Question One:

Question 4 Pegasus Ltd is a wholly-owned subsidiary of Sarkar plc. Although the subsidiary has performed satisfactorily, Sarkar plc is considering selling its subsidiary to another conglomerate in order to raise finance. The most recent balance sheet of Pegasus Ltd is as follows: Statement of financial position (balance sheet) as at 30 September 20X4 Em Em Em Fixed assets Freehold land and buildings at cost 53.5 Less Accumulated depreciation 10.2 43.3 Fixtures and fittings at cost 8.6 Less Accumulated depreciation 2.9 5.7 Motor vehicles at cost 3.2 Less Accumulated depreciation 1.4 1.8 50.8 Current assets Stock at cost 47.5 Trade debtors 23.4 Cash at bank 21.5 92.4 Less Creditors: amounts falling due within one year Trade creditors 25.9 Corporation tax 5.4 |31.3 61.1 111.9 Less Creditors: amounts falling due after one year Debentures 49.0 62.9Assume that you are assisting financial VP, Jake Lewis of Spencer Technologies (ST). Your first task is to estimate ST's cost of capital. Mr Lewis has provided you with the following data, which he believes is relevant to your task: (1) The firm's marginal tax rate is 40%. (2) The current price of ST's noncallable bond (12 % per annum coupon with 15 years remaining to maturity) is $1, 153.72. ST does not use short-term interest-bearing debt on a permanent basis. New bonds would be privately placed with no flotation cost. (3) The current price of the firm's preferred stock (10%, $100 par value, perpetual quarterly dividend) is f113.10. ST would incur flotation costs of $2 per share on a new issue of preferred stock. (4) ST's common stock is currently selling at $50 per share. Its last dividend (DO) was $4.19, and dividends are expected to grow at a constant rate of 5% in the near future. ST's beta is 1.2, the yield on Treasury bonds is 7%, and the market risk premium is estimated to be 6%. The firm uses a four percentage point risk premium under the bond-yield-plus-risk- premium approach. (5) The floatation cost of issuing new common stock is 15% for value up to $300,000 and 25% for value above $300,000 (6) ST's target capital structure is 30% long-term debt, 10% preferred stock, and 60% common equity. (7) The forecast retained earnings for the coming year are $300,000. To structure the task somewhat, Lewis has asked you to answer the following questions: a. (1) What is the market interest rate on ST's debt and its component cost of debt? (2) What is the firm's cost of preferred stock? b. (1) What is ST's estimated cost of retained earnings using the CAPM approach? (2) What is ST's overall, or weighted average, cost of capital (WACC) when retained earnings are used as the equity component?Capital and reserves Ordinary $0.50 shares 25.0 Retained profit 37.9 62.9 Extracts from the profit and loss account for the year ended 30 September 20X4 are as follows: Em Net profit after taxation 9.3 Dividend proposed and paid 3.3 A bid of $3.50 per share for the shares in Pegasus Ltd has been received from Coric plc. The agreed price would be paid in shares by the bidding company. The following details were taken from a financial newspaper concerning the shares of Zing Ltd, a business similar to Pegasus (?) operating in the same industry that is listed on the Stock Exchange and Coric plc, the conglomerate company that has made the bid: 20X3-20X4 High Low Stock Price Dividend Cover Yield P/E (net (times (gross%) (times) 640p 580 Zing 615p +5p 12.0p 2.5 2.2 20.5 1089p 530p Coric 1089p +2p 15.0p 3.0 1.5 24.2 An independent valuer has recently estimated the current realisable value of the company's (Peagasus) assets as follows: Em Freehold land and buildings 104.2 Fixtures and fittings 3.5 Motor vehicles 0.4 Stocks 58.0 The balance sheet values of the remaining assets were considered to reflect their net realisable values. Tax on dividends is assumed to be at a rate of 10%. Required: (a) Calculate the value per share of Pegasus Lid using the following valuation methods: (i) net assets (liquidation) basis; and (ii) price/earnings ratio basis. (b) Briefly evaluate the strengths and weaknesses of each of the share valuation methods set out in (a) above. (c) Comment on the bid that has been received from Coric plc and explain whether or not the bid should be accepted