Required: (a) (i) Derive the various after tax costs of finance and the overall weighted average cost of capital for both Rosehip plc and Sage plc. (ii) Mr Tea has asked for your advice as he wishes to switch his investment from Rosehip plc to Sage plc but retain his investment profile. Carefully explain showing all calculations what actions Mr Tea would have to take in order to achieve this position. Fully explain your answer. Would you advise Mr Tea to go ahead with such a switch? Also, calculate Mr Tea’s income position in Rosehip plc and Sage plc both before and after the switch. (b) Explain how you would try to estimate the beta factor of a new project with different characteristics to current operations. Discuss the theoretical and practical problems you might encounter.
Required: (a) (i) Derive the various after tax costs of finance and the overall weighted average cost of capital for both Rosehip plc and Sage plc. (ii) Mr Tea has asked for your advice as he wishes to switch his investment from Rosehip plc to Sage plc but retain his investment profile. Carefully explain showing all calculations what actions Mr Tea would have to take in order to achieve this position. Fully explain your answer. Would you advise Mr Tea to go ahead with such a switch? Also, calculate Mr Tea’s income position in Rosehip plc and Sage plc both before and after the switch. (b) Explain how you would try to estimate the beta factor of a new project with different characteristics to current operations. Discuss the theoretical and practical problems you might encounter.
Financial Reporting, Financial Statement Analysis and Valuation
8th Edition
ISBN:9781285190907
Author:James M. Wahlen, Stephen P. Baginski, Mark Bradshaw
Publisher:James M. Wahlen, Stephen P. Baginski, Mark Bradshaw
Chapter10: Forecasting Financial Statement
Section: Chapter Questions
Problem 10PC
Related questions
Question
Required:
(a) (i) Derive the various after tax costs of finance and the overall weighted average cost of capital for both Rosehip plc and Sage plc.
(ii) Mr Tea has asked for your advice as he wishes to switch his investment from Rosehip plc to Sage plc but retain his investment profile. Carefully explain showing all calculations what actions Mr Tea would have to take in order to achieve this position. Fully explain your answer. Would you advise Mr Tea to go ahead with such a switch? Also, calculate Mr Tea’s income position in Rosehip plc and Sage plc both before and after the switch.
(b) Explain how you would try to estimate the beta factor of a new project with different characteristics to current operations. Discuss the theoretical and practical problems you might
encounter.
Transcribed Image Text:Caso Introductlon to questions 4 and 5
There has been much recent volatility within a specific highly technical sector of the
electronic components industry. This industry sector comprises specialist businesses
delivering essential components, custom solutions and highly technical servicing
support. The industry's operating environment has experienced many changes in
recent years, driven by technological developments. This has been both challenging
and exciting for those doing business within the environment.
Rosehip plc, Sage plc and Peppermint plc all operate within this industry. Rosehip
and Sage are the focus of question 4. The focus of question 5 concerns a decision-
making problem of Peppermint.
Question 4
Rosehip plc and Sage plc are two companies that are facing the same business risk.
They have both experienced significant growth in recent years although the
efficiency of the current financial markets is questionable. Rosehip plc had planned
to continue the company's growth trend in 2020 but the Covid-19 pandemic has
restricted that plan to some extent. However, a favourable climate for borrowing has
helped fuel the growth, enabling the management to invest heavily in the one
specific sector.
Despite rumours that Sage plc were considering a reduction in dividend distribution
policy, both Rosehip plc and Sage plc continue to distribute all earnings to their
shareholders. Rosehip plc has operating earnings before interest and tax of £104
million per annum. The company is financed by 61 million ordinary shares with a
market value of 420p each and by £204 million 10% irredeemable debentures with a
current market value of £150 per £100 nominal.
Sage plc is financed by 16 million ordinary shares with a market value of 610p each
and by £64 million 5% irredeemable debentures currently trading at 75 percent. Sage
plc has operating earnings before interest and tax of £27.5 million per annum.
Mr Tea is a shareholder in Rosehip plc, with a holding of 12,810 ordinary shares. Mr
Tea is thinking of selling his shares in Rosehip plc and buying shares in Sage plc, as
he believes he may be able to make a capital gain by doing so. Mr Tea is confident
that he is able to borrow or lend at a very competitive rate of interest.
The rate of corporation tax is 25%.
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