Problem 1
TriglassPlc has three types of capital. The market capitalization of its equity is $20 million. These ordinary shares have a beta of 0.9, as measure over the past five years of monthly returns which may be taken as the appropriate adjustment to the average risk premium. The current risk-free rate on government bonds is 4.5%. The historical equity risk premium is 5% per year. The market value of its irredeemable non-participating non-convertible preference shares is $5 million and the rate of return being offered is 7.5% per year. The debt of the firm amount to $15 million and costs 6.5% per year before allowing for tax shield benefits. The corporation tax rate is 30%. Calculate the WACC for Triglass plc.
Problem 2
Nike Ltd has issued share capital 4 million ordinary shares, with a par value of $1 each share. The board of the company has accepted the proposal for a new venture and therefore needs to raise $2 million.
The finance director has suggested that this finance be raised by way of a 1 for 4 rights issue which will be priced at a 30$ discount to the current market price of $3 per share.
a) Calculate the theorical ex-rights price per share
b) Calculate the cash raised
c) Calculate the value of the rights
The finance director also recommended having the rights issue underwritten by an investment ban or relevant finance house at the time of issues.
d) Explain underwriting and consider whether underwriting is a valid expense at this time
e) An investment bank sponsoring an issue will usually charge a fee of between 2-4% of the issue proceeds and then pays part that fee, 1.25-3% of the issue proceeds, to sub underwriters.
f) Explain why, in general, rights issues are priced at a discount to the prevailing market price of the shares
g) Calculate and discuss the factors that determine whether the actual ex-rights share price is the same as the theoretical ex-rights share price.
Problem 3
Arsenal projects plc wishes to invest in a new product area. The project will last 8 years and the equipment which cost $1,500,000 will have no disposable value at the end of the project.
It is planned that the outcome will be:
Sales volume: 24,000 units per year
Sales price: $65.00 per unit
Variable direct costs: $53.00 per unit
There are no other costs. Taxation and inflation can be ignored for this case.
Required:
a) Calculate the internal rate of return (IRR) of this project based on these estimates.
b) Management is very conscious of the possibility that some of the assumptions may change and, therefore, requires a review of the project's IRR using sensitivity analyses.
Calculate revised IRRs assuming that sales volume increases by 5%, then assume that sales price increases by 5% and, finally assume that the cost sales increases by 5%.
c) Critically review the finding in b) above discuss which of the variable data should be monitored more closely and why.
Problem 4
Mr. Arsenal has the opportunity to invest in the shares of two companies- Tropicana plc and Waterfall plc. Tropicana plc is a tropical leisure wear manufacturer and waterfall plc manufacturers a range of adult and children's waterproof clothing. The return on both these companies is likely to be influenced by the state of the weather. The following table shows the return that can be expected from each company's share for different weather conditions:
Weather Conditions Probability Return on Return on
of occurrence Tropicana plc Waterfall plic
Hot 0.3 30% -5%
Moderate 0.5 10% 6%
Wet 0.2 8% 40%
Required:
a) Calculate the expected return and standard deviation of a 100% investment in Tropicana plc.
b) Calculate the expected return and standard deviation of a 100% investment in waterfall plc.
c) Mr Arsenal is also considering combining both shares in a portfolio. Calculate the expected return and standard deviation for both of the following portfolio combinations if the covariance of Tropicana and waterall is -99.2
%invested in Tropicanplc % invested in waterfall plc
Portfolio 1 50% 50%
Portfolio 2 25% 75%
Explain to Mr Arsenal why investing in a portfolio is beneficial to a risk averse investor. Make reference to appropriate diagrams in your answer.
d) Critically discuss the following statements about stock market efficiency:
a) The weak form of the efficient market hypothesis implies that it is possible to generate abnormal profit by analyzing and finding patterns in part share price movements.
b) The semi-strong form of the efficient market hypothesis implies that fund managers who study detailed publicly available information about a company, such as financial accounts and newspaper reports should be able to outperform the market.
c) The strong form of the efficient market hypothesis implies that directors with privileged private information about a company are able to make superior returns.