Theory of Finance

TUTORIAL QUESTION PACK AC690 JANUARY 2012

Question 1

Big Plans PLC is a successful company, manufacturing medical devices, which it sells into four large US multinationals operating out of Ireland. Profit before corporation tax and preference dividend at year end 31 December 2009 is expected to be €3,840,000. Earnings have been constant for the last number of years and are always fully distributed.

The directors of Big Plans PLC are considering an expansion. Budgets have been completed and the expansion is expected to cost €1,000,000 in up front costs and to return additional profits of €240,000 per year before tax and interest from the start of 2010.

If the expansion plan goes ahead the company will change its dividend policy and distribute only 50% of profits available for distribution. If the expansion does not proceed, the company will continue to distribute all of its profits available for distribution. Earnings for 2010 will continue at €3,840,000.

To fund this expansion, Big Plans PLC is considering issuing 12% irredeemable debentures at par. The company’s existing capital structure has the following book value:

Issued ordinary share capital, €0.50 nominal value €3,000,000

Issued 5% (irredeemable) Preference shares €1 nominal value €6,000,000

The current market value, at 31 December 2009, of Ordinary and Preference shares is €2 and €0.80 respectively (ex-dividend).

The rate of corporation tax may be assumed to be 12.5%.

Requirements:

a) Calculate the current weighted average cost of capital (WACC) at the 31 December 2009 for Big Plans PLC, using the market values of the capital mix on the basis that the expansion project does not go ahead.

(20 marks)

b) Calculate the WACC on the 31 December 2010 on the basis that the debentures have been issued and the expansion has occurred. The market value for ordinary shares and preference shares remain the same at the 31 December 2010 as they were at the 31 December...