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Calculate the book value and market value cost of capital (WACC) for Faith PLC PLC
APC308 Financial Management Weighting – 100% of the marks for this module
This is an individual assignment of 3,000 words. (+ or – 10%)
Students are required to submit their assignments through Turnitin on Canvas and JIRA for marking. Only assessments submitted through Canvas and JIRA will be marked.
Requirements: You must answer any TWO
Question 1- Cost of capital and Capital structure The newly appointed finance director of Faith PLC is currently reviewing the capital structure of her company. She is convinced that the company is not financing itself in a way that minimises its cost of capital (WACC). The company’s financing as at 31 December 2020 is as follows:
£000
Ordinary shares, £1 each
30000
Reserves
5000
7% preference shares, £1 each
10000
10% bonds (irredeemable 31 December 2018)
15000
Total capital
60000
Other information from stock market (as at 31December 2020): Ordinary share price (ex-div) £2.56
Preference share price (ex-div) 75p
Bond price for 10% bonds £107 per £100
Last 5 years’ dividends (most recent last): 23p, 25p, 27p 29p, 31p
The new finance director, Ms. Zara Green feels that by issuing more debt the company will be able to reduce its cost of capital. She proposes the issue of £16m of 12 per cent redeemable bonds. These bonds will be sold at a 5 per cent premium to their par value and will mature after seven years. The funds raised will be used to repurchase ordinary shares which the company will then cancel. Ms. Green expects that this repurchase will cause the company’s share price to rise to £2.95 and the future dividend growth rate to increase by 15 per cent (in relative terms). Zara expects the price of the 10 per cent bonds to be unaffected, but the price of the preference shares to fall to 68p. Corporate tax stands at 30 per cent. Required:
(a) Calculate the book value and market value cost of capital (WACC) for Faith PLC PLC. (10 marks)
(b) Given the proposed changes to Faith PLC capital structure, recalculate the company’s cost of capital to reflect these changes and comment on the finance director’s projections. (10 marks)
(c) Critically discuss whether you agree that companies, by integrating a sensible level of gearing into their capital structure, can minimise their weighted average cost of capital, ensuring the response integrates relevant empirical research within this area of study. (15 marks)
(d) Critically evaluate the relationship between WACC and IRR on investment; also discuss the effects of agency problem on potential viable investment for Faith PLC, ensuring the response is supported with relevant academic research. (15 marks)
Question 2 - Investment Appraisal Techniques Pizza Mat (PM) Limited a fast food company is considering purchasing a new storage machine for
£588.5m. The company is expecting an annual cash inflow of £233.7m from the sale of its products and an annual cash outflow of £33,2m for each of the seven years of the machine’s useful life. The annual cash outflows do not include annual depreciation charges for the machine. The machine is depreciated using a straight-line method. The machine is expected to last for seven years, with a residual value estimated to be at the rate of 13% of the original cost of the machine. The cost of capital for (PM) Limited is 8%.
You are required to:
(a) Calculate (to two decimal places ) using the following investment appraisal techniques, and provide brief recommendations as to the economic feasibility of acquiring the machine:
The Payback Period.
The Accounting Rate of Return.
The Net Present Value.
The Internal Rate of Return
(20 marks)
(b) Alternatively, the financial director of (PM) Limited is proposing to use 50% the total capital outlay for the above investment to repurchase some of the equity capital and the remaining funds to pay for cash dividends. Ensuring the response draws upon relevant academic research and theories within this highly topical area of financial management, critically evaluate the effects of this proposal on the company. (10 marks)
(c) Critically evaluate the benefits and limitations of each of the differing investment appraisal techniques, ensuring the use of relevant academic literature. (20 marks)
Question 3 – Mergers and Takeovers The managing directors of Kings PLC are considering what value to place on Dragon PLC, a company that they are planning to take-over soon. Kings’ share price is currently £4.25 and the company’s earnings per share stand at 31p. Kings PLC weighted average cost of capital is 11%.
The board estimates that annual after-tax synergy benefits resulting from the takeover will be £5.36m, that Dragon’s distributable earnings will grow at an annual rate of 2.5%. That duplication will allow the sale of the £32m of assets, net of corporate tax (currently standing at 22%), in a year’s time. Calculate the book value and market value cost of capital (WACC) for Faith PLC PLC
Information relating to Dragon PLC:
Financial Statement of Dragon PLC
£m
£m
Non-current assets
233
Current assets
56
Total assets
289
Equity
Ordinary Shares (£0.5)
105
Reserves
64
Total equity
169
7% bonds
74
Current liabilities
46
Total liabilities
120
Statement of Profit or Loss extracts £mProfit before interest and tax 62.0
Interest payments 6.5
Profit before tax 55.5
Taxation 15.1
Distributable earnings 40.4
Other financial market information :APC308 Financial Management
Current ex-div share price
£2.45
Latest dividend payment
14p
Past four years dividends payment
9p, 10.5p, 11p, 12p
Dragon’s equity beta
1.35
Treasury bills yield
5.5%
Market risk rate
12%
Given the above information calculate the value of Dragon PLC using the following valuation methods:
a) Price/earnings ratio (10 marks)
b) Discounted cash flow method (10 marks)
c) Dividend valuation method (10 marks)
d) Drawing relevant academic literature on the mergers and takeovers, critically discuss the problems associated with using the above valuation techniques. Based on your opinion, which of the above valuation techniques would you recommend with economic justifications to the board of Kings PLC to pursue in this acquisition. (20 marks)
Table 1 Applied Penalties for Exceeding the word count.
Word limit
Penalty
Actual Word Count
Exceeds limit by up to 10%
No penalty – tolerance band (see below)
3300
Exceeds limit by 10.1-20%
-5%
3301 – 3600
Exceeds limit by 20.1-30%
-10 %
3601 - 3900
Exceeds limit by 30.1-40%
-15 %
3901 - 4200
Exceeds limit by 40.1-50%
-20 %
4201 - 4500
Exceeds limit by more than 50%
Mark of zero
4501+
The learning outcomes for this module assessed by this piece of work are
Knowledge
Examined and critically evaluated the key strategic decisions that a business may have to make and appreciated how accounting and finance can assist in making and evaluating those decisions.
A critical understanding of specific analytical skills in key decision areas within strategy and finance at local and international level
A critical understanding of the limitations of the current state of financial theory in making strategic business decisions
Skills
Applied the key valuation concepts and methodologies of financial decision making in order to contribute to the wider decision making of the organisation
Assessment Criteria Your seminar tutor on the basis of the following generic criteria will assess the paper. Calculate the book value and market value cost of capital (WACC) for Faith PLC PLC
Assessment Regulations For further information regarding Assessment Regulations, extenuating circumstances or extensions and academic integrity, please refer to your Programme Handbook on the University of Sunderland in London information page on Canvas.
Reading List Please access your reading list from the library website. To access it, please go to https://moduleresources.sunderland.ac.uk/ and search for your module.
Submission guidelines There are currently two steps that you need to follow to ensure that you successfully submit your work for marking. Your submission links will become available approximately 3 weeks prior to your submission deadline, along with detailed instructions on how to submit your assignment, but in the meantime please feel free to also watch this Assignment Submission Instructions video.
Grading You will be marked in accordance to the University of Sunderland assessment criteria attached below
Assessment Criteria - APC308 Financial Management
Categories
Grade
Relevance
Knowledge
Analysis
Argument and Structure
Critical Evaluation
Presentation
Reference to Literature
Pass
86 –
100%
The work examined is exemplary and provides clear evidence of a complete grasp of the knowledge in all calculations, understanding and skills appropriate to the Level of the qualification. There is also ample excellent evidence showing that all the learning outcomes and responsibilities appropriate to that Level are fully satisfied. At this level it is expected that the work will be exemplary in all the categories cited above. It will demonstrate a particularly compelling evaluation, originality, and elegance of argument, interpretation or Discourse. There must be a perfect match of ALL above criteria to at least 90% calculations and interpretations of each task attempted.
76-85%
The work examined is outstanding and demonstrates comprehensive knowledge in calculations, understanding and skills appropriate to the Level of the qualification. There is also excellent evidence showing that all the learning outcomes and responsibilities appropriate to that level are fully satisfied. At this level it is expected that the work will be outstanding in majority of the categories as cited above or by demonstrating particularly compelling evaluation and elegance of argument, interpretation or discourse. ALL the above criteria must have a perfect association to at least 80% of the expected calculations and interpretations in each tasks attempted,
70 – 75%
The work examined is excellent and is evidence of comprehensive knowledge in calculations, understanding and skills appropriate to the Level of the qualification. There is also excellent evidence showing that all the learning outcomes and responsibilities appropriate to that level are satisfied. At this level it is expected that the work will be excellent in majority of the categories cited above or by demonstrating particularly compelling evaluation and elegance of argument must be clearly linked with at least 70% of calculations, and interpretation or discourse of each task attempted.
60 – 69%
Directly relevant to the requirements of the assessment
A substantial knowledge of at least 60% of overall calculations with a clear and relevant interpretations, showing a clear grasp of themes, questions and issues therein
Good analysis, clear and orderly approaches associated with relevant theories and model(s).
Generally coherent and logically structured, using an appropriate mode of argument and/or theoretical mode(s)
May contain some distinctive or independent thinking; may begin to formulate an independent position in relation to theory and/or practice.
Well written, with standard spelling and grammar, in a readable style with acceptable format
Critical appraisal of up-to- date and/or appropriate literature. Recognition of different perspectives. Very good use of source material. Uses a range of sources
50 – 59%
Some attempt to address the requirements of the assessment: may drift away from this in less focused passages
Adequate knowledge of a fair range of at least 50% of overall calculations with a clear and relevant interpretations, with some intermittent evidence of an appreciation of its significance
Some analytical treatment, but may be prone to description, or to narrative, which lacks clear analytical purpose
Some attempt to construct a coherent argument, but may suffer loss of focus and consistency, with issues at stake stated only vaguely, or theoretical mode(s) couched in simplistic terms
Sound work which expresses a coherent position only in broad terms and in uncritical conformity to one or more standard views of the topic
Competently written, with only minor lapses from standard grammar, with acceptable format
Uses a variety of literature which includes some recent texts and/or appropriate literature, though not necessarily including a substantive amount beyond
library texts. Competent use of source material.
40 – 49%
Some correlation with the requirements of the assessment but there is a significant degree of irrelevance
Basic understanding of the subject but addressing a limited range of calculations with relevant and basic interpretations
Largely descriptive or narrative, with little evidence of analysis of theories and model(s)
A basic argument is evident, but mainly supported by assertion and there may be a lack of clarity and coherence
Some evidence of a view starting to be formed but mainly derivative.
A simple basic style but with significant deficiencies in expression or format that may pose obstacles for the reader
Some up-to-date and/or appropriate literature used. Goes beyond the material tutor has provided. Limited use of sources to support a point. Weak use of source material.
Fail
35 – 39%
Relevance to the requirements of the assessment may be very intermittent, and may be reduced to its vaguest and least challenging terms
A limited understanding of a narrow range of at least 30& of overall calculations associated with relevant interpretations
Heavy dependence on description, and/or reliance on paraphrase been commonly identified. Calculate the book value and market value cost of capital (WACC) for Faith PLC PLC
Little evidence of coherent argument with lacks development and may be repetitive or thin
Almost wholly derivative where writer’s contribution rarely goes beyond simplifying paraphrase
Numerous deficiencies in expression and presentation; the writer may achieve clarity (if at all) only by using a simplistic or repetitious style
Barely adequate use of literature. Over reliance on material provided by the tutor.
The evidence provided shows that the majority of the learning outcomes and responsibilities appropriate to that Level are satisfied.
30 – 34%
The work examined provides insufficient evidence of the knowledge in calculations with appropriate interpretations, understanding and skills appropriate to the Level of the qualification. The evidence provided shows that some of the learning outcomes and responsibilities appropriate to that Level are satisfied. The work will be weak in some of the
15-29%
The work examined is unacceptable and provides little evidence of the knowledge in calculations with basic interpretations, understanding and skills appropriate to the Level of the qualification. The evidence shows that few of the learning outcomes and responsibilities appropriate to that Level are satisfied. The work will be weak in several of the indicators.
0-14%
The work examined is unacceptable and provides almost no evidence of the knowledge in calculations with few interpretations, understanding and skills appropriate to the Level of the qualification. The evidence fails to show that any of the learning outcomes and responsibilities appropriate to that Level are satisfied. The work will be weak in the majority or all
APC308 Financial Management
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