QUESTION TWO You have been recently recruited as a financial analyst by ALG Inc., a boutique investment bank based in London. You have been assigned to assist one of its biotechnology start up clients, Baylor plc., having recently floated on the London Stock Exchange through an IPO, is currently planning to increase its production capacity through a significant investment in a new virus research laboratory. The senior associate director has assigned you as the primary liaison manager of this client, given your financial management training. Shortly, later that day, you receive the following email: Jeremy Stanway, Finance Director Baylor plc. Birmingham. Our Ref.: 310522-ALG01 May 1st, 2022. J. Kamantakis, Financial Analyst, Baylor Liaison Manager, ALG Inc., London. Dear Kamantakis, Re.: Financing for Proposed Expansion Project I have been informed that you manage our account with ALG. My name is Jeremey Stanway, and I am the Finance Director at Baylor plc. Following a meeting of the Board of Directors we are currently planning to increase our production capacity through a significant investment in a new virus research laboratory. I am proposing to finance the project with long term funding in the form of a mix of new equity and new 5% irredeemable debentures. I am currently considering the matter of the cost of capital for this particular investment project as I consider the company's existing weighted average cost of capital (WACC) to be the appropriate discount rate to employ in appraising the proposed investment. I have obtained the following up to date information from our records: 1. The company has 130 million 1 ordinary shares in issue, which are currently trading at 250p per share. 2. An annual dividend of 13.6p per share has just been paid which compares with an annual dividend of 10.0p per share paid four years ago. 3. The company has 125 million of 4% redeemable debentures in issue, which are currently trading ex-interest, at 98 per 100 of debentures, and are redeemable at par in five years' time. 4. The corporation tax can be assumed to be 17% for the foreseeable future. 5. The beta of Baylor is estimated to be 3.25. 6. The 91-day Treasury bill with face value of 1,000 has been trading, on average, at 990 for some weeks. 7. I have employed a 364-day count for the calendar year. 8. The regulations recently introduced by the government, to encourage investment in this industry, mean that a 100% writing down allowance is available in the year that any fixed assets are purchased, provided it is for sole use in the bio-technology industry. I hope you will move this project forward and look forward to hearing from you. Yours sincerely, Jeremy Stanway, Finance Director Baylor plc. Birmingham. REQUIRED: It would be of immense help if you would respond by submitting to the Board of Baylor a report that incorporates ALG's formal banking advice: a) on Baylor's prevailing WACC, with supporting calculations and including the following computed items in your calculations: i. growth rate, g. ii. dividend yield. iii. cost of equity. iv. internal rate of return on the redeemable debentures. V. Pre-tax cost of debt. vi. Post-tax cost of debt. (21 marks) b) of the difficulties that Baylor might face when attempting to calculate the WACC. (5% marks) c) on the following dissenting opinions formally recorded in the minutes at the previous meeting of the Board of Directors. i. Baylor's Managing Director (MD) has, however, expressed some concerns regarding the proposed financing of the new factory. The MD feels that the company should use only debt to finance its future projects in order to maximise the wealth of the shareholders. He feels that the finance for this project should be raised solely through a new issue of 5% irredeemable debentures and that the debenture interest rate of 5% should, therefore, be the appropriate discount rate to employ in appraising the new investment. ii. Production Director (PD), on the other hand, cannot understand why the company should be concerned about the cost of capital when it has access to retained profits, as they have no cost. (7 marks) (TOTAL MARKS -33%) QUESTION TWO You have been recently recruited as a financial analyst by ALG Inc., a boutique investment bank based in London. You have been assigned to assist one of its biotechnology start up clients, Baylor plc., having recently floated on the London Stock Exchange through an IPO, is currently planning to increase its production capacity through a significant investment in a new virus research laboratory. The senior associate director has assigned you as the primary liaison manager of this client, given your financial management training. Shortly, later that day, you receive the following email: Jeremy Stanway, Finance Director Baylor plc. Birmingham. Our Ref.: 310522-ALG01 May 1st, 2022. J. Kamantakis, Financial Analyst, Baylor Liaison Manager, ALG Inc., London. Dear Kamantakis, Re.: Financing for Proposed Expansion Project I have been informed that you manage our account with ALG. My name is Jeremey Stanway, and I am the Finance Director at Baylor plc. Following a meeting of the Board of Directors we are currently planning to increase our production capacity through a significant investment in a new virus research laboratory. I am proposing to finance the project with long term funding in the form of a mix of new equity and new 5% irredeemable debentures. I am currently considering the matter of the cost of capital for this particular investment project as I consider the company's existing weighted average cost of capital (WACC) to be the appropriate discount rate to employ in appraising the proposed investment. I have obtained the following up to date information from our records: 1. The company has 130 million 1 ordinary shares in issue, which are currently trading at 250p per share. 2. An annual dividend of 13.6p per share has just been paid which compares with an annual dividend of 10.0p per share paid four years ago. 3. The company has 125 million of 4% redeemable debentures in issue, which are currently trading ex-interest, at 98 per 100 of debentures, and are redeemable at par in five years' time. 4. The corporation tax can be assumed to be 17% for the foreseeable future. 5. The beta of Baylor is estimated to be 3.25. 6. The 91-day Treasury bill with face value of 1,000 has been trading, on average, at 990 for some weeks. 7. I have employed a 364-day count for the calendar year. 8. The regulations recently introduced by the government, to encourage investment in this industry, mean that a 100% writing down allowance is available in the year that any fixed assets are purchased, provided it is for sole use in the bio-technology industry. I hope you will move this project forward and look forward to hearing from you. Yours sincerely, Jeremy Stanway, Finance Director Baylor plc. Birmingham. REQUIRED: It would be of immense help if you would respond by submitting to the Board of Baylor a report that incorporates ALG's formal banking advice: a) on Baylor's prevailing WACC, with supporting calculations and including the following computed items in your calculations: i. growth rate, g. ii. dividend yield. iii. cost of equity. iv. internal rate of return on the redeemable debentures. V. Pre-tax cost of debt. vi. Post-tax cost of debt. (21 marks) b) of the difficulties that Baylor might face when attempting to calculate the WACC. (5% marks) c) on the following dissenting opinions formally recorded in the minutes at the previous meeting of the Board of Directors. i. Baylor's Managing Director (MD) has, however, expressed some concerns regarding the proposed financing of the new factory. The MD feels that the company should use only debt to finance its future projects in order to maximise the wealth of the shareholders. He feels that the finance for this project should be raised solely through a new issue of 5% irredeemable debentures and that the debenture interest rate of 5% should, therefore, be the appropriate discount rate to employ in appraising the new investment. ii. Production Director (PD), on the other hand, cannot understand why the company should be concerned about the cost of capital when it has access to retained profits, as they have no cost. (7 marks) (TOTAL MARKS -33%)
