32 DD Co has a dividend payout ratio of 40% and has maintained this payout ratio for several years. The current dividend per share of the company is $050 per share and it expects that its next dividend per share, payable in one year's time, will be $052 per share.

The capital structure of the company is as follows: $m $m

Equity Ordinary shares (nominal value $1 per share) = 25

Reserves35-- 60

Debt Bond A (nominal value $100)20

Bond B (nominal value $100)10--- 30

--- 90

Bond A will be redeemed at nominal in ten years' time and pays annual interest of 9%. The cost of debt of this bond is 983% per year. The current ex interest market price of the bond is $9508. Bond B will be redeemed at nominal in four years' time and pays annual interest of 8%. The cost of debt of this bond is 782% per year. The current ex interest market price of the bond is $10201. DD Co has a cost of equity of 124%. Ignore taxation.

Required: (a) Calculate the following values for DD Co:

(i) ex dividend share price, using the dividend growth model; (3 marks)

(ii) capital gearing (debt divided by debt plus equity) using market values; and (2 marks)

(iii) market value weighted average cost of capital. (2 marks) (b) Discuss whether a change in dividend policy will affect the share price of DD Co. (8 marks) (c) Explain why DD Co's capital instruments have different levels of risk and return. (5 marks)

(20 marks)

33. PV Co, a large stock-exchange-listed company, is evaluating an investment proposal to manufacture Product W33, which has performed well in test marketing trials conducted recently by the company's research and development division. Product W33 will be manufactured using a fully-automated process which would significantly increase noise levels from PV Co's factory. The following information relating to this investment proposal has now been prepared:

Initial investment = $2 million

Selling price (current price terms) = $20

per unit Expected selling price inflation = 3% per year

Variable operating costs (current price terms) = $8 per unit

Fixed operating costs (current price terms) = $170,000 per year

Expected operating cost inflation = 4% per year

The research and development division has prepared the following demand forecast as a result of its test marketing trials. The forecast reflects expected technological change and its effect on the anticipated life-cycle of Product W33. Year 1 2 3 4 Demand (units) 60,000 70,000 120,000 45,000

It is expected that all units of Product W33 produced will be sold, in line with the company's policy of keeping no inventory of finished goods. No terminal value or machinery scrap value is expected at the end of four years, when production of Product W33 is planned to end. For investment appraisal purposes, PV Co uses a nominal (money) discount rate of 10% per year and a target return on capital employed of 30% per year. Ignore taxation.

Required:

(a) Calculate the following values for the investment proposal:

(i) net present value; (5 marks)

(ii) internal rate of return; and (3 marks)

(iii) return on capital employed (accounting rate of return) based on average investment. (3 marks)

(b) Briefly discuss your findings in each section of (a) above and advise whether the investment proposal is financially acceptable. (4 marks)

(c) Discuss how the objectives of PV Co's stakeholders may be in conflict if the project is undertaken. (5 marks) (20 marks)