BusinessFinance

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Question1

Item | Value | Item | Value |

bonds outstanding | $3,220,000,000 | price per preference share | $97.77 |

bond years | 10 | Bank loan | $555,000,000 |

bonds trading at | $102.50 | interest rate pa | 4% |

par value | $100 | tax rate | 30% |

ordinary shares | 696,000,000 | risk premium | 6% |

price per share | $15.34 | Risk-free rate | 2.52% |

preference shares | 5,000,000 | beta | 0.61 |

par value of preference shares | $100 |   |   |

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

Calculating CAPM

Where=Risk-free rate

=Beta of the security

=Expected Market Return

=premium rate

Riskfree rate = 2.52%

RiskPremium = 6%

Beta= 0.61

Substitutingthe values

=2.52% + 3.66% = 6.18%

CAPM= 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

=0.72%

Thecost of preferred stock is determined as:

Preferredshares = 5000000×$97.77 = $488850000

=5.54%

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%))

=6.18%

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 |

Funding Type | Funding Amount | % Cost | Dollar Cost |

Debt | $3775000000 | × 0.72% | = $27,180,000.00 |

Preferred Stock | $488850000 | × 5.54% | = $591,485,856.00 |

Common Stock | $10,676,640,000 | × 6.18% | = $30,210,930.00 |

Totals | $14,940,490,000 | ×12.44% | = $648,876,786.00 |

Fromthe table, the cost of capital of the company is $648,876,786.00.

Question2

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 31

^{st}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

Capitalexpenditures $541,000

Netincome $546, 000

Thecapital value $648,876,786.00

EBIT$1,066,000,000

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

EPS= $0.81

Priceper share/market value per share = $15.34

EarningsMultiplier = Market price per share/Earnings Per Share (EPS)

=$15.34/$0.81

=$18.94

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.

Question3

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

=$4

Marketvalue = $102.50

CurrentYield = $4/$102.50

=0.39

=3.9%

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

=0.98%

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

=$15.94

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

Dividing$648,876,786.00/$203580000gives 2.3

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)

References

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.