ACC00152 Business Finance Assignment 1: Memo to Management 2
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Newpeak Ltd is a large Australian based gold miner with operating mines both in Australia and overseas.
Note. For the purpose of this assignment, Newpeak is a fictitious company but you may assume that the company’s size, operations and risks are similar to those of Newcrest Ltd., Australia’s largest listed gold mining company, and therefore base any required assumptions on the related data of Newcrest Ltd. which can be found in DatAnalysis on the SCU Library website.
Question 1: Cost of Capital (7 marks)
Use the following information to calculate Newpeak’s cost of capital as at 31st December 2015:
Newpeak had $3220m in 10 year bonds outstanding which were trading at 102.5% of their par value. These bonds are rated Baa2 by Moody’s (bond rating agency).
Newpeak had 696m ordinary shares outstanding trading at $15.34 per share and 5m 7% non-voting, non- cumulative preference shares outstanding with a par value of $100 trading at $97.77 per share.
Newpeak had a bank loan of $555m with an interest rate of 4% pa.
Newpeak has a tax rate of 30%.
To estimate Newpeak’s cost of ordinary equity, use the CAPM with a market risk premium of 6% and the 10 year Australian Treasury Bond rate as the risk free rate. Government and corporate bond interest rate information can be found on the F2 & F3 statistical tables on the RBA website. Assume Newpeak’s beta is the same as Newcrest’s and is not expected to change in the near future.
Set out full workings in a clear and logical manner, include an explanation of your method and reference any data from external sources.
Marks for Question 1 will be awarded for appropriate choice of input figures (1.5 marks), correct application of techniques in estimating cost of capital (4 marks), explanation of method and referencing of data sources (1.5 marks).
- (a) Assuming Newpeak’s distribution policy has been similar to Newcrest’s over the last 10 years, explain why the total distribution model would not be appropriate for valuing Newpeak’s shares. (1 mark)
- (b) Calculate the theoretical value of Newpeak’s shares at 31st December 2015 using the discounted free cash flow model. Last year’s EBIT was $1066m and you are forecasting this to grow to $2000m by a constant growth rate over the next 5 years at which point the EBIT should stabilize indefinitely into the future. You can assume that on average new capital expenditures will equal depreciation and there will be no further investment required in net working capital. The company has cash and investments of $837m. The cost of capital will remain the same as calculated in question 1. (3 marks)
- (c) If Newpeak’s earnings per share were $0.81 in 2015, calculate the value for Newpeak’s shares using the multiplier method and the price/earnings ratio for BOTH Newcrest Ltd and the industry and discuss the possible reasons why these values differ from each other and the value calculated in part (b). (2 marks)
- (d) If Newspeak’s current share price is $17.76, explain whether or not you would recommend buying shares in Newpeak. (1 mark)
Question 3: Capital Structure (6 marks)
With interest rates at historic lows, management at Newpeak are proposing a capital restructure whereby the company issues an additional $2000m in 10 year bonds with a coupon rate equal to the current market yield for Newpeak’s existing bonds and plans to use the full amount of the proceeds to repurchase shares.
Answer each of the following:
- (a) Explain how each of the various groups of providers of capital to the firm from question 1 are likely to feel about this decision. (2 marks)
- (b) Assumingtheincreaseintheriskoffinancialdistressandassociatedcostsarenegligible, calculate the initial increase in Newpeak’s share price (currently $17.76) directly as a result of this new debt issuance. Hint: You first need to calculate the increase in the total firm value.
- (c) Using your answer to part (b) calculate how many shares the company should repurchase and the new resulting debt to equity ratio when the repurchases are complete. (1 mark)
- (d) Mining is an inherently risky business. Describe the numerous types of business risks to which Newspeak is exposed and advise on the overall appropriateness of management’s decision regarding the capital restructure. (2 marks)