Albie plc is a UK manufacturing company funded by ordinary share equity and irredeemable loan notes, and both types of funding are traded on exchanges. Ordinary shareholders who invest in Albie plc expect annual dividends which grow each year. The company's financial year runs from 1st April to 31st March. The company is considering a major investment in a new product and it needs to calculate an appropriate discount rate to use in a net present value CAPEX appraisal. A decision has been made to spend some time identifying and determining an optimal capital structure-based weighted average cost of capital (WACC), and then applying that WACC as the NPV discount factor. This decision has resulted in some disagreement within the senior management team. One director, Director X, is of the view that to spend time identifying and determining an optimal capital structure-based WACC would be inappropriate and strongly suggests that the new investment should be financed out of retained profits, and thus the equity cost of capital should be used. That director acknowledges that the company has loans but argues that the loan notes were issued many years ago and the cash raised then has already been spent. Another director, Director Y, is also of the view that to spend some time identifying and determining an optimal capital structure-based WACC is inappropriate as there is no such thing as an optimal capital structure, and the loans should play a more significant role in calculating the projected NPV of the proposed new project. Another director, Director Z, is if the view that in determining WACC, it is important to determine the cost of ordinary equity to subsequently include it in the WACC calculation, and that the Capital Asset Pricing Model (CAPM) is the most appropriate way of doing that On 31st March 2022 Albie plc's share price was 165p (ex-dividend) and the 7% loan notes were quoted at 85 per 100 nominal. The loan notes are irredeemable. Both the ordinary shares dividend of 15 million, and the loan notes interest for the year ended 31st March 2022 have already been paid. Ordinary share dividends have been growing at 5% annually over recent years. The company pays annual corporation tax at the rate of 20%. The draft financial statements for Albie plc are detailed immediately below. Albie plc Income Statement for Year to 31 March 2022 million Revenue 735 less Annual expenses -603 Operating profit (EBIT) 132 less Loan interest -7 Profit before tax (net profit) 125 less Taxation -25 Profit for the year 100 Albie plc Statement of financial position as 31 March 2022 million Non-current assets Current asssets 460 Total assets 900 440 Equity Ordinary shares issues with 0.50 nominal value Share premium Retained profits Total equity 150 50 350 550 Non-current liabilities 7% irredeemable loan notes at nominal value 100 Current liabilities 250 Total equity + liabilities 900 Required a) Determine the company's WACC, at 31st March 2022, based on the information provided. Explain any assumptions made and justify all figures used. In your calculations, round to two (2) decimal places. [6 marks] b) Discuss and contrast the comments made by Directors X and Y. In so doing draw upon theoretical arguments underpinning the capital structure debate. (10 marks] c) Explain the nature of the Capital Asset Pricing Model (CAPM) and illustrate how it may be used to determine the cost of ordinary equity. [4 marks] [TOTAL 20 Marks] DISCOUNT TABLES 1% 2% 3% 4% 5% 6% 7% 8% 9% 10% Rate Year 0 1 2 3 4 5 6 1.000 0.990 0.980 0.971 0.961 0.951 0.942 0.933 0.923 0.914 0.905 1.000 0.980 0.961 0.942 0.924 0.906 0.888 0.871 0.853 0.837 0.820 1.000 1.000 0.971 0.962 0.943 0.925 0.915 0.889 0.888 0.855 0.863 0.822 0.837 0.790 0.813 0.760 0.789 0.731 0.766 0.703 0.744 0.676 1.000 0.952 0.907 0.864 0.823 0.784 0.746 0.711 0.677 0.645 0.614 1.000 0.943 0.890 0.840 0.792 0.747 0.705 0.665 0.627 0.592 0.558 1.000 0.935 0.873 0.816 0.763 0.713 0.666 0.623 0.582 0.544 0.508 1.000 0.926 0.857 0.794 0.735 0.681 0.630 0.583 0.540 0.500 0.463 1.000 0.917 0.842 0.772 0.708 0.650 0.596 0.547 0.502 0.460 0.422 1.000 0.909 0.826 0.751 0.683 0.621 0.564 0.513 0.467 0.424 0.386 7 8 9 10 11% 12% 13% 14% 15% 16% 17% 18% 19% 20% Rate Year 0 1 2 3 4 5 1.000 0.901 0.812 0.731 0.659 0.593 0.535 0.482 0.434 0.391 0.352 1.000 0.893 0.797 0.712 0.636 0.567 0.507 0.452 0.404 0.361 0.322 1.000 0.885 0.783 0.693 0.613 0.543 0.480 0.425 0.376 0.333 0.295 1.000 0.877 0.769 0.675 0.592 0.519 0.456 0.400 0.351 0.308 0.270 1.000 0.870 0.756 0.658 0.572 0.497 0.432 0.376 0.327 0.284 0.247 1.000 0.862 0.743 0.641 0.552 0.476 0.410 0.354 0.305 0.263 0.227 1.000 0.855 0.731 0.624 0.534 0.456 0.390 0.333 0.285 0.243 0.208 1.000 0.847 0.718 0.609 0.516 0.437 0.370 0.314 0.266 0.225 0.191 1.000 0.840 0.706 0.593 0.499 0.419 0.352 0.296 0.249 0.209 0.176 1.000 0.833 0.694 0.579 0.482 0.402 0.335 0.279 0.233 0.194 0.162 6 7 8 9 10 Albie plc is a UK manufacturing company funded by ordinary share equity and irredeemable loan notes, and both types of funding are traded on exchanges. Ordinary shareholders who invest in Albie plc expect annual dividends which grow each year. The company's financial year runs from 1st April to 31st March. The company is considering a major investment in a new product and it needs to calculate an appropriate discount rate to use in a net present value CAPEX appraisal. A decision has been made to spend some time identifying and determining an optimal capital structure-based weighted average cost of capital (WACC), and then applying that WACC as the NPV discount factor. This decision has resulted in some disagreement within the senior management team. One director, Director X, is of the view that to spend time identifying and determining an optimal capital structure-based WACC would be inappropriate and strongly suggests that the new investment should be financed out of retained profits, and thus the equity cost of capital should be used. That director acknowledges that the company has loans but argues that the loan notes were issued many years ago and the cash raised then has already been spent. Another director, Director Y, is also of the view that to spend some time identifying and determining an optimal capital structure-based WACC is inappropriate as there is no such thing as an optimal capital structure, and the loans should play a more significant role in calculating the projected NPV of the proposed new project. Another director, Director Z, is if the view that in determining WACC, it is important to determine the cost of ordinary equity to subsequently include it in the WACC calculation, and that the Capital Asset Pricing Model (CAPM) is the most appropriate way of doing that On 31st March 2022 Albie plc's share price was 165p (ex-dividend) and the 7% loan notes were quoted at 85 per 100 nominal. The loan notes are irredeemable. Both the ordinary shares dividend of 15 million, and the loan notes interest for the year ended 31st March 2022 have already been paid. Ordinary share dividends have been growing at 5% annually over recent years. The company pays annual corporation tax at the rate of 20%. The draft financial statements for Albie plc are detailed immediately below. Albie plc Income Statement for Year to 31 March 2022 million Revenue 735 less Annual expenses -603 Operating profit (EBIT) 132 less Loan interest -7 Profit before tax (net profit) 125 less Taxation -25 Profit for the year 100 Albie plc Statement of financial position as 31 March 2022 million Non-current assets Current asssets 460 Total assets 900 440 Equity Ordinary shares issues with 0.50 nominal value Share premium Retained profits Total equity 150 50 350 550 Non-current liabilities 7% irredeemable loan notes at nominal value 100 Current liabilities 250 Total equity + liabilities 900 Required a) Determine the company's WACC, at 31st March 2022, based on the information provided. Explain any assumptions made and justify all figures used. In your calculations, round to two (2) decimal places. [6 marks] b) Discuss and contrast the comments made by Directors X and Y. In so doing draw upon theoretical arguments underpinning the capital structure debate. (10 marks] c) Explain the nature of the Capital Asset Pricing Model (CAPM) and illustrate how it may be used to determine the cost of ordinary equity. [4 marks] [TOTAL 20 Marks] DISCOUNT TABLES 1% 2% 3% 4% 5% 6% 7% 8% 9% 10% Rate Year 0 1 2 3 4 5 6 1.000 0.990 0.980 0.971 0.961 0.951 0.942 0.933 0.923 0.914 0.905 1.000 0.980 0.961 0.942 0.924 0.906 0.888 0.871 0.853 0.837 0.820 1.000 1.000 0.971 0.962 0.943 0.925 0.915 0.889 0.888 0.855 0.863 0.822 0.837 0.790 0.813 0.760 0.789 0.731 0.766 0.703 0.744 0.676 1.000 0.952 0.907 0.864 0.823 0.784 0.746 0.711 0.677 0.645 0.614 1.000 0.943 0.890 0.840 0.792 0.747 0.705 0.665 0.627 0.592 0.558 1.000 0.935 0.873 0.816 0.763 0.713 0.666 0.623 0.582 0.544 0.508 1.000 0.926 0.857 0.794 0.735 0.681 0.630 0.583 0.540 0.500 0.463 1.000 0.917 0.842 0.772 0.708 0.650 0.596 0.547 0.502 0.460 0.422 1.000 0.909 0.826 0.751 0.683 0.621 0.564 0.513 0.467 0.424 0.386 7 8 9 10 11% 12% 13% 14% 15% 16% 17% 18% 19% 20% Rate Year 0 1 2 3 4 5 1.000 0.901 0.812 0.731 0.659 0.593 0.535 0.482 0.434 0.391 0.352 1.000 0.893 0.797 0.712 0.636 0.567 0.507 0.452 0.404 0.361 0.322 1.000 0.885 0.783 0.693 0.613 0.543 0.480 0.425 0.376 0.333 0.295 1.000 0.877 0.769 0.675 0.592 0.519 0.456 0.400 0.351 0.308 0.270 1.000 0.870 0.756 0.658 0.572 0.497 0.432 0.376 0.327 0.284 0.247 1.000 0.862 0.743 0.641 0.552 0.476 0.410 0.354 0.305 0.263 0.227 1.000 0.855 0.731 0.624 0.534 0.456 0.390 0.333 0.285 0.243 0.208 1.000 0.847 0.718 0.609 0.516 0.437 0.370 0.314 0.266 0.225 0.191 1.000 0.840 0.706 0.593 0.499 0.419 0.352 0.296 0.249 0.209 0.176 1.000 0.833 0.694 0.579 0.482 0.402 0.335 0.279 0.233 0.194 0.162 6 7 8 9 10