1 Buit plc is trying to estimate its value under the current strategy. The managerial team have…

1 Buit plc is trying
to estimate its value under the current strategy. The managerial team have
forecast the following profits for the next five years:

Depreciation of fixed capital items in each of the
first two years is 2m. In each of the following three years it is 3m.

This has been deducted before arriving at the profit
figures shown above. In years 1, 2 and 3 capital expenditure

will be 5m per year which both replaces worn-out
assets and pays for fresh investment to grow the business. In the

fourth and fifth year capital expenditure will be
3m.

The planning horizon is

1 Buit plc is trying
to estimate its value under the current strategy. The managerial team have
forecast the following profits for the next five years:

Depreciation of fixed capital items in each of the
first two years is 2m. In each of the following three years it is 3m.

This has been deducted before arriving at the profit
figures shown above. In years 1, 2 and 3 capital expenditure

will be 5m per year which both replaces worn-out
assets and pays for fresh investment to grow the business. In the

fourth and fifth year capital expenditure will be
3m.

The planning horizon is four years. Additional
working capital will be needed in each of the next four years. This

will be 1m in year 1, 1.2m in year 2, 1.5m in year
3 and 1.8m in year 4.

The company is partially financed by debt it owes
20m and partially by equity capital. The required rate of

return (WACC) is 10 per cent.

The forecast profit figures include a deduction for
interest of 1.2m per year, but do not include a deduction for

tax, which is levied at 30 per cent of forecasted
profits, payable in the year profits are made.

The company also owns a number of empty factories
that are not required for business operations. The current

market value of these is 16m.

a Calculate the future cash flows for the company to
an infinite horizon assume year 5 cash flows apply to each

year thereafter. Discount the cash flows and
calculate the present value of all the cash flows.

b Calculate corporate value and shareholder value.

Q173;

1 Mythier plc, in
its first year, produced profits after deduction of tax but before deduction of
interest of 1m. The amount invested by debt holders was 4m. Equity holders
also invested 4m. Interest paid during the year was 0.24m and the weighted
average cost of capital is 8 per cent, while the cost of equity capital is 10
per cent.

a Calculate economic profit using the entity
approach.

b Calculate economic profit using the equity
approach.

c Describe the advantages of using economic profit in
the modern corporation.

d Explain the difficulties with economic
profit.

Q174;

1 Explain and
contrast economic profit and shareholder value analysis.

2 a Tear plc has not
paid a dividend for 20 years. The current share price is 580p and the current
share market index level is 3,100. Calculate total shareholder returns for the
past three years, the past five years and the past ten years, given the
following data:

b Comment on the problems of total
shareholders returns as a metric for judging managerial performance.

c Calculate the wealth added index for
ten and five years for Tear plc given the following assumptions:

l The
required rate of return on shares of the same risk class as Tear plc, over both
ten and five years, was 9 per cent per year.

l The
company had 10 million shares in issue throughout the entire period.

d Discuss the advantages of the wealth
added index compared with the total shareholder return. What are the
difficulties

in the practical use of the wealth added
index?

Q175;

1 Sity plc has paid out all earnings as dividends since it was
founded with 15m of equity finance 25 years ago. Today

its shares are valued on the stock market
at 90m and its long-term debt has a market value and book value of 20m.

a How much market value added (MVA) has
Sity produced?

b What is Sitys market to book ratio
(MBR)?

c Given that another company, Pity plc,
was founded with 15m of equity capital five years ago and has paid out all
earnings since its foundation and is now worth (equity and debt) 110m (90m
equity, 20m debt), discuss the problems of using the MVA and the MBR for
inter-firm comparison.

d Calculate the excess return (ER) for
both Sity and Pity given that the required rate of return for Sity is 8 per
cent per year and the required rate of return is 10 per cent per year for Pity.
Sity has paid only two dividends: 2m was paid five years ago and 3m was paid
three years ago. Pity has paid 2m in dividends at the end of every year since
its foundation.

e Discuss the advantages and
disadvantages in using the MVA and ER to judge managerial performance.

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