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Estimation of Adjusted Present Value of a Company
Question
MyCompany Plc is a company currently engaged in manufacturing of toys. It wishes to diversify into the manufacturing of mobile phones.
The investment details:
The company’s equity beta is 1.07 and is currently debt to equity ratio of 30:70, however the company’s gearing will change as a result of new project.
Firms involved in mobile phones have an average equity beta of 1.12 and an average debt to equity ratio of 40:60
Assume that the debt is risk free, that the risk free rate is 8% and that the expected return from the market portfolio is 20%.
The new project will involve the purchase of new machinery for a cost of £1200,000 (net of issue costs), which will produce annual cash inflows of £650,000 for 3 years. At the end of this time it will have no scrap value.
Corporation tax is payable in the same year at a rate of 33%. The machine will attract writing down allowances of 25% p.a. on a reducing balance basis, with a balancing allowance at the end of the project life when the machine is scrapped.
The financing details:
The new investment will be financed as follows:
Debentures (redeemable in 3 years’ time): 45%
Rights issue of equity: 55%
The issue costs are 4% on the gross equity issued and 2% on the gross debt issued.
Estimate the Adjusted Present Value for MyCompany Plc based on information given above
Summary
The question belongs to financial management and it discusses about Adjusted Present Value for a company and its advantages.
Total Word Count 208
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