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...

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 Sity’s 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.