Question

Problem #3 (27 Marks) Phillips Pharmaceuticals Limited (PPL) shares are publicly traded on the Toronto Stock Exchange. The common shares currently trade at a market price of $30.00 per share. PPL recently paid a dividend on its common stock of $1.50 per share. The company maintains a 60% payout policy and has a Return on Equity (ROE) of 10%. The company beta is 0.9. PPL also has long-term bonds trading on public markets. The bonds are currently trading at a quoted price of 96.54. These 5.75% semi-annual bonds have ten years left until they mature. Winter 2020 Assignment #2 PPL is considering a project that will expand its production facilities. The project is expected to produce annual cash flows before tax of $100,000 for the next eight years. The project is considered to be of similar risk to the risk of the firm itself. It will cost PPL $400,000 this year to get this project up and running. The assets will have no value in 8 years' time. Shuting Tia, PPL's manager of finance, has collected current data from the firm's underwriters. • Government of Canada 91-day Treasury bills are currently yielding 4.25%. • The expected return on the S&P/TSX Composite Index is forecast to be 10% in the next year New equity capital could be raised by the firm at the current market price, with flotation costs of 4.75% of the value of the issue. New bonds could be sold, with flotation costs of 3.67%. • The firm faces a corporate tax rate of 40% The assets belong in an asset class with a CCA rate of 30%. • The company will seek to maintain the current capital structure based on existing market value weights. Assume flotation costs are expensed at time = 0.

Answer 1

(4) - 4.85 °/s ECRM) = 10°C ß = 0.9 according to security market line, Ke ús calculated using CAPM model Ke = Rf + ß[E(RM) -R4] -0.045 10.94 = 4.25 + 0.9 [10-4.25] = 4.25 +0.9 (5.75) = 4.25 + 5.175 ke=9.425 % cost of equity = 9.425% Scanned with CamScanner

(b) According to Divident alis count Model, where D, = Dividends expected neat period Po - wwurent market value o equity U g = expected growth ratě j duidende Po= $30 g = 1 - divůdend payout ratio) ROE = (1 - 0.6) 610 = 0.4x10 = 4 % Do = $1.5 D. = D. (1+9) = 1.561+ 0.04) = $1.56 re=bi + g. = 1.56 + 0.04 30 c) = 0.052 +0.04 = 0.102 Ire = 10.2 % cost of debt - Interest (1-tax) = 5.75 (1-0.4) = 5.75 x 0.6 ka = 3.45% Scanned with CamScanner

v - d) Market vale Market value current market & total shares - price / share outstanding = 30 x 100000 = $ 3000000 = wirent quo te x total wo. of puce /bond bonds = 96.54 x 10000 (assuming face 7 I value to be $100 =$965400 market value 4 equity weight of equity = muity debt = 3000000 3000000 + 965400 - 3000000 3965400 = 0.75654 = 75.654 % weight of debt = debt equity + debt =965400 3965400 = 0.24345 = 24.345 % Scanned with CamScanner