Reference no: EM131532282

Question 1

Note: This WACC question is a little longer than usual to give you the opportunity to practice multiple elements of the topic. In the actual exam, you can expect this question to be a little shorter to accommodate a maximum mark of 10. Typically the calculation components will comprise a maximum of 8 marks, and the discussion/ theory component to a maximum of 2 marks.

Crown Resorts wish to determine its after-tax Weighted Average Cost of Capital (WACC) so it can evaluate the feasibility of investment projects. The following sections outline information derived from the most recent balance sheet for the financial year.

Debentures

The company has issued $2,500 million worth of debentures with a face value of $100 each. These contacts promise investors a coupon rate of 4.4% p.a. on a quarterly basis. The debentures will mature in 60 years, and are currently trading at a market price of $73 each.

Bank loan

Crown has outstanding bank loans to the value of $110 million. The company expects to make monthly repayments of $790,000 for 30 years.

Preference shares

The company has 20 million preference shares on issue, trading at a market price of $68 per share. Preference shareholders receive a fixed dividend of $6.20 each year. These shares have a par value of $100 each.

Ordinary shares

The current market valuation of Crown Resorts shares on the ASX is $10.05 each. The company has 750 million ordinary shares on issue (par value of $1 each), and recently paid a $0.25 semi-annual dividend. The company's directors are optimistic that future earnings and dividend growth will continue at a rate of 6% p.a.

1. Determine the after-tax costs of debt for the debentures and the bank loan.
2. Determine the after-tax costs of equity for the preference and ordinary shares.
3. Determine the weights necessary to compute the WACC.
4. Discuss if it is more appropriate to use book values or market values to determine the weights and why.
5. Calculate the after-tax WACC for your company.
6. Discuss two assumptions necessary for Crown Resorts to use this WACC to evaluate future investment projects.

Question 2

Note: This question is a little longer than usual to give you the opportunity to practice multiple elements of the Time Value of Money concept. In the actual exam, you can expect this question to be a little shorter to accommodate a maximum mark of 10.

Complete the following questions.

(a) Ordinary share

Beeker Software Solutions recently paid its shareholders a $0.58 annual dividend. The company recently launched a new smartphone application, doubling battery life for users. The company's management expects dividends to grow at an accelerated rate of 8% p.a. for the next three years, then slow to a rate of 4% p.a. thereafter. The current market price for the company's shares is $7.20.

Determine the fair value of these shares to you, given your required rate of return is 13% p.a. Then discuss if you would invest in the ordinary shares of Beeker Software Solutions.

(b) Corporate bond

Beeker Software Solutions recently issued corporate bonds, each with a face value of $100,000. These bonds pay semi-annual coupons at a rate of 9.2% p.a., and have 6 years remaining till maturity. The bonds are currently selling at a price of $115,000 each.

Determine the fair value of these bonds to you, given your required rate of return is 10.5% p.a. Then discuss if you would invest in the corporate bonds of Beeker Software Solutions.

(c) Deferred perpetuity

Beeker Software Solutions recently announced that it will delay payment of semi-annual dividends to preference shareholders for three years, to free up funding during this growth phase. When dividend payments resume, the company promises to distribute $12 s.a. for each issued preference share. These shares are currently trading in the market at a price of $150 per share.

Your required rate of return is 11% p.a. Determine the fair value of these shares to you, and discuss if you would invest in the preference shares of Beeker Software Solutions.

(d) Annuity due

Would you invest in an asset promising equal payments of $190 at the start of each month, for five years, if your required rate of return is 10.8% p.a. and the investment will cost $9,000 to purchase?

(e) Integrated Time Value of Money problem

You plan to set aside an equal amount at the start of each fortnight for the next three years to buy a house. You expect to earn an interest rate of 6.5% p.a. compounding fortnightly.

The price of a three bedroom house in Butler currently averages at $420,000. Property market analysts forecast prices in the suburb will grow at a rate of 2% p.a. over the next few years.

You hope to use the accumulated funds as a deposit for a home loan. Suppose that a bank will lend you the balance needed for the purchase (minus the deposit). You expect the interest rate on your home loan to be 7.8% p.a. compounding weekly. You play to repay your home loan over a 25 year period on a weekly basis. You determine that you can afford to repay $700 at the end of each week over the term of your home loan.

How much should you set aside at the start of each fortnight for the next three years in order to save for the deposit needed to service the home loan under the conditions stated?