Petalt plc wishes to carry out

Petalt plc wishes to carry out a shareholder value analysis for which it has gathered the information shown in the table below:

The managers do not yet know the but do have the following information. The capital is in three forms:

1. A floating-rate bank loan for £1 m at 2 per cent over bank base rate. Base rates are currently 9 per cent.

2. A 25-year vanilla bond issued 20 years ago at par (£100) raising £lm. The bond has an annual of 5 per cent and is currently trading at £80. The next is due in one year.

3. Equity capital with a market value of £2m.

Latest annual sales £lm

Sales growth rate ………………………………………. 10%

Operating profit margin before tax ……………………. 10%

Tax rate on corporate profits …………………………… 31%

Incremental fixed capital investment ………………….. 17% of sales change

Incremental working capital investment ………………. 6% of sales change

Planning horizon ………………………………………. 5 years

The rate of return available by purchasing long-term government securities is currently 6 per cent and the average risk premium for shares over the risk-free rate has averaged 5 per cent. Petalt’s shares have an above-average risk and its historic beta as measured by the co-movement of its shares and the market index correctly reflects the risk adjustment necessary to the average risk premium – this is 1.3.

Required

a. Calculate the cost of bond finance.

b. Calculate the finance.

c. Calculate the weighted average Calculate shareholder value using Rappaport’s method.

e. Conduct sensitivity analysis on the calculated shareholder value by altering the operating profit margin and the number of years in the planning horizon. Show a table containing alternative profit margin assumptions and planning horizon assumptions.

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