The CFO of Yorkshire, wants to measure its cost of capital. Unfortunately, the company's cost of...

 

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The CFO of Yorkshire, wants to measure its cost of capital. Unfortunately, the company's cost of equity data is not available. The firm decided to use a surrogate finn i.e. Langdon ple which is a firm in the same industry, for this purpose. He managed to produce 2 different discount rates. He would like to find out if there are any errors in the cost of capital calculations. The cost of debt is 6% CAPM Extimate Beta of Langdon: 1.2 Market portfolio return: 20% Risk-free rate: 5% Inflation: 3% The cost of capital is 5% + (20%-5%)1.2 - 23 %. The inflation-adjusted discount rate is 23% +3% -26% Dividend Growth Model Estimate Langdon plc Year 2016 2018 2019 2020 (b) Fixed Assets Current Assets Less: Current Liabilities Financed by: Ordinary equity Average share price (pence) 386 218 192 &(DP)-g, where D, is the expected dividend, P is the market price and g is the growth rate of dividends ((28.40pence/150pence)-0.09)-9.93%). When inflation is included, the discount rate is 12.93% Other financial information on the 2 companies is presented here: (£0.25) Reserves Bank Loans 260 Yorkshire 2000 14,400 15,200 -7.800 21,800 0 Dividend per share (peace) 18.46 20.12 21.94 4,000 13,000 4,800 21,800 26.06 Langdon 1000 15,200 15,600 -7.400 23,400 0 Notes 1. The ex-dividend share price of Langdon ple is 150 pence. 2. Yorkshire's board of directors has recently rejected a takeover bid of £12 millica. 3. Corporate tax is paid at the rate of 30% Required: Evaluate the assumptions of Modigliani-Miller assumptions do you think are not realistic ? Provide support your answers. 3,600 11,000 8,800 23,400 Evaluate the 2 estimates of cost of capital and discuss any incorrect figures that exist. Resolve this problem by giving new solutions based upon both methods. Put forward clearly the assumptions in your discussion. (16 marks) Evaluate which of your revised estimates Yorkshire should use as the discount rate for capital investment appraisal. (4 marks) Propositions. Which proper explanations to (5 marks) [Total: 25 marks] The CFO of Yorkshire, wants to measure its cost of capital. Unfortunately, the company's cost of equity data is not available. The firm decided to use a surrogate finn i.e. Langdon ple which is a firm in the same industry, for this purpose. He managed to produce 2 different discount rates. He would like to find out if there are any errors in the cost of capital calculations. The cost of debt is 6% CAPM Extimate Beta of Langdon: 1.2 Market portfolio return: 20% Risk-free rate: 5% Inflation: 3% The cost of capital is 5% + (20%-5%)1.2 - 23 %. The inflation-adjusted discount rate is 23% +3% -26% Dividend Growth Model Estimate Langdon plc Year 2016 2018 2019 2020 (b) Fixed Assets Current Assets Less: Current Liabilities Financed by: Ordinary equity Average share price (pence) 386 218 192 &(DP)-g, where D, is the expected dividend, P is the market price and g is the growth rate of dividends ((28.40pence/150pence)-0.09)-9.93%). When inflation is included, the discount rate is 12.93% Other financial information on the 2 companies is presented here: (£0.25) Reserves Bank Loans 260 Yorkshire 2000 14,400 15,200 -7.800 21,800 0 Dividend per share (peace) 18.46 20.12 21.94 4,000 13,000 4,800 21,800 26.06 Langdon 1000 15,200 15,600 -7.400 23,400 0 Notes 1. The ex-dividend share price of Langdon ple is 150 pence. 2. Yorkshire's board of directors has recently rejected a takeover bid of £12 millica. 3. Corporate tax is paid at the rate of 30% Required: Evaluate the assumptions of Modigliani-Miller assumptions do you think are not realistic ? Provide support your answers. 3,600 11,000 8,800 23,400 Evaluate the 2 estimates of cost of capital and discuss any incorrect figures that exist. Resolve this problem by giving new solutions based upon both methods. Put forward clearly the assumptions in your discussion. (16 marks) Evaluate which of your revised estimates Yorkshire should use as the discount rate for capital investment appraisal. (4 marks) Propositions. Which proper explanations to (5 marks) [Total: 25 marks]

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Solution a Evaluation of the two estimates of cost of capital for Langdon PLC and resolution of any ... View the full answer