Brief:

Its summer 2019 and you have started to work as a finance manager of a big London based holding company ABC plc. You are generally happy to get this job after your graduation from Leeds Business School. Its something that you always wanted, the nice and challenging city job where you can use your vast academic knowledge that you gained through your time at Leeds Business School. The company ABC plc. is a big holding company with multiple operation in the UK and abroad. The company is involved in construction, retail, asset management and contracting jobs for NHS. It also has its subsidiary in south Asia to take advantage of cheap labour for its contacting jobs. The company has an effective board of directors that oversee the activities of executives including the CEO and CFO.

Review Goal Congruence:

As a new recruit you are having your probationary period and you are being deputised in various divisions to gain hands on experience. You started your training from planning and strategy division and working closely with top team who are responsible to develop and formulate strategies. The company has a set compensation policy but recently the policy has been under scrutiny due to its apparent ineffectiveness. You have been asked to go through the current remuneration policy a

The separation of ownership and control is an obvious thing to ensure the smooth operation of the company. However, this separation may raise worries among the shareholders about entrenchment and managerialism by the managers. This eventually will lead to agency cost which the company needs to minimise through various mechanisms. One of the popular ways to control this agency cost is to offer attractive remuneration packages to managers so that they work in the interest of shareholders. In relation to this the chairperson of ABC plc states that "We have the responsibility of overseeing the company, acting as a check on managerialism, so that shareholders best interests are prioritised. "

The existing remuneration policy consists of three components:

Fixed remuneration: salaries of the senior managers of the ABC plc can only be amended upon approval of the general meeting of shareholders.

Variable remuneration: ABC plc takes a balanced and proportionate approach regarding the variable remuneration. Senior managers of ABC plc plc receive a fixed salary plus a percentage of sales.

Others: contribution pension premiums, travel allowance and holiday allowance.

At present, Chief executive officer of ABC plc. receives a fixed salary of 120,000 plus 4% of sales.

As mentioned before, the board of the company wants to re-evaluate the effectiveness of the existing remuneration policy and wants to have new proposals to change the policy provided that the new policy would be better than the old policy in terms of satisfying the financial and nonfinancial objectives of the company.

Portfolio adjustment:

After a successful tenure at central budgeting division, it's now time to spend some time with Portfolio management division. One of the main tasks of this division is to invest surplus fund in a small portfolio of equity shares. The team of financial analysts of the portfolio management division usually advising the ABC plc whether is a good time to buy, sell, or hold certain shares of their portfolio. During your time in this division, you were asked to help the Financial analyst team to evaluate the portfolio and provide your opinion.

The CAPM is one method that may employed by analysts to help them reach their conclusions. The current market return is 12 per cent and the rate earned on Treasury bills is 5 per cent. Details of the portfolio hold by the ABC plc are :

Company No. shares Beta Share price () Dividend yield (%) Expected Return (%)

Flower 70,000 1.27 3.75 5.6 13.0

Garden 150,000 1.53 4.25 3.5 21.0

House 200,000 1.01 2.50 4.2 19.0

Ice cream 80,000 0.95 4.50 6.2 10.5

Jungle 130,000 1.89 3.50 4.8 15.5

a)Comment on risk of ABC Plc's portfolio compared with the risk of the market portfolio with the support of appropriate calculations included in appendix.

b)Advice with rational on how ABC Plc should change the composition of its portfolio with the support of appropriate calculations included in appendix.

Capital structure and Cost of capital:

After a successful tenure at Portfolio management division, it's now time to spend some time at central financing division. One of the main tasks of this division is to evaluate different financingoptions along with the cost related to those options and select the best option which will maximise shareholders' wealth. During your time in this division, you were asked to help the central finance team to evaluate the potential options and provide your opinion on this.

ABC Plc is planning an expansion of existing business activities. It needs to raise funds for this expansion. One of the managers of Financing division, Bob, stated that WACC should be used in all circumstances.Another manager Ted stated "It is in the management's interest to keep the financial gearing level as low as possible, while it is in the shareholders' interests to keep it at a high level. The team have decided to calculate its weighted average cost of capital in preparation of this.

The ordinary shares of ABC plc have a nominal value of 50 pence per share and are currently trading on the stock market on an ex dividend basis at 5.97. ABC plc has an equity beta of 1.15.

The loan notes have a nominal value of 100 and are currently trading on the stock market on an ex-interest basis at 105.50 per loan note. The interest on the loan notes is 7% per year before tax and they will be redeemed in six years' time at a 7% premium to their nominal value.

The risk-free rate of return is 4% per year and the equity risk premium is 6% per year. ABC plc pays corporation tax at an annual rate of 25% per year.

a)Critically assess Manager Bob's comment.

b)Comment on any difference between the market value weighted average cost of capital and the book value weighted average cost of capital of ABC plc, all calculation to support your comment should be included in the appendix.

c)Critical discussion of the impact of capital structure on cost of capital and firm value considering manager Ted's comment.