Question

Q.1) Atlanta plc has recently developed an innovative new range of equipment that is expected to lead to the company growing rapidly. It is expected that the company will grow at 12% per annum for five years. Over time, as the market share of this new equipment increases, the firm's growth rate will reach a steady state. At that point, the firm may grow at 2% per annum. Assume that the market required rate of retum on the stock is 9%. The firm's most recent dividend was £3 per share. Using the differential growth model calculate the present value of Atlanta's shares. [Total: 15 Marks) Q.2) Tyson plc engages in multinational trade and is thinking about expanding the company through further investment. This investment is thought to have a beta of 3.7. The company currently values its equity at £3.5 million and its debt at £2.7 million. The cost of debt is 5.5% and the corporation tax rate is 25%. The current yield on government bonds is 0.75% and the retum on the market is 1.5%. a. Work out the cost of equity for Tyson Plc. (5 marks) b. Using your answer from (a) work out the weighted average cost of capital (WACC). (10 marks) [Total: 15 Marks]

Answer 1

1. The value of the stock is computed as shown below:

= Dividend in year 1 / (1 + required rate of return)¹ + Dividend in year 2 / (1 + required rate of return)² + Dividend in year 3 / (1 + required rate of return)³ + Dividend in year 4 / (1 + required rate of return)⁴ + Dividend in year 5 / (1 + required rate of return)⁵ + 1 / (1 + required rate of return)⁵ [ ( Dividend in year 5 (1 + growth rate) / ( required rate of return - growth rate) ]

= (3 x 1.12) / 1.09 + (3 x 1.12²) / 1.09² + (3 x 1.12³) / 1.09³ + (3 x 1.12⁴) / 1.09⁴ + (3 x 1.12⁵) / 1.09⁵ + 1 / 1.09⁵ x [ (3 x 1.12⁵ x 1.02) / (0.09 - 0.02) ]

= 3.36 / 1.09 + 3.7632 / 1.09² + 4.214784 / 1.09³ + 4.72055808 / 1.09⁴ + 5.28702505 / 1.09⁵ + 1 / 1.09⁵ x [ ($ 77.03950787) ]

= 3.36 / 1.09 + 3.7632 / 1.09² + 4.214784 / 1.09³ + 4.72055808 / 1.09⁴ + 82.32653292 / 1.09⁵

= 66.36 Pounds Approximately

2.a. cost of equity is computed as shown below:

= risk free rate + beta x (return on market - risk free rate)

= 0.75% + 3.7 x (1.5% - 0.75%)

= 3.525%

WACC is computed as follows:

= cost of debt x (1 - tax rate) x weight of debt + cost of equity x weight of equity

= 0.055 x (1 - 0.25) x [ 2.7 million / (2.7 million + 3.5 million) ] + 3.525% x 3.5 million / (2.7 million + 3.5 million)

= 3.79% Approximately

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