[syeda]

Could you please help solve this Qs

query: 1) confusion as to how to incorporate growth & inflation both?
2) this question is about cashflows growing & inflating in perpetuity what about if we are given ‘x’ no. of years of project life

(GL) operates a chain of large retail stores in country X where the functional
currency is CX. The company is considering to expand its business by establishing similar retail
stores in country Y where functional currency is CY. As a policy, GL evaluates all investments
using nominal cash flows and a nominal discount rate.
The required investments and the estimated cash flows are as follows:
(i) Investment in country X
CX 7 million would be required to establish warehouse facilities which would stock
inventories for supply to the retail stores in country Y at cost. At current prices, the annual
expenditure on these facilities would amount to CX 0.5 million in Year 1 and would grow
@ 5% per annum in perpetuity.
Investment in country Y
Investment of CY 800 million would be made for establishing retail stores in country Y.
At current prices, the net cash inflows for the first three years would be CY 170 million,
250 million and 290 million respectively. After Year 3, the net cash inflows would grow at
the rate of 5% per annum, in perpetuity.
(ii) Inflation in country X and Y is 7% and 20% per annum respectively and are likely to remain
the same, in the foreseeable future. Presently, country Y is experiencing economic difficulties
and consequently GL may face problems like increase in local taxes and imposition of
exchange controls.
(iii) The current exchange rate is CX 1 = CY 45.
(iv) GL’s shareholders expect a return of 22% on their investments. GL uses this rate to evaluate
all its investment decisions.

thanks

[syeda]

could u also plz guide over time management issue in the paper
this is not my first attempt
so im quite confident about my preparation
but really worried about the time management issue which affected me previously

[syeda]

thanks
i actually copy paste

[syeda]

what would u say for this question?
(in this qs it is treated as a beta equity)

please see in capital words: AVERAGE BETA

part of qs & solution is reproduced below:

38 Mercury Training (6/08, amended) 45 mins
Mercury Training was established in 1999 and since that time it has developed rapidly. The directors are
considering either a flotation or an outright sale of the company.
The company provides training for companies in the computer and telecommunications sectors. It offers a variety
of courses ranging from short intensive courses in office software to high level risk management courses using
advanced modelling techniques. Mercury employs a number of in-house experts who provide technical materials
and other support for the teams that service individual client requirements. In recent years, Mercury has diversified
into the financial services sector and now also provides computer simulation systems to companies for valuing
acquisitions. This business now accounts for one third of the company’s total revenue.
Mercury currently has 10 million, 50c shares in issue. Jupiter is one of the few competitors in Mercury’s line of
business. However, Jupiter is only involved in the training business. Jupiter is listed on a small company
investment market and has an estimated beta of 1.5. Jupiter has 50 million shares in issue with a market price of
580c. The AVERAGE BETA for the financial services sector is 0.9. Average market gearing (debt to total market value)
in the financial services sector is estimated at 25%.
Other summary statistics for both companies for the year ended 31 December 2007 are as follows:
Mercury Jupiter
Net assets at book value ($million) 65 45
Earnings per share (c) 100 50
Dividend per share (c) 25 25
Gearing (debt to total market value) 30% 12%
Five year historic earnings growth (annual) 12% 8%
Analysts forecast revenue growth in the training side of Mercury’s business to be 6% per annum, but the financial
services sector is expected to grow at just 4%.
Background information:
The equity risk premium is 3.5% and the rate of return on short-dated government stock is 4·5%.
Both companies can raise debt at 2.5% above the risk free rate.
Tax on corporate profits is 40%.
Required
(a) Estimate the cost of equity capital and the weighted average cost of capital for Mercury Training. (8 marks)

Solution:
(a) Step 1
Ungear beta of Jupiter and Financial Services sector
?a = ?g e
e d
V
V ? V (1- T)
Jupiter = 1.5 ×88 / {(12x 0.6) +88}
? ?
= 1.3865
FS sector = 0.9 ×75/ {(25x 0.6) +75}
? ?
= 0.75
Step 2
Calculate average asset beta for Mercury
?a = (0.67 × 1.3865) + (0.33 × 0.75) = 1.175

[syeda]

thanks
so i’ll have to use it as an asset beta

[Author]

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