Task 4 Your company operates in a sector with a higher than the average market business...
Fantastic news! We've Found the answer you've been seeking!
Question:
Transcribed Image Text:
Task 4 Your company operates in a sector with a higher than the average market business risk and this contributes to its current equity beta of 1.8. The finance director has asked you to estimate a revised equity beta and a revised cost of capital based on a financial restructuring to reduce the outstanding non-current liabilities by 50%. The funds to pay back the debt would be raised by selling selected high street stores, keeping only those stores with a good high-street presence. Whilst the focus here is on the cost of capital and financial risk, there might be additional benefits for the company. This is because the non-current assets are shown at historic book values and have not been revalued to current market value levels, therefore it is anticipated that there will be funds left over after paying down the debt. Any such remaining funds will be available for future investments including developing online services. Statement of Financial Position - Extract Non-current assets Current assets Total assets Share capital (£1 per share par value) Reserves Non-current liabilities (6% redeemable bonds) Current liabilities Equity and Liabilities £000 18,200 4,100 22,300 2,500 6,500 11,000 2,300 22,300 Shares are currently trading at 400p each. It is assumed that the market value of equity will be unchanged by this proposal. Task 4 continued on next page... Task 4 continued from previous page... The non-current liabilities consist of bonds, redeemable in 2 years, which are BBB rated and 150 basis points over the risk free rate of interest. If the proposal were enacted and borrowing reduced, the bonds are forecast to be rated A+, and be 100 basis points over the risk free interest rate. The risk free rate is 3.5% and the market risk premium is estimated to be 5%. The corporation tax rate is 20%. Required: a) Calculate the weighted average cost of capital based on both the company's existing capital structure, and, based on the capital structure if the proposal is implemented. For the proposed capital structure use a cost of equity of 10.4%. Show all workings. (7 marks) b) Discuss the validity that the current market value of equity will be unchanged by the proposal. (3 marks) c) Discuss with reference to capital structure theory the validity of the assumption that reducing debt will reduce the company's cost of capital. You should also refer to the scenario and to your calculations in part (a) to support your arguments. (15 marks) Word limit for discussion (both parts (b) and (c)) is 750 words (Question total 25 marks) Task 4 Your company operates in a sector with a higher than the average market business risk and this contributes to its current equity beta of 1.8. The finance director has asked you to estimate a revised equity beta and a revised cost of capital based on a financial restructuring to reduce the outstanding non-current liabilities by 50%. The funds to pay back the debt would be raised by selling selected high street stores, keeping only those stores with a good high-street presence. Whilst the focus here is on the cost of capital and financial risk, there might be additional benefits for the company. This is because the non-current assets are shown at historic book values and have not been revalued to current market value levels, therefore it is anticipated that there will be funds left over after paying down the debt. Any such remaining funds will be available for future investments including developing online services. Statement of Financial Position - Extract Non-current assets Current assets Total assets Share capital (£1 per share par value) Reserves Non-current liabilities (6% redeemable bonds) Current liabilities Equity and Liabilities £000 18,200 4,100 22,300 2,500 6,500 11,000 2,300 22,300 Shares are currently trading at 400p each. It is assumed that the market value of equity will be unchanged by this proposal. Task 4 continued on next page... Task 4 continued from previous page... The non-current liabilities consist of bonds, redeemable in 2 years, which are BBB rated and 150 basis points over the risk free rate of interest. If the proposal were enacted and borrowing reduced, the bonds are forecast to be rated A+, and be 100 basis points over the risk free interest rate. The risk free rate is 3.5% and the market risk premium is estimated to be 5%. The corporation tax rate is 20%. Required: a) Calculate the weighted average cost of capital based on both the company's existing capital structure, and, based on the capital structure if the proposal is implemented. For the proposed capital structure use a cost of equity of 10.4%. Show all workings. (7 marks) b) Discuss the validity that the current market value of equity will be unchanged by the proposal. (3 marks) c) Discuss with reference to capital structure theory the validity of the assumption that reducing debt will reduce the company's cost of capital. You should also refer to the scenario and to your calculations in part (a) to support your arguments. (15 marks) Word limit for discussion (both parts (b) and (c)) is 750 words (Question total 25 marks)
Expert Answer:
Answer rating: 100% (QA)
a The weighted average cost of capital WACC is the weighted average of the cost of each type of capital where the weights are the proportions of each type of capital in the companys capital structure ... View the full answer
Related Book For
Accounting Principles
ISBN: 978-1118342190
11th Edition
Authors: Jerry Weygandt, Paul Kimmel, Donald Kieso
Posted Date:
Students also viewed these accounting questions
-
Sunray Solar Ltd. is a growing company with a hot new marketing plan. On January 1, 2019, it had 127,850 shares outstanding, and it issued an additional 44,700 shares during the year. The company...
-
MY NOTES ASK YOUR TEACHER (a) A small Styrofoam bead with a charge of -60.0 nC is at the center of an insulating plastic spherical shell with an inner radius of 20.0 cm and an outer radius of 34.0...
-
TK company had the following summary of its operation SALE Services Gross Receipts P4,000,000 Net Sales Direct costs of services Cost of Goods Sold Other deductible expenses Net income before EAR...
-
What is the result of the following? A. 0 B. 0.007 C. The code does not compile due to line 7. D. The code does not compile due to line 8. E. The code does not compile for another reason. 1: import...
-
Practice with the balance of payments: Current account = Capital account + Change in official reserves a. Current account = 2$10, Capital account = $15. What is the change in reserves? b. Current...
-
The comparative balance sheets for 2018 and 2017 and the statement of income for 2018 are given below for Wright Company. Additional information from Wright's accounting records is provided also....
-
How have families changed in the United States in the past half century?
-
Candid, Inc., is a manufacturer of digital cameras. It has two departments: assembly and testing. In January 2014, the company incurred $ 800,000 on direct materials and $ 805,000 on conversion...
-
What is MTSS, Define the characteristics and main elements of MTSS Define the characteristics and main elements of MTSS Outline the data that supports it being used in the classroom & building &...
-
The Swift Company is planning to finance an expansion. The principal executives of the company agree that an industrial company such as theirs should finance growth by issuing common stock rather...
-
You will review and compute three years of vertical and horizontal analyses of the Ford Motor Company. Note that this is not a ratio analysis but an internal assessment of the income statement and...
-
Roberta Coy makes custom mooring covers for boats. Each mooring cover is hand sewn to fit a particular boat. If covers are made for two or more identical boats, each successive cover generally...
-
Finding a desirable job often involves intense moments of uncertainty, doubt and uncomfortableness. Occasionally, great jobs just land in people's laps, but usually there is quite a bit of unseen...
-
Educators should be familiar with the materials used within the classroom to provide students with scientific learning opportunities. Often, the teacher needs supplemental materials to provide rich,...
-
A company has a $36 million portfolio with a beta of 1.2. The futures price for a contract on an index is 900. Futures contracts on $250 times the index can be traded. What trade is necessary to...
-
Rely only on the fact pattern in this question and the materials listed in the course syllabus to answer the following questions. You may assume that I have provided you with all relevant information...
-
3 . Landlord L owns two contiguous parcels of land. L leases both parcels to Tenant T for $ 1 , 0 0 0 per month per parcel or a total of $ 2 4 , 0 0 0 per year; the rent is payable at the end of each...
-
In Exercises find dy/dx by implicit differentiation. xy - y = x
-
Some product development expenditures are recorded as development expenses and others as development costs. Explain the difference between these accounts and how a company decides which...
-
The three accounts shown below appear in the general ledger of Herrick Corp. during 2014. Instructions From the postings in the accounts, indicate how the information is reported on a statement of...
-
S. Pletcher and F. Holt share net income and net loss equally. (a) Which account(s) is (are) debited and credited to record the division of net income between the partners? (b) If S. Pletcher...
-
A scientist wants to determine whether people who live in places with high levels of air pollution get more colds than people in areas with little air pollution. Do you think it is possible to design...
-
Draw a simple random sample of eight animals from the list of 40 animals in the table. Exercises 2124 refer to the population of animals in the following table. The population is divided into four...
-
Your school colors In Exercises 1524, determine whether the data described are qualitative or quantitative.
Study smarter with the SolutionInn App