Homage Corp. has two major operating divisions, manufacturing and property sales with turnovers (sales revenue) of $260 million and $620 million respectively. Balance sheet for Homage Corp $ million Land and buildings 78.4 Plant and machinery 140.0 Current assets 245.2 Total Assets 463.6 Current liabilities Long term Bank loan 5.568% 20-year semi-annual Coupon bond ($1000 par) Total Liabilities Common shares ($2.50 par) Retained earnings Total Owners' equity Total equity and liabilities 180.0 53.6 50.0 283.6 50.0 130.0 180.0 463.6 The coupon bond is currently trading at 118.4. The bond was issued 4 years ago. The current percent cost of the coupon bond and bank loan are almost identical. The marginal corporate tax rate is 25%. Tax is payable in the year that the relevant cash flow arises. Summarized cash flow data for Homage Corp $ million Cash turnover Divisional operating expenses 803 Central costs Interest charges Tax expense 14 Dividends 15 880 8 11 The current share price of Homage is $29.60. Homage's equity beta is 1.15. The historical risk free rate has averaged 4.0% and the market portfolio return is 12%. The projected real, pre-tax financial data ($ million) of the two divisions are as follows: Year 0 1 2 3 4 5 6 onwards Manufacturing Operating net cash flows 54 57 62 60 65 70 Allocated central costs 4 4 4 4 4 Tax deductible depreciation 13 11 8 Net working capital 68 75 92 100 95 102 80 4 10 8 8 Property sales Operating net cash flows Allocated central costs Tax deductible depreciation Net working capital 42 4 5 55 48 3 5 72 50 3 5 63 54 3 5 50 56 3 5 65 60 3 5 70 45 -In deriving before-tax operating net cash flows, allocated central costs, tax deductible depreciation and net working capital have not been considered. Allocated central costs reflect actual operating expenses. -General inflation rate is expected to remain at approximately 2.8% per year. Homage is considering a demerger whereby the two divisions are floated separately on the stock market. The coupon bond debt would be serviced by the property division and the bank loan debt would be serviced by the manufacturing division. The average equity betas in the manufacturing and property sectors are 1.578 and 1.7815 respectively. The gearing levels (by market values) in manufacturing sector are 35% debt, 65% equity while the gearing in the property sales are 50% equity, 50% debt. -A demerger would involve a one-off after tax cost of $16 million in year one which would be split evenly between the two companies. There would be no other significant impact on expected cash flows. -If the demerger occurs, the allocated central costs would rise to $6 million per year for each company. Required: (a) Compute the market value of Homage Corp. and its debt-to-equity ratio. What is the WACC of Homage? (10 points) (6) Using real cash flows, evaluate whether or not it is expected to be financially advantageous to the original shareholders of Homage Corp. for the company to separately float the two divisions on the stock market. Your evaluation should use both time horizons of Year 1-15 and Year 1, 2, 3, 4, 5, 6-perpetuity In any gearing estimates, the manufacturing division may be assumed to comprise 60% of the market value of equity of Homage Corp., and the property sales division 40%. Show all your computations to earn full credit. State clearly any three assumptions that you make in your analysis. (30 marks) c) State and briefly explain 5 pieces of additional information and analysis that would assist in the decision process (10 points) Homage Corp. has two major operating divisions, manufacturing and property sales with turnovers (sales revenue) of $260 million and $620 million respectively. Balance sheet for Homage Corp $ million Land and buildings 78.4 Plant and machinery 140.0 Current assets 245.2 Total Assets 463.6 Current liabilities Long term Bank loan 5.568% 20-year semi-annual Coupon bond ($1000 par) Total Liabilities Common shares ($2.50 par) Retained earnings Total Owners' equity Total equity and liabilities 180.0 53.6 50.0 283.6 50.0 130.0 180.0 463.6 The coupon bond is currently trading at 118.4. The bond was issued 4 years ago. The current percent cost of the coupon bond and bank loan are almost identical. The marginal corporate tax rate is 25%. Tax is payable in the year that the relevant cash flow arises. Summarized cash flow data for Homage Corp $ million Cash turnover Divisional operating expenses 803 Central costs Interest charges Tax expense 14 Dividends 15 880 8 11 The current share price of Homage is $29.60. Homage's equity beta is 1.15. The historical risk free rate has averaged 4.0% and the market portfolio return is 12%. The projected real, pre-tax financial data ($ million) of the two divisions are as follows: Year 0 1 2 3 4 5 6 onwards Manufacturing Operating net cash flows 54 57 62 60 65 70 Allocated central costs 4 4 4 4 4 Tax deductible depreciation 13 11 8 Net working capital 68 75 92 100 95 102 80 4 10 8 8 Property sales Operating net cash flows Allocated central costs Tax deductible depreciation Net working capital 42 4 5 55 48 3 5 72 50 3 5 63 54 3 5 50 56 3 5 65 60 3 5 70 45 -In deriving before-tax operating net cash flows, allocated central costs, tax deductible depreciation and net working capital have not been considered. Allocated central costs reflect actual operating expenses. -General inflation rate is expected to remain at approximately 2.8% per year. Homage is considering a demerger whereby the two divisions are floated separately on the stock market. The coupon bond debt would be serviced by the property division and the bank loan debt would be serviced by the manufacturing division. The average equity betas in the manufacturing and property sectors are 1.578 and 1.7815 respectively. The gearing levels (by market values) in manufacturing sector are 35% debt, 65% equity while the gearing in the property sales are 50% equity, 50% debt. -A demerger would involve a one-off after tax cost of $16 million in year one which would be split evenly between the two companies. There would be no other significant impact on expected cash flows. -If the demerger occurs, the allocated central costs would rise to $6 million per year for each company. Required: (a) Compute the market value of Homage Corp. and its debt-to-equity ratio. What is the WACC of Homage? (10 points) (6) Using real cash flows, evaluate whether or not it is expected to be financially advantageous to the original shareholders of Homage Corp. for the company to separately float the two divisions on the stock market. Your evaluation should use both time horizons of Year 1-15 and Year 1, 2, 3, 4, 5, 6-perpetuity In any gearing estimates, the manufacturing division may be assumed to comprise 60% of the market value of equity of Homage Corp., and the property sales division 40%. Show all your computations to earn full credit. State clearly any three assumptions that you make in your analysis. (30 marks) c) State and briefly explain 5 pieces of additional information and analysis that would assist in the decision process (10 points)