Subject 2 (25%) Aiolos plc. is a small firm that produces and sells industrial machinery. The following figures of the company are from the most recent financial period: Sales 20,000,000 Earnings before interest and taxes 2,000,000 Debt 10,000,000 Interest expenses before tax 1,000,000 Capital Expenditures 1,000,000 Depreciation expenses are 50% of capital expenditures Book value of equity 10,000,000 Also, you have collected financial information concerning the industrial machinery sector of listed companies (all figures are on an average basis) Beta coefficient of listed companies of the sector 1.30 Financial leverage in terms of debt to market value of equity 20% Firms in the sector trade three times (3x) their book value of equity Effective tax rate 20% tax rate. The management of Aiolos plc. expects that the company will experience a two- stage growth pattern. Specifically, during the first period which will last for the next 5 years, net income, capital expenditures and depreciation will have a 25% growth rate per annum, whereas during the second period (i.e. steady state), net income will have a 7% growth rate to infinity and capital expenditures and depreciation will offset each other. Working capital requirements are estimated to remain stable during both growth periods, while the proportion of net capital expenditure changes with debt will remain to 0.3 for the next five years. The yield-to-maturity of the 10 year government bond is 3%, while the market risk premium is 5%. Required: A. Estimate the cost of equity for this Aiolos plc. (5 points) B. Estimate the value of the owner's stake in Aiolos plc., using the free cash flow to equity approach. (15 points) C. Identify and briefly describe any qualitative aspects of growth. (5 points) Subject 2 (25%) Aiolos plc. is a small firm that produces and sells industrial machinery. The following figures of the company are from the most recent financial period: Sales 20,000,000 Earnings before interest and taxes 2,000,000 Debt 10,000,000 Interest expenses before tax 1,000,000 Capital Expenditures 1,000,000 Depreciation expenses are 50% of capital expenditures Book value of equity 10,000,000 Also, you have collected financial information concerning the industrial machinery sector of listed companies (all figures are on an average basis) Beta coefficient of listed companies of the sector 1.30 Financial leverage in terms of debt to market value of equity 20% Firms in the sector trade three times (3x) their book value of equity Effective tax rate 20% tax rate. The management of Aiolos plc. expects that the company will experience a two- stage growth pattern. Specifically, during the first period which will last for the next 5 years, net income, capital expenditures and depreciation will have a 25% growth rate per annum, whereas during the second period (i.e. steady state), net income will have a 7% growth rate to infinity and capital expenditures and depreciation will offset each other. Working capital requirements are estimated to remain stable during both growth periods, while the proportion of net capital expenditure changes with debt will remain to 0.3 for the next five years. The yield-to-maturity of the 10 year government bond is 3%, while the market risk premium is 5%. Required: A. Estimate the cost of equity for this Aiolos plc. (5 points) B. Estimate the value of the owner's stake in Aiolos plc., using the free cash flow to equity approach. (15 points) C. Identify and briefly describe any qualitative aspects of growth. (5 points)
