Jackson Cinemas Co is a long-established chain of cinemas in the country of Taria. Twenty years ago Jackson Cinemas Co's board decided to convert some of its cinemas into sports gyms, known as the jack clubs. The number of jack clubs has expanded since then. JacksonCinemas Co's board brought in outside managers to run the jack clubs, but over the years there have been disagreements between the clubs' managers and the board. The managers have felt that the board has wrongly prioritised investment in, and refurbishment of, the cinemas at the expense of the jack clubs. Five years ago, Jackson Cinemas Co undertook a major refurbishment of its cinemas, financing this work with various types of debt, including loan notes at a high coupon rate of 10%. Shortly after the work was undertaken, Taria entered into a recession which adversely affected profitability. The finance cost burden was high and Jackson Cinemas Co was not able to pay a dividend for two years. The recession is now over and Jackson Cinemas Co has emerged in a good financial position, as two of its competitors went into insolvency during the recession. Jackson Cinemas Co's board wishes to expand its chain of cinemas and open new, multiscreen cinemas in locations which are available because businesses were closed down during the recession. In two years' time Taria is due to host a major sports festival. This has encouraged interest in sport and exercise in the country. As a result, some gym chains are looking to expand and have contacted Jackson Cinemas Co's board to ask if it would be interested in selling the jack clubs. Most of the directors regard the cinemas as the main business and so are receptive to selling the jack clubs. The finance director has recommended that the sales price of the jack clubs be based on predicted free cash flows as follows: 1. The predicted free cash flow figures in $millions for jack clubs are as follows: Year 1 2 3 4 390 419 455 490 2. After Year 4, free cash flows should be assumed to increase at 52% per annum. 3. The discount rate to be used should be the current weighted average cost of capital, which is 12%. 4. The finance director believes that the result of the free cash flow valuation will represent a fair value of the jack clubs' business, but jackson Cinemas Co is looking to obtain a 25% premium on the fair value as the expected sales price. Other information supplied by the finance director is as follows: 1. The predicted after-tax profits of the jack clubs are $454 million in Year 1. This can be assumed to be 40% of total after-tax profits of jack Cinemas Co. 2. The expected proceeds which Jackson Cinemas Co receives from selling the EV clubs will be used firstly to pay off the 10% loan notes. Part of the remaining amount from the sales proceeds will then be used to enhance liquidity by being held as part of current assets, so that the current ratio increases to 15. The rest of the remaining amount will be invested in property, plant and equipment. The current net book value of the non-current assets of the jack clubs to be sold can be assumed to be $3,790 million. The profit on the sale of the jack clubs should be taken directly to reserves. 3. Jackson Cinemas Co's asset beta for the cinemas can be assumed to be 0952. 4. Jackson Cinemas Co currently has 1,000 million $1 shares in issue. These are currently trading at $1575 per share. The finance director expects the share price to rise by 10% once the sale has been completed, as he thinks that the stock market will perceive it to be a good deal. 5. Tradeable debt is currently quoted at $96 per $100 for the 10% loan notes and $93 per $100 for the other loan notes. The value of the other loan notes is not expected to change once the sale has been completed. The overall pre-tax cost of debt is currently 9% and can be assumed to fall to 8% when the 10% loan notes are redeemed. 6. The current tax rate on profits is 20%. 7. Additional investment in current assets is expected to earn a 7% pre-tax return and additional investment in property, plant and equipment is expected to earn a 12% pre-tax return. 8. The current risk-free rate is 4% and the return on the market portfolio is 10%.Jackson Cinemas Co's current summarised statement of financial position is shown below. The CEO wants to know the impact the sale of the jack clubs would have immediately on the statement of financial position, the impact on the Year 1forecast earnings per share and on the weighted average cost of capital. $m Assets Non-current assets 15,621 Current assets 2,347 ------- Total assets 17,968 ------- Equity and liabilities Called-up share capital 1,000 Retained earnings 7,917 ------- Total equity 8,917 ------- Non-current liabilities 10% loan notes 3,200 Other loan notes 2,700 Bank loans 985 ------- Total non-current liabilities 6,885 ------- Current liabilities 2,166 ------- Total equity and liabilities 17,968 ------- Required: (a) Calculate the expected sales price of the jack clubs and demonstrate its impact on Jackson Cinemas Co's statement of financial position, forecast earnings per share and weighted average cost of capital. (b) Evaluate the decision to sell the jack clubs.