states that business organizations
pay dividend after undertaking all the investment opportunities from retained earnings. This
theory draws conclusion somewhat similar to dividend irrelevance theory. So according to this
theory Dividend payment would be like as:

Dividend = Net Income – Required retained earnings to meet capital expenditure (Box, 2017).

So dividend here is the left over or residual after undertaking possible investment opportunities.

Walter’s Model: Walter’s Model argues that dividend policy impacts the valued of a firm. This
theory further argues that investment policy and dividend policy of a business organization is
linked with each other. There is a relationship between internal rate of return and cost of capital
which impacts the dividend policy of a firm (Samiksha, 2020).

Dividend Irrelevance Theory: Dividend irrelevance theory is alternatively known as MM

theory. This theory suggests that dividend policy is irrelevant to the investors’ investment
decision. In other words, investors do not consider dividend while making investment decision.

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Because investors can design own profit policy from his portfolio and can derive earning if any
firm does not declare dividend in a particular year.

Dividend of British American Tobacco Plc

BAT Plc pays final dividend in a year with four quarterly interim dividend so that investors can
get regular cash flows from the company (British American Tobacco Plc, 2019). The group has
declared interim dividend 210.6p per share in 2020, final dividend 203.0p per share in 2019 and
195.20p final dividend in 2018 which reflects the 4% and 7.89% growth in 2019 and 2020
respectively (British American Tobacco Plc, 2019). (See appendix for further details)

How BAT Plc manage the risk associate with dividend

As already mentioned, BAT Plc provided dividend to shareholders regularly. Paying dividend
regularly reduces the cash reserve which may hamper the investment decision. Besides some
investors consider paying dividend regularly as a bad signal for the company.

To mitigate the risk generated from paying dividend regularly BAT Plc’s strategies are as
follows

BAT Plc used cash pooling and zero balancing bank account structure which will increase the
efficiency of using cash reserve (British American Tobacco Plc, 2019). BAT Plc has significant
amount of investment in highly liquid short term asset like as money market funds so the
company believes that it will be able manage liquid fund immediately by selling this instruments.
To ensure sufficient working capital, BAT Plc has entered into factoring arrangements and
supply chain finance arrangement (British American Tobacco Plc, 2019). To mitigate the profit
reduction short term and long term management incentive scheme has been revised which will
cut off additional cost.

Sources of Fund: Sources of funds are the available options from where an organization can
collects its’ required fund. A firm can collect fund from either internal or external sources also.

Two Capital Structure Theory

MM Approach: MM approach states that under perfect market condition firms’ value is not
affected by the decision of capital structure. Consequently it is irrelevant to think about capital
structure while determining firm’s value (Brigham and Ehrhardt, 2002).. Rather firm’s value is
determined by the expected future cash flows. This theory is highly criticized among the

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financial experts. Because assumptions of this theory like as there is no brokerage cost, not
taxation and no bankruptcy cost are not realistic.

Signaling Theory: Signaling theory states that investors can use the management’s decision
about raising capital as an indication of firm’s future prospective (Brigham and Ehrhardt, 2002)..
So analyzing the firm’s decision about capital structure can be used as an indicator of investors
investment decision. According to this theory, management decides to raise equity capital when
financial prospect deems not promising. So investing in that organization will not be a prudent
decision.

Capital Structure of British American Tobacco Plc

Observing the annual report of BAT Plc 2019, it can be concluded that capital structure of BAT
Plc consists of both equity and debt capital. For the year of 2018 debt capital was £80654 million
which was 45% of total capital and debt capital decreased to £76845 million in 2019 which was
55% of total capital. Debt capital of BAT Plc consists of long term debt and short debt capital.
Current liabilities was £18823 and £16329 million in 2019 and 2018. Long term liabilities was
£58022 and £64325 in 2019 and 2018. Equity Capital consists of proceeds from share issues,
retained earnings, reserves and share premium (see appendix for further details) .

BAT Plc borrowing risk and the way to mitigate the risk
Annual report of BAT Plc identified some of the risks, the company might face due to having
this capital structure. Manager opined that this highly leveraged capital structure might cause
them to reduce creditworthiness which will cause the funding cost to rise up. Besides lenders or
controlling authorities might impose restriction to raise debt capital further in their loan
covenant. Besides high leverage might causes the operating cost to increase which may result
lower cash flows for the firm.

To mitigate this risk BAT Plc has taken some steps the management deems fit.

BAT Plc is reducing its’ total borrowing year by year. Total borrowing was £122211 million,
£128163 million and £129523 million in 2019, 2018 and 2017 respectively. The reduction rate
was 4.65% and 1.05% in 2019 and 2018 respectively. Management believes that it will help to
deleverage the capital structure and thus will reduce borrowing risk. Maturity of debt obligation
of BAT Plc is 9.1 years (British American Tobacco Plc, 2019). BAT Plc has targeted to reduce
the debt maturity up to five years. Besides short term sources of fund of BAT Plc is backed by

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undrawn committed line of credit and cash. Commercial Paper issued by BAT International Plc
is guaranteed by BAT Plc which will help to keep the borrowing risk of the group lower (British
American Tobacco Plc, 2019).. Management has issued debt capital having different maturity
which brings the refinancing risk at lower level.

Section C: Ratio Analysis

Profitability Ratio
Return on Capital Employed
Return on capital employed is a profitability ratio which measures the how efficiently a company
can generate profit using its’ capital (Kieso, Weygandt and Warfield, 2015). Here capital refers
to as the sum of total equity and long term liabilities. Mathematically it can be written as:

Earningsbefore interest∧Taxes
ROCE= ×100
Total equity+ Non Current Liabilities

Explanation:

2019 2018
9620 9944
×100 × 100
64160+58022 65688+64325
= 7.87% =7.65 %

From the above calculation, it is obvious that ROCE of BAT Plc was 7.65% 7.87% in 2018 and
2019 respectively. In 2019 this ratio increases 2.87%. Clearly the reason for this increment is
larger reduction (-6.02%) of capital employed compared to the reduction (-3.75%) of earnings
before interest and taxes from 2018 to 2019. Synonymously it can be concluded that though
capital employment decreases in 2019, but efficiency of using capital has increased compared to
2018.

Operating Profit Margin

Operating profit margin is a profitability ratio which measures how much portion of sales
revenue can be converted into operating profit (Kieso, Weygandt and Warfield, 2015). In other
words it calculates how much profit has left to pay interest and taxes. Mathematically it can be
shown as

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 Operating Profit
Operating Profit Margin= × 100
Total Sales

Explanation

2019 2018
9016 9313
×100 ×100
25877 24492
34.84% 38.03 %
Operating profit margin of BAT Plc was 38.03% and 34.84% in 2018 and 2019 respectively.
This ratio decreased almost 8.38%. Increment of depreciation, employee benefit cost and other
operating cost causes the ratio to fall in 2019. Though proceed from sales also increased in 2019
but it was not sufficient to make the ratio stable in 2019.

Efficiency Ratio
Inventory Turnover Days
Inventory turnover days measures how many days a company need to replace its’ inventory to
sales. In other words it measures the days need flow cash in the company from inventories
(Kieso, Weygandt and Warfield, 2015). It is an efficiency ratio related to sales. It considers the
cost of goods while calculating the ratio. Formula for calculating this ratios is

Inventory
Inventory Turnover Days= ×365
Cost of Goods Sold

Explanation

2019 2018

6094 6029
× 365 × 365
9332 8707

238.35 days 252.78 days

Inventories turnover days ratio was 252 days and this ratio decreased to 238 in 2019.
Mathematically it is occurred due to increasing of cost of goods sold. Alternatively it means that
in 2019, BAT Plc took less time to convert its’ inventories into sales revenue. This is happened
due to improvement in product demand and improvement in supply chain.

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Account Receivable Days
Account receivable days ratio measures how much time a firm take collect payment from
accounts receivable. It is a efficiency ratio measures the efficiency of a firm of collecting short
term payments (Kieso, Weygandt and Warfield, 2015). Formula of accounts receivable days is as
follows

Receivables
Receivable Days= ×365
Sales Revenue

Explanation

2019 2018

4341 4273
×365 ×365
25877 24492

61.23 days 63.68 days

In 2019, BAT Plc has receivable days ratio 63.68 days which reduced to 61.23 days in 2019. It
alternatively implies that the company needs 2 days less to collect payment of its’ receivables.
The company get paid in every two months or 6 times in a years. This became possible due to
less increment rate of accounts receivable (1.60%) compared to the larger increment of sales
revenue (5.65%)

Liquidity Ratio
Current Ratio
Current ratio measures the firm’s ability to meet the short term debt obligation using its’ cash
and cash equivalent or short term assets (Kieso, Weygandt and Warfield, 2015). This ratio is an
indicator of firm’s liquidity. Formula of this ratio is

Current Asset
Current Ratio=
Current Liabilities

Explanation

2019 2018

13274 12655
18823 16329

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 0.71 0.78

Current ratio of BAT Plc is below 1 for both 2019 and 2018 which indicates that the company
might face liquidity risk when short term liabilities will be due. Though 0.70 and 0.78 current
ratio is not much of concern. Current ratio further decreased to 0.71 in 2019 from 0.78 in 2018.
Annual report reveals that 78% increase of short term borrowings is a reason behind this
increment.

Acid Test Ratio

Acid Test ratio measures the firm’s ability to meet immediate short term obligation using its’
short term assets. This ratio measures the liquidity of a firm similar to current ratio except one
exception. Acid test ratio does not include inventories in current asset (Kieso, Weygandt and
Warfield, 2015). So here current asset indicates cash and cash equivalent only. The formula for
acid test ratio is

Current Asset−Invenories
Acid Test Ratio=
Current Liabilities

Explanation

2019 2018

13274−6094 12655−6029
18823 16329

0.38 0.41

As the table indicates that acid test ratio drastically fell down while inventories is opted out. It
implies that in the absence of inventories, BAT Plc will face severe liquidity crisis to meet short
term obligations. Management should think twice before taking any liabilities whether it is short
term or long term.

Shareholder Raito
Earnings Per share
Earnings per share measures how much earnings of a company can be distributed to ordinary
shareholders (Kieso, Weygandt and Warfield, 2015). Higher earnings per share ratio indicates
higher profitability and thus become lucrative to the investors. Formula of this ratio is

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 Net Income( Attributed¿Ordinary Shareholders)
EPS=
Number of Oridinary Shares

Explanation

2019 2018

5704 6032
22.84 22.85

249.7 p 264 p

Earnings per share of BAT Plc was 249.7p per share and 264p per share in 2019 and 2018
respectively. EPS decreases almost 5.41% from 2018 to 2019. The main reason for this reduction
is the reduction of net income due to the increment of operating cost.

Dividend Payout Ratio

Dividend payout ratio measures the total amount of dividend paid to shareholder from net
earnings. This dividend indicates how much fund a firm has in its’ hand for reinvesting or
business growth (Kieso, Weygandt and Warfield, 2015). Formula of this ratio is

Total Dividend
Dividend PayOut Ratio= ×100
Net Profit

Explanation

2019 2018
4598 4347
× 100 ×100
5849 6210
78.62% 70.00 %
Dividend payout ratio was 70% and 78.62% in 2018 and 2019 respectively. That alternatively
implies that BAT Plc has distributed more than 70% of profit to its’ shareholder in the form of
dividend. It indicates that BAT Plc does not have any plan to expand its’ business.

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 References
o Bowles, J., 2020. British American Tobacco - An Open Letter From Jack Bowles On
BAT’S Response To The COVID-19 Pandemic. [online] Bat.com. Available at:
<https://www.bat.com/group/sites/UK__9D9KCY.nsf/vwPagesWebLive/DOBPBP5R>
[Accessed 1 December 2020].
o Box, G., 2017. Dividend Theories. [online] Statistics and Risk Management. Available at:
<http://jukebox.esc13.net/untdeveloper/RM/RM_L9_P5/RM_L9_P55.html> [Accessed
30 November 2020].
o Brigham, E. and Ehrhardt, M., 2002. Financial Management. 10th ed. Melbourne:
Thomson Learning, pp.620-648.
o British American Tobacco Plc, 2019. Annual Report And Form 20-F. London, p.47.
o Cavale, S., 2020. BAT Says No Material Impact Yet From COVID-19 Outbreak. [online]
Reuters. Available at: <https://fr.reuters.com/article/us-britishamericantobacco-outlook-
idUSKBN215222> [Accessed 1 December 2020].
o Geller, M., 2017. Britain Investigates British American Tobacco For Corruption. [online]
U.S. Available at: <https://www.reuters.com/article/us-bat-sfo-idUSKBN1AH3HD>
[Accessed 1 December 2020].
o Goodley, S., 2019. British American Tobacco Issued With £900M Dutch Tax Bill.
[online] the Guardian. Available at:
<https://www.theguardian.com/business/2019/sep/20/british-american-tobacco-issued-
with-900m-dutch-tax-bill> [Accessed 1 December 2020].
o Johal, S., 2019. Unlucky Strike: British American Tobacco Embroiled In Dutch Tax
Evasion Scandal | Littlelaw. [online] LittleLaw. Available at:
<https://www.littlelaw.co.uk/2019/10/03/unlucky-strike-british-american-tobacco-
embroiled-in-dutch-tax-evasion-scandal/> [Accessed 1 December 2020].
o Kieso, D., Weygandt, J. and Warfield, T., 2015. Fundamentals Of Intermediate
Accounting. Hoboken, N.J.: Wiley.
o Lansdown, H., 2020. British American Tobacco Plc Dividend Payments | BATS
Dividends. [online] Hargreaves Lansdown. Available at:
<https://www.hl.co.uk/shares/shares-search-results/b/british-american-tobacco-plc-

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 ordinary-25p/dividends> [Accessed 30 November 2020].
o Morton, M., 2020. British American Tobacco: Can Share Price Hold Up As COVID And
ESG Start To Bite?. [online] The Armchair Trader. Available at:
<https://www.thearmchairtrader.com/british-american-tobacco-can-share-price-hold-up-
as-covid-and-esg-start-to-bite/> [Accessed 1 December 2020].
o Samiksha, S., 2020. Theories Of Dividend: Walter's Model, Gordon's Model And
Modigliani And Miller's Hypothesis. [online] Your Article Library. Available at:
<https://www.yourarticlelibrary.com/theories/theories-of-dividend-walters-model-
gordons-model-and-modigliani-and-millers-hypothesis/29462> [Accessed 30 November
2020].

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 Appendices
Appendix A: Historical Dividend Growth of BAT

Sources: (Lansdown, 2020)

Appendix B: Capital Structure of BAT

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Appendix C: Balance Sheet of BAT

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