Argus plc is a UK based house builder, primarily focusing on constructing large luxury properties for the top end of the market. Argus has 200 million of total assets on the balance sheet. These are financed by a combination of ordinary shares, bonds and a variable rate bank loan. Further information:

EQUITY 3 million ordinary shares, with a nominal value of 0.10, were issued five years ago at a price of 11.00 and currently trade on the LSE at 30.00. The estimated cost of equity is 8% Retained profit and other equity reserves on the balance sheet total 30 million

BONDS 100 million nominal value of Argus bonds, with a maturity of 15 years at issuance, were issued at par 5 years ago. The bonds pay a 7% coupon annually and are trading at 103.24 per 100 nominal. BANK LOAN The bank loan is privately held, pays a variable interest linked to market rates, which is currently 2% and cannot be traded.

TAX Corporate tax rate is 22%

Part A (22 marks)

Requirements:

1. Using market values where possible, determine Argus WACC (10 marks)
2. Argus is expanding beyond the UK into international house construction, where it will primarily be building low cost, environmentally friendly properties in the developing world. Argus has been appraising this expansion, which will require a 300 million investment using NPV analysis, discounting cashflows using the WACC calculated in i). Give two reasons and justify each in a single sentence why this WACC may not be appropriate for the project (4 marks)
3. Chimera Construction is a house builder whose existing operations are focused on low cost, environmentally friendly properties in the developing world. Argus has been analysing the business and financial model of Chimera to assist in its expansion into the new market. Argus has noted that Chimera has considerably more leverage in its financing and also that corporate tax rate in most of the countries that Chimera operates is lower than the UK.

Key information:

Chimera:

Equity beta: 1.2 Debt to Total Financing 0.8 Average tax rate 16%

Argus Debt to Total Financing 0.6 Average tax rate 22%

Calculate an equity beta for Argus for the new investment in isolation based on making any adjustments required to Chimeras beta (4 marks)

4. Give one advantage and one disadvantage, from the perspective of the company seeking finance, for each of the following options: (4 marks)

• Equity
• Straight bonds
• Convertible bonds
• Preference shares