- Skyview ltd is a manufacturing company that specialises in ski lift systems. The company was incorporated in 2012, and after unprecedented levels of growth was successfully floated on the London Stock Exchange on 1 April 2017 at an issue price of £2.10 per share. The company now requires additional capital of £4 million to fund an expansion programme due to commence in 2022.
The current capital structure of Skyview ltd as at 31 March 2021 is as follows:
- 1,000,000 ordinary £1 shares, currently trading at a market value of 321p ex div. A final dividend of 21p per share has recently been paid. After the first year of floatation, a final dividend of 16p per share had been paid and this level of growth was sustained annually and is expected to continue in the future.
- £2,000,000 of irredeemable debt. This debt has a coupon rate of 8% (pre-tax) and an ex int market value of £78.
- £5,000,000 of redeemable debt. This debt has a coupon rate at 5% (pre-tax) and is redeemable in five years’ time at par. The current ex int market value is £91.
Assume a 30% rate of corporation tax.
REQUIRED
- Calculate the weighted average cost of capital (WACC) for Skyview ltd.
- Explain the relevance of this WACC figure in relation to the investment decision, the financing decision and the dividend decision, and discuss the extent to which the decisions are inter-related.
(c) Evaluate the main arguments in relation to an issue of bonds as a method of raising the finance for the expansion as opposed to an issue of equity shares.
- Experian Holiday Club is considering two potential investments to expand its holiday parks in Europe. Both investments will allow the company to use an existing holiday park for 5 years, after which time a new lease would need to be renegotiated. Details of the two projects are as follows:
| £000s | £000s | |||
| Project: | A | B | ||
| Initial capital investment required: | 65,000 | 140,000 | ||
| Expected profits from the projects: | ||||
| Year 1 | 6,000 | 8,000 | ||
| Year 2 | 13,000 | 29,000 | ||
| Year 3 | 15,000 | 33,000 | ||
| Year 4 | 45,000 | 85,000 | ||
| Year 5 | 60,000 | 145,000 | ||
| Internal Rate of Return (approx.) | 31.35% | – |
In both cases, profits have been calculated by taking the projected cash flows from the projects and deducting depreciation of the initial capital investment on a straight-line basis over 5 years. The normal policy of Experian Holiday Club is not to undertake any project with a payback of more than three years. Because of the high commercial risks involved, funding for either project would only be available at a fixed rate of 20%.
REQUIRED:
- Calculate the Accounting Rate of Return (ARR) and Payback Period of both projects.
- Calculate the Net Present Value of both projects using the company’s required rate of return for discounting purposes.
- Calculate the IRR for project B.
- Assuming that Experian Holiday Club only wishes to undertake one of the projects, which of the two is preferable? Give reasons for your decision and refer
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