Question Three Hypo plc is an international company in the UK. The company is financed by...

Transcribed Image Text:

Question Three Hypo plc is an international company in the UK. The company is financed by both common stock and debt. The firm has a target debt-equity ratio of 0.7 and after tax cost of debt of 5.5%. The equity currently has a beta of 1.15, the expected return on the equity market is 10.5% and the annual risk free rate is 4.5%. Hypo is considering updating its operating system. Initial costs are 35 million. The updated system will result in initial after-tax cash savings of 2.5 million at the end of the first year, and these savings will grow at a rate of 3% per year indefinitely. a) In calculating the WACC, if you had to use book values for either debt or equity, which would you choose? Explain. b) Calculate the WACC for the Hypo plc. (3 marks) (7 marks) c) Calculate the NPV of the project and explain whether the company should take on the project. (8 marks) d) Hypo's Financial Manager is considering reducing next years' dividend payment to shareholders to fund the project since this is a free source of finance. Explain why the earnings which will be retained in this way are not a free source of finance. Windows, " (7 marks) Question Three Hypo plc is an international company in the UK. The company is financed by both common stock and debt. The firm has a target debt-equity ratio of 0.7 and after tax cost of debt of 5.5%. The equity currently has a beta of 1.15, the expected return on the equity market is 10.5% and the annual risk free rate is 4.5%. Hypo is considering updating its operating system. Initial costs are 35 million. The updated system will result in initial after-tax cash savings of 2.5 million at the end of the first year, and these savings will grow at a rate of 3% per year indefinitely. a) In calculating the WACC, if you had to use book values for either debt or equity, which would you choose? Explain. b) Calculate the WACC for the Hypo plc. (3 marks) (7 marks) c) Calculate the NPV of the project and explain whether the company should take on the project. (8 marks) d) Hypo's Financial Manager is considering reducing next years' dividend payment to shareholders to fund the project since this is a free source of finance. Explain why the earnings which will be retained in this way are not a free source of finance. Windows, " (7 marks)