Ques 1,2&3 (Section1) May 19th

Description

1 (i) Equity investors in Stirling plc. require a 14% return on alternative investments of identical risk. The most recent dividend payment of 4p per share was paid on the 28th February 2020. It is estimated that dividend payments for the next five years (2021-2025) will grow at 10% per annum. Beyond 2025, it is estimated that the growth in dividend payments will be a constant 4% per annum. Using the dividend valuation model calculate the current share price of Stirling plc. (6 marks) (ii) Assuming that there are 50 million shares in issue, use your answer in question 3 to calculate the equity valuation of Stirling plc. (2 marks) (iii) Stirling plc. currently has in issue 10-year corporate bonds with a total face value of £10 million. Each bond has a face value of £100. The coupon payment on the bond is 6% per annum and the bond is due to mature in 2025. This means that Stirling plc. has five years of interest payments left to maturity (2021, 2022, 2023, 2024 & 2025). In 2025, in addition to its final interest payment, Stirling plc. will have to repay the £10 million to its debt investors. Given that the next best alternative investment for its debt holders is presently 4%, calculate the present value of Stirling’s debt. (5 marks) (iv) Stirling plc. has 10 million perpetual preference shares in issue. Each preference share pays an annual dividend of 5p and the investors require a return of 10% on alternative investments of identical risk. Calculate the current preference share price and preference share valuation of Stirling plc. (4 marks) (v) The value of Stirling plc. is the sum of the value of equity plus the value of preference shares plus the value of debt. Use your answers in questions ii, iii and iv to calculate the total value of Stirling plc (3 marks) [Total: 20 marks] Q.2 Quebec plc. is a large conglomerate company and is considering three potential investment projects for which it is assumed they have sufficient funds. The relative risk of each project has been assessed and the beta for each project is given below: ​Project 1 β = 1.8 ​Project 2 β = 1.3 ​Project 3 β = 0.8 The company’s financial structure is presently 80% equity and 20% debt. The pre-tax cost of debt is 6% and the cost of equity is calculated using the Capital Asset Pricing Model (CAPM) where the risk-free rate is 3% and the market risk premium is 8%. The corporate tax rate is 20%. The financial manager has provided the following estimates of after-tax cash flow for the three projects that are assumed to have equal lives of 5 years. Year Project 1 (£) Project 2 (£) Project 3 (£) 0 (3,600,000) (1,900,000) (10,900,000) 1 925,500 450,000 2,600,000 2 1,030,000 660,500 2,750,000 3 1,110,000 555,000 2,800,000 4 1,150,000 500,000 3,000,000 5 1,110,000 475,000 2,900,000 Using an appropriate cost of capital for each investment project, evaluate the viability of the three projects. Resulting from your financial evaluation, make a recommendation to the board of directors as to which, if any, projects Quebec plc. should undertake. (18 marks) Outline the reasons for your choice of cost of capital for each of the three projects and discuss any concerns that you may have with your recommendation.​​​​(2 marks) [Total: 20 marks] Q.3 Suppose you have a portfolio with 70% of stock funds and 30% of bond funds. The returns on your portfolio are influenced by economic growth and you expect the likelihood of an economic recession to be 20%, normal economic growth to be 60% and an economic boom to be 20%. Given this, the expected returns on, and variance of, stock funds and bond funds are outlined in the table below: Scenario Return on Stock Fund= (%*1) Variance of Stock Fund Return on Bond Fund (%) 1 (i) Equity investors in Stirling plc. require a 14% return on alternative investments of identical risk. The most recent dividend payment of 4p per share was paid on the 28th February 2020. It is estimated that dividend payments for the next five years (2021-2025) will grow at 10% per annum. Beyond 2025, it is estimated that the growth in dividend payments will be a constant 4% per annum. Using the dividend valuation model calculate the current share price of Stirling plc. (6 marks) (ii) Assuming that there are 50 million shares in issue, use your answer in question 3 to calculate the equity valuation of Stirling plc. (2 marks) (iii) Stirling plc. currently has in issue 10-year corporate bonds with a total face value of £10 million. Each bond has a face value of £100. The coupon payment on the bond is 6% per annum and the bond is due to mature in 2025. This means that Stirling plc. has five years of interest payments left to maturity (2021, 2022, 2023, 2024 & 2025). In 2025, in addition to its final interest payment, Stirling plc. will have to repay the £10 million to its debt investors. Given that the next best alternative investment for its debt holders is presently 4%, calculate the present value of Stirling’s debt. (5 marks) (iv) Stirling plc. has 10 million perpetual preference shares in issue. Each preference share pays an annual dividend of 5p and the investors require a return of 10% on alternative investments of identical risk. Calculate the current preference share price and preference share valuation of Stirling plc. (4 marks) (v) The value of Stirling plc. is the sum of the value of equity plus the value of preference shares plus the value of debt. Use your answers in questions ii, iii and iv to calculate the total value of Stirling plc (3 marks) [Total: 20 marks] Q.2 Quebec plc. is a large conglomerate company and is considering three potential investment projects for which it is assumed they have sufficient funds. The relative risk of each project has been assessed and the beta for each project is given below: ​Project 1 β = 1.8 ​Project 2 β = 1.3 ​Project 3 β = 0.8 The company’s financial structure is presently 80% equity and 20% debt. The pre-tax cost of debt is 6% and the cost of equity is calculated using the Capital Asset Pricing Model (CAPM) where the risk-free rate is 3% and the market risk premium is 8%. The corporate tax rate is 20%. The financial manager has provided the following estimates of after-tax cash flow for the three projects that are assumed to have equal lives of 5 years. Year Project 1 (£) Project 2 (£) Project 3 (£) 0 (3,600,000) (1,900,000) (10,900,000) 1 925,500 450,000 2,600,000 2 1,030,000 660,500 2,750,000 3 1,110,000 555,000 2,800,000 4 1,150,000 500,000 3,000,000 5 1,110,000 475,000 2,900,000 Using an appropriate cost of capital for each investment project, evaluate the viability of the three projects. Resulting from your financial evaluation, make a recommendation to the board of directors as to which, if any, projects Quebec plc. should undertake. (18 marks) Outline the reasons for your choice of cost of capital for each of the three projects and discuss any concerns that you may have with your recommendation.​​​​(2 marks) [Total: 20 marks] Q.3 Suppose you have a portfolio with 70% of stock funds and 30% of bond funds. The returns on your portfolio are influenced by economic growth and you expect the likelihood of an economic recession to be 20%, normal economic growth to be 60% and an economic boom to be 20%. Given this, the expected returns on, and variance of, stock funds and bond funds are outlined in the table below: Scenario Return on Stock Fund (%*1) Variance of Stock Fund Return on Bond Fund (%*2) Variance of Bond Fund Recession -11 0.25 12 0.10 Normal growth 12 0.12 6 0.06 Economic boom 30 0.33 -2 0.20 Calculate the expected return on your portfolio and the portfolio variance and standard deviation. Assume the correlation coefficient between stocks and bonds is -0.5​[Total: 10 marks] Variance of Bond Fund Recession -11 0.25 12 0.10 Normal growth 12 0.12 6 0.06 Economic boom 30 0.33 -2 0.20 Calculate the expected return on your portfolio and the portfolio variance and standard deviation. Assume the correlation coefficient between stocks and bonds is -0.5​[Total: 10 marks]