Managerial Economics
QUESTION 1:
Angel plc is a listed industrial business and is considering a major investment. The investment projects team needs an appropriate rate at which to discount the estimated after-tax cash flow for the investment. Following the business’s normal practice, this is to be based on the weighted average cost of capital (WACC).
Figures, relating to long-term financing, included in the business’s most recent balance sheet are: £m
Ordinary shares of £0.50 each (160 million) 80
Share premium account 27
Revaluation reserve 26
Profit and Loss account 9
7.2% loan stock 67
The loan stock interest for the current year has just been paid. Interest is payable at the end of each of the next three years and all of the loan stock is to be redeemed, in cash at 5% premium, at the growth rate of 7% over recent years.
A dividend of 18 pence per share has just been paid. Dividends have shown an average annual growth rate of 7% over recent years.
The current share price is 210 pence and the loan stock has a market value of £97 (per £100 nominal).
The corporation tax rate is expected to be 30% for the foreseeable future.
Required:
a) Estimate the business’s WACC. Explain your workings and any assumptions made. Justify the basis of the weightings used to calculate the business’s WACC.
b) Explain any criticisms which could be made of using the figure deduced in (a) as the discount rate for assessing the investment under consideration.
c) Explain how capital asset pricing model (CAPM) could be used as an alternative means of deducing a suitable discount rate to be used in the assessment of the investment. Your explanation should include outline of the model’s strengths and weakness.
QUESTION 2:
Chamberton plc is a stock exchange listed business, which wishes to raise £ 100m to invest in a new project that is expected to generate operating profit of about £20 million each year. Three possible sources have been suggested:
Angel plc is a listed industrial business and is considering a major investment. The investment projects team needs an appropriate rate at which to discount the estimated after-tax cash flow for the investment. Following the business’s normal practice, this is to be based on the weighted average cost of capital (WACC).
Figures, relating to long-term financing, included in the business’s most recent balance sheet are: £m
Ordinary shares of £0.50 each (160 million) 80
Share premium account 27
Revaluation reserve 26
Profit and Loss account 9
7.2% loan stock 67
The loan stock interest for the current year has just been paid. Interest is payable at the end of each of the next three years and all of the loan stock is to be redeemed, in cash at 5% premium, at the growth rate of 7% over recent years.
A dividend of 18 pence per share has just been paid. Dividends have shown an average annual growth rate of 7% over recent years.
The current share price is 210 pence and the loan stock has a market value of £97 (per £100 nominal).
The corporation tax rate is expected to be 30% for the foreseeable future.
Required:
a) Estimate the business’s WACC. Explain your workings and any assumptions made. Justify the basis of the weightings used to calculate the business’s WACC.
b) Explain any criticisms which could be made of using the figure deduced in (a) as the discount rate for assessing the investment under consideration.
c) Explain how capital asset pricing model (CAPM) could be used as an alternative means of deducing a suitable discount rate to be used in the assessment of the investment. Your explanation should include outline of the model’s strengths and weakness.
QUESTION 2:
Chamberton plc is a stock exchange listed business, which wishes to raise £ 100m to invest in a new project that is expected to generate operating profit of about £20 million each year. Three possible sources have been suggested: