WACC – Knowsia

FM – L2 – Q119 – Business valuations

Calculate offer price for SmallCorp using a forward P/E multiple of 8.0 based on expected earnings

Question

LargeCorp is considering a takeover bid for SmallCorp, another company in the same industry. SmallCorp is expected to have earnings next year of GH₵86,000. If LargeCorp acquires SmallCorp, the expected results from SmallCorp will be as follows:

	Year after the acquisition
	Year 1	Year 2	Year 3
Sales	GH₵200,000	GH₵280,000	GH₵320,000
Cash costs/expenses	120,000	160,000	180,000
Capital allowances	20,000	30,000	40,000
Interest charges	10,000	10,000	10,000
Cash flows to replace assets and finance growth	25,000	30,000	35,000

From Year 4 onwards, it is expected that the annual cash flows from SmallCorp will increase by 4% each year in perpetuity. Tax is payable at the rate of 30%, and the tax is paid in the same year as the profits to which the tax relates. If LargeCorp acquires SmallCorp, it estimates that its gearing after the acquisition will be 35% (measured as the value of its debt capital as a proportion of its total equity plus debt). Its cost of debt is 7.4% before tax. LargeCorp has an equity beta of 1.60. The risk-free rate of return is 6% and the return on the market portfolio is 11%.
Required:

(a) Suggest what the offer price for SmallCorp should be if LargeCorp chooses to value SmallCorp on a forward P/E multiple of 8.0 times.

(b) Calculate a cost of capital for LargeCorp.

Answer

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Tags: Acquisition, Business valuations, Cash Flows, DCF, Perpetuity, WACC
Level: Level 2

Topic: Business valuations

FM – L2 – Q38 – Cost of capital

Calculate cost of equity and WACC for Akomo Plastics Plc's investment in chemicals manufacturing using CAPM and given beta data.

Question

Akomo Plastics Plc is engaged in plastics manufacture. It is now considering a new investment that would involve diversification into chemicals manufacture, where the business risk is very different from the plastics manufacturing industry.
Research has produced the following information about three companies currently engaged in chemicals manufacturing, in the same part of the industry that Akomo Plastics Plc is planning to invest.

Company	Equity beta	Financed by:
A	2.66	40% equity capital, 60% debt capital
B	1.56	75% equity capital, 25% debt capital
C	1.45	80% equity capital, 20% debt capital

Akomo Plastics Plc is financed by 60% equity capital and 40% debt capital, and would intend to maintain this same capital structure if the new capital investment is undertaken.
The risk-free rate of return is 5% and the return on the market portfolio is 9%. Tax is at the rate of 25%. You should assume that the debt capital of Akomo Plastics Plc and Companies A, B and C is risk-free.

Required
(a) Calculate a suitable cost of equity for the proposed investment by Akomo Plastics Plc in chemicals manufacturing.

(b) Suggest a weighted average cost of capital that should be used to carry out an investment appraisal (NPV calculation) of the proposed project.

Answer

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Tags: Asset beta, Capital structure, CAPM, Chemical manufacturing, Cost of Equity, Equity beta, Financial Risk, investment appraisal, Tax shield, WACC
Level: Level 2

Topic: Cost of capital

FM – L2 – Q21 – Discounted cash flow

Calculate NPV for a machine investment at Tema Electrical Plc and recommend if it should be undertaken, considering cash flows, WACC, and tax.

Question

Tema Electrical Plc is considering whether to purchase a machine for the manufacture of a new product, Product X. It has been estimated that Product X would have a life of four years and at a selling price of GH¢8 per unit, annual sales demand would be 400,000 units in Year 1, 600,000 units in Year 2 and 800,000 in each of Years 3 and 4.

Variable production and selling costs would be GH¢6 per unit. Incremental annual fixed cost expenditures (all cash cost items) would be GH¢500,000 in Year 1, rising by GH¢20,000 each year.

The machine, which has an annual output capacity of 700,000 units of Product X, would cost GH¢1,200,000 and would have a resale value of GH¢200,000 at the end of Year 4. Capital allowances would be available on a 25% annual reducing balance basis, with a balancing charge or allowance in the year of disposal. Tax at 25% is payable one year in arrears of the profits to which it relates.

Tema Electrical Plc is financed 70% by equity capital and 30% by debt capital. The equity has a cost of 10% and the debt has a cost of 8.9% (before tax).

Required

Calculate the net present value of the proposed project and recommend whether the investment in the machine should be undertaken.

Answer

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Tags: capital allowances, Cash Flows, Cost of Capital, Discounted cash flow, Financial management, investment appraisal, NPV, project evaluation, Taxation, WACC
Level: Level 2

Topic: Discounted cash flow

FM – L2 – Q20 – Cost of capital

Calculate WACC using dividend growth model for cost of equity, given dividend, share price, and debt details.

Question

A company, Volta Ventures Ltd, has just paid an annual dividend of GH¢0.18. Investors expect the annual dividend to grow by 3% each year in perpetuity. The current share price is GH¢1.55, and the total market value of the company’s shares is GH¢1,200,000.

The company has debt capital on which the yield is 7.8% before tax. The rate of tax is 30%. The total value of the company’s debt is GH¢350,000.

Calculate the weighted average cost of capital. Use the dividend growth model to estimate the cost of equity.

Answer

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Tags: Cost of Equity, Debt Capital, Dividend Growth Model, Financial management, WACC
Level: Level 2

Topic: Cost of capital

Tag (SQ): WACC

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FM – L2 – Q119 – Business valuations

Calculate offer price for SmallCorp using a forward P/E multiple of 8.0 based on expected earnings

FM – L2 – Q38 – Cost of capital

Calculate cost of equity and WACC for Akomo Plastics Plc's investment in chemicals manufacturing using CAPM and given beta data.

FM – L2 – Q21 – Discounted cash flow

Calculate NPV for a machine investment at Tema Electrical Plc and recommend if it should be undertaken, considering cash flows, WACC, and tax.

FM – L2 – Q20 – Cost of capital

Calculate WACC using dividend growth model for cost of equity, given dividend, share price, and debt details.

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FM – L2 – Q119 – Business valuations

Calculate offer price for SmallCorp using a forward P/E multiple of 8.0 based on expected earnings

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FM – L2 – Q38 – Cost of capital

Calculate cost of equity and WACC for Akomo Plastics Plc's investment in chemicals manufacturing using CAPM and given beta data.

You're reporting an error for "FM – L2 – Q38 – Cost of capital"

FM – L2 – Q21 – Discounted cash flow

Calculate NPV for a machine investment at Tema Electrical Plc and recommend if it should be undertaken, considering cash flows, WACC, and tax.

You're reporting an error for "FM – L2 – Q21 – Discounted cash flow"

FM – L2 – Q20 – Cost of capital

Calculate WACC using dividend growth model for cost of equity, given dividend, share price, and debt details.

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