price per preference share
bonds trading at
interest rate pa
price per share
par value of preference shares
Calculation of the trading value per bond
Thebonds are trading at 102.5% of the par value
Thatis 102.5%×$100 = $102.50 per bond
Identification of the beta of New Crest Mining Limited
FromYahooFinance = 0.61
Identification of risk-free rate from the 10-year bond rates
Monthlybond rate = 2.52
=Beta of the security
=Expected Market Return
Riskfree rate = 2.52%
RiskPremium = 6%
=2.52% + 3.66% = 6.18%
Calculating the cost of capital
Theformula for calculating the cost of capital is the combined cost ofdebt and equity that has been acquired by a company so that it canfund its operations. The cost of capital takes considers the cost ofdebt, common stock, and preferred stock. The formula for thecalculation of the cost of capital involves many differentcalculations of the three different components
Thecost of debt is calculated as:
Theinterest expense is calculated as debt multiplied by debt rate
$555,000,000×4% = $22200000
Additionalinterest expense is the carrying value of bonds multiplied by half ofthe annual yield to maturity = $3,220,000,000× 102.50/2 = $1650250000
Theamount of debt outstanding is
Substitutionof the values gives
Thecost of preferred stock is determined as:
Preferredshares = 5000000×$97.77 = $488850000
Thecost of common stock involves the risk-free return, the average rateof return expected and a differential risk return.
AverageStock Return – Risk-Free Return = Market Premium Risk
2.51%+ (0.61 × (6%))
Thecommon stock funding = ordinary shares multiplied by the price pershare
=696,000,000× $15.34 = $10,676,640,000
Allthe three calculations have to be then added together, and theirweighted average calculated to get the blended cost of capital forthe company. The cost of each piece is multiplied by the amount ofoutstanding funding that is associated with it.
Total Debt Funding
× Percentage Cost
= Dollar Cost of Debt
Total Preferred Stock Funding
× Percentage Cost
= Dollar Cost of Preferred Stock
Total Common Funding
× Percentage Cost
= Dollar Cost of Common Stock
= Total Cost of Capital
Fromthe table, the cost of capital of the company is $648,876,786.00.
Disadvantages of total distribution model in valuing shares
Valuingshares by use of the distribution model can lead to misleadingresults since the amount of profit that has been accrued by thecompany would be too little and not appear significant. This can havea vast influence on the investors and the choices they would makeconcerning the business.
Calculating theoretical share value as at 31st Dec. 2015.
FreeCash Flow to the Firm (FCFF) is calculated as
EBIT(1-tax rate) + non-cash charges (income) – capital expenditures –working capital
Usingthe Discounted Cash Flow model for a non-constant growth is given bythe formula
Assumingthat the free cash flow is expected to grow indefinitely at aconstant rate, the formula becomes
Theis the cost of capital to the firm, r is the appropriate cost ofcapital, t is the period, and g is the estimated growth rate.
Assumingthat the cash flow is expected to grow at a rate of for time and to lateron, the formula used is
RCis the weighted average of the cost of capital.
Thecash flow from operations is $837,000,000
Netincome $546, 000
Thecapital value $648,876,786.00
Sinceit is assumed that there are no non-cash charges, we substitute thevalues as
TheFree Cash Flow to the firm (FCFF) =$1,066,000,000-$541,000-$648,876,786.00
FreeCash Flow is equal to $416,582,214
Estimatedgrowth rate is calculated by subtracting the current EBIT fromexpected EBIT then divided by the current EBIT and multiplied by 100%
Thatis ($2000m-$1066m)/$1066m×100% = $934m/$1066m×100% = 87%
Thisis then divided by 5 to get the estimated growth rate per year =87%/5 = 17.4%
Therate in cash would then be 17.4% multiplied by the current value=17.4% ×$1066m = $185.484m
Thecurrent value of firm is calculated as
Sincethe values are expected to remain constant, the values will be,
TheCurrent value of the firm is = $ 0.90
Multiplier method of valuation
Priceper share/market value per share = $15.34
EarningsMultiplier = Market price per share/Earnings Per Share (EPS)
Thisis much more than the $0.90 calculated in (b).
Thedifference is because of the fact that the earnings multiplier doesnot take into account the details of the company and the interestsand other expenses, which are closely monitored by the discountedcash flow model.
Recommendations for buying shares in Newpeak
Asreflected by the share price of the company, which is $17.76, almostclose to the $18.94 calculated above, the company is most likelymaking profits and has an attractive market value. For this reason,investing in the company by purchasing their shares is advisable andrecommended.
Addition of coupon rate and how providers of capital can be affected
Acoupon is an annual interest rate that is paid on a bond. This isdisplayed as a percentage of the face value. The providers of thecapital are most likely to feel discouraged and even disgusted by thedecision since the concept of the coupon has lost favor.
Thereasons behind the loss of favor are: in case the investors losetheir bonds through any means, they do not have any recourse and alsohave no hope of regaining their investment. The concept of theanonymity of the bearer bonds has also been used widely by moneylaunderers. Investors do not wish to buy bonds at face value and getlower earnings if they can get better earnings in other firms (Ross2016).
Coupon rate = annual coupon payments/bond’s par value
Theannual interest payment on the bond = stated interest rate × parvalue of the bond
=4% × $100
Marketvalue = $102.50
CurrentYield = $4/$102.50
Newbonds amount = $3220,000,000 + $2000000000
Theresulting amount = $5220m
Witha yield of 3.9% and a tax rate of 30%, the after-tax cost of debtwill be 3.9%(1-30%) = 2.73%
Thecoupon rate = $100/$102.5
Multiplyingthe yield with the price per share and adding the result to the priceper share gives the current price per share
=(3.9%×15.34) + 15.34
Thisamount is less than the current price of the company, which is 17.76because the introduction of the coupon lowered the yield per bond andtherefore many investors might have stopped investing in the company.
From the new share price of $15.5, the company can purchase
$2000,000,000/$15.94shares = 125470514 shares
Debtto equity ratio = total liabilities/total shareholders equity
Thetotal liabilities can be regarded as the value of debt while theshareholders equity.
Theshareholders equity can be calculated as the current yield multipliedby the new bond value.
$5220,000000× 3.9% = $203580000
Thetotal liabilities will be $648,876,786.00
Mining is a very risky business which involves many different types of business risks. Newspeak is exposed to many of these risks
Inthe mining industry, the most relevant business risk to investors isthe volatility in the price and currency. The currencies fluctuatelargely and their prices are also not stable. Introducing a new bondsystem in the structure of the business is therefore not a wise moveas the investors will shy from investing in the business.
Theaccess to energy is also a very risky aspect of the mining industrywith many mining investors fearing likely rises in energy costs whichmay in turn lead to a jeopardized profitability of the company. It istherefore to keep the business favorable to both the investors andthe customers through a balance of the accounts (EY, 2016)
Ross,S. (2016). Howdoes a bond’s coupon interest rate affect its price?Investopedia.
EY.(2016). BusinessRisks Facing Mining and Metals 2015-2016.Building a Better Working World.